Sustainable investment set to grow as investors focus on climate

By Gavin Hinks

green investment, ESG strategy, responsible investment

Sustainable investment has improved its profile among asset owners and managers, indicating that further pressure to adapt to climate change is on the way for corporate boards.

Researchers spoke to 650 institutional investors around the world and reported that the proportion who “do not believe in” sustainable investment has fallen significantly over the past 12 months, from 18% in 2018 to just 11% this year.

While that may be good news for policymakers and campaigners concerned that investors put more pressure on companies to operate sustainably, the research from asset management firm Schroders also found that almost one in five investors globally (19%) do not place assets in sustainable investment funds. And this despite the avalanche of announcements from asset managers unveiling sustainability funds in recent times.

However, according to Jessica Ground, global head of stewardship at Schroders, the research shows that “even the most sceptical” of investment institutions now recognise the value of sustainable investment. She also said the trend was now global and no longer tied to specific regions. Further growth in sustainable investment can also be expected.

“The study emphasises that this only going to grow over the next five years with the likes of climate change now viewed by investors globally as the most important issue for stewardship engagement,” she said.

Among engagement topics, respondents revealed that climate change had become the most important (now rated the most important by 54% of respondents), eclipsing corporate strategy (53%) for the first time. This may be recognition that climate change has become a core part of strategy and for many companies will lead discussion on strategic direction.

An overwhelming number of investors believe sustainability to “play a greater role” over the next five years.

However, more European respondents—84%—were certain of this than in Asia Pacific, where the figure was 67%. That would concur with observations that market players in Far Eastern markets are still adjusting their thinking to the sustainability and climate change debate.

Challenges ahead

If investors are to continue the trend they will need better information and data, according to the survey. Globally, 76% of investors said sustainability investing was “challenging”, highlighting issues with a “lack of transparency reported data”.

There has been growing pressure on companies around the world to adopt the G20’s Task Force on Climate-related Financial Disclosures (TCFD) guidelines on reporting climate-related risk.

During a recent summit in Tokyo, Bank of England governor Mark Carney warned that companies that failed to adjust to a net-zero carbon emissions world would “cease to exist”.

He also warned that the financial system was not moving fast enough to integrate the climate crisis into investment decisions.

“Like virtually everything else in response to climate change, the development of a more sustainable financial system is not moving fast enough for the world to reach net zero.

“To bring climate risks and resilience into the heart of financial decision-making, climate disclosure must become comprehensive, climate risk management must be transformed, and investing for a two-degree world must go mainstream,” he said.

Meanwhile, a review of FTSE 100 annual reports found that just one in five companies mentioned the TCFD and only four “provided fulsome TCFD disclosures within their annual report”.

Just nine companies included climate change “within discussion of their strategy”. Only two of those “explained how their strategy is resilient to climate change”, though 57% of companies “explicitly referred” to climate change.

According to Veronica Poole, head of corporate reporting at advisory firm Deloitte, which was behind the review: “Businesses are facing increased scrutiny of their impact on people and the planet.

“The expectation of business is changing, and the licence to operate can no longer be taken for granted.”

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Big Four accountancy firms see decline in combined audit income growth

By Gavin Hinks

Big Four, PwC, Deloitte, EY, KPMG

The growth in audit fees for Big Four firms has fallen back significantly to one of its lowest levels since 2010.

Audit fees grew by 1.7% for Big Four firms combined—PwC, EY, Deloitte and KPMG—in 2017–18, compared with 5.7% the previous year, its highest rate of growth in the current decade.

In 2009–10, the year following the financial crisis, Big Four audit income shrank by 2.2% on the previous year.

The latest audit report on key trends in the accountancy profession from the Financial Reporting Council revealed how the UK audit profession has fared over the past year.

Audit and the audit profession has been under close scrutiny since the collapse of construction and outsourcing giant Carillion in January 2018. The government has since ordered a number of reviews looking at the audit market and audit regulation.

The latest report shows that the Big Four rely slightly less now on audit fees from publicly listed companies, even though they now undertake the audits of members of the FTSE 100 index. In 2018 audit fees from listed companies accounted for 19.4% of overall revenues. In 2007, a year before the financial crisis, the share was a quarter of all income.

The figures suggest that the Big Four may be going through an adjustment. Income from non-audit clients has risen to 72.1% of total fees, compared with 68.7% in 2016. In 2007 that figure stood at less than 60%.

Audit in the spotlight

Auditors have been under greater scrutiny since the financial crisis when many observers asked why they had failed to sound the alarm over finances in stricken banks.

The European Union placed the profession under a microscope with a new audit directive implemented in 2016. The directive introduced new reporting responsibilities for audit committees; mandatory audit firm rotation; and restrictions on the non-audit services that could be supplied to audit clients. There was also a cap on the non-audit fees that could be charged to audit clients.

The new rules prompted a movement by clients to new audit providers but witnessed little progress in encouraging new entrants to the audit market for large cap companies.

Further examination of audit followed the collapse of Carillion. The Kingman Review recommended the replacement of the Financial Reporting Council with a new body, the Audit, Reporting and Governance Authority (ARGA) with new powers.

However, Sir John Kingman, author of the report, recently complained that central government seems to have made no progress in pushing the new powers through parliament. Those powers could include ordering an evaluation of an audit committee or even the removal of an auditor.

Elsewhere, the Competition and Markets Authority looked at the audit market, recommending that audit be operationally split from other services. Government is still to legislate on those proposals.

Meanwhile, a further review, by Sir Donald Brydon, is looking at the quality and effectiveness of the audit process itself. He is expected to report later this year.

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New UK stewardship code puts focus on investor engagement

By Gavin Hinks

boardroom, board executives

Investor engagement with boards and companies is set to come under much closer scrutiny following the release of a new stewardship code by the UK’s watchdog for corporate reporting and governance.

The Financial Reporting Council (FRC) published the new code this week confirming, as expected, that it would place a much heavier emphasis on outputs rather than inputs: signatories to the code must report on their actual stewardship activities and their outcomes, rather than just their policies.

Recommendations to shift the emphasis of the code, or abolish it, were made a report last year by Sir John Kingman after he had reviewed the work of the FRC.

A statement from the FRC said the new code includes a requirement for investors to detail their activities and its outcomes “including their engagement”.

Perhaps more significantly, those following the code must also “take environment, social and governance factors, including climate change, into account”. The order is likely to trigger a fresh round of investigation as investors ensure they have measures in place to monitor these areas. Numerous indexes interrogate sustainability activity but the “social” in ESG has proved difficult to measure so far.

Sir Jon Thompson, chief executive of the FRC, called on investors to sign up to the newly revised code and warned investors they would be “held to account” on the quality of their reporting through “regular review”.

“Asset owners and beneficiaries will then be able to see if those investing on their behalf are doing so in accordance with their needs and views,” Sir Jon said.

“They will also be able to see the impact of their manager’s decisions, particularly in relation to environmental, social and governance issues, including climate change.”

The FRC’s chair, Simon Dingemans, called the revision “ambitious”. However, he emphasised that the code is still voluntary.

“We are looking for widespread adoption by the investment community, reinforcing the attractiveness of the UK as a place to do business and delivering real benefits to the economy, the environment and society.”

Integrated investment

The code’s Principle 7 captures the need for integrating ESG issues into investment decisions. It says: “Signatories systematically integrate stewardship and investment, including material environment, social and governance issues, and climate change, to fulfil their responsibilities.”

Principle 9 in the code covers the document’s significant new emphasis on the consequences of policy and contact with invest companies.

It says: “Signatories should describe the outcomes of engagement that is ongoing or had concluded in the preceding 12 months, undertaken directly or by others on their behalf.”

This might include how outcomes of engagement have affected investment decisions and the action taken by companies as a result of engagement.

The code has also been extended to cover asset owners, such as pension funds and insurance companies.

Those signed up to the code are also required to “explain their organisation’s purpose, investment beliefs, strategy and culture”. They must also demonstrate their purpose and beliefs through “appropriate governance, resourcing and staff incentives”.

The code is not only intended to address the behaviour of asset owners and managers but also responds to criticism of the FRC in a review of the regulator by Sir John Kingman, which also looked at its handling of stewardship. In his final report last year Sir John wrote: “The Stewardship Code, whilst a major and well-intentioned intervention, is not effective in practice.”

It was Sir John who recommended the code “focus on outcomes and effectiveness and not on policy statements”. He added the code should be abolished if it could not be reformed because it was acting as a “driver of boilerplate reporting”.

Sir John also proposed that government should consider whether more powers were need to “assess and promote compliance” with the code.

He asked that the FRC “engage at a more senior level in much wider an deeper dialogue with UK investors”. Sir John also recommended the abolition of the FRC and replacement with a new body, with new powers and funding arrangements to be called the Audit, Reporting and Governance Authority.

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Feeling drained? Why leaders must learn to manage their energy

By Manfred F. R. Kets de Vries

stressed CEO at his desk

When I ran into Dirk, a banking CEO whom I had known for some time, I asked him why he looked so down. After a short silence, he responded with an avalanche of words. He had been feeling exhausted. At work, he had too many meetings, often with people he didn’t like. Given his position, Dirk felt his only option was to masquerade as a positive person. But it wore him out. He was also suffering from insomnia and the little sleep he managed to get was filled with nightmares. Clearly, Dirk wasn’t in very good mental shape.

I asked Dirk if he had ever used a diary to record his daily activities. Perhaps such a diary would illuminate what drained—and energised—him. He could even identify salient positive and negative themes on this self-created “energy barometer”. Awareness of the situations that affected him negatively would help him find ways to pre-empt them.

My encounter with Dirk made me consider the bad habits and situations that often drain our energy. They can beset all of us. But do we recognise the symptoms and are we willing to do something about them?

Common energy drainers

To find out more about what can zap energy, I have been asking the executives in my annual CEO seminar at INSEAD about the habits, situations or mind-sets that affect their mental health. The list was an interesting one.

Addiction to the internet and other passive media

Unsurprisingly, most of the executives complained about being addicted to the internet. Not only did the endless stream of communications stress them out, they also admitted that they spend a considerable amount of time on social media and other online activities, distracting them from their primary tasks. In the same vein, some said that they spend hours mindlessly watching television or streaming services.

Inability to master one’s own time

Many executives confessed that they were ineffective at setting priorities. They had a hard time deciding what was important and sticking to their schedule. They also had problems setting boundaries and felt their time was at the mercy of other people’s priorities. Interestingly enough, while some executives complained about a lack of structure in their lives, others said that their lives were overstructured – with little freedom to pursue energy-giving endeavours.

Excessively high expectations

Some of the executives often felt like they were trying to please everybody. Yet an even greater number of executives succumbed to perfectionism. They were very tough on themselves and unable to accept the idea that they could make mistakes (as a way to grow and develop). Instead, some of them were masters at tormenting themselves, stressing over things they couldn’t control.

Continuing unproductive relationships

Another common complaint was having to deal with negative people. Some executives explained how exhausting it was to play the role of a “bin” in which everyone dumps their problems. Others noted they were oversensitive to certain people who knew how to push their buttons and were difficult to avoid, like a boss or a family member. This observation led some to realise that they had stayed too long in an unhappy relationship. Although it drained them, they didn’t necessarily know how to get out of it.

Poor eating habits

Given their constant pressures, many executives found themselves with poor eating habits. They ate too much fast food or ate excessively to soothe themselves. Indeed, quite a few of them had serious weight problems. Others told me that they self-medicated (e.g. by taking drugs and drinking excessively) to numb the pain of their taxing emotional labour.

“Hurry sickness”

Many executives shared that their workload and hectic business travel schedules made them prey to “hurry sickness”. Just like White Rabbit in Alice in Wonderland, they always felt frantic, like time was running out.

Frankly speaking, a number of executives admitted that many of their energy-draining activities served to avoid bigger issues in their lives. They preferred to resort to “manic defence”, a behaviour pattern whereby people try to distract themselves with a flurry of activities or by faking the opposite of the thoughts or feelings plaguing them. Some added that they had a tendency to bury unpleasant issues into mental “boxes”. Of course, these issues tend to resurface in uglier, even more energy-draining ways, at the most unexpected time.

Correcting the imbalance

Aside from sapping your energy, all the activities and situations mentioned take up the days, hours and minutes that could be devoted to invigorating ones. What does your “energy barometer” look like? Do some of the themes above resonate with you? If so, what are you doing about it? You could restructure your life to focus on energy-boosting activities, such as:

  • Creative endeavours
  • Spending time with family and friends
  • Exercising
  • Walking outdoors.

According to the executives, another major pastime that fell by the wayside was reading. It is a pity, as reading is an activity that can build empathy and comes with many other psychological and neurological benefits.

Aristotle wrote about eudaimonia, a concept referring to the “highest human good” and describing a life aimed at maximising happiness through virtue. A deeply meaningful life is achieved by engaging with others—family, friends and fellow citizens—in mutually beneficial activities. The Greek philosopher further drew a distinction between eudaimonia and hedonia, which is the pursuit of subjective wellbeing via the pleasures afforded by food, sex and social interactions. He suggested that both hedonic and eudaimonic pathways are crucial to living a happy, fulfilling life.

If wellbeing and happiness are eluding you, remember to put on your oxygen mask first before assisting others, just like you would on a plane in an emergency. In terms of energy, we must all take care of ourselves before we can take care of others. Martyrdom or always keeping up a brave front are not the way to go. There is nothing weak about being “less than perfect” and asking for help. Opening up about your unhappiness, as Dirk did, is the courageous first step towards replenishing your precious energy.

Manfred F. R. Kets de Vries is the Distinguished Clinical Professor of Leadership Development & Organisational Change at INSEAD and the Raoul de Vitry d’Avaucourt Chaired Professor of Leadership Development, Emeritus. He is the programme director of The Challenge of Leadership, one of INSEAD’s top executive education programmes.

This article originally appeared on INSEAD Knowledge. Read the original version here.

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TCFD summit confirms climate risk should be your board’s priority

By Richard Howitt

climate, climate change, ice melting

The recent global summit of the Task Force on Climate-related Financial Disclosure (TCFD) made it clear that companies will increasingly be subject to challenge on management of climate risk by regulators, investors and wider stakeholders.

The necessity for “climate competence” to be a core skill for corporate boards had already been underlined through the publication of guidance for Effective Climate Governance on Corporate Boards at the World Economic Forum in January.

There was a call for increased quality and quality of TCFD reporting, now standing at 800, in the Task Force’s last Status Report in June.

But as climate protests fill news bulletins around the world, this month’s summit in Tokyo is potentially far more significant, in setting a pathway for climate risk to become integral and unavoidable for mainstream corporate governance in all economic sectors.

A major push

If the original TCFD recommendations were a call to action, the summit charted an action plan through which they will be implemented.

Bank of England Governor Mark Carney used the summit to warn that regulation requiring TCFD reporting is probably two years away, appealing to businesses present to develop their own reporting in the meanwhile, to ensure mandatory measures are shaped to be most effective for business itself.

The veiled threat is that companies who delay on climate disclosure will find themselves subject to costly burden.

Full integration of TCFD recommendations in the EU’s Non-Financial Reporting Directive guidelines is a further sign that Europe may lead mandatory reporting requirements as part of its major push towards sustainable finance, also in the next two years.

Investors are themselves now rewarding and penalising companies on how far they are genuinely integrating climate risk

The UK’s own Green Finance Strategy is hardly less ambitious, setting a target for all listed companies and large asset owners to disclose their climate-related risks and opportunities by 2022 at the latest. And the capital markets regulator in Australia has issued guidance to company directors on addressing climate risk.

But the global summit was notable for its recognition that investors, not simply regulators, are themselves now rewarding and penalising companies on how far they are genuinely integrating climate risk.

One tangible initiative from the summit was new green investment guidance published by Japan’s own TCFD consortium. The effect will be a significant increase in investor engagement with companies on climate issues.

Companies present at the summit reporting anecdotal evidence of increased investor engagement on the issue included Shell, Total and Sumitomo Chemical.

A PwC report cited in Tokyo shows positive correlation between stock or share price and the quantity of TCFD disclosures made by the company, with research from the Commonwealth Climate and Law Initiative quantifying that that the risk of non-disclosure is a bigger liability for the company than of disclosure itself.

Meanwhile, during the 2019 proxy season shareholder activists pressed disclosure resolutions including climate risk at no fewer than 64 company AGMs in the US alone.

An opportunity for leadership

The summit heard TCFD reporting is being adopted by companies valued at a combined market capitalisation of $118trn—an important challenge to organisations that have not yet made the shift.

Already we know that climate-related financial risk should be treated by directors as a core part of their duty to promote the success of the company. Failure to do so could expose directors to legal challenge.

But the action required is now clear. The board should ensure that material climate-related risks and opportunities are not simply reported, but fully integrated in to the company’s strategy, risk-management process and investment decisions.

Climate-related financial risk should be treated by directors as a core part of their duty to promote the success of the company

Among the actions required are ensuring board and committee structures incorporate climate risk and opportunity; recruitment of new directors with the requisite knowledge and skills; incorporating management of climate risk into executive remuneration; and fully integrating it in the company’s own risk management.

Board members must provide the leadership for the company to engage with relevant experts and stakeholders to tackle the challenge, and should ensure they are sufficiently informed themselves to maintain adequate oversight.

Lastly, boards should recognise that climate risk may involve addressing timescales beyond conventional board terms, but are within mainstream investment and planning horizons accorded to every other financial risk and opportunity.

A board responsibility

The summit underlined how existing TCFD reporting is still falling short of being decision-useful, in demonstrating strategic resilience of the company and in incorporating targets for transition to net zero.

It also enabled further discussion of the measurements required for reporting, including clarifying what is green revenue, and the definition of terms such as “environmentally sustainable”.

But as work from the Corporate Reporting Dialogue shows, almost all of the necessary indicators are already available in existing frameworks. It is not whether they are available, but how they are used.

Ultimately this is a responsibility that must reside in the boardroom itself

Plentiful assistance for board members is on hand through online resources like the TCFD Knowledge Hub organised by the Climate Disclosure Standards Board, training offered by organisations such as Competent Boards, or detailed guidance for specific sectors through specific TCFD preparer forums.

But ultimately this is a responsibility that must reside in the boardroom itself. Every company board has its own responsibility to consider where its own business model stands in relation to that transition.

And with finance ministries, central banks and regulators in the top 20 economies of the world concluding that climate change is a risk to the stability of the entire global financial system, no company can ignore this task.

Richard Howitt is a strategic adviser on corporate responsibility and sustainability, and former CEO at the International Integrated Reporting Council.

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