Sustainability, European style

US companies are facing pressure to step up sustainability reporting in line with companies in Europe and elsewhere as investors at home and abroad increasingly look for long-term value. This growing insistence on sustainability includes not only environmental impact but also issues like workers’ rights and governance, as the ESG designation replaces the more vague ‘socially responsible investment’ and new standards and reporting protocols gain traction.

The trend highlights the growing clash in investment cultures between the US and Europe. The former is characterized by the stock market’s fixation on quarterly earnings results and churning of stocks for optimal portfolio performance, while European companies tend to favor stable shareholders as partners and take a longer-term view of investment.

‘European companies are managing not for the next quarter, but for the next generation,’ says Maureen Kline, who heads up North American sustainability reporting for Italian tire maker Pirelli.

In Germany, for instance, companies have maintained large blocks of family ownership of shares even as names like Henkel, BMW and Fresenius have become world leaders with global operations.

‘These families show their presence quite clearly,’ says Rüdiger von Rosen, long-time head of the German shareholder group Deutsches Aktieninstitut.

‘They are more oriented to sustainability – it is a topic that is much discussed in Germany.’

But interest in the long term isn’t limited to German shareholders. Many of the DAX 30 companies are more than 50 percent owned by non-German shareholders, von Rosen notes, and the German stock market group, Deutsche Börse, is itself 85 percent owned by international investors.

It’s a matter of investment style rather than geographic location, says Mike Wallace, managing director at BrownFlynn, a consulting firm that specializes in sustainability and CSR reporting. ‘Public pension funds, sovereign wealth funds and retirement plans are all focused on long-term value,’ he notes.

The inaugural issue of Global Public Investor, a new research publication from the London-based Official Monetary and Financial Institution Forum, published in June, includes a survey that finds public investors ranging from state pension funds to central banks account for an increasing portion of global investment. It also finds that these investors are doing more of their management in-house and that many, including even central banks, are putting more money into equities to improve returns.

One key indicator that shareholder awareness is greater than ever before is the extent of support for the UN-supported Principles for Responsible Investment (PRI), says Wallace, who notes there  more than 1,200 PRI signatories representing more than $34 trillion in investment capital.

Big hitters

Even more significant than the number of those subscribing to these principles is their stature, Wallace notes. Signatories include the biggest names in investment management – BlackRock, Fidelity, CalPERS, Vanguard, Janus Capital, Pax, T Rowe Price, TIAA-CREF – as well as global investment banks like JPMorgan, Goldman Sachs, HSBC and Morgan Stanley.

The six PRI principles emphasize the importance of ESG issues in investment analysis and decision-making processes, ownership policies and practices. Most tellingly for corporate reporting practices, they insist on appropriate disclosure on ESG issues.

Other investor coalitions and networks include the Carbon Disclosure Project, which acts on behalf of 550 institutional investors representing $71 trillion in investment capital, as well as the Investor Network on Climate Risk and the Institutional Investors Group on Climate Change, each of which represents additional trillions of dollars in investment funds. Sustainability, in short, has gone mainstream as one of the key investment criteria.

‘At least they see the need to sign on,’ says Adam Kanzer at Domini Social Investments, an asset management firm that specializes in ESG investing. ‘It may take some time before that becomes really meaningful, but that’s where it starts.’

He adds that PRI signatories also commit to a public assessment process, with reports on implementation of the principles posted on the PRI site.

Kline says Pirelli was an early advocate of SRI reporting and in the initial stages had two investor relations teams: one to make presentations to investors with an SRI focus, the other for mainstream investors. Over time, however, this distinction faded. ‘Interest started to catch on among mainstream investors’ and has expanded over the last 10 to 15 years, she explains.

‘The investor relations department is very strategic,’ Kline says. ‘The firm really wanted to attract more stable, long-term shareholders’, and focusing on sustainability has helped achieve that. Now, more than 40 percent of Pirelli shares are held by institutions oriented toward sustainability and superior governance practices.

German companies’ willingness to address ESG concerns has also facilitated their global expansion, says von Rosen. ‘Companies have become more and more responsible, more sensitive to these issues’, and are willing to play a role in public discussions regarding environmental and working conditions.

Getting involved

It’s a theme that permeates not only Germany’s giant multinationals, but also the broad swath of small to medium-sized companies – largely family-owned – that have extensive international operations. That stands in stark contrast to most US firms, which remain preoccupied with the game of beating market earnings expectations, adds von Rosen.

But there are signs that US firms’ thinking is changing as they get more questions about integrated reporting from their board’s audit committee, says Robyn Bew, research director for the National Association of Corporate Directors (NACD). ‘It is driven in part by investor expectations,’ she notes. ‘Investors are actively using all sorts of non-financial information for buy-sell decisions.’

NACD is speaking with boards about a more holistic, inclusive definition of strategy that takes into account efficient use of resources, climate change, supply chains, urbanization and other issues relevant to sustainability reporting. Last October the group published a directors’ handbook titled Oversight of corporate sustainability activities, which emphasizes that sustainability oversight is increasingly part of the board’s responsibilities.

Indeed, sustainability initiatives can be a path to greater profitability. Kline cites Pirelli’s line of premium-priced, ‘green performance’ tires, part of the company’s goal to design products that are more environmentally friendly as well as high-performance. The company aims to have 48 percent of the tires it makes meet such specifications by 2017.

This new awareness comes in part from deeper engagement with long-term shareholders, the same ones seeking long-term value from sustainability best practices. Such practices not only burnish a firm’s reputation but can also help reduce costs by mitigating some kinds of risk, especially those related to potential human rights violations, Kline says.

Safeguarding a company’s reputation through good corporate governance and careful monitoring of environmental and social impacts is an ongoing focus of senior management across Europe, says von Rosen. Even so, European boards may be more responsive to sustainability concerns because they’re less likely to include executive directors.

At Pirelli, the board of directors approves the company’s industrial plan, which fully integrates sustainability targets through 2020 with business strategies laid out to reach them, Kline says. The board also approves the annual sustainability report. Sustainability is a focal point for the board’s audit, risk, sustainability and governance committee, which is made up solely of independent directors.

How committed boards are to sustainability is a murkier question in the US, where ‘it’s never very clear what level of engagement the board has on the issues we raise,’ says Kanzer.

As a relatively small fund, Domini’s meetings with representatives of its portfolio companies are often limited to the director of investor relations or the corporate secretary and rarely, if ever, include members of the C-suite or the board. ‘It’s a resource question,’ Kanzer acknowledges. ‘Directors don’t have time to meet with every investor.’

More important for him is whether the company takes action on the concerns he raises. It is often more effective when the investor relations director or corporate secretary puts him in touch with those actually managing the issues.

When companies are not responsive, Domini will file a shareholder proposal. Boards will urge a vote against such proposals 99 percent of the time, but that can be just part of the ‘dance’ a company does to avoid a vote even when it’s willing to help resolve the issue, says Kanzer.

US companies are facing an increase in this tactic. Wallace notes that many of the shareholder proposals tracked by Proxy Monitor involve sustainability issues. These have been submitted by shareholders as diverse as the environmental activist group As You Sow, SRI firms such as Green Century Capital Management, the New York State pension funds and faith-based investors such as the Sisters of St Dominic. The Interfaith Center on Corporate Responsibility numbers nearly 300 active members, including major religious orders and church networks. It filed nearly 200 shareholder resolutions during the 2014 proxy season and withdrew about 60 after reaching ‘significant agreements’ with targeted companies.

New rules

It was pressure from the New York City comptroller’s office (which represents $160 billion in city workers’ pension funds) about conflict minerals that nudged Intel into being more transparent about its own operations as well as its suppliers’ practices, Wallace notes. Intel has since become an industry leader on the issue. (In November the city comptroller’s office filed proposals at 75 companies simultaneously, covering environmental, proxy access and executive pay issues.)

While companies like Intel that have increased their transparency on sustainability issues are eager to tout their efforts in this regard, they are reluctant to acknowledge that they were motivated at least in part by investor pressure, says Wallace.

But the globalization of both business and the financial markets means US companies are getting caught up in a trend they can hardly fight. ‘You’re seeing data from companies in Europe, Brazil, South Africa,’ says Wallace, as these global competitors increase their focus on ESG issues.

The Corporate Sustainability Index created by the Brazilian Stock Exchange a decade ago has encouraged wide use of sustainability reporting among its listed companies. In April 2014 the European Union adopted a directive for the disclosure of non-financial information (for which read ESG) that affects an estimated 6,000 companies designated as public interest entities with more than 500 employees each.

The last thing US companies want to see is more regulation on this score, which is why firms like United Technologies, Honeywell and Ingersoll Rand are trying to stay ahead of regulators by conducting dialogues with the government on issues such as the reduction of carbon emissions through energy-efficient practices.

‘It is hard for large-cap companies to ignore issues like climate change, workers’ rights in supply chains or political contributions,’ says Kanzer.

But rather than regulators, it is shareholders and customers who are driving the trend to greater disclosure on ESG issues. Like it or not, US companies need to pay heed.