Investors' resolve to forge ahead with ESG goals deepens for 2023

Russia's invasion of Ukraine and anti-ESG sentiment in the U.S. taught institutional investors to expect the unexpected in 2022, but those developments also deepened their resolve to forge ahead with sustainable investing goals — no matter what happens in the upcoming year.

In 2023, institutions' ESG goals will include more specific expectations placed on companies to address climate risk, labor and human rights issues including diversity, and biodiversity, investors said. Many of them also plan to make a more direct connection between executive compensation and how those ESG expectations are met.

Working toward those goals will bring more robust engagement with the companies they invest in, more collective action by investors, and a push for standardized ESG metrics to track progress in 2023, the investors noted.

It will also put more scrutiny on asset managers, as asset owners grow more discerning, said Chavon Sutton, senior investment director, sustainable and impact investing at Cambridge Associates in New York. With a growing appetite for ESG and sustainable and impact strategies, "our clients are increasingly seeking managers who are intentional about these themes, and who are fully and thoughtfully integrating ESG and (diversity, equity and inclusion) at their firms, and in their investment policies and processes," Ms. Sutton said.

Asset owners and managers should have backup in 2023 from the International Sustainability Standards Board, which is pushing to issue much-anticipated standards early this year. The standards would integrate sustainability disclosures with core financial statements. The standards will also clarify the connection between how a company incorporates sustainability and how it creates value for shareholders, ISSB said in December.

The standards will also apply to publicly held asset management firms and could give asset owners a clearer picture of their asset managers' ESG achievements. Although voluntary, ISSB's global reach should help promote adoption and could spread, at asset owners' insistence, to private firms, proponents say.

Climate risk and how companies manage that risk continue to top investors' ESG priorities. And lessons learned from investor engagement initiatives like Climate Action 100+ are inspiring similar efforts by investors to address biodiversity and social issues collectively.

Climate Action 100+ focuses on companies that collectively account for the majority of global corporate industrial greenhouse gas emissions. While the 700 investors with a collective $68 trillion in assets under management in Climate Action 100+ are far from declaring mission accomplished, their latest report found that 75% of 159 focus companies have committed to achieve net-zero emissions by 2050 or sooner across all or some of their emissions footprint, a marked improvement from the five companies committing when the initiative launched in late 2017.

A similar approach to tackling the financial impact of nature loss and biodiversity decline, the global investor initiative Nature Action 100, will launch in spring 2023. Its institutional investment members will focus on companies in key sectors considered systemically important for reversing nature and biodiversity loss with the even more aggressive time frame of 2030 for corporate progress. The initiative will target investor engagement strategies and track companies' progress against key indicators.

While negotiations at December's U.N. Convention on Biological Diversity, or COP15, were less than conclusive, institutional investors pledged to keep pushing for adoption of the biodiversity equivalent of the 2015 Paris Agreement that set the framework for addressing climate change and measuring progress.

Biodiversity "is a growing area of interest for our clients as well as for our investment teams. I expect it to be a continuing theme in 2023 and beyond," said Erin Bigley, chief responsibility officer for AllianceBernstein LP in New York, with $658 billion under management.

Also gearing up in 2023 is the Advance initiative from the United Nations-supported Principles for Responsible Investment, which describes itself as the largest collaborative stewardship initiative on social issues and human rights. Of the more than 220 investors with a collective $30 trillion in assets involved, 120 have pledged to take active roles leading or supporting engagement with 40 initial focus companies in the metals, mining and renewables sectors on social issues and human rights that impact global prosperity and investment returns.

Engagement on issues like social and human rights will be the preferred approach, except for behemoths like Norges Bank Investment Management, which runs the assets of the 12.72 trillion Norwegian kroner ($1.28 trillion) Government Pension Fund Global, Oslo.

The NBIM board decided in December to exclude two firms and a subsidiary due to "unacceptable risk" of human rights' violations.

"You are going to have a lot of investors talking to many, many companies," said Robert Fernandez, director of ESG research at Breckinridge Capital Advisors in Boston, with $41 billion under management.

Kris Nelson, head of ESG Investment Management at Russell Investments in Seattle, was surprised to find in the firm's recent ESG manager survey that only 25% of asset managers track engagement activity, but she expects to see more asset managers doing it.

"The hope is that we can make it quantifiable," Ms. Nelson said.

Engagement may no longer work when it comes to what some shareholders consider excessive executive pay.

The was one conclusion from a global shareholder summit on the subject convened by the £3.2 billion ($3.9 billion) Church of England Pensions Board, London, in December that included speakers from NBIM, the $307.2 billion California State Teachers' Retirement System, West Sacramento; Australian Council of Superannuation Investors; and the £25 billion National Employment Savings Trust, London.

"I think investors know the current system not only enables but protects excess and there is a pretense of accountability," said Adam Matthews, chief responsible investment officer at the Church of England Pensions Board.

"With many workers facing a cost-of-living crisis, it is time to hold chairs of remuneration committees accountable," he said.

The increased engagement activity on ESG issues should become evident at annual shareholder meetings this year.

"Despite some pushback on ESG-focused investing and strategies in the U.S. market, we expect 2023 governance trends to continue to revolve around ESG issues," said Brian Bueno, ESG leader for Farient Advisors LLC in New York, an executive compensation and corporate governance consulting firm that helps companies, large public pension funds and mutual funds review proxies and prepare votes.

"Environmental and social issues and the risks companies face in not addressing them aren't going away," Mr. Bueno said.

"To address and make progress on their ESG strategies, U.S. and global companies are increasingly tying their executive incentives to ESG measures and goals," particularly when it comes to climate-related measures, said Mr. Bueno. One reason is because "large investors have been formulating policies around the use of ESG incentive metrics in compensation plans."

In a 2023 global trends report, Farient found that more than 75% of large companies now incorporate stakeholder ESG measures into their incentive plans. Social measures like workforce diversity targets remained the most prevalent, growing to 72% of companies from 67% in 2021, while environmental measures grew the fastest, to 50% of companies up from 30% using environmental measures one year later.

More regulations around ESG, like corporate climate disclosure rules from the U.S. Securities and Exchange Commission and anti-greenwashing measures from European regulators, are also expected next year.

So is continued politicization of ESG investing in the U.S., although "it does a huge disservice to our clients and the industry," said Ms. Nelson of Russell Investments.

While the controversy "has muddied the waters, asset managers are more vocal that ESG is not political. ESG is about risks and opportunities. The underlying message is it is still financially material," she said.

For companies, the controversy may not change much either, said Mr. Fernandez of Breckinridge Capital Advisors.

"So many companies we talk to are already well on their way to integrating sustainability into their processes. It just feels like there is so much momentum there," he said.

As the political push and pull continues, "it's a time of reckoning" for ESG investors, said Nikita Singhal, managing director and co-head of sustainable investment and ESG at Lazard Asset Management in New York, with $221 billion under management. "In 2023, I think there will be that continued recognition and attempts to clarify what ESG is and what it is not," she said.

"Most values of companies are hidden in intangible assets. Environmental and social issues are increasingly part of long-term businesses," Ms. Singhal said. "For long-term investors the point is, this is where the world is headed."