Environmental, Social and Governance (ESG) standards are an essential tool in the toolkit of boards of directors and senior management. They help businesses focus on reducing the risk of environmental disasters, winning the war for talent, and securing the rewards that the market offers transparent, diverse and well-governed businesses, especially those in developing countries.
But make no mistake about it, as senior analysts from two major investment banks said in a private meeting last week, “You have to get the ESG right, and that has to lead to an increase in cash flow â€.
In other words, if you embrace ESG for cosmetic reasons or for political reasons, and your balance sheet, EBIT, and cash flow are negative, equity analysts will harass you and the market will punish you. Thus, analysts want to see increased discounted cash flow due to the possibility of charging more for low carbon value added products. If capital spending is to be increased to pay for ESG initiatives, it must be fully explained and “clearly accretiveâ€. The faster payback (return on investment) will also be rewarded. Finally, it should lower unit costs compared to its peers. So boards of directors need to ask themselves, “How do we make sure we monetize our ESG initiatives?” “
ESG does not remove high-carbon assets to appease activist investors seeking to end the use of fossil fuels, or to force companies to stop selling weapons. It is also not appropriate to use ESG when Airbnb announced in 2019 that it would not list properties for rent in the West Bank, only to backtrack a few weeks later under massive pressure from the state. from Texas. It is all militant political management.
ESG leadership, for boards and management, is asking, “What are our greatest environmental liabilities and how can we improve them?” “” Are there better, more sustainable, efficient and profitable means of production that we should be using? “” Are we providing our employees with the right services, benefits and incentives to maintain a loyal and successful workforce? Do we have the right governance policies in place to ensure best practices in the operations and management of the business?
Asset managers are not wrong to ask whether companies include ESG in their management and oversight – companies that outperform companies that don’t – especially in emerging markets. However, they are wrong when they do not answer the question “and is the balance sheet positive and cash flow accretive?” All of this means that the risk assessment increases and part of the risk is political risk. Access if a business is vulnerable to trade wars, lockdowns or carbon taxes are legitimate concerns. Making arbitrary political decisions as opposed to strict fiduciary decisions is not legitimate. A strict standard of care and loyalty never includes politics.
Sadly, like those public pension plans that seek to politically strip fossil fuel companies (or gun manufacturers, arms companies, private prison companies, or whatever business politicians think shouldn’t work) ), the state of Texas is now on the verge of passing legislation that will prohibit the state pension fund, the teachers’ pension fund, and the K-12 endowment fund from hiring managers of assets that use the ESG “E†as a risk screening tool. However, whether it is an investment or a manager selection, the decision is made on the basis of being pro-Big Oil or anti-Big Oil, both clearly violate fiduciary duty. It is never appropriate for political leaders to inject politics or political litmus tests into the management of public pensions.
That the Texas legislature now prohibits administrators and staff of state pensions and endowments from investing with asset managers who use ESG as part of their risk assessment is just as bad as politicians who arbitrarily ban investments in fossil fuel companies. Again, a strict standard of care and loyalty never includes politics.