On January 14, 2021, Laurel Hill Advisory Group (“Laurel Hill”) and Fasken hosted a webinar on ESG (environmental, social and governance) considerations of which companies should be aware for the upcoming 2021 proxy season. The webinar’s panelists were David Salmon of Laurel Hill and Emilie Bundock, Stephen Erlichman and Grant McGlaughlin of Fasken and was moderated by Gordon Raman of Fasken. Set out below are some of the comments made by the speakers on the webinar.
The importance of ESG considerations in today’s corporate governance model has developed over the past 50 years. In the early 1970’s the Milton Friedman view of corporations was the dominant business mindset. In a forceful New York Times article he said that business leaders that “believed business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends …[were]… preaching pure and unadulterated socialism”. Since that time, certainly in North America, corporations have assumed a central role in the growth of economies. With that central role has come the recognition that corporations play a greater role in society, as noted in 2017 by Larry Fink, the head of Blackrock. In his annual letter to CEOs he wrote: “ To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”
This shift in view, particularly in the United States, has occurred as part of a broader debate about “corporate purpose”. Leading thinkers in the United States, such as Martin Lipton, would articulate corporate purpose today as being “to conduct a lawful, ethical, profitable and sustainable business in order to create value over the long-term, which requires consideration of the stakeholders that are critical to its success (shareholders, employees, customers, suppliers, creditors and communities) [emphasis added]”. In this view, a broader “corporate purpose” of considering stakeholder interests is less about socialism than it is about “sustainability”.
In Canada the link between sustainability and stakeholder interests has been a little easier for the business community to grapple with since our corporate law clearly acknowledges that the duty of boards of directors is to “act in the best interests of the corporation”, which may involve not only considering shareholder interests but may involve a consideration of stakeholder interests.
Once the relationship between “sustainability” and “stakeholder” considerations is accepted, the importance ESG considerations in corporate governance principles becomes much clearer.
The “S” of ESG
The United Nations Principles for Responsible Investment (UNPRI) were created in 2006 and provide examples of many ESG issues. With respect to the “S” of ESG, the UNPRI states that they are issues “relating to the rights, well-being and interests of people and communities” and then the UNPRI provides a long sample list of S issues. The takeaway from this list is that the S in ESG is how a company is managing its relationships with its employees, the communities in which it operates, its suppliers and customers, and the political environment in which it carries on business. The reason investors want to understand how a company is managing S (as well as E and G) is that these factors can be material to a company’s sustainability and long-term value.
In the past S may have had less attention than E and G, but Covid-19 has been an eye opener on S, causing investors and companies to focus much more on the workforce, including employee health, safety and well-being. We expect this focus on S to continue.
The “E” of ESG
The “E” in ESG stands for “environment” and has been a major focus of corporations engaged in activities known as having environmental impacts such as extractive industries, petroleum and other chemical industries and industrial industries more generally. Today however the scope of what is considered relevant environmental matters has broadened; the focus on climate change is now seen as an overarching issue relevant to all industries. The main reason for this is that scientists are urging all stakeholders to take action now on greenhouse gas (GHG) emissions and adaptation to climate change if we want to limit or postpone the significant impacts climate change has and will continue to have on the environment but also on our lives and our economy. As the temperature rises, natural disasters are getting more frequent and tend to pose a greater threat to assets and infrastructure, while physical conditions in which businesses operate are changing and certain industries are forced to relocate or alter their business model. Investors need accurate climate-related financial information to be able to assess which companies are diligently addressing those issues and consequently are more likely to seize opportunities and which ones will struggle or experience financial losses.
The “G” of ESG
Without the “G” there would be no “E” & “S” in ESG. Governance is the key underpinning of all ESG issues and governance starts at the Board level. Not only is governance important in dealing with ESG matters, many studies have shown that good governance is strongly correlated to a company’s performance. Proper oversight by the Board of management, independence of directors, focus on purpose and culture, appropriate risk management, meaningful review of executive compensation and appropriate reporting and disclosure are key indicators of good governance. A thoughtful and transparent approach to ESG issues will increase investor confidence and employee engagement, improve relationships with key regulators and enhance the “brand” of the company.
The Directors E&S Guidebook
The Canadian Coalition for Good Governance (CCGG) published The Directors’ E&S Guidebook in 2018 (under Fasken partner Stephen Erlichman’s watch as CCGG’s Executive Director at that time) in order to help boards of directors in developing a robust principles based approach to the governance, oversight and disclosure of E&S factors that are, or may become, material to a company’s long term value. This focus can be different from that of corporate social responsibility (CSR). The Guidebook has 29 principle-based governance recommendations under 8 key governance topics, those 8 topics being: corporate culture; risk management; corporate strategy; board composition; board structure; board practices; performance evaluation and incentives; and disclosures to shareholders. The Guidebook, which is a worthwhile read for all directors of public companies, in effect asks boards to consider E&S issues through a governance lens.
Consequences If Companies Don’t Provide ESG Disclosure
Leadership –both boards and executives- are being held accountable if there isn’t appropriate oversight and disclosure of ESG matters. While oversight of ESG matters by boards was once considered as being beyond a board’s scope, the failure to have oversight of such matters is now often viewed by many as a possible breach of fiduciary duty. Boards that are aware of, and have oversight over, ESG considerations are seen to be managing risk and ultimately putting their companies, and their companies’ stakeholders, in a better position to succeed; operate with social license and purpose; and, ultimately, drive alpha. In contrast, those boards that are not are putting themselves in this position are viewed as taking on risk – financially, strategically and reputationally.
A more direct linkage arises in regard to voting and financing matters. Increasingly investors recognize the risk of poor ESG practices and are pushing issuers to not only incorporate sustainability, climate change and societal matters into their over-all strategy, but in the absence of doing so are using their voting and investing power to drive this change. Many have indicated they will no longer invest in companies that do not meet minimum defined thresholds in these areas or, if already invested, will vote against directors that do not reflect these concerns or show some sort of progress. As evidence, a recent study by an international public relations firm noted that 91% of Canadian institutional investors surveyed believed that maximizing returns to shareholders can no longer be a corporation’s only goal. In the same study 67% of those investors chose to invest more in companies that were excelling against ESG KPIs. If we view it from the standpoint of the competitive landscape for raising capital, issuers that focus on ESG considerations, particularly when being compared to others in the issuers’ space, will put themselves in a far better position to obtain capital then those who do not have a focus on ESG. And this is not even touching on sustainability linked debt or lending tools. This goes for any companies, large or small. It is simply a matter of the impact.
Effective board leadership is owning ESG considerations and looking to be part of the solution. Those that are doing it well are providing 1) oversight; 2) engaging stakeholders; 3) driving progress; and 4) disclosing. While the proxy advisors’ policies serve as good practice for an issuer, they are general. Engaging with your shareholders will provide a much more appropriate consideration for the board and ultimately, a better application.
ESG Disclosure Frameworks, Standards and Metrics
Unfortunately there are a myriad of voluntary ESG disclosure frameworks, standards and metrics that exist worldwide. The ones mentioned most often are: CDP Global (formerly the Carbon Disclosure Project); The Climate Disclosure Standards Board (CDSB); the Global Reporting Initiative (GRI); the International Integrated Reporting Council (IIRC); the Sustainability Accounting Standards Board (SASB); the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD); and the United National Sustainable Development Goals (SDGs). There also are industry specific ESG disclosure frameworks, standards and metrics. Fortunately, organizations around the world are starting to work together to ease confusion by trying to create an ESG disclosure regime that is clear, consistent and complete. In Canada there is a growing convergence toward using the TCFD framework for ESG disclosure and the SASB standards within the TCFD framework. The TCFD framework has 4 pillars: governance; strategy; risk management; and metrics and targets. The SASB standards contain 77 industry specific standards, each of which has industry specific disclosure topics and related accounting metrics as well as a technical protocol for compiling data.
ESG Disclosure and Shareholder Activism
Over the past few years, shareholders have ramped up pressure on companies to tackle climate change and human rights issues and the COVID-19 pandemic is not going to change that. Shareholder proposals calling on corporations to adopt and meet GHG emissions reduction targets and to adopt a reconciliation plan and report in respect of internationally-recognized standards for Indigenous Peoples’ rights including the UN Declaration on the Rights of Indigenous Peoples (UNDRIP) and International Labour Organization Convention 169 concerning Indigenous and Tribal Peoples (ILO 169) are no longer exceptional. Corporations must be careful in how they set their goals and be mindful of potential legal actions in the event of omission to disclose material climate-related financial risks or misleading or incomplete disclosure of material ESG risks. While such legal actions might not result in convictions or lead to significant financial losses, they have the potential to cause reputational harm.
ESG Considerations in M&A
Attention to ESG matters by companies can show benefits in potential M&A transactions in three ways. One, these ESG compliant companies can be more attractive to a greater number of pools of capital and, as a result, could see likely see increased returns for shareholders and other stakeholders. A company that discloses and considers ESG matters likely will be more valuable than a company that fails to address these issues. Two, addressing ESG matters will reduce the risk of a potential re-price if diligence revealed significant ESG issues. Three, a company that proactively deals with ESG matters should not be targeted by activist shareholders for failure to address these key issues. Such an attack could have a serious negative effect on share price, brand reputation and employee engagement. Proactively addressing ESG matters can have a significant positive effect on any potential future M&A activity and may be a key area of focus by buyers in future transactions.
The foregoing is a taste of what was discussed in the January 14 ESG webinar. For the detailed discussion of the importance of ESG considerations in the upcoming 2021 proxy season, please see the Fasken Proxy Season Preview webinar.