© 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.