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ESG: threats and opportunities for investors and the companies they invest in

by Nigel Kendall
Image of saplings covered with American banknotes, representing investing in ESG (Environmental, Social and Corporate Governance)

What is the likely impact on governance and corporate behaviour?

Recently, MSCI ran one of its global events in London, titled Global ESG and Climate Risks, though the speakers covered much more than climate issues. To me, there were some very strong messages coming across, which would have been taken to heart by the investment managers and analysts attending.

Two years ago, we published an article arguing that ESG was now becoming mainstream, having been accepted by the huge passive investing institutions. So, their acceptance that good ESG performance produced superior performance was likely to become self-reinforcing, and hence self-fulfilling, in terms of company valuation. And this was what companies ought to be taking seriously now.

What has happened in the last couple of years in the way ESG is coming to be regarded, and how is this likely to affect the attitudes of investors and hence the increased incorporation of ESG principles into boardroom policies?

Current research by MSCI

The research presented by the MSCI speakers covered, broadly: the problems created by the proliferation of indestructible plastic waste, the need for much increased innovation in the field of antibiotics to address the dangers of growing antibiotic resistance, difficulties in recruitment of vital skills due to poor treatment of employees, benefits and disadvantages of different levels of ownership control, and the potentially catastrophic impact of climate change on certain real estate values.

Taking these in turn:

Plastic waste

The essence of the arguments presented by the speaker from Japan, a country which is one of the biggest users of plastic packaging, was that a combination of declining demand for non-bio-degradable plastics, regulatory pressure to withdraw such materials, and push-back from appalled customers and others, would collectively become a very serious threat to the producers of these plastics.

Of the US companies exposed to risk as a result of the focus on plastic packaging, those particularly vulnerable were the ones in the fields of diversified chemicals and commodity chemicals.

Conversely, those companies with existing bio-degradable products, or with such products in development, and also companies providing recycling, would all have a future, and possibly a promising one.

The fact that the results of global research by organisations like MSCI is becoming widely known by investing institutions means that companies in these sectors are effectively being named and shamed. MSCI will be looking for evidence that companies at risk have acknowledged their failings in this key environmental area and that their governance policies reflect the vital need to innovate to replace the environmentally unfriendly products.


Here, as most people know, due to the increasing global and indiscriminate use of antibiotics, particularly in farmed animals and in the developing world, there is growing bacterial resistance to the currently available medical solutions to bacterial infection.

Unfortunately, due to the poor financial returns for research into antibiotics, compared with those in the more popular fields, such as cancer, there has been comparatively little new product development in this sector for many years. The resulting market failure has led to a dangerously limited number of new drugs coming through the pipeline.

The threats to the global human population are clear, but the dangers are also present for companies, particularly in the packaged food and agricultural products sectors, which will be under increasing government scrutiny by regulators.

The opportunities are there for the few big pharma companies which are bringing forward promising new drugs in this field, albeit only one company studied has indicated a probability of more than 50% for the success of its new product. But the threats are there for the packaged food companies. Is their policy-planning taking this into full account, and does their perceived corporate behaviour and governance give the public authorities confidence not to intervene, with potentially dire effects on their business models?

Employee working conditions

The speaker from China described how China’s transition from an economy based on manufacturing, mining, construction and farming to one increasingly driven by financial services, technology and health and social services, required different skills.

However, the tradition was still one of what she described as 9:9:6, translating as 9.00am to 9.00pm, 6 days per week, or even 10:10:6, hence involving excessive overtime. These intensive working conditions were coming to be regarded by an increasingly educated younger generation, with exposure to the world outside China, as unacceptable. This was coupled with internet-based communication leading to company reputations regarding employment conditions becoming widely known, and the result was that highly skilled people were avoiding such companies, or even emigrating to more congenial countries.

Hence, poor employment practices were depriving companies of the skilled workers necessary for their competitive development, and employee engagement was seen to lag that of their western peers.

Although this analysis was of the Chinese economy, there are parallels in the developed world, as evidenced by the success of Glassdoor, where employees can enhance or damage the reputation of their former employers, by posting their experiences.

Ownership control

There has been increasing debate in recent years about the benefits and disadvantages of different forms and levels of control of listed companies. Most recently, the failure of the WeWork planned IPO led directly to the diminution of the voting rights of the founder, Adam Neuman, and his removal as CEO.

The arguments in favour of preferential rights to founding members are in support of the supposed long-term perspective of a founder, compared with the perceived short-term focus of most investing institutions. The counter-argument highlights the difficulty of removing a founder figure who has become a threat to the company’s progress, and additional issues to do with the suppression of minority rights.

The MSCI research in this area of governance described its classification as:

  • Largest owners:
    • Controlling: largest shareholder group holds 30% or more of voting rights
    • Principal: largest shareholder group holds 10 – 30% of voting rights
    • Widely held: no shareholder holds more than 10% of voting rights
  • Key owner types:
    • Founder: founder plays an active role and is a shareholder
    • Family: family holds 10% or more of votes and has a board seat
    • State: state directly or indirectly holds 10% or more of votes
    • Corporate parent: issuer is a subsidiary (30% or more) of a parent which itself may be listed

MSCI’s analysis showed which countries made most use of control-enhancing mechanisms, and, perhaps most interestingly, presented a chart for China illustrating how certain companies with significant enhanced voting control were also those with significant skill shortages.

It would seem that this kind of analysis of governance structures will increasingly be deployed to judge the susceptibility of listed companies to policy mistakes, and influence investment decisions accordingly.

Climate change strategy

Perhaps one of the most thought-provoking parts of the MSCI meeting was that devoted to climate change and its potential impact on real estate. The questions posed by the speaker were: what is climate risk, and how to assess it?

In response, MSCI’s presenter described the detailed research they had carried out in various parts of the world to assess what were the major challenges to property in those locations, measured even down to the equivalent of postal code, and to what extent were measures being taken to protect against the dangers. To this end, they assessed the potential for storm and flood damage at one extreme and drought and water shortage at the other. Some situations were well protected for the foreseeable future, like rising sea levels in London with its Thames Barrier and Netherlands with its extensive coastal defences. Others were substantially unprotected, like South Africa and Australia against drought and water shortage.

The research endeavoured to assess the forward-looking probability of extreme events, the locations likely to be affected, and the financial impact of the resulting damage. The key point here, is the term “forward-looking”, as opposed to the use of historical data. And the key implication is for the influence on future insurance costs for those in the areas likely to be affected. These risks are not perceived as being priced into current insurance contracts.

So, what we take from this work, is that whether company boards are comprised of climate change believers or deniers, the way their insurers will look on their companies in future will be dictated by research coming out of bodies like MSCI. And beyond the insurers, the same research will influence current and potential investors and financial backers of those companies.

By extension, companies working in those industries seen as contributing to global warming, such as coal mining, oil and gas, and transportation, will be increasingly avoided by environment-conscious investors. Indeed, that was the message from a representative of one big institutional investor, describing the way his company was modifying its investment priorities.

So boards charged with assessing and disclosing value at risk need to wake up to the implications of the changing climate on their businesses. They need to recognise that their governance processes and resulting corporate behaviour may have to be modified because the insurance industry is now getting information which may change their lives. And the banks which finance their activities won’t be far behind, as they assess the potential threats to the real estate on which their lending is secured.

Implications of ESG for corporate governance and behaviour

Most of the speakers drew a link between the Environmental and Social dangers by which global companies were threatened, either as offenders or victims, and the actions which they were perceived to be taking, through refraining from harmful activities, or innovating to find solutions. Hence they found themselves looking at the Governance and corporate behaviour of the affected companies, since sustainability in the face of the various threats identified, and hence investability, would depend on their governance.

Some large private companies, like Ikea, currently publicising its focus on environmental considerations, and Mars, with its historical purpose statement talking about a mutuality of benefit for consumers, staff, suppliers etc, are able to plan for the long-term sustainability of their businesses. They can ignore the short-term results pressures to which publicly listed companies have to respond.

But the research by organisations like MSCI, and the emergence of new global standards of reporting promoted by bodies like the Task Force on Climate-related Financial Disclosures, chaired by Michael Bloomberg, will force all companies to move beyond a single-minded focus on shareholder value.

Regardless of contrary views, insurers anticipating future claims, banks looking at the security of their portfolio of loans, and investors reading the analysis, will make it happen.

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