© Starling Trust Sciences 2020

Governance: Putting the G in ESG By STEPHEN SCOTT MAY 17, 2021

inancial sector regulators have made the supervision of culture and conduct risk a priority. This dovetails with increased investor focus on environmental, Fsocial and governance (ESG) issues. Factors regarding corporate culture, and the conduct it promotes, that are of interest to regulators are largely the same as those in which investors take interest, given implications for governance and operational resilience. As these powerful trends merge, they look set to amplify one another.

Governance: Putting the G in ESG 1 Which ESG factor impacts most to your investment decision?

2020 13% 82% 5%

2019 9% 88% 5%

2018 5% 91% 4%

5% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Environmental Governance Social Source: Russell Investments 2020 Annual ESG Manager Survey

There is a strong case to be made that governance have proven more resilient over the course of the interests will receive more attention as we move pandemic.4 But the relationship between governance past the COVID-crisis. “Whilst the focus on failures and harmful social outcomes is robust. sustainability and ESG factors is good, we think that in addition it would be worth considering whether While there may be differences in prioritization or more traditional elements of corporate governance interpretation of specific ESG measures, on broader deserve attention,” PwC opined in an October 2020 levels a consensus is emerging. “ESG is often a letter to the European Commissioner for Justice. “In good proxy for quality of management,” said Brunno particular, the importance of whether corporate Maradei, Global Head of Responsible Investment at transparency and corporate governance in relation Aegon Asset Management.5 At the same time, ESG to business continuity and the sustainability of the risks top the list of near-term concerns for executives business model could be enhanced.”1 Governance in the banking and finance sector.6 “The ESG boom concerns outstrip environmental and social factors is now being driven as much by risk management as for asset managers, Russell Investments reports in its activism: COVID-19 has shown company executives ‘2020 annual ESG survey: turning up the volume’, which and financiers around the world the perils of ignoring canvassed 400 asset managers globally. Of those so-called ‘externalities’,” the Financial Times ‘Moral surveyed, 82% said governance led their ESG-related Money’ column offers.7 decisions in 2020, while 13% of respondents said environmental and 5% said social.”2 Such sentiment aligns closely with evolving regulatory priorities. “If the last decade of bank “The pandemic has taught us that if businesses are supervision was about designing rules that lead to to defend against future shocks, protect workers more resilient bank balance sheets, the next will be and ultimately support long-term growth, the social about designing supervisory tools and strategies element within ESG should be considered just as that lead to more resilient bank cultures,” Carolyn critical as environmental and governance factors,” Rogers, Secretary General of the Basel Committee said Naim Abou-Jaoude, CEO of Candriam Investors on Banking Supervision, observes in Starling’s 2021 Group and Chairman of New York Life Investment Compendium. read here “And the goal in the decade Management International.3 A BlackRock study ahead must be for banks to improve their risk culture found the firms with a better record on social issues

Governance: Putting the G in ESG 2 and operational resilience by at least the same margin governance professionals to identify the corporate as they have improved their financial resilience in governance trends that will impact boards and the decade past.” directors in 2021. “The largest institutional investors continue to increase their expectations around board A STEADY DRUMBEAT oversight of human capital management (HCM) and corporate culture,” it finds. “As part of the economic At Davos earlier this year, more than 60 global fallout from the pandemic and the social justice businesses committed to the core Stakeholder movements in many regions, demand for disclosure Capitalism Metrics released by the World Economic of more HCM data (e.g., gender pay gap, safety Forum’s International Business Council (IBC).8 This incidents, employee turnover) has skyrocketed.”13 statement was the culmination of work that began In its 2021 report on emerging governance issues in the summer of 2019, when the IBC initiated a for boards, under the rubric, “Mission Critical’ Risks discussion regarding ESG concerns and aspirations and the Corporate ‘Mission’ Converge,” the National that are central to business risk and performance. Association of Corporate Directors observes that IBC members were concerned for the challenges that “companies are confronting a panoply of employee corporations face in demonstrating and human-capital management long-term value creation for all issues that are critical to long- stakeholders on an internationally term value creation at a time when consistent basis across industries. “There is no doubt that investors and others are seeking Under the chairmanship of Bank increasing societal commitments from corporations of America CEO Brian Moynihan, expectations and to align their governance principles the IBC launched a collective regulatory pressure place with stakeholder capitalism.”14 effort to establish a core set greater scrutiny on how investors are effective of ESG metrics and related A forced departure of Rio Tinto’s stewards of the assets disclosure requirements that CEO in September last year, after entrusted to their care.” could be reflected in mainstream risk management failures led to annual reports on a consistent uk financial disaster at the company’s Juunkan basis across all industry sectors reporting council Gorge mine, has resonated and countries.9 across boardrooms worldwide.15 “Reputation is now the thin red line Some progress in this direction was between license to operate and made before plans to reset the basis of capitalism failure,” said Edentree Investment Management’s ran headlong into the challenges of addressing Head of Responsible Investment Policy & Research, the COVID pandemic. Progress was stalled.10 But Neville White.16 “There is no doubt that increasing now, as we the world begins to emerge from the societal expectations and regulatory pressure place pandemic’s lockdown impacts, sustainable capitalism greater scrutiny on how investors are effective interests seem set to surge11 and a prioritization of stewards of the assets entrusted to their care,” argued ESG interests looks to be part of the post-pandemic the UK’s Financial Reporting Council in October.17 In ‘new normal.’12 October, the head of Norway’s $1 trillion Oil Fund, Norges Bank Investment Management—the world’s In part, this is driven by investor demand. Russell largest sovereign wealth fund—told the Financial Reynolds Associates interviewed over 40 global Times that he aims to “use risk in a more clever way”— institutional and activist investors, pension fund increasing divestments for ESG reasons.18 managers, proxy advisors and other corporate

Governance: Putting the G in ESG 3 IF YOU CAN’T MEASURE IT, In July, the Sustainability Accounting Standards YOU CAN’T MANAGE IT Board (SASB) and the Global Reporting Initiative (GRI) announced an initiative aimed at creating With $2.6 trillion in client assets in its wealth basic ESG reporting standards and clarifying the management business, UBS has begun to recommend methodology used to grade companies’ ESG ESG-driven investment strategies to all clients. “The reporting.26 Then, in September, five framework evidence is there to show this is a credible way to and standard-setting bodies of international invest … [and] a credible way to outperform,” said significance came together to publish a shared vision Tom Naratil co-president of UBS Global Wealth for more comprehensive corporate ESG reporting Management and president of UBS Americas.19 This and issued a joint statement of intent to work adds to the already loud call for consistent and together to drive towards this. With SASB and GRI, reliable ESG metrics and reporting standards. Efforts the Climate Disclosure Standards Board (CDSB), to define and measure ESG related factors now the International Integrated Reporting Council abound. In addition to the IBC effort referenced above, (IIRC), and an environmental impact-oriented NGO which issued initial results last September,20 the past (CDP), committed to collaboration and to engaging year has witnessed a flurry of initiatives to define the with other relevant global actors, including the ESG landscape usefully. Last July, market data firm International Organization of Securities Commissions Refinitive announced the launch (IOSCO), the European Commission, of the world’s first “sustainable- and the World Economic Forum’s finance league table.”21 A month International Business Council, the later, Bloomberg announced its own Whether out of interest International Financial Reporting proprietary ESG scores.22 Others are in value or values, Standards Foundation (IFRS).27 demand from investors following suit. has put firms under Consolidation continued as the increased pressure And yet at the same time, asset to expand their ESG- year progressed. In November, managers worry that a lack of related disclosures SASB and the IIRC announced consistent, industry wide ESG their intent to merge and to work ratings leaves them unable to towards further simplifying the “effectively compare investments corporate reporting system.28 As which are marketed as sustainable,” says Steven the year drew to a close, SASB head Janine Guillot Maijoor, chair of the European Securities and suggested that we might see full convergence of Markets Authority (ESMA).23 The numerous and ESG standards within the next 12 to 24 months.29 In often divergent standards-providers that have quietly March this year, the IFRS Foundation announced the evolved over the past decades now face pressure formation of a Working Group to help accelerate from industry giants like Blackrock to consolidate standards convergence. IOSCO established its own around a common framework.24 Even as Bloomberg Working Group to support the IFRS Sustainability promotes its proprietary ESG scores, it is reaching Project, naming the US Securities and Exchange out to encourage consolidation around the underlying Commission (SEC) and the Monetary Authority of standards which drive them.25 Singapore (MAS) as co-leads of a new Technical Expert Group (TEG).30 The last year has seen a flurry of activity among ESG standards setting bodies designed to address demands for simplification and consolidation of the cacophonous ESG standards landscape.

Governance: Putting the G in ESG 4 SHOW ME WHAT YOU’VE GOT Companies will be expected to share much more non-financial data going forward, even while there “It is important to distinguish between ‘values-driven remains uncertainty as to what form such disclosures investing’, strategies aligned with an investor’s own should take. Note, for instance, that the Board of environmental, social and governance preferences, Governors of the Investment Company Institute (ICI) which prioritize impact over returns, and ‘value- unanimously approved a statement encouraging US driven’ investing that incorporates material ESG public companies to provide enhanced reporting on factors alongside other traditional financial metrics ESG factors.35 According to a survey of 600 investors while still seeking to maximise returns,” wrote Cyrus in North America, Europe and Japan, by the end of Taraporevala, president and CEO of State Street March this year, 94% of investors will have engaged Global Advisors in August last year.31 with boards on matters such as workforce diversity and corporate culture.36 Whether out of interest in value or values, demand from investors has put firms under increased As the Biden administration takes shape, expectations pressure to expand their ESG-related disclosures. are that companies will face pressure to disclose “Positive action and transparency on ESG matters greater ESG data and to produce more fulsome can help companies protect their valuations as sustainability metrics.37 “Our regulations have not more global regulators and governments mandate kept up with this new landscape of institutional ESG disclosures,” argued George Serafeim in a investor-driven corporate governance,” the acting late 2020 Harvard Business Review article. But such chair of the SEC argued in a February speech transparency will not be achieved, he adds, by relying this year.38 Such demands, however, highlight the on “words you see on a wall when you enter company challenges of establishing adequate and broadly headquarters, mission statements posted on websites, accepted ESG metrics. “In response to investor or grandiose speeches by CEOs in town halls,” In fact, demand, investment advisers and funds have Serafeim notes, “Research has shown those to be expanded their various approaches to ESG investing ‘cheap talk’ that is unrelated to real outcomes in the and increased the number of product offerings organization.”32 across multiple asset classes,” the SEC Division of Examinations wrote in a Risk Alert last month. “This Regulators have also urged caution at the current rapid growth in demand, increasing number of ESG state of affairs in ESG disclosures. Disclosures by products and services, and lack of standardized and public companies of such non-financial information precise ESG definitions present certain risks.” 39 aren’t always “clear or useful,” according to a July 2020 report released by the US Government WHAT’S NEXT? Accountability Office (GAO). Institutional investors interviewed by the GAO said they need more reliable Most investors now believe that ESG-minded capital information on ESG matters so as to develop a better deployment generates positive returns.40 They understanding of the risks that could affect the point to studies which find a positive correlation financial performance of companies they own over between ESG and corporate success. “Companies’ time. 33 Despite the present lack of clarity, investors sustainability initiatives appear to drive better are nevertheless forging ahead and adopting a variety financial performance due to factors such as improved of investment strategies that incorporate evolving risk management and more innovation,” finds one ESG disclosures to varying degrees.34 meta-study summarizing the results of over a thousand peer reviewed papers and another two

Governance: Putting the G in ESG 5 dozen meta-studies, published in the last five years, And given the priority that investors place on which took into account the findings from another governance, it is reasonable to expect that the G 1,400 underlying studies.41 in ESG will receive more attention going forward. Where governance matters overlap with expectations Yet a recent study from a number of prominent law regarding firm purpose, culture, conduct risk and schools and the European Corporate Governance other material non-financial risk issues, the growing Institute, points to “infirmities” in standard corporate convergence between these two trends are very governance data sets, leading to “an error rate likely to accelerate. exceeding eighty percent in the G-Index, the most widely used proxy for ‘good governance’ in law and STEPHEN SCOTT is a globally finance.”42 Debate will continue but there can be recognized risk management expert no question that ESG interests—and reliable ESG and CEO of Starling, a US-based metrics—will feature prominently among investors, leader in the RegTech space. boards, regulators, policymakers and legislators worldwide in the near-term.

Governance: Putting the G in ESG 6 ENDNOTES

1 Michael Stewart, Letter to European Commissioner for Justice, Oct. 8, 2020. https://www.pwc.com/gx/en/about/pdf/pwc-response​ -to-ec-roadmap-on-sustainable-corporate-governance.pdf 2 Chris Sloley, “Why G is Dominating the ESG Debate Among Asset Managers,” Citywire Selector, Oct. 12, 2020. https://citywireselector​ .com/news/why-g-is-dominating-the-esg-debate-among-asset-managers/a1410724 3 Hazel Bradford, “COVID-19 Pushes Social Issues to ESG Forefront,” Pensions & Investments, Aug. 10, 2020. https://www.pionline.com​ /special-report-esg-investing/covid-19-pushes-social-issues-esg-forefront 4 Jasper Jolly, “Investing in Firms with Better Record on Social Issues Pays, Study Finds,” The Guardian, May 17, 2020. https://www​ .theguardian.com/business/2020/may/18/investing-in-firms-with-better-record-on-social-issues-pays-study-finds 5 Brunno Maradei, “Why ESG Matters in a Crisis,” Interview, Institutional Investor, June 9, 2020. https://www.institutionalinvestor.com​ /article/b1ly879667bxnt/why-esg-matters-in-a-crisis 6 Bloomberg, “ESG Risks Top the List of Near-Term Concerns for Finance Executives,” Pensions & Investments, Feb. 2, 2021. https://www​ .pionline.com/esg/esg-risks-top-list-near-term-concerns-finance-executives 7 Gillian Tett et al., “How to Stay Ahead of the ESG Curve in 2021,” Financial Times, Dec. 30, 2021. https://www.ft.com/content/89db3fff​ -3ae9-4299-8e72-9f9b65bd3996?shareType=nongift 8 Madeleine Hillyer, “Global Business Leaders Support ESG Convergence by Committing to Stakeholder Capitalism Metrics,” World Economic Forum, Jan. 26, 2021. https://www.weforum.org/press/2021/01/global-business-leaders-support-esg-convergence-by​ -committing-to-stakeholder-capitalism-metrics-73b5e9f13d 9 World Economic Forum, “Toward Common Metrics and Consistent Reporting of Sustainable Value Creation,” Consultation Draft, Jan. 2020. https://www.weforum.org/whitepapers/toward-common-metrics-and-consistent-reporting-of-sustainable-value-creation 10 Andrew Edgecliffe-Johnson & Billy Nauman, “CEOs’ Plans to Reset Capitalism Bump into Reality of Pandemic,” Financial Times, Aug. 21, 2020. https://www.ft.com/content/34e702fe-0ea4-460a-b4fc-b9f3fce4b0ce?shareType=nongift 11 Pippa Stevens, “Sustainable Investing is Set to Surge in the Wake of the Coronavirus Pandemic,” CNBC, June 7, 2020. https://www.cnbc​ .com/2020/06/07/sustainable-investing-is-set-to-surge-in-the-wake-of-the-coronavirus-pandemic.html 12 Steve Waygood, “ESG Will Be New Normal of Post-Pandemic World,” The Asset, June 5, 2020. https://www.theasset.com/article-esg​ /40717/theasset.com 13 Jack O’Kelley et al., “2021 Global and Regional Trends in Corporate Governance,” Russel Reynolds Associates, Feb. 11, 2021. https://www​ .russellreynolds.com/insights/thought-leadership/2021-global-and-regional-trends-in-corporate-governance 14 Adé Heyliger et al., “‘Mission Critical’ Risks and the Corporate ‘Mission’ Converge,” 2021 Governance Outlook, National Association of Corporate Directors and Partners, 2020, p. 45. https://www.weil.com/~/media/files/pdfs/2021-governance-outlook--weil.pdf 15 "Juukan Gorge: Rio Tinto investors in pay revolt over sacred cave blast," bbc.com, May 7, 2021. https://www.bbc.com/news/business-57018473 16 Paulina Duran & Byron Kaye, “Rio Tinto Exits Seen Reverberating Across Boardrooms,” Reuters, Sept. 11, 2020. https://www.reuters​ .com/article/us-rio-tinto-ceo-governance-idUSKBN2620YE 17 Oliver Rowe, “Regulator Gives Guidance to Investors on the UK Stewardship Code,” Financial Management, Oct. 7, 2020. https://www​ .fm-magazine.com/news/2020/oct/frc-uk-stewardship-code-2020.html 18 Richard Milne, “Norway’s New Oil Fund Chief Seeks More ESG-driven Divestments,” Financial Times, Oct. 7, 2020. https://www.ft.com​ /content/39e5f806-1797-4b6a-8961-e223dbb53722 19 Gillian Tett et al., “UBS Backs Sustainable Investing with Landmark Recommendation,” Financial Times, Sept. 11, 2020. https://www.ft​ .com/content/aa7d96d1-492b-487f-a1e1-f14e0ffc9d37?shareType=nongift 20 Gillian Tett, “Big Four Accounting Firms Unveil ESG Reporting Standards,” Financial Times, Sept. 22, 2020. https://www.ft.com/content​ /16644cb2-f0c1-4b32-b44c-647eb0ab938d?shareType=nongift 21 Billy Nauman, Patrick Temple-West & Kristen Talman, “Who’s On Top in the First Sustainable Finance League Table?,” Financial Times, July 24, 2020. https://www.ft.com/content/15655c72-584b-42c9-a230-5626b48ee394?shareType=nongift 22 Bloomberg, “Bloomberg Launches Proprietary ESG Scores,” PR News Wire, Aug. 11, 2020. https://www.prnewswire.com/news-releases​ /bloomberg-launches-proprietary-esg-scores-301109999.html 23 Billy Nauman, “Fund Managers Struggle to Compare ESG Apples with Oranges,” Financial Times, May 11, 2020. https://www.ft.com​ /content/6ff72af4-5d76-11ea-ac5e-df00963c20e6 24 Leslie P. Norton, “BlackRock Pushes for Single Reporting Framework for ESG,” Barron’s, Oct. 30, 2020. https://www.barrons.com​ /articles/blackrock-pushes-for-single-reporting-framework-for-esg-51604053801 25 Zach Church, “For Bloomberg’s New ESG Scores, Ideas from Across Industries,” MIT Sloan School of Management, Dec. 7, 2020. https://mitsloan.mit.edu/ideas-made-to-matter/bloombergs-new-esg-scores-ideas-across-industries 26 Alexa Belonick, Will Talcott Carter & Alfredo Silva, “SASB and GRI Team Up to Tackle The Opaque Landscape of ESG Reporting,” JD Supra, Aug. 11, 2020. https://www.jdsupra.com/legalnews/sasb-and-gri-team-up-to-tackle-the-80450/

Governance: Putting the G in ESG 7 27 Charles Tilley, “A Shared Vision for a Comprehensive, Globally Accepted Corporate Reporting System,” Integrated Reporting, Sept. 11, 2020. https://integratedreporting.org/news/a-shared-vision-for-a-comprehensive-globally-accepted-corporate-reporting-system/ 28 Integrated Reporting, “IIRC and SASB Announce Intent to Merge in Major Step Towards Simplifying the Corporate Reporting System,” Nov. 25, 2020. https://integratedreporting.org/news/iirc-and-sasb-announce-intent-to-merge-in-major-step-towards-simplifying-the​ -corporate-reporting-system/ 29 Leslie P. Norton, “ESG Standards Convergence Could Happen in Next 12 to 24 Months, Accounting Body Chief Says,” Barron’s, Dec. 14, 2020. https://www.barrons.com/articles/esg-standards-convergence-could-happen-in-next-12-to-24-months-accounting-body-chief​ -says-51607968355 30 Regulation Asia, “IOSCO Forms Working Group to Aid IFRS Sustainability Project,” Mar. 31, 2021. https://www.regulationasia.com​ /iosco-forms-working-group-to-aid-ifrs-sustainability-project/?ct=t(31Mar2021RA-Refinitiv)&goal=0_d30b640721-28eb96c04d​ -116645589&mc_cid=28eb96c04d&mc_eid=4a22c7d59f 31 Cyrus Taraporevala, “US Regulators Wrong to Dismiss ESG Investing for Pensions,” Opinion, Financial Times, Aug. 2, 2020. https://www​ .ft.com/content/81b267f4-414b-4c5a-b775-91c2f1a2f661 32 George Serafeim, ”Social-Impact Efforts That Create Real Value,” Harvard Business Review, Sept.–Oct. 2020. https://hbr.org/2020/09​ /social-impact-efforts-that-create-real-value#social-impact-efforts-that-create-real-value 33 U.S. Government Accountability Office, “Disclosure of Environmental, Social, and Governance Factors and Options to Enhance Them,” July 2020. https://www.gao.gov/assets/gao-20-530.pdf 34 Billy Nauman, “ESG Surges as Investors Search for Better Corporate Citizens,” Financial Times, Sept. 13, 2020. https://www.ft.com​ /content/20f6c929-2fbf-47d5-973c-8c18607fc604?shareType=nongift 35 Investment Company Institute, “ICI Board Unanimously Calls for Enhanced ESG Disclosure by Corporate Issuers,” News Release, Dec. 7, 2020. https://www.ici.org/news-release/20_news_esg 36 Kevin Martin, “Companies Must Prepare to Share Much More Non-Financial Data,” Financial Times, Jan. 24, 2021. https://www.ft.com​ /content/d328ba92-5af1-46d2-b3a4-05f15c9ba964?shareType=nongift 37 Kristin Broughton & Mark Maurer, “Companies Could Face Pressure to Disclose More ESG Data,” The Wall Street Journal, Dec. 9, 2020. https://www.wsj.com/articles/companies-could-face-pressure-to-disclose-more-esg-data-11607263201?st=lhbf3881apf6ycz&reflink​ =article_email_share 38 Allison Herren Lee, “Every Vote Counts: The Importance of Fund Voting and Disclosure,” Speech at the 2021 ICI Mutual Funds and Investment Management Conference, Mar. 17, 2021. https://www.sec.gov/news/speech/lee-every-vote-counts 39 U.S. Securities and Exchange Commission, “The Division of Examinations’ Review of ESG Investing,” Risk Alert, Apr. 9, 2021, p. 2. https://www.sec.gov/files/esg-risk-alert.pdf 40 Lisa Brown, “Most Investors Now Believe ESG Has a Positive Impact on Returns,” GlobeSt, Dec. 1, 2020. https://www.globest.com​ /2020/12/01/most-investors-now-believe-esg-has-a-positive-impact-on-returns/?slreturn=20210408152308 41 Ben Maiden, “Meta-Study Underlines Ties Between ESG and Corporate Success,” IR Magazine, Feb. 22, 2021. https://www.irmagazine​ .com/esg/meta-study-underlines-ties-between-esg-and-corporate-success 42 Jens Frankenreiter et al., “Cleaning Corporate Governance,” University of Pennsylvania Law Review, Forthcoming, Virginia Law and Economics Research Paper, no. 2021-05, Virginia Public Law and Legal Theory Research Paper, no. 2021-16, Columbia Law and Economics Working Paper, no. 644, Univ. of Wisconsin Legal Studies Research Paper, no. 1690, European Corporate Governance Institute, Finance Working Paper, no. 738/2021, Feb. 11, 2021. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3796628

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