Putting the S in ESG

'I don’t know who put ESG together, but it makes no sense,’ says Mikkel Skougaard, group sustainable development senior expert – and former IRO – at Hungarian energy giant MOL. ‘Yes, it’s all non-financial data, but looking from a risk point of view, E, S and G cover completely different risks that have nothing to do with each other. E is an externality risk, S is a reputational risk and G is an agency risk.

‘Also, E and S are very much sector-specific, whereas G is sector-neutral or agnostic, in the sense that a financial firm does not need better governance than an automotive firm. So grouping ESG together is often rather unhelpful, or at least does not facilitate analysis.’

This lumping together of environmental, social and governance issues also makes it harder to paint an accurate picture of where investor focus lies. ESG accounted for $22.89 trillion, or 26 percent, of professionally managed assets in Asia, Australia, New Zealand, Canada, Europe and the US at the end of 2016, according to McKinsey – up from 21.5 percent in 2012 – and it’s clear the big names are increasingly seeking to align their money with their values and ensure long-term, sustainable growth. But while many companies have made great strides in environmental and governance reporting, the social element of ESG has largely been left behind.

This is something the researchers at the NYU Stern Center for Business and Human Rights highlight in their analysis 12 leading ESG frameworks, published in March 2017. Report authors Casey O’Connor and Sarah Lebowitz write: ‘Investors should be able to rely on the ESG industry to provide data that helps them identify strong performers and assess risk. When it comes to evaluating companies on their toxic waste emissions (E) or vulnerability to fraud and corruption (G), investors now have tools to assist them. But the ESG industry is still falling short of this objective when it comes to S.’

And it seems that investors agree – with some of them starting to raise their voice about the need for improved reporting on social issues.

A QUALITATIVE ISSUE
There are a number of reasons why the S element has fallen behind. It covers an array of issues, from health and safety to human capital and more, and in some areas, social issues do cross over into environmental, mixing up the numbers. But it also comes down to the fact that social issues have to be assessed qualitatively rather than quantitatively, says Lara Blecher, former engagement services executive at Pensions & Investment Research Consultants (Pirc), which advises institutional investors with assets in excess of £1.5 trillion ($2.1 trillion). ‘Investors like numbers,’ she explains, ‘so it can be hard for them to understand how to use more qualitative assessment measures.’

Highlighting just how difficult it can be to assess social issues, Blecher – who now works for the Principles for Responsible Investment – uses the example of a firm with low trade union membership. ‘It could be that people feel comfortable enough approaching their employers so they don’t feel the need to join a trade union,’ she says. ‘But on the flip side, maybe they’re too scared to do so or have been intimidated into not joining. Unless you have a good qualitative grasp of the issues, you don’t have a great sense of what’s going on within that metric.’

Blecher says that, overall, ‘there’s just very little social reporting’. She even describes the two companies she mentions as doing a better job than most in this area – Unilever and UK utility SSE – as ‘not reporting fantastically well on social’, though they ‘seem to have grasped better than other companies why it’s important and to be making an effort.’

Still, these two companies ‘may constitute examples that companies and investors can look to as stepping stones to move forward on this issue.’

THE VALUE OF PEOPLE
The reason Blecher cites SSE as an example is that the energy company is ahead of the trend on what’s set to be a big thing in social: human capital reporting. In 2015 SSE published a PwC-commissioned report into the value of its employees – calculated at £3.4 billion as at April 1, 2014. It reports, for example, that for every £1 SSE invests in apprentices, there is an economic return of £4.29 on that investment – rising to £7.65 for technical trainees.

And this is just the sort of thing CalSTRS wants to see more of. As part of the Human Capital Management Coalition – an organization comprising 25 investors with $2.8 trillion in assets – the large, vocal US pension fund petitioned the SEC in July to require issuers to disclose information about their human capital management policies, practices and performance.

One of the challenges of the S in ESG, says Anne Sheehan, who retired as director of corporate governance at CalSTRS last month, is that some people have a problem with the link to value creation – ‘issues such as human capital, supply chains, things that can turn into reputational problems if they’re not handled well,’ she says. ‘We want a little more granularity on how companies are managing that greatest of assets: human capital – how they handle recruitment, retention, how they value employees. This will give us a better flavor as to how companies are managing these issues and how they value their employees.’ 

And whether or not companies think they’re already offering that information through integrated reporting (something Blecher says has yet to truly materialize) or in their sustainability report, for example, CalSTRS and the Human Capital Coalition want it in the financials – because this information represents a risk or an asset for the company, explains Mary Morris, investment officer at the pension fund. 

POWER FROM THE PEOPLE 

Part of the reason for the big push is the fact that for CalSTRS, some of its biggest holdings are in the so-called Faang stocks: Facebook, Apple, Amazon, Netflix and Google – all companies where, regardless of whether or not they need mammoth servers or a global shipping network, what really counts is the people. And Sheehan and Morris both say securities law simply needs to catch up with the market, which has moved a long way away from bricks and mortar. 

In fact, much of what the coalition is asking for is information companies already collect – and even report on to meet Equal Employment Opportunity Commission (EEOC) requirements in the US. 

‘What investors are saying is, We know companies have this information and use it to manage and measure the value of their human capital. The information is more in-depth and robust than what’s required to meet EEOC requirements. So why not share it?’ says Morris. ‘Companies have the information and many of them probably have a good story to share, but they don’t do it. There isn’t much value unless it’s shared with investors and other stakeholders.’ 
 

MOVING FORWARD ON SOCIAL 
Part of the difficulty in getting individual companies to disclose on human capital, for example, is that they sometimes worry about personnel decisions or confidentiality, explains Sheehan. But that’s not what CalSTRS wants. It wants to see strategy and know the company understands the value in the social elements of its business. ‘As companies, as IROs, become more comfortable speaking to investors about this, I think we’ll start seeing better disclosure,’ says Morris. 

Even as increasing numbers of companies start to publish at least some social elements, the fact that the issues can be so broad – and the fact that they’re often grouped together with the E and the G – makes analysis difficult. Not to mention the fact that there’s no unified reporting system in place.

Then there are the timelines. The impact of social investments might take 25 years to manifest, points out Blecher. Companies need to find a way to ‘report on progress and impact in a way that allows investors to see a good trajectory for their investment purposes,’ she adds. Instead, she finds that ‘a big problem in reporting on social issues, but also generally, is that it’s very process-based: We’re doing X, Y and Zand you read it and think, OK great – so what? You really want to see what the impact is.’ In fact, the NYU Stern researchers find that of the more than 1,700 S indicators they examine in their analysis, only 8 percent actually evaluate the effects of company practices. 

Ultimately, however, Blecher says responsibility falls on both companies and investors. ‘We still get a lot of companies saying, Oh, this is really interesting because we just don’t get asked about it that much,’ she says. But if companies have managed to be complacent on the S in ESG because investors haven’t been shouting loudly enough, the trillions of dollars behind the demand for greater disclosure means that’s set to change.

Improving reporting

In their study 12 leading ESG frameworks in March 2017, Casey O’Connor and Sarah Lebowitz of the NYU Stern Center for Business and Human Rights find that despite the growing interest in ESG investing, reporting of the ‘S’ element has failed to keep up with reporting on environmental and governance issues. 

The report highlights four areas where companies – and the ESG industry – should focus in a bid to move social reporting forward: 

1. Measure your real-world effects, not just your efforts 

2. Diversify the data – the ESG industry should look beyond the information provided by companies, such as data from trade associations, for example 

3. Establish and rely upon clear standards for evaluating social impacts. O’Connor and Lebowitz suggest industry-specific frameworks 

4. Target investors as the primary audience. Companies and the ESG industry need to package their social data with investors in mind.

This article appeared in the spring 2018 issue of Corporate Secretary sister publication IR Magazine