If there is one topic that has gathered the most momentum in the investment world in recent years then it is that of ESG (environmental, social and governance) factors. ESG risks have increasingly been analysed alongside traditional financial risks as investors become ever more aware of their impact on outcomes for all businesses, as well as society and the planet, and therefore returns. ESG is fundamental to carrying out not just investment but responsible investment.
The immediate impact of COVID-19 may be necessarily diverting attention, but the ongoing pandemic is also serving as a reminder that ESG issues are indeed risks that investors need to manage. It could also perhaps prove to be a turning point and accelerate the trend of ESG becoming a routine part of investment decision making rather than a secondary consideration.
In the pre-COVID world, climate change concerns and the urgent need to transition to a low-carbon economy had unsurprisingly drawn much of the focus, and indeed many local authorities formally declared a climate emergency in 2019. The ‘S’ of ESG has tended to be relegated by the ‘E’, but social considerations are now receiving more thought and attention as a knock-on impact of the pandemic.
Responsible investment moves beyond simply assessing ESG risks. One of the key principles for asset owners is that of active ownership, forming part of a wider set of stewardship responsibilities, which focuses on using the position and rights of ownership to influence the behaviour and activities of investee companies. This most readily applies to listed equities, where investors, as partial owners of companies, can engage with company management on ESG and other matters (either individually or in collaboration with other investors) and use their shareholder voting rights to publicly express approval/disapproval on relevant issues.
One related and oft-quoted debate is the approach to fossil fuel investments. Should investors rightly concerned about climate change completely divest from shares in fossil fuel producers? Some universities have taken this approach and there are certainly campaign groups who think this should be the case for local authorities too (principally via their pension funds), particularly in light of the aforementioned climate emergency declarations. On the other hand, many institutional investors argue that divestment prevents engagement with an industry that will be a major part of the carbon transition over the coming decades. By remaining shareholders, investors can preserve their seat at the table and through dialogue and collaborative pressure influence change and demand tangible commitments and timelines from the energy industries. Investors will also then in a better position to monitor compliance with the agreed milestones and timetable for change.
Whichever side of that debate you fall on, research does suggest that engagement between investors and companies provides benefits for both parties, characterised across ‘communicative’, ‘learning’ and ‘political’ dynamics. Although measuring the financial impact is difficult, studies have found that companies experience improved profitability following successful engagement.
Local authority treasury departments are unlikely to be investing directly in equities and engaging with companies as described above themselves. However, any investments in pooled funds essentially represent an outsourcing of these practices to fund managers and so it is appropriate to ‘engage with the engagers’ and consider each managers’ approach to active investment, company engagement and ESG issues.
Engagement is but one area of a broad and ever-evolving subject. There are no easy answers or standardised approaches to ESG and ultimately each local authority will need to decide upon its own approach to responsible investment, with agreement from elected members. Arlingclose’s ‘ESG and Responsible Investment in Local Authority Treasury Management’ service provides an in-depth report designed to assist local authorities incorporate and monitor ESG factors in their treasury investment decisions. In addition to this report, the service includes a series of presentations with fund managers which will look at their engagement and other relevant ESG issues in more detail.