19 May 2022

Financial and ESG performance - benefits of worlds colliding

In the past business owners segmented financial and accounting reporting to shareholders from telling anyone else interested about ESG 'performance'. Not any more, finds David Walker

It was once the case companies separated their financial and non-financial performance, and the associated reporting. Accounts went to shareholders. The then-nascent practice of environmental, social and governance (ESG) disclosures went to anyone else interested.

Not at any more, speakers said at the recent RIMS/WTW Asia Pacific Risk conference. They emphasized linkages between the two worlds, and various dangers of not reporting to stakeholders on ESG credentials.

Kevin Bates, group head of risk and insurance at LendLease, acknowledged "ESG disclosure on its own will not drive financial performance", but adds that "sustainability initiatives appear to drive better financial performance".

ESG issues, which may be non-financial by nature, could have "a substantial financial impact" on a firm's overall performance, Bates added.

The way a company treats people and addresses issues such as diversity and health and safety will impact profitability though positive moral and lower absenteeism, he offered as an example.

"ESG was considered for the longest time as a lower [priority] whereas now regulators are taking note, things are changing."

Marisa Trasatti, general counsel at US medical device manufacturer Sciton, concurred, saying ESG was "becoming ever more important to shareholders and investors, and foremost on the minds of all stakeholders."

Why investors like hearing about ESG

Having strong policies and programmes for ESG issues makes for stronger long-term financial positions, according to Hugh Andrew, managing director responsible for the asset management, leasing and marketing, and property management of Asia property fund portfolios at global investor BlackRock. He attributed this, in part, to analysts and the market ascribing higher equity valuations to companies that 'score' better on ESG precepts, because scoring well can equate to a lower risk of owning their shares.

"Not every analyst will have the high moral compass the community will have, and they will weight the value of certain things the company does - whether E,S or G, or sales and marketing, or financial management," Andrew said, "but we are seeing a much better promotion and higher weighting of ESG."

By issuing a $500m green bond in 2018, Swire Properties could diversify its institutional investor base, and senior sustainability manager Patrick Ho says interest payable on subsequently-issued sustainability-linked loans has fallen as the global real estate manager/developer hit annual ESG targets pre-agreed with its ESG-focused lenders as triggers for lowering interest.

"We see a lot of great responses in how investors are seeing our performance. A lot of ESG-focused investors are interested in buying our stock. It's becoming more of a market differentiator when we promote our buildings to the market, and tenants are picking up on a lot of ESG considerations when they lease offices or rent space for retail shops," he says.

Making properties more environmentally-friendly, and telling clients this through BREEAM validation, allows Swire to capture "fast-growing demand" in APAC from prospective tenants with climate-related goals of their own to meet, Ho explained. "There is generally a 10% premium for rental, comparing BREEAM-certified against non-certified buildings in a lot of first-tier cities in APAC countries."

Rowan Douglas, head, climate and resilience hub at WTW, said companies increasingly see "the new competitive landscape", including ESG performance and telling the outside world about it, as being "about opportunity as much as managing risk".

The limits of ESG benefits

But there are limits as to how far ESG credentials can aid a company's passage through the commercial world - BlackRock's Andrew says he is "yet to meet an investor prepared to give up yield...because they want us to be greener. Maybe the day will come when every investor will want every asset class to be sustainable, but I think that's a little way off."

And he found underwriters not budging on portfolio insurance premiums recently, despite him explaining the ESG aspects that imbued the asset manager's approach to investing in property.

Munich Re's Kevin Leong, head of facultative & corporate - property Asia, said scoring high on ESG "may affect how you are accepted by an NGO or a capital provider, but less so on the insurance side".

But insurers that themselves fall short on ESG measures – or reporting on them - may themselves be unknowingly missing business.

Deyna Feng, director of the captive programs at Cummins Insurance, said stockmarket investors have ESG as "one thing they want to take into account [when investing] and to know if companies have good ESG scores - and if they do not they are seriously think if it's worth a long-term investment, [and] it is the same thing when it comes to re/insurance. A lot of insurers include [ESG] in their annual reports to show they are 'ESG companies' and to help us make a decision to say 'they are a good partner for us and our long-term development'. If they have not done anything in relation to ESG, we may think about it."

Board responsibility

As knowing about and reporting by non-financial precepts gains in importance across corporate sectors, Andrew says ESG should be made "a responsibility for all boards because it touches every part of everything we do. You may have every member of the board having a certain amount of knowledge [about ESG] and debating it at board level, or you add it to existing committees' roles, such as risk."

LendLease's Bates stated: "There is a level of dynamism around and if you do not adapt you are in a lot of trouble. It is required of risk professionals to make adjustments in their risk management strategies," across all three lines of a firm's risk management defences.

Senior executives who do not acknowledge the importance of non-financial facets of operating may well have it forced upon them.

Su-Yen Wong, chairman at the Singapore Institute of Directors, described the recent threat made by Dutch institutional investors to vote against executive pay plans of some US fossil fuel firms un-aligned to the Paris Agreement, as "just the tip of the iceberg. If you look at the principle of 'following the money', the institutional investment world is starting to exert real influence through investment policy. Executive compensation will be used to try to shift [ESG] forward, whether boards want it or not."

Reporting on non-financial activities may also aid recruitment and retention of valuable staff, the Singapore Institute of Directors' Wong says.

"We have come a long way since Milton Friedman always focusing on shareholder value. In particular the employees' voice matters in an era where many companies are still grappling with how to find the right talent. The pandemic has also driven a shift in expectations in what people expect from life and work and their employers. Leaders of the future are unequivocally, absolutely committed to creating a better world and voting with their feet in terms of the kinds of organisations they want to work for. The people dimension is critically important for companies to get right.

"Leaders in organizations need to be attuned to new rules, and forge new contracts. It's easy for leaders to say 'these Millennials are too soft', but we need to listen and think about how to forge a new contract, because the old contract – a job for life – is dead. It died a long time ago and we need to create a new contract based on new realities."