Revised Stewardship Code sharpens the focus on ESG factors

The UK Stewardship Code forms part of the FRC’s mission to promote transparency and integrity in business. The 2020 version of the Code was published by the FRC earlier this month. Under the Code, it is incumbent on asset owners and asset managers to disclose how they have prioritised ESG factors when assessing investments.

The introduction to the 2020 Code recognises that, in addition to governance, environmental and social factors have become material issues for investors to consider when making investment decisions and carrying out their stewardship role. The revised Code sets out 12 principles for asset owners and managers. Principle 7 requires asset owners and managers to explain in their Stewardship Reports, which will be public documents, either:

• how integration of stewardship and investment has differed for funds, asset classes and territories and the way they have ensured that tenders have included material ESG factors as part of a requirement to integrate stewardship and investment, or

• the processes used to integrate stewardship and investment, including material ESG issues, to align with the investment time horizons of clients and beneficiaries and to ensure service providers have received clear and actionable criteria to support integration of stewardship and investment, including ESG factors.

The Stewardship Code is not the only set of principles urging corporates and investors to concentrate on sustainability and ESG factors. The Sustainable Development Goals and Principles of Responsible Investment, published under the auspices of the UN, have a similar purpose. Corporates are under increasing pressure to incorporate ESG factors into their executive remuneration policy and practice. And there is evidence that corporates are taking positive action. Interestingly, however (and, perhaps, counter-intuitively) whilst many ESG factors are long term in nature, research indicates that those corporates which have included ESG metrics in their remuneration policies have done so in connection with their short-term incentives.

Whilst corporates have been required to address a range of Governance issues for some time, under various corporate governance codes, now they are paying closer attention to Environmental and Social factors. One of the difficulties is that ESG is likely to mean different things to different companies. For example, research indicates that oil & gas companies place greater emphasis on employment conditions, safety and physical damage to the environment, whilst financial services companies are more likely to be concerned about customer service.

Larger companies have established ESG/Sustainability teams or departments and committees. One of the first questions to consider is: what does ESG mean for us? Other important initial questions are: what are we going to do about it? and who is accountable? For a multi-national company, what it is going to do about ESG may well differ for each of the territories in which it operates.

Not all companies will have the resources to establish a department dedicated to ESG. However, there can be a positive financial advantage for corporates that have developed a coherent ESG policy, as increasingly lenders offer finer rates to corporates with a clear ESG policy.

To comply with the Stewardship Code, asset owners and managers must ask themselves and address questions similar to those asked of the Boards of the corporates in which they invest. In addition, they must understand the action corporates have taken (or intend to take) to address ESG factors and the reasons for taking such action. That understanding can only be achieved through constructive engagement, as encouraged by the Stewardship Code and a willingness on all sides to listen and to be clear and open. Corporates and their investors will need to start on their respective sides of the bridge and walk to the centre. That will require a good deal of co-operation and commitment (both of time and thought) and flexibility. If the Stewardship Code, adherence to which is voluntary, can help to bring that about, it will have made a stride towards breaking down the antipathy, which has sometimes existed between corporate Boards and their investors, for the benefit of all stakeholders globally.

For further information about the issues raised in this article or to discuss any questions you may have, please contact Paul Norris.

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