As investors and other stakeholders apply pressure for sustainable policies on the environment and society, companies are changing their ways, somewhat—and also pushing back.
On an earnings call with stock market analysts earlier this year, Mauricio Gutierrez, CEO of NRG Energy, a large American electric utility, suddenly switched topics. “I want to talk to you about our comprehensive sustainability framework,” Gutierrez told the analysts. “Sustainability is embedded in our culture, aligned with our strategy and necessary for our long-term success.”
NRG was considered one of the nation’s top air polluters as recently as 2017, making Gutierrez’ lengthy homage to sustainability on a financial earnings call an especially dramatic illustration of how environmental, social and governance (ESG) issues have transformed corporate policies and executive responsibilities in the US, Europe and Asia.
“I think management teams just have to continuously evaluate business risk, destruction, emerging risks and opportunities that environmental and social disruptors present to companies,” says Kristen Sullivan, a leader of Sustainability and Key Performance Indicator services at Deloitte & Touche who leads the firm’s ESG and sustainability practice. “These are now no different than other emerging risks, such as cyber and digital risks.”
One gauge of the importance of ESG inside corporate board rooms: In 2019, 132 major corporations reported having hired a chief sustainability officer, up from just 25 in 2004, according to Guoli Chen, a Professor of Strategy at Insead’s graduate business school in Singapore.
Multiple factors have combined to raise sustainability into a keystone of corporate policy, says Chen. Major influences include heightened sustainability awareness among millennial investors and the resulting pressure on large investment firms that can push a company’s share price down dramatically if they decide to exclude it from their ESG index funds.
“There’s been a big shift in recent years away from the Anglo-Saxon model that holds that company management’s sole purpose is to serve the shareholder,” Chen says.
Larry Fink, CEO of BlackRock—the world’s largest investment manager with more than $7 trillion in assets—fired a shot across the bow in January, when he warned CEOs that his firm would use sustainability as a major factor in allocation decisions. The firm would henceforth make “sustainability integral to portfolio construction and risk management” and would be “exiting investments that present a high sustainability-related risk, such as thermal coal producers; launching new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment stewardship activities.”
Regulators Step In
Another factor forcing boards and management to reckon with sustainability is government regulations requiring integration of ESG factors into company policy. Following the adoption in 2015 by the United Nations of its 17 Sustainable Development Goals, the European Commission adopted a series of ESG rules and regulations as the Action Plan: Financing Sustainable Growth. It includes a requirement for EU companies to publish an annual sustainability report alongside their profit and loss statements and orders investment firms to publicly disclose the sustainability risks in each of their investments.
“Companies are more and more integrating things like being climate neutral in their business strategies,” says Alexandre Affre, Deputy Director General of BusinessEurope, a Brussels-based corporate lobbying group. “It’s becoming mainstream for sustainability to be part of a board’s considerations and then execute these strategies.”
The sustainability data disclosure requirement is fairly vague, leaving it up to the individual companies to decide what exactly to make public each year. An effort is gathering steam in Brussels to define the required disclosures more precisely, but groups like BusinessEurope are opposed.
“We are concerned it may become overly prescriptive and remove flexibility,” says Affre. While companies don’t oppose further changes in the rules, he adds, they want to be sure the requirements don’t become a burden on management.
Sustainability disclosure requirements are even less defined in the US, although 90% of S&P 500 companies published sustainability reports in 2019, up from just under 20% in 2011. The Securities and Exchange Commission (SEC) added a requirement in August that companies report on their management of “human capital resources,” equivalent to the society category in ESG terminology.
ExxonMobil’s corporate sustainability report, for example, covers its management of climate change risk, workplace safety issues, community issues, human rights and governance issues such as diversity, and ethics on the board of directors.
Many large US companies worry about the increasing demands on the CFO and other corporate officials to track and disclose reams of sustainability data, says Virginia Harper Ho, law professor at the University of Kansas, who published a study on corporate “disclosure overload” in September of last year.
“Companies are absolutely concerned about the increased costs and burdens of compliance with the new disclosure regulations,” Ho says. “There’s been pushback not just on new rules, but on what you might call prescriptive rules that companies can’t get around.”
“The mindset of management—at most companies—is largely, how do I drive sustainability in its broadest sense in terms of long-term value and a continued license to operate in the face of disruption and changing stakeholder expectations?” says Deloitte’s Sullivan.
ESG risks have nevertheless become accepted as genuine business risks that affect the company’s future earnings, Sullivan adds. Ratings agencies such as Moody’s, Fitch and Standard & Poor’s have been snapping up ESG risk data on companies to ease the process of integrating it into their overall credit worthiness assessments. With lenders increasingly relying on such data, whether or not a company gets a loan could depend on its ESG status.
“Because CFOs are often the lead risk managers, I think they have become more sophisticated about how ESG trends will translate into business risk, how the company is driving value and what’s going to put that value at risk,” Sullivan says.
Some companies are also pushing back against the time commitments that sustainability reporting requires of top executives, when the current economic crisis presents more existential issues—and US regulators have responded.
After considerable lobbying from company executives, the SEC recently put in place new rules for the proxy advisory firms on which many investment funds lean for research and advice on how to vote on sustainability issues at annual meetings, requiring the firms to submit their decisions to company management in advance so management has a chance to respond. The SEC also made it harder for individual shareholders to keep submitting proxy questions on sustainability issues, because of the burden they place on management.
In contrast to European regulators’ support of sustainability initiatives by investment advisers, the US Department of Labor also slapped restrictions on pension funds, banning the application of “non-pecuniary goals” to investment decisions. This was a clear reference to the ESG criteria many funds have adopted and could affect the stock price of ESG high performers, since private pension funds account for one-third of the asset ownership on all US stock markets.