While the 2010s have laid the groundwork for ESG corporate practices, the 2020s will put ESG in action. Companies will actively incorporate ESG-related practices in the upcoming decade as environmental and social issues have gained significant momentum in the past decade.
Following are some of the trends in the ESG space that will drive the decisions and actions of companies, investors, and regulators in 2020 and beyond.
The primary focus will be on climate change
Though an issue of importance since 2010, climate change will be an even more dominant theme in 2020. Even the world’s leading companies have valued the climate risks to their business at nearly $1 trillion (Unfccc).
Governments round-the-world are currently concentrating more on climate-rated problems and are creating regulations to urge companies and investors to commit to net-zero emissions. In fact, governments are unanimously planning to make this a standard practice by the end of this decade.
As companies have started recognizing the risks and opportunities associated with climate change, all sectors, particularly the ones that are emissions intense and have shown resistance in the past, will have to shift to the low-carbon economy without any inhibitions.
While firms will watch out for new business opportunities and present themselves as climate leaders, investors will focus on engagements around climate change.
Environmental & Social (E&S) issues will top the list of governance activities
While traditional corporate governance will continue to play a significant role in improving management incentive structures, shareholder rights, and board quality, the governance of environmental and social (E&S) issues will gain special attention from boards and investors, as management of E&S risks has emerged as a new standard of corporate governance practices.
Today companies’ corporate social responsibility efforts are not just an act of “giving back to society”. It is also a ‘sustainability investment’ to improve risk management and create long-term shareholder value methodically. Also, with sustainability experts becoming essential additions to many boards, understanding and assessing a company’s impact on the environment and society has become a matter of paramount importance.
ESG disclosures will be the new normal
By the end of this decade, disclosures on ESG factors will become institutionalized and widely disseminated. Owing to the reforms in corporate governance, there will be increased pressure from the investors’ side. This will stimulate the change largely. Regulations along with comply-or-explain codes will also play a significant role in addressing E&S issues.
Even in the past decade, corporate governance codes, disclosures, say-on-pay, executive compensation, and broad-gender diversity mandates were imposed at various geographies of the globe as jurisdictions became aware of the governance standards.
Verifications and assurance will play a significant role in assuring the accuracy of the ESG disclosures. Reporting frameworks like the Global Reporting Initiative will be the blueprint for building reporting standards for the investment community.
Asset managers will move from ESG stewardship to ESG integration
As a result of enhanced ESG disclosures, investment professionals will assess ESG risks before making investment decisions. However, it is not yet clear as to when or to what extent will ESG risk assessments impact cash flows. Engagement and proxy voting will include ESG risks along with proposals listed on the meeting agenda. Furthermore, regulatory initiatives like the EU Action Plan and market-driven solutions will contribute significantly to the development and establishment of standards for sustainable finance.
Data and Technology will drive ESG Practices
Data and technology will be instrumental in enabling companies and governments to measure, calculate, and monitor ESG factors. The combo will also drive significant changes in the ability of companies to assess the materiality and impact of ESG factors on long-term value creation.
Even more so, data and technology will pave the way for the creation and enhancement of international frameworks on several key issues by providing better visibility on challenging metrics such as resource consumption, biodiversity, etc.
Frontier technologies like data analytics, AI, machine learning, etc, will help in identifying patterns between economic performance and ESG factors. These technologies will also enable companies to measure ESG impacts and risks accurately and in real-time, thereby helping them to make informed capital allocation decisions.
ESG-related shareholder activism will continue to soar
Though the U.S, regulatory actions carried out in recent times may pose difficulties for shareholders in filing resolutions, ESG- related shareholder activism and ESG engagement will continue to rise in 2020 and beyond.
Over the last several decades, investors used shareholder resolutions as the handbook to spot and vet governance and E&S issues. Also, until recent times, the focus of asset managers were only in refining corporate practices.
However, in the last five years, the elite group of asset managers have shifted to a more proactive stance and are now initiating policies that focus on director over-boarding, board refreshment, and board gender diversity.
Recent letters from the CEOs of BlackRock and SSGA are pieces of evidence for the active participation of asset managers in ESG-related shareholder activism. Matter of fact, they are now introducing reforms and devising policies to hold boards accountable for ESG-related activities.
However, shareholder resolutions will continue to drive change, even if the proposal filing process turns into a more challenging task for proponents.
Diversity and Inclusion will extend beyond boardrooms
Companies and investors will focus on diversity across the entire organization and not just boardrooms. Policies will be revised for equal pay and opportunity. Corporate culture will witness a revolution once again. At present, in the US, female participation in company CEO and board chairs is only 6% and 5%. However, U.S boards are actively working on this subject and is expecting to surpass the 30% threshold of female participation by the early years of this decade (Harvard Law School Forum). Despite starting from a shallow base, the number of top female executives will be more than double by the end of this decade.
Geopolitics and public pressure will continue to shape the ESG landscape
As corporate behaviour is directly and indirectly influenced by populism, trade wars, geopolitical tensions, etc, politics will have an ever-increasing role in structuring the ESG environment. Business collaborations as well as mergers and acquisitions in energy, technology, and industrial sectors, are likely to be affected by national security concerns. Trump blocking Broadcom’s takeover of Qualcomm on national security grounds in 2018 is a perfect example of this fact.
In addition, public pressure on various social and environmental issues increases the pressure on companies and shareholders to maintain compliance with ESG regulations.
Adoption of ESG-related practices is likely to be the primary focus of industries and jurisdictions in this decade. Companies that ignore ESG aspects will miss potential opportunities and face greater risks. On the other hand, embracing ESG stewardship can help companies gain a competitive advantage.
Overall, ESG will be a differentiating factor for entities in 2020 and the years ahead.