It's not just BlackRock's CEO that has words for companies. Cyrus Taraporevala, the CEO of State Street Global Advisers, another large asset manager, has recently sent his own letter to company boards cautioning that SSGA's engagement on sustainability this year will also include the possibility of a proxy vote against directors "to press companies that are falling behind and failing to engage." While directors can play a vital role in catalyzing action on ESG matters, SSGA recognizes that, in many ways, our understanding of ESG is still in its early stages, making board oversight of ESG something of a challenge. To help demystify sustainability for directors, SSGA has developed a framework intended to provide a roadmap for boards—where to begin—in conducting oversight of sustainability as a strategic and operational issue.
SSGA has long engaged on a number of ESG issues, especially governance matters, but, in the last several years, Taraporevala has recognized that issues such as climate change, labor practices and consumer product safety are having an increasing impact on shareholder value. Accordingly, he contends, "addressing material ESG issues is good business practice and essential to a company's long-term financial performance—a matter of value, not values."
SSGA has witnessed some recent progress in directors' recognition of the effect of ESG issues—the impact of climate on the flow of capital and business risk; the impact of corporate culture, diversity and other intangible issues on long-term value. For example, SSGA's "Fearless Girl" campaign (see this PubCo post) led 583 companies to add or commit to adding women to their boards. For the most part, however, the progress toward sustainability goals has been marginal. According to Taraporevala, "fewer than 25% of the companies we've evaluated have meaningfully identified, incorporated and disclosed material ESG issues into their strategies." And, interestingly, he contends that shareholder activists are not necessarily helping matters: "some shareholder activists continue to focus on specific or narrow ESG issues in piecemeal fashion—often creating confusion for investors, boards and company leadership without fundamentally tackling the ESG issues material to long-term shareholder performance."
R-FactorTM scoring system.To address these deficiencies, SSGA has launched the "R-Factor" scoring system, which has generated unique ESG scores for over 6,000 listed companies. Based on the SASB framework and drawing on data from four ESG data providers, R-Factor is designed to allow SSGA to assess a company's performance against its peers on "financially material and sector-specific ESG issues." SSGA believes that "a company's ESG score will soon effectively be as important as its credit rating."
SSGA is now planning to put its R-Factor ESG scores into action. This proxy season, SSGA "will take appropriate voting action" against directors at companies in the S&P 500, FTSE 350, and various other indices where those companies "are laggards based on their R-Factor scores and...cannot articulate how they plan to improve their score. Beginning in 2022, we will expand our voting action to include those companies [that] have been consistently underperforming their peers on their R-Factor scores for multiple years, unless we see meaningful change."
ESG Framework for Directors. SSGA believes that directors still exhibit some "ambivalence" about their roles in ESG oversight. However, directors have a significant role to play in promoting action on ESG issues. During engagements, SSGA wants to "understand how boards are developing ESG-aware strategies, as well as how they are overseeing and incentivizing management to consider and measure performance of financially material ESG issues."
To help directors better understand how to approach the issues—to demystify ESG—SSGA has developed a framework for directors, intended to provide guidance on "where to begin and what to focus on when it comes to ESG." As discussed in the framework, over the past three years, SSGA has "found few companies that have fully incorporated ESG into their strategy and operations." While SSGA expects ESG to become a "mainstream" boardroom issue this year, both investors and companies face the challenge that they are still "in the early days of understanding and managing the risks and opportunities that ESG poses to businesses and economies."
SSGA cautions that directors should not necessarily take comfort in the production of sustainability reports, which historically have been prepared for a broad group of stakeholders and often address issues that are not necessarily financially material for investors. As a result, directors still need to ferret out which issues matter to investors and relate to long-term value creation. Which sustainability issues are financially material? How are these issues relevant to the company's strategy, its business operations or both?
SSGA's approach adapts current board oversight practices to ESG, "contextualiz[ing] ESG as a strategic and operational issue that needs to be overseen and managed.... Prioritizing ESG within an organization requires concerted effort from the top, and board members have a critical role to play as catalysts for change."
ESG as a Strategic Consideration. SSGA advocates the use of scenario planning tools to evaluate the impact of ESG issues on the business—the same way that it would evaluate potential changes in tariff policy or interest rates—and consider the results in the context of developing or adapting the company's long-term strategy. For example, SSGA suggests, "considering climate change in its strategic planning process could result in a company choosing a different location for a plant to mitigate the physical impacts of climate change. Alternatively, based on different carbon price assumptions, a company could allocate capital to renewable energy projects or invest in the greening of existing infrastructure." In another illustration, where a company has made a public commitment to gender diversity or human rights, and is considering an acquisition, as part of its due diligence regarding the target, the board "might need to consider not only the practices of a potential acquisition target but also potential impacts on the assumed synergies as a result of those practices."
ESG as an Operational Consideration. Financially material ESG issues can be hard to identify as part of operations, but if not properly managed, they can negatively affect company performance. The example SSGA suggests here is the opioid crisis and the ESG issue of public health. A company may routinely monitor marketing and sales practices "for its products with revenue objectives in mind. But a comprehensive ESG approach to that issue would also look at the impacts of such practices on public health." Failure to focus on the ESG aspect "has increased regulatory costs and called into question the companies' social license to operate."
In light of the difficulty for investors of understanding "the broader dimensions of ESG risks," SSGA underscores the importance "for companies to identify, manage and publicly disclose what they consider to be financially material ESG issues." That disclosure should also help investors to "fully credit those that effectively manage and mitigate these risks." SSGA observes that use of the SASB framework by an increasing number of companies allows investors "to compare and reward companies with strong performance in these areas."
The roadmap for directors developed by SSGA for approaching and overseeing ESG involves the following steps:
- Ask management to obtain the company's R-Factor score from SSGA. Companies can request their R-Factor scores, accompanied by scores of industry peers, at this link.
- Determine the company's financially material ESG issues by first becoming familiar with financially material ESG issues facing the industry (identified by SASB) and then identifying any other financially material ESG issues applicable specifically to the company's business.
- Make ESG a board agenda priority by first conceptualizing the strategic and operational ESG risks (as discussed above), then determining the appropriate board oversight structure for ESG issues, and memorializing these determinations by updating board charters and governance documents to reflect board involvement and oversight of ESG.
- Review periodic reporting with respect to financially material ESG information by first determining which of the ESG issues identified is currently being managed and disclosed, then determining whether new data needs to be collected for those or other ESG issues and then establishing "a sense of urgency to build infrastructure needed to deliver this data on a periodic basis."
- Manage ESG performance by setting goals and managing against them and by aligning management incentives to correspond with ESG goals; communicate with investors by developing "board fluency" in discussing how ESG is incorporated into the company's long-term strategy.
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