INFORMED ARTICLE BY RICHARD DAVIES

Moving Forward with ESG in an Uncertain World

After a successful Society conference, the IR community has returned to the familiar challenges from politics, regulation and markets. Richard Davies reviews the trends, particularly in corporate governance.

The IR Society conference in June affirmed several of the trends long discussed in this column:

  • the rise of passive investment, leading to the increasing importance of ESG issues to the working lives of IROs;
  • the changing qualities of the sell-side and buy-side as MiFID II finally starts to bite;
  • the challenge for public companies to find capital in an equity market which no longer supports them as it used to do;
  • the shrinking of public equity in terms of number of companies listed in the UK and beyond; and
  • the difficulties of squaring sustainability with the continued quest for growth.

As ever, it was easier to pose the question than find the answer but at least there was lively debate and the will  to  keep on trying to find the solution.

Like many others, I was struck by the impression of the IR profession in the UK being placed at the centre of capital market changes, good  and  bad,  but  also as reactive and informed by the wider economic and political realities of the current situation.

It seemed difficult to posit any way forward on any issue when our general future as a nation remains, to use that now hackneyed adjective, uncertain. In a world where our potential (and, as I type, seemingly likely if only perhaps  initially for a few short days) future prime minister, has given an expletive-led rant about British business, it is difficult for any profession to imagine its future or set itself any goals.

We find ourselves in a perfect storm of regulatory change, structural shifts in markets and an increasing focus on non- directly financial issues such as sustainability, which were until only recently viewed as niche and marginal.

The governance debate

Life has become more difficult for the IRO but the new paradigm also brings new opportunities. As discussed in previous columns, this is a chance for IROs to take charge of the governance and wider ESG story at public companies and make IR a wider brief, the hub of how companies explain themselves to the markets.

We know increasing numbers of IROs are seeing themselves as the centre of the governance debates at their companies, working with their company secretary teams to produce the best outcomes at AGMs (by way of consolidated outreach campaigns to portfolio and governance fund managers and analysts at both active and passive managers), ensuring that the reporting on non-financial metrics and general ESG issues is to the highest quality and appropriately focused, and building towards a situation where investors believe that ESG concerns are ‘baked-in’ to the business in terms of board conviction.

Of course, boards have to believe in all this for this to really work but there has been a major shift in attitudes in recent years, driven by the realisation that not only do increasing numbers of investors take these issues seriously but also that their own roles are at stake in the new harsh world of annual re-election.

The challenges of ESG

ESG has seriously  gone  mainstream  and so quickly – the rate of change of uplift of interest in this issue in IR in the UK is phenomenal (as witnessed by our recent conference). The challenges of the industry remain:

  • the lack of a common measurement of value (which would help develop the theory of social accounting and provide a quantitative financial modelling scenario);
  • the over-abundance of rating agencies whose similar questionnaires clog up the inboxes of UK plc;
  • the reliance (whatever they may say) of investors on ratings agencies to influence investment decisions, with the unintended consequence of box- ticking having significant power over the life of the company potentially;
  • the lack of a centralised common format for ESG reporting which encourages multiple overlapping data points for similar data categories with correlated time-wasting by companies filling out forms;
  • the lack of a regulated framework within which rating agencies should operate, other than the generic market regime, which can produce market distortions not helpful to either issuers or investors; and
  • the trend towards process becoming more important than insight, with safety found by companies in boiler-plate disclosure and investors moving more to an AI investment approach based on a quantitative rating of company behaviour.

We are still in the early days of ESG. The sector and issuers are still finding their feet, both in terms of understanding what should be reported and how. Given that some of the issues in the space have become partly political – the current emphasis by the government on the application of Section 172 of the Companies Act being a good example – these are debates that are only beginning. It is very sad therefore that during these turbulent times, one of the wisest minds of the governance world, Peter Montagnon, has recently suddenly passed away. As one of the godfathers of UK governance, Peter could always be relied upon to provide honest, intellectually robust and always useful insights into how the sector should develop.

A dear friend and a member of my company’s advisory board, I treasured his wit and grace, and I shall miss him  deeply. I dedicate this piece of writing to Peter and give thanks for his contribution to our industry in ways we have yet to understand fully. May he rest in peace.

DIVIDEND ARBITRAGE: UTILISING THE TAX SYSTEM

Mark Robinson has completed our latest article, looking at the complex trading strategy that is dividend arbitrage. This tax efficiency trade has increasingly come under the spotlight in Europe, and we have sought to understand where similar activities are occurring in the UK market.

You can read the piece by clicking here.

 

RD:IR SPONSORS THE IR MAGAZINE AWARDS – EUROPE 2019

The team at RD:IR were proud to attend and sponsor the 29th IR Magazine Awards – Europe on 20 June last week. The event was held at the glamorous & Victorian 8 Northumberland Avenue. Paul Sinha did a fantastic job of hosting the evening, keeping attendees entertained after dinner during the awards ceremony.

It was a pleasure to be part of an event that celebrated excellence in investor relations from across the continent. Attendance was high from European companies far and wide. We congratulate all nominees and winners of the awards, with a special mention to our client Northgate plc. They won the award for the best small cap IR website.

Many thanks to the team at IR Magazine on putting the event together. We look forward to continuing to promote the IR profession and attending the next event!

L-R: Zak Dyson (RD:IR); Morten Buus (RD:IR); Laura Tremino Martin (Repsol); Thomas O’Grady (RD:IR); Miguel Santisteve (Leaders Arena)

IR SOCIETY CONFERENCE 2019

RD:IR was once again Gold Sponsor for the Investor Relations Society Conference, now in its 33rd year. The conference was hosted on 18 June at Kings Place in King’s Cross, London, with 400 people in attendance from issuers and service providers alike. Working so closely with the IR Society allows us to be at the forefront of the development of the IR profession, but also to feature heavily at the conference. It was great to see so many people brandishing RD:IR-branded tea towels emblazoned with our signature crumpet! We sincerely hope all attendees enjoy thinking of market-leading IR services while drying their dishes.

As with last year, the conference was very well hosted by the BBC’s own Evan Davis, who was joined on stage by the great and good of the IR and investment worlds. John Allan, chairman of Tesco and Barratt Developments, and president of the CBI, started the day with the keynote address. Setting the scene, he opened by mentioning that sustainability, climate change and corporations’ effects on the environment were at the forefront of younger generations’ minds. The distrust of corporations by the general public is something that the corporate world needs to address, and John noted that “thinking about your shareholder register will continue to be very important”. Of course, with climate change covered, no opening address would be complete without a mention of Brexit. John made his views clear that a no-deal scenario would be profoundly negative for British business, the economy and people. This would lead to a further depreciation of sterling, which may indeed encourage greater levels of foreign direct investment but would weaken British business’ purchasing power abroad and open companies to potential takeovers from foreign corporations. None of his comments on Brexit were too positive, but he did not become hysteric, instead noting that life will go on even with short-term disruption and long-term degradation. With so much negativity present in the political and business environment, John stressed that it is hugely important for IR professionals to remain honest and transparent. IROs are the eyes and ears of companies, so they must remain in constant contact with all stakeholders, unafraid to deliver unpopular messages if so required.

The day continued with seven different sessions interspersed with two keynote interviews with Susan Hooper and Sarah Bates respectively. The running theme throughout all sections of the day was ESG, which is a theme that seems to have almost wholly eclipsed MiFID II and – dare I say – Brexit. The former seems to have brought about a lot less change than anticipated, and the latter is such an unknown that people and companies do not know in which direction to head without further details from the government – no-deal, May’s deal or some other future? With ESG in mind, Gareth Hayward of Charles Stanley told the audience that he had recently been told by a company that they focused on what they called the three P’s: planet, people and profit. It would not have been too long ago that ‘planet’ would not have made this list.

There was wide agreement throughout the day that ‘ESG’ can be a problem label. It can be interpreted in so many different ways, so it is either better to break it down into its component parts or use the term ‘sustainable’, as per the suggestion by Andrew Parry of Hermes Investment Management. However, there is definite recognition that ESG issues, in whatever form, have been rising rapidly in the past twelve months and are now front-and-centre for most industry professionals. Indeed, Evan Davis asked for a show of hands by the audience to see who recognised this change and everybody agreed that they had noticed the change over the past year.

Rather contrary to the message of the day from many speakers was that put forth by the IROs. There was agreement that while the buy-side seem to bang the ESG and sustainability drums externally, it is exceptionally rare that investors will ever ask about ESG issues when in meetings with IROs. So it appears there is still work to be done for ESG to truly permeate all aspects of the investment industry. To aid this push, the afternoon panel dedicated to ESG made the case that ESG factors should not be thought of as entirely separate to the financial health of a company. It is far more accurate and helpful to see ESG issues and sustainability as part of how to value a company, with these topics being included into traditional reporting. There is still a long way to go for ESG ratings to be successfully implemented, however, and this is improving all the time.

Despite ESG being so dominant, there was space for other topics, and MiFID II was still a considered one. Now in play for 18 months, any effects from the legislation should be at least starting to be seen. Anne Scott of Kames Capital noted that analyst interaction has decreased by around 30%, though corporate access has stayed at a fairly constant level. In line with the declining level of analysts, Steve Davies of Jupiter has seen research declining, so his approach is to have fewer analysts but pay them more. This would be to avoid the process of ‘juniorisation’ that is taking hold in the industry, where quality declines as more junior analysts produce the research.

MiFID II was then considered by a panel of IROs, two of whom were from larger caps Sainsbury’s and easyJet and have seen a very limited reduction in analyst coverage, if at all. On the contrary, Richard Amos of small-cap Wilmington has seen coverage reduce quite considerably, meaning he is now considering going the route of sponsored research. The challenge is to keep this trustworthy and avoid the market viewing the research as conflicted due to the corporate footing the bill. A solution to this suggested would be to have the research without any investment recommendations and more focused on being an honest review of a company.

The interaction between investors and issuers has fundamentally changed since MiFID II came into force, with the sell-side becoming less relevant in many respects. Dani Saurymper of AXA Investment Managers told the audience that he has taken it upon himself to organise a recent roadshow to meet corporates. He found these corporates to be very accommodating to his requests and there was no sell-side either present or needed. This model of direct access is something we are likely to see much more of as both issuers and buy-side firms build out their corporate access teams. In addition, conferences and capital market days are something that will prove very useful as the market continues to adapt, as noted by Carl Murdock-Smith of Berenberg.

To build and maintain strong relationships with investors, outsourcing entirely to third parties is not the answer, but David Phillips of Hays noted that outsourcing is still a very useful tool because IROs are only going to become more busy. Being able to have assistance with 7am email announcements and meeting organisation from third party providers are things that will only boost any IR strategy. This level of organisation will always be required, as Sarah Heald of Pennon Group noted that while video conferencing is on the rise, investors will always want to see the whites of the eyes of an issuer’s board before investing.

In addition to MiFID II and ESG issues, many other topics were touched upon in what was a very full event. Evan Davis’ interview with Susan Hooper at the beginning of the afternoon was very interesting indeed. Susan is an NED of Uber, Wizz Air, Affinity Water and The Rank Group, as well as being on the board for the DExEU. She primarily focused on the role of NEDs in the efficient running of companies, noting that they exist to “kick the tyres of the strategy, fundamentals and culture” of a company. Climate change and sustainability are important to Susan, so she has identified that an important challenge for boards over the coming years will be to give a positive message to stakeholders that isn’t about growth. This will prove difficult in an environment where business ‘success’ and ‘growth’ are often synonymous, but the pressure exerted on the environment by business means a requirement for less consumption.

The final interview of the day was with Sarah Bates, the chair of Merian Global Investors. She focused on the changing investment environment and how ownership of companies has transitioned hugely with the rise of passive investments and ETFs. Sarah said that part of the role of being an IRO was to make yourself and your company available and easy to deal with, not hiding away when times get tough. Investor relations is where the bridge between investors and issuers is created, so it forms a vital part of an issuer’s longevity and ability to connect with the market.

In all, the day was interesting and well organised. We thank the team at the IR Society hugely for their hard work and look forward to seeing many of the attendees at other events throughout the year.

RICHARD DAVIES MODERATES IR MASTERCLASS

The second panel (L-R: Trelawny Williams, Rob Beale, Andrew Ninian, Richard Davies)

On 25th April 2019 Richard Davies, Managing Director of RD:IR, curated and moderated the first of two IR Masterclasses for 2019, organised by the IR Society and hosted at the offices of Instinctif Partners. This Masterclass looked at topics relating to governance.

Richard opened the morning with a broad overview of the current investment and IR landscape, as well as introducing the various speakers. Richard commented that the environmental, social & governance (ESG) industry is growing at notable pace, with portfolio managers becoming more aware of these issues, as well as the governance teams.  This has led to a culture for 2019 in which every AGM is potentially contentious.

Following the introduction, Richard gave way to Tom Nolan of Fidelity Management & Research Company, who spoke in-depth about the macroeconomic environment and how this could develop in the short- to mid- term. His research had concluded that there are three points that stand out the most within macroeconomics:

  • The economic cycle is mature yet still has legs;
  • Consensus expectations are finally reflecting some caution;
  • Risk assets are typically exhibiting more volatility, but returns are still strong.

With these points in mind, it was noted that the global economy is in late cycle and about to go into a cyclical pickup. Tom took the view that a recession is not likely soon, which is contrary to a lot of market commentators. To bolster this thinking, Tom presented evidence of interest rates not having risen, as these rates have risen directly prior to previous recessions. Tom proceeded to dig into a great deal of economic data, discussing everything from Brexit to Trump, UK politics to trade wars.

The first panel came to the stage after Tom, consisting of Will Pomroy of Hermes Investment Management, Leighton Barnish of Emperor, and Simon Gleadhill of Howden Joinery Group. Their topic of discussion was the increasing challenges of ESG reporting. An eye-watering $30tn is now flowing into ESG matters one way or another, making this a very pertinent topic. It was noted that ESG topics have been considered by investors for quite a few decades, under the different guises of more specific terms like ‘governance’, ‘CSR’, and ‘sustainability’. While in the past, companies focused heavily on health & safety, modern times have seen a shift towards environmental and equality issues at company level, and this will become more relevant as Generation Z replaces Millennials and Generation Y as investors, consumers and employees.

Simon Gleadhill took the view that getting investor feedback is crucial to understanding how to report on the company – what do investors want to hear about, and what are their main concerns? The panel agreed that it is possible to give too much ESG information to investors, flooding annual reports with every case study and detail. Websites can be used to showcase most data and case studies, but annual reports should be thought through and targeted to specific audiences. To demonstrate this shift over time, a fact was offered that ten years ago a CFA study found that almost no CFA members were paying attention to ESG matters, compared to a notable 73% today.

An important point to take away from the first panel session was that the ESG marketplace is very crowded with various metrics. There are myriad indices in existence. Will Pomroy stated that Hermes, for example, conducts its own research into companies to understand a company’s ESG standing. The crowded marketplace is a sign of good, however. Leighton Barnish said that Moody’s conducted a retrospective analysis and found that there was an almost perfect correlation between companies they downgraded and those companies’ poor sustainability record. This added evidence to the idea that ESG-focused investing does not affect returns, and in fact having a strong sustainability record could benefit a company.

The second panel was made up of Andrew Ninian of The Investment Association (IA), Trelawny Williams of Brunswick, and Rob Beale of Capital Group, looking at the AGM season for 2019 and investor concerns for the meetings. Broadly speaking, these concerns were around governance, with the primary focus being on boards and board members. A list of the top five issues for 2019 was read out and summarised, with those issues being:

  • Board diversity
  • Directors’ pensions
  • Overboarding
  • Directors’ tenure
  • Proxy advisory agency (PAA) transparency

Andrew Ninian told the audience that the IA’s view is that diversity is positive for sustainability and long-term growth. He referenced the aim to have one-third of all board members to be female, established by the Hampton-Alexander Review, and how the IA has been contacting companies to ask them to change the make up of their boards. An approach of ‘one and done’ has been adopted by a lot of companies apparently, meaning they have appointed one female board member and then considered their work on diversity done. This is something the IA has been battling against, believing that diversity should be something constantly addressed and with a full commitment to and belief in the end goal. The view was taken that pay gap analyses based on other aspects than gender are also on the way.

With regard to the broader topic of boards acting in the best interests of all stakeholders, Trelawny Williams noted that there is no enforcer of section 172, Companies Act 2006. This causes a potentially confusing interpretation of the law and an inconsistent approach between companies. The question was asked as to whether the successor to the current Financial Reporting Council (FRC) will have some enforcement capabilities to bring understanding and discipline to the market.

The power that PAAs have over the outcome of companies’ general meetings was acknowledged as an issue, along with the view that those same PAAs also provided a very useful and important function. Steps have been taken to address the one-way nature of the information that PAAs give to investors, with Glass Lewis now allowing companies to comment on its recommendations. Andrew Ninian praised the incoming Shareholder Rights Directive II (SRD II) that the EU has instigated, and which will become law later this year. This legislation places requirements on PAAs for them to be more transparent in what they are recommending and how they have come to their conclusions. We have published a piece on SRD II, which is available to read here.

The top tip from the speakers at the end of the second panel session was for companies to keep communicating with stakeholders and the wider market. If a board has chosen to do something, it should be open and explicit as to why, explaining itself with clarity.

The third and final panel session for the morning included Adrienne Monley of Vanguard and Simon Bailey of JLC Investor Relations. With Vanguard having recently opened up an office in London, and with $350-400bn invested in the UK, it was interesting to hear from such a major fund manager. The topic of discussion for Adrienne and Simon was the impact on IR from the rise of passive investing. Simon Bailey kicked off by noting that around a third of the investment market is now passive, but that it is never a case of simply active versus passive. Both approaches to investing coexist, and passive could not exist without active managers pricing and providing liquidity to the market. With this in mind, Adrienne noted that Vanguard actively manages around $1tn of investments in the USA, despite the fact that Vanguard is most well known for its passive investing.

Adrienne Monley made it clear that passive investors like engaging with companies just as much as active investors. This is particularly relevant during times of down markets, as investors tend to seek more engagement with companies, and so more resources are focused on stewardship.

With Vanguard being an US-based manager and Adrienne Monley’s experience being heavily US-focused in the past, her experience has been that governance and wider ESG issues are spoken about more openly in the UK than the USA. In addition, she noted that boards are more open over here and are happier to engage with large shareholders. It is very common in the US for the top three holders of a company to own most of the shares; in the UK, share registers are more dispersed.

SRD II was brought up as an important next step in market clarity, and the point was made that this will impact PAAs. The speakers agreed that PAAs have an important role to play, especially with fund managers having to research so many companies, so they should still occupy an important place in the market, but the new legislation will place greater emphasis on their transparency.

Engagement was the key point of the final session. Both Adrienne Monley and Simon Bailey were of the view that engaging with passive investors is what companies should be doing. The message was that passive is going to be considered the new normal, so companies may as well get used to it.

As ever, the IR Masterclass was a very insightful event and we thank the IR Society for organising the event.

RD:IR works in the governance area with companies to assist their communication with the market, either on a one-off or retained basis. Please get in touch to discuss this or any of our other services further.