Customers, employees and corporate activists, including socially conscious investors, have been focusing on issues now commonly associated with CSR and corporate sustainability for several decades, particularly in the areas of environmental protection and human rights; however, CSR has taken on a new urgency for corporate directors and managers as institutional investors, including large public pension funds, have become more interested in, and concerned about, environmental protection, human rights, health and safety and diversity and have shown greater appreciation for the benefits of pursuing corporate sustainability as opposed to only rewarding short-term profitability. The submission by the BT Governance Advisory Service to the Australian Parliamentary Joint Committee on Corporations and Financial Services in 2006 provided an illustration of how and why institutional investors seek out companies that understand the need for a longer term approach to risk:
“Long term investors expect organizational decision makers to have a regard for the interests of stakeholders other than shareowners when those stakeholder interests have the capacity to influence shareowners’ interests. We believe that companies that manage their stakeholders’ interests are managing their shareowners’ interests, especially over the long-term. This arises from the fact that risks to companies arise not just from typical financial risks but also from regulatory, community and litigation risks.”
Sustainability has become an important issue for the major institutional investors and asset managers and the marketplace is seeing an increase in smaller, more specialized investment funds that are primarily oriented toward providing capital to companies that excel in their environmental, social and governance (“ESG”) practices and which focus on ESG-oriented activities such as climate change and impact investing. The goal of investors is to encourage their portfolio companies to contribute to the successful pursuit of environmental and social outcomes which continuing to provide investors with a suitable financial return.
A number of factors have contributed to the surge in the interest of investors in corporate sustainability and the ESG practices of their portfolio companies:
- Recognition in the financial community that ESG factors play a material role in determining risk and return;
- Understanding and acceptance that incorporating ESG factors is part of investors’ fiduciary duty to their clients and beneficiaries;
- Concern about the impact of short-termism on company performance, investment returns and market behavior;
- Increased legal requirements protecting the long-term interests of beneficiaries and the wider financial system;
- Pressure from competitors seeking to differentiate themselves by offering responsible investment services as a competitive advantage;
- Increasing activism of beneficiaries who are demanding transparency about where and how their money is being invested; and
- Concern regarding value-destroying reputational risk associated with environmental and social issues such as climate change, pollution, working conditions, employee diversity, corruption and aggressive tax strategies in a world of globalization and social media.
A reported prepared by The Conference Board in November 2017 highlighted several important market and regulatory drivers of increased ESG activism among institutional investors. First, there seems to be a clear shift in expectations among institutional investors’ own shareholders with respect to ESG voting and engagement and institutional investors must now contend with the demands of their shareholders to support environmental and social proposals in line with their fiduciary duties. Second, in 2015 the US Department of Labor amended its guidelines interpreting the “prudent investor” standard for Employee Retirement Income Security Act (“ERISA”) fiduciaries to affirm that although ERISA does not allow fiduciaries to sacrifice the economic interests of their beneficiaries to promote public policy goals, fiduciary duties do permit consideration of ESG factors in investment analysis and voting practices when necessary to advance beneficiaries’ economic interests. The DOL’s change in position aligned the US with guidelines that had already been approved in a growing number of other countries that directly endorsed or encouraged public pension funds and other investment fiduciaries’ incorporation of ESG considerations in investment analysis. Third, consortiums of investors are being formed to exert influence on their peers to promote better oversight of ESG risk. One example is the voluntary Framework of US Stewardship and Governance formed in 2017 by a group of institutional investors representing over $20 trillion in US equity investments to encourage investors “to continue to engage directly with companies and to make their proxy voting and engagement practices and policies more transparent as part of a balanced approach to corporate and shareholder accountability”.
The consensus today among institutional investors is that “corporate sustainability” is no longer limited to the environmental practices of the company, but should be broadly construed to include all of the challenges that should be overcome–economic, environmental and social–and all of the actions that should be taken in order for the corporation’s business model to survive and thrive currently and into the future. The President and CEO of State Street Global Advisors (“SSGA”) has informed the directors of SSGA’s portfolio companies that SSGA defines sustainability “as encompassing a broad range of environmental, social and governance issues that include, for example, effective independent board leadership and board composition, diversity and talent development, safety issues, and climate change.”
The potential benefits to institutional investors have been highlighted by the Conference Board, which has argued that CSR enhances market and accounting performance, lowers the cost of capital, improves business reputation, and fosters new revenue growth when it is channeled toward product innovation. Similarly, the Chairman and CEO of BlackRock, Inc., the largest asset manager in the world, wrote in his 2016 Annual Letter to the CEOs of BlackRock’s portfolio companies that “[o]ver the long-term, environmental, social and governance (ESG) issues—ranging from climate change to diversity to board effectiveness—have real and quantifiable financial impacts”. While many investors argue that focusing on corporate sustainability is necessary in order for companies to identify and mitigate the risks to current operations due to climate change, shortages of natural resources and ignoring basic human rights issues, investors also believe that developing and implementing innovating solutions to environmental problems, improving workplace conditions and forging strong relationships with local communities will lead to better economic performance for the business.
Investors are embracing “responsible investment”, which has been described in the Principles for Responsible Investment (https://www.unpri.org/about/the-six-principles) backed by the United Nations (“PRI”) as “an approach to investing that aims to incorporate environmental, social and governance (“ESG”) factors into investment decisions, to better manage risk and generate sustainable, long-term returns”. Investors that have committed to adherence to the PRI have undertaken to incorporate ESG issues into their investment analysis and decision making processes, be “active owners” of the companies in which they invest, incorporate ESG issues into their own ownership policies and practices, seek appropriate disclosure on ESG issues from their portfolio companies and report on their own activities and progress toward implementing the Principles. The PRI are based on the assumption that institutional investor have a fiduciary duty to act in the best long-term interests of their beneficiaries and that ESG issues can affect the performance of investment portfolios and must be attended to in order for the investors, and their portfolio companies, to improve their risk management and generate sustainable, long-term returns. In other words, attention to ESG not only helps investors achieve better long-range investment returns, thereby meeting the goals of their beneficiaries, but also aligns investor priorities with broader societal goals.
|The Principles for Responsible Investment
The Principles for Responsible Investment (“PRI”), which is supported by, but not part of, the United Nations, considers itself to be the world’s leading proponent of responsible investment. The PRI has explained its work as understanding the investment implications of environmental, social and governance (“ESG”) factors and supporting its international network of investor signatories in incorporating these factors into their investment and ownership decisions. Signatories to the PRI commit to the following six principles and the accompanying possible actions for incorporating ESG issues into their investment analysis and decision making processes and their relationships with portfolio companies:
Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
· Address ESG issues in investment policy statements.
· Support development of ESG-related tools, metrics, and analyses.
· Assess the capabilities of internal investment managers to incorporate ESG issues.
· Assess the capabilities of external investment managers to incorporate ESG issues.
· Ask investment service providers (such as financial analysts, consultants, brokers, research firms, or rating companies) to integrate ESG factors into evolving research and analysis.
· Encourage academic and other research on this theme.
· Advocate ESG training for investment professionals.
Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
· Develop and disclose an active ownership policy consistent with the Principles.
· Exercise voting rights or monitor compliance with voting policy (if outsourced).
· Develop an engagement capability (either directly or through outsourcing).
· Participate in the development of policy, regulation, and standard setting (such as promoting and protecting shareholder rights).
· File shareholder resolutions consistent with long-term ESG considerations.
· Engage with companies on ESG issues.
· Participate in collaborative engagement initiatives.
· Ask investment managers to undertake and report on ESG-related engagement.
Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
· Ask for standardized reporting on ESG issues (using tools such as the Global Reporting Initiative).
· Ask for ESG issues to be integrated within annual financial reports.
· Ask for information from companies regarding adoption of/adherence to relevant norms, standards, codes of conduct or international initiatives (such as the UN Global Compact).
· Support shareholder initiatives and resolutions promoting ESG disclosure.
Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
· Include Principles-related requirements in requests for proposals (RFPs).
· Align investment mandates, monitoring procedures, performance indicators and incentive structures accordingly (for example, ensure investment management processes reflect long-term time horizons when appropriate).
· Communicate ESG expectations to investment service providers.
· Revisit relationships with service providers that fail to meet ESG expectations.
· Support the development of tools for benchmarking ESG integration.
· Support regulatory or policy developments that enable implementation of the Principles.
Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
· Support/participate in networks and information platforms to share tools, pool resources, and make use of investor reporting as a source of learning.
· Collectively address relevant emerging issues.
· Develop or support appropriate collaborative initiatives.
Principle 6: We will each report on our activities and progress towards implementing the Principles.
· Disclose how ESG issues are integrated within investment practices.
· Disclose active ownership activities (voting, engagement, and/or policy dialogue).
· Disclose what is required from service providers in relation to the Principles.
· Communicate with beneficiaries about ESG issues and the Principles.
· Report on progress and/or achievements relating to the Principles using a comply-or-explain approach.
· Seek to determine the impact of the Principles.
· Make use of reporting to raise awareness among a broader group of stakeholders.
Pronouncements regarding the importance of CSR by institutional investors are tremendously impactful on the decisions made by management since those investors are among the largest shareholders of the companies they follow. CEOs must be mindful of surveys showing that CSR issues play a pivotal role in investment decisions for 90% of investors. The BlackRock Chairman’s 2017 Annual Letter to CEOs put the executive leaders of BlackRock’s portfolio companies on notice that they would be expected to consider sustainability of operations, environmental factors that affect the business, and the company’s role as a member of the community. State Street Global Advisors (“SSGA”), in a letter from its President and CEO to the directors of its portfolio companies, has made it clear that SSGA believes that CSR issues can have a material impact on a company’s ability to generate revenues over the long term and that whether the companies “clearly [communicate] their approach to sustainability and its influence on strategy” impacts how they will be classified by SSGA. A few days earlier, SSGA announced that it would consider the following issues when evaluating companies’ CSR and corporate sustainability efforts and the actions of board members in overseeing and management and setting long-term strategy:
- The company has identified the sustainability issues material to the business.
- The company has analyzed and incorporated sustainability issues, where relevant, into its long-term strategy.
- The company considers long-term sustainability trends in capital allocation decisions.
- The board is equipped to adequately evaluate and oversee the sustainability aspects of the company’s long-term strategy.
- The company’s reporting clearly articulates the influence of sustainability issues on strategy.
- The board incorporates key sustainability drivers into performance evaluation and compensation programs.
SSGA has also opined: “Today’s investors are looking for ways to put their capital to work in a more sustainable way, one focused on long-term value creation that enables them to address their financial goals and responsible investing needs. So, for a growing number of institutional investors, the environmental, social and governance (ESG) characteristics of their portfolio are key to their investment strategy.” In the same vein, an article distributed by the consulting firm PwC in October 2016 noted that “[m]ore and more, stakeholders are considering environmental, social and governance (ESG) factors when they evaluate a company’s strategy, risk profile, and ultimately, its plan for creating long-term value”. The Forum for Responsible and Sustainable Investment (www.ussif.org) provided further insights on changing investor motivations leading to the surging interest in sustainable, responsible and impact (“SRI”) investment:
“There are several motivations for sustainable, responsible and impact investing, including personal values and goals, institutional mission, and the demands of clients, constituents or plan participants. Sustainable investors aim for strong financial performance, but also believe that these investments should be used to contribute to advancements in social, environmental and governance practices. They may actively seek out investments—such as community development loan funds or clean tech portfolios—that are likely to provide important societal or environmental benefits. Some investors embrace SRI strategies to manage risk and fulfill fiduciary duties; they review ESG criteria to assess the quality of management and the likely resilience of their portfolio companies in dealing with future challenges. Some are seeking financial outperformance over the long term; a growing body of academic research shows a strong link between ESG and financial performance.”
As for the specific CSR and corporate sustainability issues that are most important to investors, and which should therefore be priorities for directors and members of the executive team, reference can be made to surveys of CSR-related shareholder proposals compiled by organizations such as the Institutional Shareholder Services Inc. (“ISS”) Governance Analytics Database. In 2016 and early 2017, for example, the most popular topics among shareholder activists included lobbying disclosure, climate change reporting, political contributions disclosure, gender pay gap disclosure and sustainability reporting, a list that highlighted a decided shift in shareholder engagement toward sustainability and away from some of the issues that had dominated in previous years such as proxy access. A little more than half of the CSR-related shareholder proposals submitted to companies in 2016 were actually voted upon since some did not meet the criteria for voting established by the company and others were removed from the ballot before the meeting based on undertakings by the company following engagement with the proponents of the proposal to voluntarily provide expanded CSR-related disclosures. Average support for those proposals that were voted upon was around 20%; however, nine proposals focusing on the following topics received majority support: board diversity, political contributions disclosure, methane emissions management, sustainability reporting, animal welfare, prohibition of sexual orientation and gender identity discrimination and gender pay gap disclosure. Companies can gather further insights by closely reviewing the proxy materials of other firms in their industry and the published voting records and pronouncements of their major institutional investors.
In the 2017 proxy season, shareholders at ExxonMobil, Occidental Petroleum, and PPL Corp. voted by overwhelming majorities in favor of proposals urging these boards to assess and report on the financial risks their companies face as a result of climate-related regulation. These proposals passed with the support of BlackRock, State Street Global Advisors, and Vanguard, all of whom have voting and investment policies that include environmental, social, and governance (“ESG”) considerations and risk assessment. In 2017, Fidelity followed suit and revised its proxy voting guidelines to state that it “may support shareholder proposals calling for reports on sustainability, renewable energy and environmental impact issues” as well as proposals on board and workplace diversity.
The published voting guidelines of ISS for the 2017 proxy season reflected the growing support among institutional investors for ESG-related proposals. Among other things, the guidelines called for generally supporting resolutions requesting that a company disclose information on the risks related to climate change on its operations and investments, such as financial, physical, or regulatory risks; generally voting for proposals requesting that a company report on its policies, initiatives, and oversight mechanisms related to social, economic, and environmental sustainability; and supporting proposals seeking reports of company’s efforts to respond on a range of ESG issues, including climate impact mitigation, board and workplace diversity. Proposals that called for the adoption of GHG reduction goals from products and operations were to be considered on a case-by-case basis and proposals seeking a company’s endorsement of social/environmental issue principles that support a particular public policy position were opposed.
Institutional investors are themselves under increasing pressure from their own investors, as well as peers, activist groups and non-governmental organizations, to proactively embrace CSR and corporate sustainability. For example, in 2006 investors with over $2 trillion in assets under management pledged to commit to the UN Principles for Responsible Investment (“PRI”), which require that environmental, social and governance issues be incorporated into investment analysis and decision making and that shareholders committed to the Principles proactively engage their portfolio companies regarding CSR and corporate sustainability issues and goals. At the time the Principles were first announced, the then-UN Secretary General observed:
“In signing on to these principles, you are publicly committing yourselves to adopt and live up to them. And you are expressing your intent to channel finance in ways that encourage companies and other assets to demonstrate corporate responsibility and sustainability. In short, you have given a vote of confidence to corporate responsibility – not as a luxury, not as an afterthought, not as a goal to be achieved someday, but as an essential practice today.”
By 2016, more than half of all publicly traded debt and equity worldwide was held by investors who were signatories to the PRI, and US signatories accounted for nearly 20% of the total participation and included both traditional backers of environmental and social proposals and mainstream investment companies like BlackRock, Fidelity, State Street and Vanguard. Not to be forgotten is that in addition to the assets managed by these well-known mainstream investors, more than 20% of all assets under management in the US were invested based on sustainable, responsible or impact investing strategies.
A survey of whether institutional investors affected a firm’s commitment to CSR for a large sample of firms from 41 countries over the period 2004 through 2013 found that institutional ownership was positively associated with firm-level environmental and social commitments. A July 2017 report issued by US SIF Foundation indicated that managers of $8.72 trillion of the overall total of $40 trillion assets under management in the US, about 22%, included sustainability in their investment decision making. A November 2017 reported by The Conference Board stated that surveys of institutional investors by major consulting firms since at least 2014 have found, on average, that 70% to 80% saw ESG information as important or essential to their investment analysis.
This article is part of the Sustainable Entrepreneurship Project’s extensive materials on Sustainability and Corporate Governance.
 Parliamentary Joint Committee on Corporations and Financial Services, Corporate responsibility: Managing risk and creating value (2006), 68.
 V. Harper Ho, Director Notes: Sustainability in the Mainstream–Why Investors Care and What It Means for Corporate Boards (The Conference Board, November 2017), 10-12, electronic copy available at: https://ssrn.com/abstract=3080033 (based on information available at UNPRI, Signatories, https://www.unpri.org/signatory-directory/).
 Interpretive Bulletin Relating to the Fiduciary Standard under ERISA in Considering Economically Targeted Investments, 29 C.F.R. § 2509.15-01 (October 26, 2015). The guidance in effect prior to October 26, 2015, which had been in place since 2008, generally prohibited ERISA from selecting investments on the basis of any non-economic factors. Interpretive Bulletin Relating to Investing in Economically Targeted Investments, 73 Fed. Reg. 61,734 (October 17, 2008).
 According to the Report, many jurisdictions in the midst of changing their conceptions of fiduciary duty to permit, or even impose a positive duty on, investors to incorporate financially material ESG factors into their investment decision making. Sources cited included UNEP-FI, A legal framework for the integration of environmental, social, and governance issues into institutional investment (2005), http://www.unepfi.org/fileadmin/documents/freshfields_legal_resp_20051123.pdf; UNEP-FI, Fiduciary Duty in the 21st Century (2015), http://www.unepfi.org/fileadmin/documents/fiduciary_duty_21st_century.pdf; and OECD, Investment governance and the integration of environmental, social, and governance factors, (2017), 48-50.
 Investor Stewardship Group, “Framework for U.S. Stewardship and Governance”, https://www.isgframework.org/. Stewardship codes have also been introduced in a number of foreign countries as a means for encouraging or requiring institutional investors as asset owners or managers to disclose how their investment strategy contributes to the medium and long-term performance of the investor’s assets.
 Letter from Ronald P. O’Hanley, President and CEO, SSGA, to Board Members, 1-2 (January 26, 2017), available at ssga.com.
 M. Tonello, Corporate Investment in ESG Practices (The Conference Board, Inc.: August 5, 2015).
 Annual Letter from Larry Fink, Chairman and CEO, BlackRock, to CEOs (February 1, 2016), available at blackrock.com.
 Tomorrow’s Investment Rules: Global Survey of Institutional Investors on Non-Financial Performance, 5 (Ernst & Young, 2014).
 Annual Letter from Larry Fink, Chairman and CEO, BlackRock, to CEOs (January 24, 2017), available at blackrock.com.
 Letter from Ronald P. O’Hanley, President and CEO, SSGA, to Board Members, 1-2 (January 26, 2017), available at ssga.com.
 SSGA, Incorporating Sustainability Into Long-Term Strategy (January 23, 2017), available at ssga.com.
 SSGA, Performing for the Future: ESGs Place in Investment Portfolios Today and Tomorrow (2017), available at ssga.com.
 https://www.ussif.org/sribasics. The Forum for Responsible and Sustainable Investment is a valuable online resource with information and educational materials on sustainable and responsible investing trends, performance and sustainable investment, proxy voting, shareholder proposals and community investing.
 H. Gregory, “Corporate Social Responsibility, Corporate Sustainability and the Role of the Board”, Practical Law Company (July 1, 2017), 5-6 (citing Institutional Shareholder Services Inc., United States 2016: Proxy Season Review—Environmental and Social Issues (October 26, 2016), available at isscorporatesolutions.com (subscription required)).
 V. Harper Ho, Director Notes: Sustainability in the Mainstream–Why Investors Care and What It Means for Corporate Boards (The Conference Board, November 2017), 2, electronic copy available at: https://ssrn.com/abstract=3080033. See also V. Harper Ho, “’Comply or Explain’ and the Future of Nonfinancial Reporting”, Lewis & Clark Law Review, 21 (2017), 318; and V. Harper Ho, “Risk-Related Activism: The Business Case for Monitoring Nonfinancial Risk”, Journal of Corporate Law, 41 (2016), 648.
 https://www.issgovernance.com/file/policy/2017-us-summary-voting-guidelines.pdf, 57-63.
 Ban Ki Moon, UN Secretary General Speech at the NYSE announcing the UN Principles for Responsible Investment (April 26, 2006).
 V. Harper Ho, Director Notes: Sustainability in the Mainstream–Why Investors Care and What It Means for Corporate Boards (The Conference Board, November 2017), 3 and Table 1, electronic copy available at: https://ssrn.com/abstract=3080033 (based on information available at UNPRI, Signatories, https://www.unpri.org/signatory-directory/).
 A. Dyck, K. Lins, L. Roth and H. Bocconi, “Do Institutional Investors Drive Corporate Social Responsibility? International Evidence” (November 18, 2015). Interestingly, the researchers found that while domestic institutional investors and non-U.S. foreign investors accounted for the identified positive associations, U.S. institutional investors’ holdings are not related to environmental and social scores. Similarly, higher scores are associated with long-term investors such as pension funds but not with hedge funds.