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June 2021 | Issue 235
Opinion ESG
We should be mindful of the transfer of power to the C-suite that inheres in ESG
Duncan Sankey
Portfolio director and head of credit research Cheyne Capital
quotation mark
As shareholder returns become one factor among many, the C-suite becomes more powerful
I am not making a case against environmental, social and corporate governance (ESG). First, its ends are noble and important — and not just to the perpetuation of the social-market model that most of us cherish but, in the case of the environment, to averting an existential threat to humanity itself.
Second, the case has been tried, and it was won by the ESG advocates. Funds that do not at least make obeisances to responsible investment and scrutinise portfolios for ESG issues risk haemorrhaging institutional investors, while companies that ignore them face challenging funding conditions and risk becoming market pariahs.
But still we should be mindful of the transfer of power to the C-suite that inheres in ESG and makes the focus on governance more important.
ESG means fund managers must require companies to abandon their singularity of focus on shareholder returns (once contractual obligations have been met and laws and regulations honoured) in favour of allocating attention — and capital — to a diverse and disparate range of issues, including climate change, environmental degradation, community relations, human rights, labour welfare and diversity.
Implicit in this is a transfer — possibly unwitting — of a whole range of responsibilities from what was traditionally the purview of governments to that of corporations. And, piercing the veil of corporate agency, that really means the assignment of such authority to the corporation’s senior executive officers. Setting aside for now the desirability of delegating huge areas of environmental and social policy to an elite accountable only to their shareholders, this development creates a whole new set of challenges for investors.
Headlines can divert from true ESG picture
There is a risk that management teams will pursue environmental and social agendas at a superficial, ‘box-ticking’ level, while avoiding painful initiatives of real consequence. Worse still, they may choose to advance headline-grabbing initiatives to steer public focus away from social and environmental transgressions of greater materiality both to society and to their company’s bottom line.
To pick a high-profile example, Facebook’s glossy paean to sustainable workplaces touts that its Menlo Park HQ has provided a “safe home for over 4,000 birds”, which, while laudable, does not really compensate for its failure to provide a safe home for 419 million user records allegedly found on an online unsecured server, or the personal data of 87 million users reportedly shared without consent and used to influence voters (both cases rated by MSCI as “severe” controversies).
At a social media platform, the security of data — not the sustainability of data centres — should be foremost among management priorities.
While MSCI scores Facebook’s governance in the average range relative to peers (while noting concerns about executive pay and ownership structure), corporate behaviour ranks well below. If we are to gain a fuller understanding of a company’s approach to ESG (and cut through the greenwashing), we first need a holistic understanding of a company’s governance, which considers more qualitative and admittedly more subjective variables, and which focuses on deeds over words. We should examine how managements have actually treated other stakeholders in the past (at prior positions) and how governance structures channel their motivations.
Relevant KPIs must be tied to executive pay
Among other things, we need to look at how C-level executives are paid: alignment of rewards with those of shareholders can no longer be adequate if managements are to serve other constituencies. If a C-suite is truly committed to labour welfare and decarbonisation, it would be appropriate to include related key performance indicators and targets in their remuneration structures.
Non-executive directors can offer a constructive challenge to management teams and ensure they tackle social and environmental issues in substance rather than form. This is partly a function of appropriate expertise, but also one of true independence, which is likely to be impaired by management and board sharing common social and educational backgrounds (and so adds another argument for increasing board diversity). Get the approach to G right, and E and S will follow.
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Global credit funds & CLO's
June 2021 | Issue 235
Published in London & New York.
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