31 May 2024

While the shift to responsible investment to support ESG strategies has been on the rise for some time now, there are a number of significant challenges in the transition, including obstacles to Responsible Investing and outdated systems for Proxy Voting. We explored the matter with Jonathan Nelson and Cherien van Ampt, both ESG experts at Varrlyn.

What is your favorite ESG trend at the moment?

Cherien: I would for sure say Responsible Investing, a domain that incorporates environmental, social, and governance considerations in investment decisions. The trend has roots in socially responsible investments (SRI), however, it has now merged with traditional investment theory and practice.

I am also intrigued by proxy voting, and the impact it can have on shareholder proposals. I see it as one of the most critical components of Responsible Investing and better ESG outcomes. But I think that this area needs more transparency and a stronger and more integral tracking system.

Jonathan: I agree that the upswing in environmental & social risks-related shareholder proposals is a trend that’s worth merit. Also notable is the pushback on such proposals over the recent two years in the United States against “woke” investing, which is a derogatory term to denote investing that has as its goal investing in companies that uphold ESG best practices/ objectives.

The US political climate is completely at odds with the EU’s regulations with this regard, specifically SFDR. Most importantly, the application of SFDR and CSRD will extend to many US-based companies with significant operations in Europe.

For me the most interesting development over the past decade has been the push to fully integrate ESG-related concerns into fixed income products. I don’t mean sustainable financing per se (green bonds, social bonds, sustainability bonds, etc), but rather the incorporation of sustainability factors into the fixed income process.

Fixed income investments are often seen as more of a stable bedrock than equity investment, even though most asset managers and owners hold fixed income and equity positions within the same company (private and public). Since the financial crisis of the late 2000s, many investors have been pushing to increase the importance of fixed income investments in order to balance out the market-led behavior that affects stock prices.

Fully integrated sustainability concerns via investment through fixed income instruments potentially leads to a downstream effect where these issues are implicitly incorporated into the company’s public valuations.

Responsible Investing comes with its challenges. How do you look at this?

Cherien: Although Responsible Investment is an important and welcome development, it is only one part of the solution to environmental (E) as well as social (S) problems.

Many investors believe that Responsible Investment, especially the elimination of stocks with high carbon intensity, will make a big difference in reducing the world’s carbon emissions. Personally, I’m open to the suggestion if this will be the case. In the US, Wall Street has a financial interest to deliver investment solutions that investors desire. Wall Street can encourage investors to believe wrong things or make it difficult for investors to see how certain type stock are solving E&S problems.

I think the main benefits of Responsible Investment are the greater transparency (disclosure) regarding companies’ impact on environmental & social risks (E&S). This results in better E&S outcomes, more accurate company valuations by analysts, more effective engagement of investors, behavior change by consumers, and more robust regulatory and legal frameworks.

Jonathan: Actually, most asset managers do take this into account in their internal stock valuation, even if it is not actively reflected in the market price via exchanges.

In this regard, Impact Investing, which takes into account both profitability and bottom-line return and performance, has been on the upswing for somewhat shy of a decade. More recently, the field has been gaining exponential momentum. What I am unsure about is corporate and issuer’s genuine focus on sustainability and their determination to “walk the talk”.

Multiple companies are using ratings agencies to receive ESG-oriented ratings that are favorable to their own objectives for investor funding or pre-IPO marketing, as well as public perception. The increased focus on regulation which mandates disclosure and alignment of ESG-data and information disclosed by companies does indeed push this towards the realm of compliance, which has typically been the perfunctory execution of legal and regulatory requirements.

This approach contrasts with the marketing of ESG and sustainability-related issues, which often highlights such areas as a fundamental part of a company’s culture and commitment to the welfare of the planet, or at least the use of its resources (and consequently, the use of investor-provided capital). In short, I am unsure if efforts by companies to incorporate industry-related ESG and sustainability-related best practices are truly genuine.

Cherien: Indeed, I think consumers and the industry should continuously raise the bar itself and expect nothing less than progress. Responsible Investing will provide benefits on its own – win/win (lower carbon output and better stock valuation) and win/neutral (lower stock price and no impact on carbon output); but consumers and government/regulator mandates must make the more significant changes.

Investors, which play a key role in driving progress, should increasingly consider Responsible Investing. However, they must also realize that this is only one (and probably easiest) step towards addressing E&S problems. They should also be aware that their electoral votes will significantly impact.

What is a development in the space you would love to be part of yourself?

Cherien: Opportunities in businesses that increase the efficiency and transparency of existing Proxy Voting systems. The proxy voting system has taken an added importance amid growing interest in ESG issues and how investors vote on related shareholders proposals. Company’s like Institutional Shareholder Services (ISS) and Glass Lewis provide guidance.

Shareholders who want to vote their proxies depend on them to execute their proxy votes. But with only limit players dominating the space it’s debatable if investors getting the diversity of perspectives, they need to make informed proxy votes? I’d like to be part of alternatives to this.

Proxy Voting is a way to hold companies accountable. However, its outdated system is being scrutinized due to ESG issues. Somewhere in the ‘70s, the stock exchange’s custody, trading, and settlement parts became more efficient and transparent. In my view, the proxy voting system is likely to change significantly over the next 10-20 years. I’d love to be a part of that movement in any shape or form.

Jonathan: On Cherien’s point above, I certainly hope that the proxy voting system changes significantly over the next 10-20 years. The post-Covid push to allow for electronic meetings at Annual General Meetings allows for even greater shareholder participation, which some issuers embrace and others do not, because increased participation would allow for increased shareholder participation and, potentially, greater pushback against the agenda’s put forth by management.

While legislations in the US and Europe mandate the voting at Annual General Meetings at all public companies in which asset managers and owners invest, voting electronically and participating electronically are two different things. Active participation (read: criticism of management’s agenda and potential opposition to it) at AGMs is something that many issuers have historically tried to downplay.

Source: https://www.consultancy.eu/news/10276/responsible-investments-a-progressing-and-changing-landscape