Time to separate the G from ESG, argues SquareWell Partners

‘Governance should be viewed as the means of facing environmental and social risks and opportunities – not as an isolated element.’ That’s according to a new note published by SquareWell Partners, which argues that governance needs to be ‘put back in the spotlight’ as ESG has become increasingly synonymous with sustainability.

In response to MSCI’s recent 2022 ESG trends to watch report, which states that climate change has overtaken corporate governance as the most-pressing ESG issue commanding investors’ attention, SquareWell says ‘this perception that governance is a competing issue to climate change for companies’ and investors’ attention is wholly misleading’.

Active versus passive

SquareWell says part of this melding of E, S and G is down to the growth of passive investments, as well as the growth of the ESG industry, as it puts it: ‘the proliferation of disclosure frameworks on ESG issues alongside the myriad of ESG ratings and research providers’.

These two trends, argues the firm, have had the ‘unintended consequence’ of driving a focus on sustainability as a disclosure item, rather than as a matter requiring strategic deliberation within the boardroom. ‘In contrast to this, by virtue of their investment strategy, only active managers are able to identify those companies that are communicating an integrated strategy that aims to capture the risks and opportunities presented by global trends and, therefore, attribute a lower valuation to those that don’t,’ it says.

It adds that ‘legacy’ governance issues such as overboarding and director independence remain relevant and that, increasingly, investors are in fact demonstrating stricter views on governance issues compared with those of proxy advisers. For example, it says that last year, among the largest 100 US and European companies, only 29 percent and 21 percent, respectively, of directors receiving 10 percent or more opposition faced a negative recommendation from ISS and Glass Lewis.

Sustainability governance

Board expertise and accountability, board diversity and executive pay remain key issues, while sustainability governance is a growing topic of concern for both investors and proxy advisers.

‘In late 2020 and 2021, a growing number of asset managers codified their expectations with regards to the board’s responsibility to oversee sustainability opportunities and risks that the company faces,’ writes SquareWell. ‘We have seen investors opposing board member elections on a wide range of sustainability issues – the most frequently cited reasons were the lack of sufficient sustainability disclosures (in line with TCFD and/or SASB) and failure to sufficiently oversee material environmental and social risks, including climate-related risks.’

It also notes that Glass Lewis updated its policy for 2022, advising companies that it will recommend against responsible board members for not establishing an oversight mechanism to manage environmental and social issues.

ISS further ‘raised its expectations’ around climate governance for the largest corporate greenhouse gas (GHG) emitters, warning companies that it might recommend against the re-election of the responsible board members where firms do not have appropriate climate disclosures in place, such as TCFD-aligned reporting or disclosure of ‘appropriate’ quantitative GHG reduction targets.

In a move underscoring its belief that it’s time to split G from E and S, SquareWell says it is ‘shifting’ its own identity away from an adviser in the ESG space. Instead, it says that in future it ‘will work to support our clients to be governed in a way that ensures sustainability’.