On 20 June 2016, the Singapore Exchange (SGX) introduced sustainability reporting on a ‘comply or explain’ basis. This requires Singapore-listed companies to publish an annual sustainability report covering five components, namely material environmental, social and governance (ESG) factors; policies, practices and performance; targets; sustainability reporting framework; and they Board Statement.
This is the second in the series of Sustainability Reporting Seminars organised by GCNS to assist listed companies in clarifying the principles and rationale behind the new SGX requirements, and better understand why companies should go beyond tacking the box during the course of their sustainability reporting work. In particular, companies should realise the importance of corporate sustainability to investors, and recognise that analysing corporate sustainability performance allows investors to gain a clearer understanding of a company’s quality of management and long-term performance potential.
In this session, invited speakers included Mr Maurice Meijers, CEO of RobecoSAM Singapore, Mr Dominic Godman, Partner of Arabesque Singapore and Mr Benjamin McCarron, Founder and Managing Director of Asia Research and Engagement.
Mr Meijers gave an insightful account of the fundamental issues involving sustainability that influence investors. He first highlighted the importance of understanding interchangeable terms like sustainability, ESG and impact investing. Mr Meijers noted that these terms can be viewed as a continuum in the different ways of sustainability investing. Most investors consider investing based on an exclusion model, that is, excluding certain sectors like those involved in nuclear weaponry. Alternatively, investment decisions could be norm-based; those connected with pension plans involved in the health-care industry would exclude tobacco companies. The next step involves ESG integration and active ownership, where information on ESG issues and risks are integrated as part of the investment framework that includes financial analysis and quality of management. Finally, the more ‘hard-core’ process involve impact investing, thematic funds, and clean tech.
Mr Meijers demonstrated through slides of European examples how most investors generally follow the exclusionary and ESG integration models when making sustainable investment decisions. In order to do so, access to good research was critical in making more informed decisions. In RobecoSAM, the tool employed is the 100-page Corporate Sustainability Assessment (CSA), an annual questionnaire comprising 80-100 questions sent to the largest companies in the various indices like the Dow Jones. This comprehensive questionnaire includes sustainable, social and governance policies, and forms the basis of the Dow Jones sustainability index. It seems that companies that can manage the challenges of sustainability are better equipped to create value in the long term for investors. Conversely companies facing sustainability risks could also possibly be investment risks. Only topics financially relevant to investment are covered in the questionnaire, including disclosures, transparency, energy and water efficiency, human capital investment, remuneration, KPIs and issues of management. Questions are also industry specific, a matrix is created on the impact of various aspects, and companies are ranked accordingly according to granular data obtained and hotspots identified. Investors are therefore provided with a sound benchmark on which decisions may be made.
Finally, Mr Meijers pointed out that a high score on the innovative metric is likely to be an indicator of revenue growth. Also those having high sustainability scores usually have a low cost of capital.
Addressing the link between sustainability and performance, Mr Godman highlighted the importance of ESG in reducing tail risk. Drawing from a study Arabesque conducted with the University of Oxford, a review of around 200 papers on sustainability indicate a correlation between good ESG performance and good sustainability performance. 90% of such companies also enjoy a lower cost of capital, while 88% enjoy better operational performance. Most importantly 90% of such companies enjoy better stock price performance. In a similar study by Deutsche Bank and the University of Hamburg involving over 2,000 sources and 90% of cases, there was a positive correlation between corporate performance and sustainability.
Mr Godman pointed out that ESG analysis could provide information not priced into the market. Typically, financial and technical information about a company, while important, did not provide enough information about a company, particularly where it was headed in the future. Sustainability could provide information on a company’s innovative level. As an example, a company using innovation to recycle waste rather than dump it is likely to be a better investment. A company’s ability to innovate demonstrates an ability to manage future challenges arising.
Mr Godman noted that in the 1990s, around 20-25 companies globally produced a sustainability report. By 2010 this had risen to 5,000 and today this figure stands at around 8,000, demonstrating the huge amount of non-financial and non-technical data available. The limitation of non-financial data was the non-standardisation of content. Drawing from the analogy of unformatted and inconsistent financial information requiring many years to be regulated and formatted, Mr Godman surmised that the same would apply to non-financial data. The challenge was to determine which portfolio of ESG data was relevant in indicating a company’s stock price prospects and reduce tail risk. In addition such ESG data should not be used in isolation, but in tandem with financial data in order to improve returns.
Finally, turning to investor demand for such ESG strategies, Mr Godman pointed out that due to technology, the world had become more transparent, and companies were scrutinised more thoroughly in their supply chains. Issues like child labour were increasing in importance. In addition, more regulations have emerged, for instance to protect pension funds. In summary, it seems that companies that perform well in ESG tend to outperform financially.
In his presentation, Mr McCarron revealed that while global investors were already using ESG to make decisions, domestic Asian demand for ESG information was beginning to grow. This created a challenge since most ESG analysts were not regionally-based yet, but also an opportunity to stand out if such information could be provided. Mr McCarron pointed out the positive change in regulatory support between 2011 and the present in the Asia-Pacific region, and highlighted the various government-led initiatives in sustainability regulations in driving investor behaviour. Asian asset owners were beginning to ask asset managers about ESG factors. A survey involving around 30 asset owners revealed around half involved ESG as a factor in their decision-making.
Mr McCarron highlighted the importance of information disclosure and communication channels. He added that global investors may not directly ask companies for such information but rely on website information to learn elements like policy benchmarking, controversy monitoring and performance data comparison. Usually such information may be found in sustainability reports and annual reports. As far as controversies are concerned, transparency may yield positive results. In contrast, Mr McCarron believed that taking control of one’s narrative was important, and non-disclosure may result in information providers telling your story for you.