Vanguard Group CEO William F. McNabb III just tipped the list. The world’s top three asset managers—Blackrock, Vanguard, and State Street Corp.—are now calling the companies that they invest in to adopt climate risk disclosure.
In a recent open letter to corporate directors across the globe, McNabb explained that Vanguard, the $4.5 trillion mutual-fund management firm, expects businesses to embrace materiality-driven disclosures to shine more light on sustainability risks.
Summing up the challenge of climate risk, McNabb wrote that it’s the kind of risk that tests the strength of a board’s oversight and risk governance. That’s the crux of the challenge for directors. As investors ratchet up the pressure on companies to analyze their exposure to the impacts of a warming planet, they’re calling on boards to be knowledgeable about material climate risk and capable of preparing for its impacts and capitalizing on its opportunities.
As we heard in Karen Horn’s opening keynote of NACD’s 2017 Global Board Leaders’ Summit, directors can no longer ignore the inherent impact of these issues on the long-term value creation of the corporate world —ranging from climate risk, natural resource capital, and implications of the Paris Climate Agreement.
Board-level competence around climate change and other sustainability risks is the way forward. Through an understanding of what climate change means, why it matters to their business, and what their organizations are capable of changing, directors can successfully make climate risk part of their governance systems.
In a new report by Ceres called Lead from the Top, we outline ways that companies and boards can build up that competence.
But rather than settling with bringing on a director who is competent in sustainability, our report explains why companies must work to build an entire board that is competent to oversee these risks. By engaging thoughtfully on material sustainability risks as one cohesive body, this kind of board is able to ask the right questions of its management, support or challenge senior management as needed, and ultimately make informed and thoughtful decisions affecting corporate strategy and risk.
We identified three key principles that companies and boards can use as they work to build a sustainability-competent board:
1. Sustainability needs to be integrated into the director nomination process. Finding directors who can apply their knowledge about climate and other sustainability risk to relevant board deliberations is a good first step. Companies can get the right people on board by approaching this systematically as a part of the board nominations process, specifically identifying experience in material environmental, social, and governance (ESG) risks in the board skills matrix and by casting a wide net to consider candidates with diverse backgrounds and skills.
2. The whole board needs to be educated on sustainability issues that impact their company. For sustainability to become part of the fabric of board oversight and integrated into decision-making on strategy, risk, and compensation, all directors on the corporate board need to be well informed on material sustainability issues so they can lead thoughtful deliberations and make strategic decisions. Companies can do this through focused, ongoing training programs that bring in experts from outside the company and by educating the board on the connections between climate change and material impacts and the connections to risk and strategy. Embedding ESG into the existing board materials so it does not become one additional issue topic to vie for directors’ attention is essential. Sustainability managers embedded within companies can play a key role in driving this integration.
3. Boards should directly engage a diverse array of stakeholders, including investors, on sustainability issues impacting their company. With more investors paying attention to climate change and other sustainability issues, shareholders increasingly expect boards to engage directly with them on critical issues. One of the goals of McNabb’s letter was to nudge directors to engage directly with shareholders. Given this growing focus, material environmental and social factors should be made a part of any dialogue between directors and investors.
It all comes down to the bottom line. Risk and opportunity define business. Corporate boards will have a difficult time performing their fiduciary duty to the companies they lead and the shareholders that they represent without understanding the risks and opportunities created by climate change. Our report lays out practical steps directors can take as they consider how to make their board competent in addressing climate change and other environmental, social, and governance issues.
Veena Ramani is the program director of Capital Market Systems at Ceres. Ceres is a sustainability nonprofit organization working with the most influential investors and companies to build leadership and drive solutions throughout the economy.
Former DuPont CEO Ellen Kullman spoke with National Association of Corporate Directors’ (NACD) President and CEO Peter R. Gleason at the 2017 Global Board Leaders’ Summit. Kullman—known for leading the DuPont management to victory in the 2015 proxy battle against Trian Fund Management’s Nelson Peltz—shared insights into oversight of long-term value creation and tactics for succeeding in a proxy battle.
Before discussing the finer points of DuPont’s proxy battle, Kullman addressed the company’s relationship with its stakeholders. Kullman once said that DuPont adheres to stakeholder theory by focusing on four areas: engaging employees, satisfying customers, supporting the community and, in turn, providing success for shareholders. “As a company that operated all around the world, many times our manufacturing plants were the biggest employer in the area,” Kullman said. “If we wanted to be successful, we had to support the citizen.”
Gleason compared DuPont’s relationship with Wilmington, Delaware, to Corning and the company’s headquarters in his own hometown of Corning, New York. “Attracting the right talent is an investment by the company,” Gleason said. “Corning had a philharmonic orchestra in a town of ten thousand people. However, investments in the community may have been seen as low-hanging fruit to shareholders more interested in seeing direct returns.”
In the case of DuPont, its small hotel and golf course in Wilmington became activist targets despite the sense of community they created with the citizens of the town. “Young people today have a choice about where they work,” Kullman said. “If you want to attract the best and brightest, you have to make the community something they want to be a part of. Why does Google have free food and good infrastructure? It’s not a historic appendage, it’s to keep employees working hard. The question is how much [do you want to invest to retain talent] because you can never calculate a return on it.”
Tell Investors Your Story
Kullman shared a number of tactics that helped DuPont emerge victorious in its proxy fight.
1. Keep Telling Your Story to Investors: “We understood our investors and our strategy, and I don’t think [Trian] did. A board member that had been [with DuPont] for three years did a better job explaining our strategy [to investors] than I did. He kept it to the points that were important and was helpful in making the connection as a shareholder.”
2. Get Ahead of the Activist by Communicating Early and Often with Regulators: Kullman pointed out that activists’ communications tactics have a time advantage over their target companies because public companies must file shareholder communications first with the Securities and Exchange Commission (SEC). “I constantly rewrote letters to the SEC and filed responses [in order to be able to communicate with shareholders in line with the SEC rules for solicitation]. Going to CNBC would have been a no-win situation. That’s how we got that transparent information out to the investor and news community to make sure it wasn’t a one-sided innuendo from the activist.”
3. Trust the Management Team to Run the Business: “You have to have a top team. The CFO, regional vice presidents, vice presidents, and general managers of our businesses had to focus on running the company, while we took a small group of people to focus on the fight. I had to have a foot in both camps: I ran the fight during the day and the company on nights and weekends.”
4. Maintain Constant Board-CEO Communication: “You need to spend a lot of time with your board and you need to know where each board member is individually. Whenever I had an interaction with the activist, I would summarize it to the board right away. Say you want help and ideas from your board members because they have a lot of experience. At that point [in our proxy fight with Trian] there were no bad ideas.
5. Engage Retail Investors: “Proxy advisory firms came in to talk to the board and me about what we needed to do to protect ourselves. They said that retail investors vote for management, but they don’t vote. So we identified shareholders that owned more than $1 million in stock. I called them personally and some of them actually called me back.”
6. Use Social Media: “I was new to social media, but I had to learn quickly. With such a large retail base, we couldn’t assume they were all retired investors—and they weren’t. We had to use as many vehicles as possible to get our story out there.”
Learn more about the 2018 NACD Global Board Leaders’ Summit and register here.
The rise of sustainability as a governance imperative is inextricably tied to the growing influence of large institutional investors, particularly index funds, and the governance teams within them. Generally speaking, governance-focused asset managers now control more than one-third of the average public company’s shareholder register. Recently, the world’s three largest investors bulked up the staff of their governance teams dedicated to analyzing and meeting with portfolio companies, which included hiring individuals with expertise on environmental and social topics.
The heightened focus on environmental, social, and governance (ESG) analysis and corresponding engagement is heavily influenced by the Principles for Responsible Investment (PRI). The PRI promotes “active ownership” (such as engagement and proxy voting) and “ESG integration” (which is intended to improve investment decision-making by linking the analysis of ESG factors with financial performance). What began in 2006 with 200 asset owners has grown to more than 1,600 global signatories, including investment managers, with more than $60 trillion in assets.
Recently, the PRI announced that it will de-list signatories if they do not show progress in implementing the Principles. Because being a PRI signatory is commonly a requirement for asset managers to win mandates from asset owners, this move may incentivize PRI members to increase the frequency and sophistication of their engagements and add momentum to the quest for ESG data that is comparable across companies and industries.
Market participants are also seeking to understand and quantify the link between ESG and financial value. An increasing number of data providers, consultants, credit rating agencies, and nonprofits are assessing and rating companies on their performance on ESG criteria. Concurrent with that analysis is the emergence of academic and proprietary research which correlates effective ESG oversight with financial value creation, further encouraging investors to understand how companies link sustainability and business strategy.
Investors Take Action
These dynamics are already changing the market. Investor coalitions, including the Commonsense Corporate Governance Principles and Investor Stewardship Group, have been formed to issue guidance and perspectives on governance and sustainability issues. In addition, certain shareholder proposals on environmental and social issues are receiving high levels of support from a growing range of institutional asset managers. Importantly, within the past few months, both BlackRock and State Street Global Advisors have stated that if they do not perceive progress from issuers on sustainability initiatives in their engagement, they will consider voting against the nominating/governance committees of those companies.
Preparing to Engage
Given these trends, it is incumbent on issuers to take steps now to ensure that they are engaging effectively with their investors. Here are four ways to prepare:
Establish clear governance of sustainability. Investors want to know that their portfolio companies have effective governance structures in place to manage the development and execution of sustainable strategies. A coordinated program should be built with the following points in mind:
Employees across the organization need to be educated, aligned and incentivized toward common sustainability goals;
The financial risks and opportunities of sustainability activities need to be assessed for potential return on investment;
Metrics and systems need to be established to track progress against sustainability goals; and
The board and management should clearly identify who is responsible for sustainability in order to ensure the integration of sustainability considerations into strategic planning and incentives, as appropriate.
Identify the material ESG factors for your company. It is critical to identify which ESG issues have the greatest potential to create risks or provide opportunities that may impact the long-term value of your company. Investors are increasingly looking to the Sustainability Accounting Standards Board (SASB), which provides industry-specific guidance on the most potentially material ESG factors in a given industry, and other disclosure standard setters for this information.
Tell your story. Companies should be proactive in communicating with investors about sustainability. That means strengthening disclosure of sustainability governance, strategy, goals, and performance in public filings and producing enhanced sustainability reports to demonstrate the financial materiality of ESG topics. Companies will also want to ensure internal subject matter experts are equipped to engage with investors and external rating agencies.
Keep your eye on the future. Today, investors frequently compare financial disclosures to material non-financial information contained in documents such as sustainability reports. One trend that is emerging to help ensure these disclosures are complementary is integrated reporting, which combines financial and sustainability disclosure in a single, cohesive document. While still nascent, this practice is intended to provide investors with a better understanding of the link among corporate business strategy, sustainability initiatives, and short- and long-term value creation.
From traditional governance factors like compensation, board composition, and independence, to environmental and social factors like energy efficiency and diversity, sustainability is now integral to every company’s business model. As the market continues to incorporate, value, and reflect the materiality of sustainability into investment strategy and engagement, companies that can effectively tell their sustainability story will be best positioned to succeed with the world’s largest investors.
Chad Spitler is head of the Sustainability Advisory Practice at CamberView Partners.