The smart way to turn your ESG story into cheaper capital

ESG is more than an external compliance exercise. It should be part of a strategic business re-engineering process that can deliver real long-term benefits.

Demonstrate a commitment to ESG, lower your cost of capital and deliver positive ROI for your ESG programme. It sounds straightforward. In fact, matching an ESG programme to both the strategic needs of the business and the complex and varied requirements of different investor communities is extremely challenging. It requires strong internal leadership and a sophisticated external communications approach.

It’s tempting to view this as a simple IR project: tick investors’ boxes, get onto the right lists, and watch your cost of capital fall. But that is the wrong approach.

An ESG programme should not be viewed as an external compliance exercise designed simply to tick the right regulatory or investor boxes. It should be treated as part of a strategic business re-engineering process that can deliver real long-term benefits over and above any cost of capital improvements. This means that any ESG initiative has to be tailored to the unique circumstances of each business and embedded in business culture and management. The particular environmental and social policies adopted must suit the business first, and only when they have been embedded can companies then look at how to match them to the varying requirements of different providers of capital.

As one of the 70 corporates attending the recent Thoburns ESG event stressed: “Don’t let your own ESG strategy and the underlying business strategy be derailed by forcing yourself into indices you don’t fit in or to try to appeal to investors whose needs do not reflect yours.”

That advice highlights the practical complexity of reaping cost of capital benefits: to get a lower cost of capital, issuers and borrowers need to be able to satisfy investors’ ESG requirements. To do this they need to be able to communicate their own stance, and stick to it, but also to understand what investors need and how they need it to get the best possible treatment. And this is where the real complexity begins. Because it’s not at all clear what boxes need to be ticked and how.

Time and again, attendees at the Thoburns ESG meeting stressed the difficulty they have in discovering what specific ESG information different investors need, and how that intelligence feeds into practical decisions about the companies they invest in. Despite initiatives by bodies such as the United Nations’ Principles for Responsible Investment, no two investors require the same data in the same format. ESG data shapes ‘active’ funds differently than ‘passive’. Mandate decisions are increasingly and frequently incorporating ESG criteria, but those discussions almost never include issuers. “The question is what do investors want? There is a still a big information gap between capital raisers and the sources of capital,” explained one participant.

Investors feel the same way about corporates – with some justification. One voice at the Thoburns event admitted that they reported against 27 headline indicators and put out a 72-page report containing so much environmental data that “it is probably meaningless to anyone except us.”

And ESG itself is so broad, covering everything from the carbon transition to employee treatment, to social contribution, that achieving consensus and consistency on what to report and how will be a long time coming.

In the meantime then, companies who want to extract the maximum benefit from their ESG initiatives need to be proactive in bridging the information gap. To achieve ESG-driven cost of capital efficiencies they need to understand their existing equity and fixed-income investors, potential new sources of capital and the different indices and their ESG drivers. They need to identify the types of investor they want to target, rather than trying to please everyone. They need to be sensitive to how their ESG position sits relative to their peer group. And they need to tailor their messaging and reporting to those constituencies, while ensuring that their ESG programme remains tied to the fundamentals of the business.

One thing at least is relatively simple: get this right and, as study after study has proved, your cost of capital will fall. Leaving aside the ESG-linked issuance in the global bond and syndicated credit markets, the latest report from the Global Sustainable Investment Alliance says global sustainable investment AUM has hit a record US$31 trillion. This includes US$17.5 trillion managed in “environmental, social and governance” funds, an amount that has risen more than two-thirds in two years. And the latest trend, for institutional investors to shift from active to passive portfolios and immediately wanting to make them fully ESG-integrated is transforming the ETF and wider passive market too.

Companies need to start now if they are to extract the maximum benefit from these developments.