ANALYSIS: From Acronym to Concept, Investors Connect ESG Pillars

Investors have begun to shift away from approaching the term “ESG” as distinct environmental, social, and governance issues affecting a company’s financial performance. Instead, investors are increasingly conscious of whether the companies they’re investing in embody their overall values—and those values can often cut across ESG pillars.

Companies that have implemented environmental policies to address climate change, for example, may have once satisfied the value appraisals of investors seeking to make climate-conscious investments. But now investors are looking for companies to address the human displacement resulting from extreme weather as part of that same risk equation.

This development is likely to render the current political debate and regulatory action surrounding the term ESG less relevant in the coming years. Public officials and regulators alike have claimed that the term ESG is charged with underlying meanings related to political agendas or promises of certain sustainability commitments. But the current understanding of ESG as distinct environmental, social, and governance issues that may affect a company’s financial performance isn’t a view that all investors share.

And in the coming months and years, investors are going to push companies to implement more cross-pillar policies—likely bringing companies and regulators to their side of the table.

Activists Are Connecting the ESG Pillars

When investors are dissatisfied with the actions a company is taking, the company runs the risk of an activist taking a stake in the company in order to enact change. Investor activism campaigns often focus on achieving governance objectives—such as board representation or control—that would allow the activist to install a representative who can advocate for initiatives that align with the activists values.

In 2020, investor activism campaigns with objectives from at least two ESG pillars saw an uptick from 2019 counts, according to Bloomberg data. These campaigns saw another increase in numbers last year and, while 2022 data is still preliminary, this year’s totals are likely to at least meet 2021 levels by year-end.

All investor activism campaigns that cut across ESG issues since 2017 have included a governance objective, meaning that investors are consistently looking to make governance changes at companies in which they have a financial interest.

But when investor activists couple a governance objective with a social or environmental objective, they’re attempting to enact company policies that align with their values and that ensure that the company has a governance structure to support this agenda.

Companies seem to have picked up on this investor interest and have begun including potential board members bios with relevant environmental and social positions in their definitive proxy statements—which is likely to continue in the coming years.

Litigation Risks Cut Across Pillars

It’s not surprising that investors have employed a cross-pillar approach to activist campaigns because legal risk already cuts across the ESG pillars. Many ESG-related complaints include terminology belonging to at least two of the environmental, social, and governance categories. And shareholders have filed almost 70 complaints that touch on ESG issues from multiple pillars since 2020.

In an effort to reduce legal risk, companies may start implementing crossover ESG policies and programs. For example, litigation related to an oil spill may include terminology relating to the breach of environmental laws and human health implications in the area. Companies in industries that have heavy environmental risks—like energy—are likely to start building community support into their risk management policies and programs as a means of addressing investor interest.

Integrating an Interconnected ESG

As the US begins its regulatory journey into the ESG space, investors are likely to use mandated climate-related disclosure information to push for changes that traditionally have fallen within the social and governance categories.

If investors determine that a company’s management isn’t prioritizing the disclosures of accurate climate-related information in its 10-K, for example, investors may vote for a board candidate who will prioritize investor access to climate information.

And as ESG regulation continues, investors are likely to continue treating ESG as a whole, rather than its parts—regardless of the political and regulatory discourse surrounding the use of the name.

Access additional analyses from our Bloomberg Law 2023 series here, covering trends in Litigation, Transactional, ESG & Employment, Technology, and the Future of the Legal Industry.

Bloomberg Law subscribers can find related content on our ESG Practice page, as well as our Practical Guidance: ESG Risk Management page.

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