United States: How Should We Engage With Investors On Sustainability?

In this report, Change the Conversation: Redefining How Companies Engage Investors on Sustainability, sustainability nonprofit Ceres provides some guidance on how companies should best engage with their investors on the issue of sustainability. While almost half of the 600 largest U.S. public companies communicate with investors about environmental, social and governance issues, according to Ceres, they could be doing a much better job of it. To that end, Ceres offers a set of nine recommendations "to guide companies toward more meaningful and effective investor engagement on ESG issues." What is the key message? Don't "fall into the trap of positioning sustainability as the 'right thing to do,' without making the connection to the business case." And make the business case for sustainability by tying it to financial performance and demonstrating that it can drive business value. Whether or not you buy into the whole program, you may still find Ceres' perspective and examples provided helpful in guiding your engagement efforts.

According to Ceres, a quarter of dollars invested in the U.S. is now ESG investment, raising the stakes on sustainability. Likewise, companies have increased their commitments to ESG: Ceres research shows that among that 600 largest public companies, "nearly two-thirds have commitments to reduce greenhouse gas (gHg) emissions, half are actively managing water resources and nearly half are now actively protecting the human rights of their employees."

In addition, a number of respected academic and business sources confirm that, in light of risks arising out of climate change and similar issues, a "focus on a sustainable business strategy can provide a competitive advantage in stock price, cost of capital and operational performance. These trends underscore the link between ESG and financial performance, and further demonstrate that those issues once considered extra-financial are, in fact, material financial risks and opportunities impacting the bottom line." For example, Ceres cites

Nevertheless, most companies miss the boat on this point, failing "to present sustainability as an integral component of business strategy and decision-making, or as a driver of increased business resilience and revenue growth." Instead, Ceres contends, "most companies still share information in ways that reinforce the misconception that these issues are extra-financial and not material. They also fail to provide investors with the information they need to understand and value the positive impacts of sustainable business strategies on corporate health and financial performance." Moreover, concerns regarding the prospect of engagement on ESG, Ceres contends, "leads to reactive, less effective interactions with interested investors."

Ceres offers nine recommendations divided among three strategies:

First strategy: Formalize sustainable business integration

This appears to be the most critical of the three strategies presented. What does it mean? It seems to involve formalizing responsibility for oversight of ESG at the highest levels, together with understanding the business value of sustainability and integrating that concept into the business and the corporate strategy. Below are Ceres' three recommendations to implement this strategy:

• Demonstrate accountability for sustainability. Ceres here cites a 2017 CFA Institute survey in which financial analysts said that board accountability was "the most important sustainability issue in their investment analysis and decision-making." ESG integration is often seen as a "proxy for good management," reflected in "a clear governance structure that explicitly includes oversight for material environmental and social impacts." Ceres recommends that companies adopt "[f]ormal mandates and accountability for ESG performance and strategy for both management and corporate boards."
  • According to Ceres, a "sustainability-competent board displays a fundamental understanding of sustainability issues material to its business sector and integrates these issues into the fabric of board oversight and decision-making on strategy, risk and compensation." Formal board oversight structures will better position the lead independent director and/or relevant committee chair to make the best decisions about ESG-related risks and to knowledgeably engage with investors. In one example provided, the members of a company's sustainability committee were also on the comp and nom/gov committees, allowing for cross-pollination and integration of sustainability issues into board discussions on risk, governance and compensation.
  • In addition, management-level accountability structures should hold senior executives responsible for sustainability performance, incentivizing improved sustainability oversight and performance. Ceres observes that "companies with C-suite accountability for sustainability are nearly three times more likely to proactively engage with investors and are more than seven times more likely to disclose both the risks and opportunities of sustainability issues in annual financial disclosures than those without C-suite level oversight."
• Develop the sustainability business case. Companies may often discuss sustainability generally, but discussing it as a value proposition, both risks and opportunities, can be more challenging. Nevertheless, it is important, in Ceres' view, to present the value proposition, showing "direct links between sustainability and financial performance metrics." Opportunities can include not only cost savings, but also "how sustainability initiatives are driving growth and revenue generation, or improving key metrics, such as employee retention and recruitment." Where sustainability has been integrated into business strategies, companies should communicate that information, including metrics where available. Sustainability is a factor critical to long-term value creation, an important focus for many large asset managers such as BlackRock, especially in the face of increasing environmental risk. (See this PubCo post and this PubCo post) Ceres believes it is important to "articulate to investors why long-term business strategies matter, how sustainability is a critical component of those strategies and consistently include this information across all investor communication platforms."
• Cultivate collaboration between sustainability, investor relations and governance teams. Companies can sometimes silo sustainability with the ESG experts, but Ceres argues that, to better present sustainability in a business context, companies should develop closer partnerships among the sustainability, investor relations and corporate governance staffs, as well as public reporting, legal and finance. That may require some effort at demystification of these subjects, as well as coordination among the teams. IR teams are often skilled in effectively making the connection between sustainability and business performance, and that benefit can be compounded if the sustainability team can tie ESG to financial performance.

Second strategy: Identify what to disclose and where to disclose it

• Focus investor-directed disclosures on what is material, but don't ignore emerging trends. Investors want disclosures to focus on the "most business-critical issues." Although different investors prefer different disclosure frameworks, such as SASB (see this PubCo post) or GRI, Ceres advocates that companies "navigate this variance by transparently disclosing their own approaches for determining material environmental and social issues, including details on significant audiences and issues considered in the prioritization process, as well as details of how prioritized issues were then considered in strategies and decision-making." Emerging risks, such as "automation and artificial intelligence, water variability, traceability in supply chains, just transition to the low carbon economy, the gig economy, and shifts towards more global consumption," should not be ignored, and companies should "identify risks within varied time frames, both short- and long-term, and as a result, evaluate and identify emerging issues."
• Disclose decision-useful information, both quantitatively and qualitatively. "Decision-useful information," according to Ceres, is characterized by the following qualities: "consistency over time; trended performance data; comparability between companies and industries; comprehensiveness of the scope of information provided; reliability; accuracy; and inclusion of relevant and material sustainability issues." But the most important quality is to clarify the "links between sustainability and financial performance" by quantifying the impact of sustainability on risk, cost savings and revenue. But quantitative information is not enough; it must be put into context through qualitative disclosure, particularly disclosure that highlights commitment and strategic integration. One area of substantial investor interest is risk related to climate change. According to Ceres, slightly over half of the 600 largest public companies identify climate-related risks in their filings, but most disclose these risks as only a regulatory risk (68%) or as a physical risk (55%), with a smaller number citing reputational risks. Ceres identifies the 2017 recommendations and guidance of the Task Force on Climate-related Financial Disclosures (TCFD) as "a significant development in pushing for more meaningful disclosure of material climate risks across all sectors," publicly supported by over 500 companies with almost $8 trillion in market cap. For more information on the TCFD recommendations, see this PubCo post.
• Include decision-useful ESG information where investors are already looking. Investors are looking for consistency between the risks identified in the sustainability report and in the 10-K and other platforms, and may identify discrepancies as red flags. To help investors and other third parties, companies "should include decision-useful ESG information within investor-focused disclosures." Proactive disclosure could also better enable companies "to control the narrative, demonstrate how their strategies differentiate them from peers, and clearly communicate the added business value that in turn creates a competitive edge." One common location for ESG disclosure is the sustainability report and website, but Ceres suggests that including sustainability information in proxy statements, 10-Ks and annual reports would help to expand the audience. (Note, however, that it could also, in some cases, expand the potential liability.) Another missed opportunity Ceres identifies is the investor relations website.

Third strategy: Implement a proactive investor engagement strategy

Shareholder engagement is an increasingly common practice that, if successful, can be "a critical component in [asset managers'] assessment of corporate strategies and performance." But it should take place on clear days as well as cloudy ones, so that "when things are complex or there is opposition, there is no last-minute panic of trying to socialize how the company thinks about risks and opportunities." Some smaller investors may coordinate their efforts for efficiency. Ceres points out that, in the absence of proactive engagement, some larger mainstream asset managers may "limit direct contact to companies deemed to be poor performers on sustainability." According to Ceres, one "constant refrain" heard from investors is that "if a company is not talking about its sustainability strategy and performance, they may conclude the company does not have a story to tell or, even worse, it's hiding something."

• Use language that investors understand and value. One goal of the IR team should be to "communicate the company's values and strategies using language that investors understand"—including, where appropriate, financial terms such as margin and EPS, as well as business concepts such as risk mitigation, cost avoidance, revenue growth and competitive differentiation—thus positioning sustainability in the context of business performance. To permit investors to incorporate sustainability into their valuations, companies should discuss sustainability investments, risks and benefits "through the prism of [practical business concerns such as] supply chain resilience, stranded asset avoidance, cost savings and efficiency, improved product performance, consumer acquisition and increased employee retention." Notably, some asset managers do not position their questions as "sustainability" questions per se, but may instead frame them strictly as financial issues, such as supply chain stability.
• Leverage the C-suite and board of directors as key messengers. Ceres contends that including decision-makers, such as the CEO, CFO and board members, as part of the investor engagement team can be critical to success. Involvement of the CEO can help to establish the importance of the issue, while CFOs are "uniquely positioned to demonstrate to interested stakeholders, especially investors, how a company is integrating ESG considerations in decision-making related to risks, revenues and strategy," potentially attracting new investment and lowering capital costs. Similarly, where board members have formal oversight responsibility (see the first strategy)—and Ceres says that about a third of the largest public companies have taken that step—their participation in investor engagement "can effectively demonstrate 'sustainability competence' to interested investors."
• Diversify investor engagement strategies. While there is no "one size fits all," companies should consider including "decision-useful ESG information across engagement platforms," including annual meetings, investor days and earnings calls, in addition to direct private dialogues, roadshows and investor conferences. These events vary in terms of the nature of the benefits provided; some provide access to a broad audience, while others can foster constructive dialogue and understanding of investor concerns. (Interestingly, Ceres spends an entire page criticizing the virtual-only annual meeting as a limitation on shareholder rights to engage directly with management. See this PubCo post.) Here, Ceres identifies three main criteria for success: "focus on presenting sustainability in a business case frame, emphasizing its influence on risk mitigation, resilience and business growth; include company representatives with decision-making authority, in addition to internal ESG experts; and use consistent messaging across all venues."

But it's not just companies that need to up their games—investors must do so as well. In this context, Ceres calls on investors to clarify how positive sustainability performance will be rewarded by communicating priorities, demonstrating how sustainability is integrated into investment decision-making, building expertise on the value of sustainability and increasing "the sophistication of corporate engagement on ESG by asking questions that demonstrate an understanding that ESG issues are material financial issues, and by demanding that companies communicate this link."

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