ESG practices are expected to be widely adopted due to the developments made during the 2010s, which will foster a more sophisticated ESG environment in this new decade. The following highlights some of the key trends and issues likely to affect company, investor and regulatory actions in an attempt to reshape the ESG landscape in the years to come.

Climate Change: The Path to Net Zero

As governments around the world enact more climate-related regulations, climate change will be a dominant theme. As a result, expect commitments to net-zero emissions by companies and investors to become standard practice by the end of the decade. In the transition to the low-carbon economy, all sectors, including those that are emitted heavily in the past but may have shown resistance in the past, will be involved, since companies recognize the risks and opportunities associated with proactively responding to climate risks. Many firms will look to seize new business opportunities and position themselves as climate leaders. At the same time, investors will become more engaged in issues related to climate change and will start integrating climate risk into their voting policies. Investors may even vote against the boards of companies that fail to comply with climate change regulations.

The Next Phase of Good Governance: Environmental & Social Issues

In addition to traditional corporate governance issues, investors and boards will focus a great deal on environmental and social (E&S) issues in the future, especially initiatives to improve board quality, shareholder rights, and management incentive systems. A new standard in comprehensive corporate governance practices will emerge for the management of E&S risks. It is expected that corporate social responsibility efforts will extend beyond “giving back to society” in order to integrate sustainability as a tool for systematically managing risk and creating long-term shareholder value. In addition, understanding how an organization impacts the environment and society will become a crucial competency at the board level, with sustainability experts playing an increasingly important role on a number of boards.

ESG Disclosures: The New Normal

In the coming decade, ESG disclosures will become standardized and widespread. A major catalyst for change will be increased investor pressure, just as it was with corporate governance reform. In addition, regulations are likely to play a critical role, with codes of best practices that require compliance or explanation potentially addressing E&E concerns. Some jurisdictions are displaying signs of regulating corporate disclosures before they become widespread. The past decade observed a rapid spread of corporate governance standards such as disclosure of executive compensation, say-on-pay, and board-gender diversity mandates across the globe as different jurisdictions learned about implementing governance standards from each other.

In addition to existing reporting standards, those intended for the investment community may serve as the blueprint for mandated reporting as well (such as the Sustainability Accounting Standards Board and the Task Force on Climate-Related Financial Disclosures). A clear roadmap is also provided by reporting frameworks addressing broader stakeholders (such as the Global Reporting Initiative). In order to confirm the accuracy of these disclosures, verification and assurance will play an ever-increasing role.

ESG Investing: From Stewardship to Integration

Asset managers are increasingly expected to move away from ESG stewardship and toward ESG integration. Enhancing ESG disclosures will allow investment professionals to integrate
environmental, social, and governance factors into their investment decisions. More investors will systematically assess companies based on ESG risks in order to engage with and vote on proposals listed on the meeting agenda. There is no clear indication of when or to what extent the inclusion of sustainable development risk assessments will impact capital flows. As a result, as leading asset managers pursue new ESG products on the market, the investment industry must deal with growing criticism about “greenwashing.” Market-driven solutions and regulatory initiatives (such as the EU Action Plan) will be critical to the development of sustainable finance standards.

ESG Engagement: Asset Managers Take the Lead

It is estimated that ESG-related shareholder activism will increase in the 2020s, despite recent U.S. regulatory actions that may make it more difficult for shareholders to file resolutions. The resolutions of shareholders have served as a mechanism through which investors have identified and evaluated governance issues (including the governance of E&S), resulting in reforms in corporate practices and the adoption of standards (e.g., annual director elections and proxy access, among many others). Prior to this, asset managers took part in changing corporate practices by responding to shareholder proposals and proxy advisor policies.

In the past five years, however, many prominent and large asset managers have taken on a more initiative-driven role by securing regulatory approval for initiatives such as board refreshment, board gender diversity, and director overboard. According to recent letters written by the CEOs of BlackRock and SSGA, asset management firms are reaffirming their commitment to introducing reforms and holding boards accountable for higher standards of ESG management. But even when the proposal filing process becomes more difficult, shareholder resolutions will continue to play a significant role in driving change.

Economic Activism: Governance as a Driver for Change

As activists attempt to establish a case for a replacement of board members, corporate governance issues will be more prominent in proxy fights. A growing number of large asset managers (including prominent index funds) believe that improved governance can enhance long-term shareholder returns, an indication that good financial performance alone is not sufficient to shield companies from economic activism. The main arguments in favour of activism will continue to be driven by financial factors that make companies vulnerable to activism. For superior returns, activist campaigns will focus on corporate governance rather than shareholder activism. Failure to oversee environmental and social issues that have a material impact on business operations may also be employed against management in a contested situation.

Data and Technology: Smarter Analytics Drive ESG Practices, Protocols

Technology and data will enable us to measure, calculate and monitor ESG factors in order to assess their significance and impact on long-term value creation. In parallel with the Paris Climate Agreement, greater visibility on challenging metrics such as resource consumption and biodiversity will allow international frameworks and targets to be developed and/or enhanced in relation to various key topics. Investors will be able to evaluate how ESG factors affect valuations if disclosures are improved and standardized. As far as identifying patterns that link economic performance to ESG factors is concerned, artificial intelligence will play a significant role. Furthermore, companies that have the ability to measure their environmental, social, and governance impacts, and risks will be able to make better capital allocation choices.

Diversity and Inclusion: Beyond Boardroom Diversity

Companies and investors will turn their attention away from boardroom diversity to diversity across the organization, from the C-suite to the general workforce. The policies pertaining to equal pay, equal opportunity, and corporate culture will also be subject to increased scrutiny. It is expected that U.S. boards will surpass the 30 per cent threshold of female participation in the early part of the decade, moving toward gender parity near 2030, especially in large companies. Women’s participation in top executive positions is expected to nearly double by the end of the decade, despite starting from a small base. The percentage of women CEOs and board chairs in U.S. companies is currently around 6% and 5%, respectively.

Executive Compensation: Increased Focus on Metrics and Goals (including ESG)

A continuation of the trends observed in 2010 will be one in which more incentive awards will be
based on performance rather than time, and greater use of restricted stock will continue to outpace the use of stock options. Investing firms should refine their executive compensation evaluation methodologies independently from existing benchmarks established by third parties such as proxy advisors. There is a possibility that this trend may result in increased opposition to executive pay programs in vote-on-pay votes and that the significance of performance metrics and the robust nature of targets will be emphasized even more.

In light of the increasing importance of ESG factors, more companies are orienting their executive compensation programs toward ESG metrics. It remains to be seen whether ESG metrics and targets linked to executive compensation are appropriate and robust, especially if such metrics are used to increase executive compensation while financial performance and shareholder returns are disappointing.

Political Impacts: Geopolitics and Public Pressure

The ESG landscape will be increasingly shaped by politics as geopolitical tensions, trade wars, and populism directly and indirectly affect corporate behaviour. It is understandable that national security concerns may influence business alliances, mergers and acquisitions in the energy, technology, and industrial sectors. In fact, such concerns led the White House to block a Qualcomm-Broadcom merger in 2018, citing national security concerns. The Carlos Ghosn saga (former CEO of Renault and Nissan, a fugitive as this article was completed) also demonstrates how politics at the national level can have a direct impact on corporate governance. Sanctions against individuals and companies of specified countries are not going away. Further, public pressure—and very often, populist rhetoric on a wider range of social and environmental issues—may put additional regulatory pressure on companies and their shareholders in relation to ESG issues.

Seizing the ESG Moment

While the foundations have been laid for many of the trends and issues highlighted above, we expect to witness the widespread implementation of ESG-related practices across industries and jurisdictions in the next 10 years. Companies, investors, and governments who fail to act on ESG will face greater risks and miss significant opportunities compared to ESG leaders in many key areas, ranging from better access to capital to operational improvement and pursuing new business ventures.

Demonstrating leadership in ESG will become a differentiating factor for entities in the public and private sectors, and market participants have much to gain from embracing ESG stewardship as part of their competitive advantage.

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