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The big ‘ESG squeeze’ is at play and stakeholders must comply

Synopsis: There is currently a giant ESG squeeze at play and it is impacting companies from two different but equally powerful stakeholders. As sustainability issues are getting intensely scrutinized for the issuers, both governments and asset managers are pushing them to get better on reporting and actual compliance. There is a stern message from government authorities that any attempts to misrepresent or not disclose transparently will be dealt with an iron fist and will also have consequences. Similarly, institutional investors and asset managers are getting more assertive. There is strong support for ESG proposals in shareholders’ meetings with the focus area being sustainability and ESG issues. In benign cases, many investment managers nudge the companies to behave more responsibly on environmental, social, and governance issues, and in more unpleasant situations, they impose their will by pushing for the reconstitution of the board. The ESG movement has significant momentum, and several large and influential asset managers are pushing the sustainability agenda in a big way. The ‘peer pressure’ is also at work as absolutely no one can afford a negative ESG surprise. The consequences are serious for anyone who is being seen on the wrong side of the ESG movement including companies, policymakers, asset managers, and investment advisors.

ESG and the danger of misrepresentation in company’s disclosures

Because of some of the recent developments including the Coronavirus pandemic, disastrous weather-related events and the rise of the millennial investor, sustainability discussions and the impact of an organization’s operations on all the concerned stakeholders have become more mainstream. Naturally, the organizations are under pressure to become proactive in their practices and disclosures. There is increased scrutiny on the environment and issues like Climate Change, Greenhouse Gas Emissions, usage of energy per unit output and plans to replace the use of Fossil Fuels with Renewable sources of power.

As is the case in most of these situations, there are two main problems in assessing an organization’s performance and they are, a) Is there a case of wilful misrepresentation, b) Is there a problem in how different stakeholders view the same thing? For example, the challenge of Greenwashing: greenwashing is equivalent to making an unsubstantiated claim, intended to deceive the regulators, stakeholders, investors, and consumers into believing that the company is far more environment-friendly than it truly is.

This has become a major concern for many people in the ESG ecosystem who are worried and even disillusioned. For example, Tariq Fancy, who became BlackRock’s first global chief investment officer for sustainable investing in early 2018 was not a big fan of ESG investing. A few months ago, he wrote that sustainable investing is nothing more than “marketing hype”. Fancy is also publishing an insider’s account of his ESG investing experiences called, “The Secret Diary of a ‘Sustainable Investor.’” which may certainly open a can of worms.

Recently, he did a very interesting interview with the Financial Times titled “The whistleblower who calls ESG a deadly distraction: How an ex-BlackRock executive lost faith in sustainable finance” with Patrick Temple-West and Kristen Talman. Fancy says that ESG potentially is a dangerous placebo, a lot of marketing that answers inconvenient truths with convenient fantasies. “There’s no evidence that ESG investing has done anything…….Even worse, it’s becoming a deadly distraction that slows the kinds of reforms that actually would have a real-world impact.”

We agree that the Greenwashing issue directly relates to misrepresentation of companies’ performance or track record on environment-related matters but it would be myopic to look at this as a problem that does not concern Governance. Any deliberate attempt on a company’s part to report incorrect or misleading data reflects poorly on the intent because transparency and maintaining data disclosure standards are much broader issues.

Any company which is attempting to report data that they know is neither complete nor correct should be held guilty on governance too. The unethical practices of a few companies can’t undermine the overall progress being made on environmental issues, but for asset managers and investors, this is an important challenge to address. Here, the role of regulators will be critical because they can directly confront the companies and start investigations.

‘Greenwashing’ is a problem that regulators are acknowledging

Now the governments are trying to address this ‘Greenwashing’ menace. In this context, the recent BBC News article ‘Efforts to curb energy tariffs’ greenwashing’ is very interesting. The UK government is launching a review into how energy retailers market green tariffs to consumers and the article says that as of now, nine million British households are on energy products that are advertised as being “100% renewable” or “green”. But as it happens, not all the claims are true. The official Government statement says:

  • Government to review green electricity tariffs amid concerns energy companies could be exaggerating their environmental benefits
  • Ministers will consider whether there is currently sufficient clarity around where the energy on bills comes from
  • The review comes as a poll shows 75% of consumers believe suppliers should be more transparent over their green tariffs

“Millions of UK households are choosing to make the green switch and more and more of our energy comes from renewables, but I want people to know that when they sign up to a green tariff, they are investing in companies that make a conscious choice to invest in renewable energy,” said Climate and Energy Minister Anne-Marie Trevelyan.

In this, the role of perception and what the consumers have to say is very interesting. On this issue, nearly two-thirds (62%) of UK energy consumers say their purchasing decisions are influenced by how eco-friendly an energy tariff is. However, 75% believe suppliers should be open and transparent about their tariffs, including how much of their renewable energy they buy from other companies.

How US regulators are targeting greenwashing

The victory of Joe Biden in the US Presidential elections provided a major boost to ESG in the United States and very quickly, there was a change in the stance that the regulators had taken. In March 2021, the U.S. Securities and Exchange Commission or SEC’s Enforcement Division announced its Climate and ESG Task Force with an aim to identify ESG-related misconducts. The task force will look for “gaps or misstatements in issuers’ disclosure of climate risks under existing rules”.

The concern of greenwashing is not just limited to the companies, but there are also attempts to address if the funds that are marketing their products as ESG funds or the investment advisors who sell their products as sustainability focuses, are doing it truthfully. The task force is also mandated to analyze “disclosure and compliance issues relating to investment advisers’ and funds’ ESG strategies”.

Because of the increased usage of ESG as an investment filter by the asset managers, there is more awareness of these issues among the companies. Many of the companies are voluntarily adopting a proactive approach to environmental matters. But some are taking shortcuts as well. More focus on ESG clearly means more greenwashing attempts.

We think that this is an important development. We must expect that the regulations will get more stringent here. There is a clear danger of ESG becoming a pure marketing tool that a few companies may use to take customers for a ride and the regulators will not be silent spectators. The governments and regulators will get more involved in framing regulations and guidelines in their attempts to ensure that the companies report truthfully.

DuPont and what the shareholders want them to report

While almost everyone knows about the ESG difficulties for Oil & Gas and Energy companies and the ExxonMobil vs. Engine No. 1 episode, many other events went relatively unnoticed. The issues may have been different but investor activism was no less intense. For example, DuPont de Nemours or DuPont.

DuPont had eight in ten voters supporting shareholder proposal asking the company to disclose its role in plastic pollution. The proposal, filed by As You Sow, received 81 percent support among the votes cast. The proposal was for DuPont’s board to release a report each year on plastic pollution and what the company was doing about it.

The shareholder proposal wants that DuPont discloses ‘trends in the amount of plastic in various forms released to the environment by the company annually, and assesses the effectiveness of the company’s policies and actions to reduce the volume of the company’s plastic materials contaminating the environment.’

There are reports that an estimated 11 million metric tons of plastics leak into oceans annually and this figure is expected to more than double in the next twenty years. As You Sow has engaged several companies on reducing plastic pellet pollution and many have agreed to report their data though not all of them have begun to provide data.

Eicher Motors: The Managing Director gets an ‘axe’

Eicher Motors Limited is an Indian automotive company that manufactures two-wheelers mainly motorcycles and commercial vehicles. In the last fifteen years, Eicher has attracted considerable investor interest because it is the parent company of Royal Enfield, which has a range of popular motorcycles. It has been a fast-selling and high-margin product. But the growth has tapered in the last few years. The current market cap of Eicher Motors is Rs710 bn (or around 9.5 bn USD).

Figure 1: Eicher Motors Stock price

Source: Google

Recently, Eicher Motors’ shareholders, at the company’s annual general meeting (AGM), rejected a proposal for the re-appointment of Siddhartha Lal as the company’s managing director for a period of five years with effect from the 1st of May of the current year. The trigger was a proposal to increase Mr. Lal’s remuneration when the last few years have been a big struggle for the company and the stock price return has been lackluster. During the AGM, the shareholders rejected the proposal of increasing his remuneration.

It was a close victory. According to a news report in The Indian Express, while 73 percent of the votes favored the re-appointment of Lal as Managing Director, the rest 27 percent were against it. As a special resolution, it needed support from 75 percent of the votes cast to pass the proposal. Out of the total 21,74,67,139 votes, 15,88,49,543 (73.04 per cent) were in favour of the re-appointment, while 5,86,17,596 (26.95 per cent) votes did not approve the proposal.

The more interesting part is the view of professional asset managers in this story. The proposal’s failure to get approval could be exclusively attributed to institutional shareholders of Eicher Motors, who were vehemently opposing the move. Out of the total 8,13,98,998 votes received in the category, 5,86,16,986 (72 percent) disapproved the proposal and 2,27,82,012 (28 percent) favoured the move.

Even individual shareholders are pushing for ESG: The Netflix case

At a time when the common perception is that almost all the investor activism on ESG and Sustainability issues is led by the institutional investors, the individual investor’s role is being seen as rather limited to a few things such as; not investing in companies or with asset managers who don’t care for ESG issues, spread awareness on what is a sustainable investment and what is not and change consumption preferences accordingly.

Hence, this Morningstar article on the topic of investor activism is fascinating……How an investor helped Netflix disclose its ESG Performance: It is encouraging to see individual investors begin to make a difference, and companies responding accordingly……which details how even individual investors are making their contribution. It is a case when an individual shareholder was not only aware of the sustainability angle in their investments but also didn’t shy away from expressing them.

Lily Bowles who is a Netflix subscriber and shareholder wanted to know how Netflix, in which she first bought shares in 2016, was doing on material ESG risks. She wanted to understand how the sustainability issues could have a financial impact on the company. As an individual shareholder, she didn’t get discouraged because of her experience in ESG and also because she was passionate about sustainability issues.

To get more information about how Netflix performed on these issues, Bowles submitted a shareholder resolution in December 2018. To cut a long story short, Netflix was very responsive and proactive. In February 2020, the company released its first Sustainability Accounting Standards Board Report. It is a great story with important learning that no effort is really small in sustainable finance and in making the world a better place.

Institutional investors are being more assertive

The message is simple here: there is overwhelming support for ESG proposals in shareholders’ meetings and the asset managers are increasingly asserting themselves on sustainability and ESG issues. In benign cases, many investment managers nudge the companies to behave more responsibly on environmental, social, and governance issues, and in more unpleasant situations, they impose their will by pushing for the reconstitution of the board.

Whether it be investors or regulators, there is an increasing demand for more transparency and more disclosures from companies. While the Covid-19 did certainly accelerate the process, the building blocks were being put into place well before that. But nonetheless, the world that we happen to reside in today finally seems to be acknowledging the need for sustainable business practices, failing which adequate repercussions are gradually being meted out.

Today, the organizations can’t operate with only profit maximization as their objective, and not only do they have to take care of the interest of all the stakeholders, they also need to ensure that their side of the story gets properly highlighted in media and in front of the investors. There are questions like, is the business being conducted ethically, and are all the applicable, relevant guidelines and regulations being followed? Is the governance structure prepared to protect the interest of all the stakeholders? Or how do the organizations identify the instances of deviant behavior and deal with them?

As there is a strong link between stock price returns and the track record of a company, many of these issues are getting increasingly important for shareholders. There is a shift in the thought process and many investors and stakeholders have started to think that an organization does not only exist to maximize profits or the return on their investments (ROIs). The ESG and Sustainability are getting more common and the entire ecosystem is witnessing this transformation.

How EMAlpha can help

As we have discussed, the changes in perception on ESG track record of a company and reactions from institutional investors have become an important driver of stock prices, and especially in cases where the volatility is high, it matters even more. The EMAlpha sentiment and ESG scores have been reasonably accurate and there is a strong link between stock price performance and these scores. This is helpful for asset managers in their decision making:

  • The news spread has become much faster with social media and the internet. Some of the reports may be difficult to immediately verify and their authenticity may also be questioned, but they still influence the stock price movement. EMAlpha tracks news flow and helps in deciphering their impact on the stock price movement.
  • The news flow analysis and their impact assessment are very difficult to track and hence, it is a cumbersome exercise for asset managers if done without optimal help from machines. EMAlpha solves this problem for portfolio managers, at both portfolio and the company level.
  • EMAlpha’s sophisticated AI-ML tools and proprietary analytical methods are based on deep domain expertise and unmatched technological prowess, helping the investors with the most effective and efficient input.
  • The local news flow collection picks up several important issues and the local language along with English news analysis can be tracked for important developments. The potential fallout of such events is usually better predicted using local news analysis.
  • In many global markets, the ownership of some stocks is highly opaque, and this is a big issue. This also often makes the stock prices volatile. EMAlpha algorithms pick up these important signals on the institutional investors of a stock.

References

  1. The whistle-blower who calls ESG a deadly distraction: How an ex-BlackRock executive lost faith in sustainable finance https://amp-ft-com.cdn.ampproject.org/c/s/amp.ft.com/content/4fdc6cdf-7bd6-41bc-b376-2137521e3017 (Accessed on 18th August 2021)
  2. The United Kingdom Government to tighten rules to stop ‘greenwashing’ of electricity tariffs https://www.gov.uk/government/news/government-to-tighten-rules-to-stop-greenwashing-of-electricity-tariffs  (Accessed on 18th August 2021)
  3. UK government to probe retail energy ‘greenwashing’ https://www.ft.com/content/f93485a7-9fa2-47bd-82e6-20414883b215 (Accessed on 18th August 2021)
  4. Efforts to curb energy tariffs ‘greenwashing’ https://www.bbc.com/news/business-58222808 (Accessed on 18th August 2021)
  5. How US and UK regulators are targeting greenwashing https://www.ftadviser.com/regulation/2021/08/13/how-us-and-uk-regulators-are-targeting-greenwashing/ (Accessed on 18th August 2021)
  6. ‘DuPont shareholders back plastic pollution report proposal: 8 in 10 votes cast support measure brought by As You Sow https://www.corporatesecretary.com/articles/esg/32563/dupont-shareholders-back-plastic-pollution-report-proposal (Accessed on 20th August 2021)
  7. Record-Setting 81% of DuPont Shareholders Approve Plastics Pollution Proposal https://www.environmentalleader.com/2021/05/record-setting-81-of-dupont-shareholders-approve-plastics-pollution-proposal/ (Accessed on 20th August 2021)
  8. Plastics spills disclosure demanded by DuPont shareholders https://www.endsreport.com/article/1714423/plastics-spills-disclosure-demanded-dupont-shareholders (Accessed on 20th August 2021)
  9. Eicher Motors MD Lal’s re-appointment rejected https://indianexpress.com/article/business/eicher-motors-md-lals-re-appointment-rejected-7463689/ (Accessed on 20th August 2021)
  10. Eicher Motors stock price https://www.bseindia.com/stock-share-price/eicher-motors-ltd/eichermot/505200/ (Accessed on 20th August 2021)
  11. Eicher Motors board to meet soon to revise MD Siddhartha Lal’s appointment resolution https://www.moneycontrol.com/news/technology/auto/eicher-motors-board-to-meet-soon-to-revise-md-siddhartha-lals-appointment-resolution-7364221.html (Accessed on 20th August 2021)
  12. Eicher Motors’ minority shareholders oppose appointment of Siddhartha Lal as Managing Director https://www.livemint.com/companies/people/eicher-motors-minority-shareholders-oppose-appointment-of-siddhartha-lal-as-md-11629451616344.html (Accessed on 20th August 2021)
  13. Not a smooth ride anymore: Is it time to bite the bullet and sell this multibagger? https://economictimes.indiatimes.com/markets/stocks/news/not-a-smooth-ride-anymore-is-it-time-to-bite-the-bullet-and-sell-this-multibagger/articleshow/85423727.cms (Accessed on 20th August 2021)
  14. How an investor helped Netflix disclose its ESG Performance. It is encouraging to see individual investors begin to make a difference, and companies responding accordingly. https://www.morningstar.in/posts/64536/investor-helped-netflix-disclose-esg-performance.aspx (Accessed on 20th August 2021)
  15. An Investor Helps Netflix Disclose ESG Performance. Investor advocate Lily Bowles’ story with Netflix is a successful one, but new restrictions on shareholder resolutions make such efforts harder to replicate. https://www.morningstar.ca/ca/news/214244/an-investor-helps-netflix-disclose-esg-performance.aspx  (Accessed on 20th August 2021)

EMAlpha Products and Services

In most Emerging Markets, information discovery is a major challenge. For example, even if global investors do show interest, how do they solve the problem of timely access to information? The world’s largest capital allocators hold USD 60 trillion and they include GPIF (Japan), GPF (Norway), ADIA (Abu Dhabi), GIC (Singapore) etc. However, only 10% of the capital gets allocated to EMs and ~90% goes to G10. The big hurdle for EMs is: Foreign investors cannot access relevant local information in a timely fashion.

Most market participants and investors from across the world realise that the low rates in G10 makes EM attractive for investors. But, a) Information access is usually a cost and time intensive process for investors, and b) In many EMs, language is a big barrier and because of multiple regional languages, there is a significant delay before news makes it to the mainstream English language. To address these issues, you need solutions like, a) Real time news collection from multiple languages and, b) Instantaneous machine translation and text analytics leading to actionable recommendations for investors.

There are further challenges such as ensuring that companies behave responsibly and that they adopt sustainable business practices. There is a need to ensure that the investors are contributing towards making the world a better place by making investment decisions which reward responsible behaviour of companies. Case in point, ESG (Environmental, Social & Governance) which is increasingly being used as a filter for investment decisions. There are other issues as well such as which data to use and a lack of a standardized framework for evaluation.

Some of these issues are too important to be postponed to a later date and it is in this regard that EMAlpha is making its contribution. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

EMAlpha also has solutions for Multilingual data collection and real time targeted information which are based on proprietary processes to collect relevant data across multiple markets. The coverage expands across emerging market equity, currencies and commodities and the work has also been very successful in testing the signals in some key markets for live trading strategies. This is a continuous cycle and a virtuous loop that allows for iterative improvement through AI-human feedback.

With developments in AI and technology in areas like NLP, there are considerable new possibilities to bridge the gap in information between Emerging Markets and the more Developed Markets. This is an area which is turning out to be very exciting because some of the tools mentioned were not available even a couple of years ago. This implies that the evolution in the field will only get faster as time goes on. While the Emerging Markets and the Capital Flow Conundrum is a complex one, there is now much more hope and optimism that with the usage of technology, things will only get better.

At EMAlpha, the ESG team is doing further research on why some issues like Social get more prominence as compared to others like Environmental or Governance issues. To look at specific cases in the context of ESG is a very intense yet interesting exercise and this has been an incredible learning experience for the EMAlpha Research team. The data, information and ratings are a humongous challenge for ESG and it takes time to reach to the depth of the issues as the field is evolving very quickly.

EMAlpha is making a solid contribution in tackling these challenges. EMAlpha has solutions for ESG which are practical, user friendly and although not too simplistic yet easy to use. EMAlpha has developed a Flexible ESG Framework Management System which is a proprietary technology that makes ESG scores framework agnostic, thus allowing for quick adaptation. In addition, the users decide what matters to them and the EMAlpha system does a classification into E, S, G and more granular categories.

We strongly believe that the entire ESG ecosystem requires multiple stakeholders to pull in the right direction in order to make it operational and that will be the most critically determining factor for ESG’s success in making the corporate responsibility actually work. Most importantly, the investors should view ‘E’, ‘S’ and ‘G’ individually and should not confound issues when it comes to the comprehensive ESG evaluation. It is important to understand the right reasons behind ESG investing because this bias could hurt their investment decision making and portfolio performance.

Research Team
EM Alpha LLC

For more EMAlpha Insights on Emerging Markets, please visit https://emalpha.com/insights/. To know how you can use EMAlpha’s unstructured data and ESG (Environmental, Social and Governance) solutions for better investment decisions, please email us at research@emalpha.com.

About EMAlpha:

EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) more accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. EMAlpha works on information discovery and ESG solutions for Investors in Emerging Markets, using AI and NLP tech. Our mission is: “To help increase capital flow, in terms of FDI and FPI, to Emerging Markets by lowering information barriers using AI/NLP”. EMAlpha Products help achieve both alpha and ESG solutions and the idea is to help asset allocators, asset managers, banks and hedge funds along with companies with cost and time efficient access to relevant information. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious. Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

Disclaimer:
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