Life Soon Will Get A Lot Harder For Companies That Fail ESG Tests: Top Stock Owner

The chief executive of the world’s largest stock owner says life is about to get a lot harder for companies that fail environmental, social and governance tests set by institutional investors.

Nicolai Tangen, who runs Norges Bank Investment Management from Oslo, says the degree to which ESG dictates a company’s prospects is “starting to hit now.” Firms that don’t adapt face a world in which financing will dry up, insurance companies will walk away, employees will defect, social-media shaming will intensify and customers will disappear, he said in an interview.

As CEO of Norway’s wealth fund, Tangen oversees about $1 trillion worth of stocks, which represents roughly 72% of the total portfolio. The rest is in bonds, real estate and renewable energy infrastructure. The 55-year-old former hedge-fund boss has been looking after Norwegians’ collective savings since late 2020. And he’s promised Norway’s government he’ll turn the fund, which was built from the country’s fossil-fuel riches, into a global leader in responsible investing.

It’s a strategy that’s ultimately intended to make money, based on a view that ESG duds will become uninvestable. The next step for the fund is to speed up the pace of divestments based on ESG risks, according to its chief corporate governance officer, Carine Smith Ihenacho. Companies are dumped if the fund decides engagement isn’t worth the effort, a tactic that’s mostly applied to smaller stocks.

For bigger companies with low ESG scores, the investor says it’s about to apply a lot more pressure. Companies are sent so-called expectation documents which encompass everything from water use, to biodiversity to children’s rights. Firms that don’t score well against those requirements can expect to be grilled by the fund, with a view to a change of strategy. If that doesn’t work, an aggressive cycle of shareholder voting awaits.

“It’s based on the belief we have that in the longer run, if companies don’t manage their ESG challenges well, they’re not going to be profitable,” Ihenacho said. If they don’t improve, then the fund can “start to vote against, for example, a director who’s responsible for climate, or a board committee chair, or the chair of the board,” she said.

This year, Norway’s wealth fund didn’t back Exxon Corp. CEO Darren Woods continuing as chairman, and demanded that the oil giant be transparent around political contributions, in an effort to stop the kind of corporate lobbying that leads to dubious climate policies.

The investor also backed a successful proposal that Chevron Corp.’s emissions targets include Scope 3, which is the broadest definition and covers the carbon footprint of its customers. And Ihenacho says the fund is now stepping up pressure on companies that can’t explain their taxation models.

It’s a strategy the fund says is more powerful than outright divestment. “If we just sold out right away, it wouldn’t solve the problem of getting towards 1.5 degrees,” Ihenacho said, referring to the critical planetary warming limit identified by scientists.

The fund’s governance structure means it’s also guided by recommendations from a Council on Ethics regarding companies to blacklist, irrespective of any financial considerations. Within that framework, the investor has excluded scores of companies such as Canadian Natural Resources Ltd., due to its “unacceptable greenhouse gas emissions,” BAE Systems Plc, because of its involvement in the “production of nuclear weapons,” and Vale SA, based on the “severe environmental damage” caused by the company.

But beyond that framework, Tangen characterizes divestment as a cop-out. “You have two camps,” he said. “One sees a problem, and just runs away. We think that approach doesn’t make much sense, because you don’t solve any problems. Somebody needs to own these companies. We think it’s better that we try to constructively move them in the right direction.”

The debate around ESG divestment versus engagement is increasingly attracting academic research. A study earlier this year showed that funding costs for companies that pollute hardly change when they’re divested, indicating that portfolio allocation ultimately does little to correct unethical behavior in the corporate world.

Authors Jonathan Berk (Stanford Graduate School of Business) and Jules Van Binsbergen (Wharton School) wrote that “given the current levels of socially conscious capital, a more effective strategy to put that capital to use is to follow a policy of engagement.”

Other studies suggest that both strategies can go hand in hand. Divestment as well as thematic and integrated strategies “have potential to help in their own way,” according to research by Jonathan Harris, director of Total Portfolio Project and an associate researcher at EDHEC-Risk.

Tangen says engagement works most of the time. “There are very few companies that don’t respond,” he said. And those that resist change face a bleak future, he said.

“You’re not going to get any financing because the banks are under increasing pressure to be very careful; you’re not going to get any insurance, because insurance companies are under pressure as well,” Tangen said. “Nobody’s actually going to work for you because for young people, it’s really, really important that their values are aligned with your values.”

And then there’s the impact of social media, which has the power to sway customer behavior, he said. “You’re not going to get any clients…if you are not sustainable.”

Hard to say. https://en.wikipedia.org/wiki/Esg_score

Towards the end of the century, however, a contrary theory began to gain ground. In 1988 James S. Coleman wrote an article in the American Journal of Sociology titled Social Capital in the Creation of Human Capital, the article challenged the dominance of the concept of 'self-interest' in economics and introduced the concept of social capital into the measurement of value.[6]

There was a new form of pressure applied, acting in a coalition with environmental groups: it used the leveraging power of its collective investors to encourage companies and capital markets to incorporate environmental and social challenges into their day-to-day decision-making.

Although the concept of selective investment was not a new one, with the demand side of the investment market having a long history of those wishing to control the effects of their investments, what began to develop at the turn of the 21st century was a response from the supply-side of the equation. The investment market began to pick up on the growing need for products geared towards what was becoming known as the Responsible Investor. In 1998 John Elkington, co-founder of the business consultancy SustainAbility, published Cannibals with Forks: the Triple Bottom Line of 21st Century Business in which he identified the newly emerging cluster of non financial considerations which should be included in the factors determining a company or equity's value. He coined the phrase the "triple bottom line", referring to the financial, environmental and social factors included in the new calculation. At the same time, the strict division between the environmental sector and the financial sector began to break down. In the City of London in 2002, Chris Yates-Smith, a member of the international panel chosen to oversee the technical construction, accreditation and distribution of the Organic Production Standard and founder of one of the City of London's leading branding consultancies, established one of the first environmental finance research groups. The informal group of financial leaders, city lawyers and environmental stewardship NGOs became known as The Virtuous Circle, and its brief was to examine the nature of the correlation between environmental and social standards and financial performance. Several of the world's big banks and investment houses began to respond to the growing interest in the ESG investment market with the provision of sell-side services; among the first were the Brazilian bank Unibanco, and Mike Tyrell's Jupiter Fund in London, which used ESG based research to provide both HSBC and Citicorp with selective investment services in 2001.

In the early years of the new millennium, the major part of the investment market still accepted the historical assumption that ethically directed investments were by their nature likely to reduce financial return. Philanthropy was not known to be a highly profitable business, and Friedman had provided a widely accepted academic basis for the argument that the costs of behaving in an ethically responsible manner would outweigh the benefits. However, the assumptions were beginning to be fundamentally challenged. In 1998 two journalists Robert Levering and Milton Moskowitz had brought out the Fortune 100 Best Companies to Work For, initially a listing in the magazine Fortune, then a book compiling a list of the best-practicing companies in the United States with regard to corporate social responsibility and how their financial performance fared as a result. Of the three areas of concern that ESG represented, the environmental and social had received most of the public and media attention, not least because of the growing fears concerning climate change. Moskowitz brought the spotlight onto the corporate governance aspect of responsible investment. His analysis concerned how the companies were managed, what the stockholder relationships were and how the employees were treated. He argued that improving corporate governance procedures did not damage financial performance; on the contrary it maximized productivity, ensured corporate efficiency and led to the sourcing and utilizing of superior management talents. In the early 2000s, the success of Moskowitz's list and its impact on companies' ease of recruitment and brand reputation began to challenge the historical assumptions regarding the financial effect of ESG factors.[11] In 2011, Alex Edmans, a finance professor at Wharton, published a paper in the Journal of Financial Economics showing that the 100 Best Companies to Work For outperformed their peers in terms of stock returns by 2–3% a year over 1984–2009, and delivered earnings that systematically exceeded analyst expectations.[12]

In 2005, the United Nations Environment Programme Finance Initiative commissioned a report from the international law firm Freshfields Bruckhaus Deringer on the interpretation of the law with respect to investors and ESG issues. The Freshfields report concluded that not only was it permissible for investment companies to integrate ESG issues into investment analysis, but it was also arguably part of their fiduciary duty to do so.[13][14] In 2014, the Law Commission (England and Wales) confirmed that there was no bar on pension trustees and others from taking account of ESG factors when making investment decisions.[15]

https://en.wikipedia.org/wiki/United_Nations_Global_Compact

The UN Global Compact was announced by then UN Secretary-General Kofi Annan in an address to the World Economic Forum on 31 January 1999,[5] and was officially launched at UN Headquarters in New York City on 26 July 2000. The Global Compact Office works on the basis of a mandate set out by the UN General Assembly as an organization that "promotes responsible business practices and UN values among the global business community and the UN System."[6] The UN Global Compact is a founding member of the United Nations Sustainable Stock Exchanges (SSE) initiative along with the Principles for Responsible Investment (PRI), the United Nations Environment Programme Finance Initiative (UNEP-FI), and the United Nations Conference on Trade and Development (UNCTAD).

And there it is, World Economic Forum

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