Co-founder of the International Corporate Governance Network, chair of LeaderXXchange, and winner of the 2019 Women in Asset Management – ESG Award in New York, Sophie L’Hélias has spent over twenty years working on corporate governance policies. She is also Kering’s lead independent Director. Here, she shares her insight into ESG’s emerging role in the investment world.
How did ESG emerge as an investor concern?
Sophie L’Hélias: Environmental, social, and governance considerations, which make up the E, S, and G of ESG, have pretty much always been around, it’s just that they weren’t approached in a joined-up way. This is something that happened in several stages. Governance has a well-established track-record, as the investment world has long known that good governance creates value. For investors, governance acts as a kind of contract of trust between them and the business, providing a safeguard that decisions will be taken in the interest of the company, shareholders, and all stakeholders. For this reason, investors take a keen interest in governance.
For years, environmental and social aspects were mainly viewed through a regulatory lens by companies and investors alike, with a few notable exceptions. On the environmental side, regulations were initially responsible for driving changes in corporate behaviors in terms of waste management, for example, or greenhouse gas emissions, through agreements such as the 1995 Kyoto Protocol and the more recent Paris Agreement signed after the COP21 climate conference in 2015.
The tipping point was reached more recently. Momentum has gathered particularly in the last three years as environmental and social aspects have been integrated as risk factors and opportunities1. Before 2016, there wasn’t much talk of ESG. The term was used on average 4,000 times a year by English-language media outlets. By 2018, that number had risen to 300,000.
Why do you think investors reached this tipping point?
Besides regulations, which created the framework, what made the difference was data transparency coupled with the emergence of new technologies enabling risks to be measured and analyzed. Once companies began to share data on their environmental and social activities, investors were able to really get a handle on ESG risks, for example by identifying which sectors were the most exposed to climate change. New technologies made it possible to collect, compare, and analyze data and then rank ESG risks in order to determine which ones were significant or material with regard to the company’s strategy and the expectations of its main stakeholders.
By harnessing the data, whether they came from academic studies, consulting firms or companies themselves, investors were able to develop various types of ESG-based investment strategies. Screening strategies came first. These identify controversial sectors in which investors do not wish to invest, such as tobacco, firearms, or pornography. Inclusive strategies were developed next, as investors employed indices that grouped companies according to specific ESG criteria, such as equality or carbon emissions, for example. The third type of investment strategy, the integrated approach, is more complex, consisting in selecting companies that meet specific investment criteria that themselves incorporate ESG risks, opportunities, and performances.
This shift did not occur at the same pace everywhere. To some extent, European firms were more predisposed to embrace corporate social responsibility – and hence ESG – because of the continent’s social and environmental regulations. US firms have a different culture and arrived later on the scene. Ironically, one of the trigger events was the US withdrawal from the Paris Agreement. This galvanized investors, who took on the subject themselves and banded together to increase their impact. Another pivotal moment was the BRT statement in August 2019, which redefined the purpose of a corporation and made a clear break with the financial short-termism of the past. So Europe showed the way, but US and Asian economic participants needed to be aligned to ensure widespread adoption and a major impact.
Between constraints and opportunities, what does integrating ESG criteria in business reporting achieve?
The question that companies ask themselves is how to turn risk into opportunity. The benefits of ESG are already showing, particularly in innovation. For example, as raw materials grow scarcer, firms in the fashion sector are looking for new solutions, which then become sources of inspiration for creators.
Likewise, corporate transparency sets up a virtuous circle in firms’ relations with stakeholders, especially customers, suppliers, and employees. Taking a real-life example from the luxury sector, jewelry brands that opted to use responsibly sourced gold, even if this decision increased their costs, were able to create these types of virtuous circles. Cost differences gradually disappeared as purchase volumes increased when the practice became widespread. Furthermore, the decision addressed the expectations of customers sensitive to a responsible purchasing approach.
In addition, just as companies strive to present themselves as the best places to work in order to attract top talent, so by integrating ESG in strategies and, crucially, offering genuine transparency on activities, outcomes and impacts, firms have a way to establish themselves as prime investments on financial markets.
With so many criteria and indices available right now, isn’t it hard for investors to assess ESG performances?
It’s true that we need to standardize assessment criteria. Investors have two basic requirements: transparency and comparability. Companies have made real headway on the first. In terms of the second, the proliferation of data and data providers is a real hindrance to data quality and relevance.
Investors and companies alike are pushing for ESG criteria to be harmonized. We are starting to see consolidation and mergers among ESG rating and research providers, with S&P acquiring Trucost, Moody’s taking over Vigeo-Eiris and Morningstar absorbing Sustainalytics. But we must be careful: while consolidation is vital, it must not lead to non-transparent assessment criteria and meaningless results. Criteria have to remain transparent. Anyone who wants to access the raw data should be able to do so. We need an open-source approach.
You have been on the Kering Board since 2016 as lead independent Director and you act as the Board’s liaison with investors on ESG matters. Tell us about your role.
The Board of Directors steers the business of the company by determining the firm’s strategy and supervising its implementation. Independent directors represent the interests of all shareholders with a view to creating long-term, sustainable value. As lead independent Director, I am also involved in organizing the work of the Board. For example, I coordinate the assessment of the Board to make sure that key competencies for the Group are represented.
As lead independent Director, I am also the Board’s liaison with investors on ESG matters. In this capacity, I took part in Kering’s recent ESG roadshows. At such events, my job is to talk with investors, answering their questions, particularly about governance and how the Board works, but also asking them about what they view as long-term issues. These roadshows involve a huge amount of work for the organizing teams, but they are important, exciting, and enriching events for the company and its stakeholders.
1 According to a recent study by LeaderXXchange and Columbia University, over 60% of board Directors and 70% of investors surveyed believe that climate risk impacts their activities.