Life Soon Will Get a Lot Harder for Firms That Fail ESG Tests: Top Stock Owner

The chief executive of the world’s largest stock owner says life is about to get quite a bit harder for firms that fail environmental, social and governance tests set by institutional investors.

Nicolai Tangen, who runs Norges Bank Investment Management from Oslo, says the degree to which ESG dictates an organization’s prospects is “beginning to hit now.” Firms that don’t adapt face a world through which financing will dry up, insurance firms will walk away, employees will defect, social-media shaming will intensify and customers will disappear, he said in an interview.

As CEO of Norway’s wealth fund, Tangen oversees about $1 trillion value of stocks, which represents roughly 72% of the overall portfolio. The remainder is in bonds, real estate and renewable energy infrastructure. The 55-year-old former hedge-fund boss has been taking care of Norwegians’ collective savings since late 2020. And he’s promised Norway’s government he’ll turn the fund, which was built from the country’s fossil-fuel riches, into a world leader in responsible investing.

It’s a method that’s ultimately intended to make cash, based on a view that ESG duds will develop into uninvestable. The subsequent step for the fund is to hurry up the pace of divestments based on ESG risks, in accordance with its chief corporate governance officer, Carine Smith Ihenacho. Firms are dumped if the fund decides engagement isn’t well worth the effort, a tactic that’s mostly applied to smaller stocks.

Pressure Campaign

For larger firms with low ESG scores, the investor says it’s about to use quite a bit more pressure. Firms are sent so-called expectation documents which encompass all the things from water use, to biodiversity to children’s rights. Firms that don’t rating well against those requirements can expect to be grilled by the fund, with a view to a change of strategy. If that doesn’t work, an aggressive cycle of shareholder voting awaits.

“It’s based on the idea we’ve that within the longer run, if firms don’t manage their ESG challenges well, they’re not going to be profitable,” Ihenacho said. In the event that they don’t improve, then the fund can “begin to vote against, for instance, a director who’s answerable for climate, or a board committee chair, or the chair of the board,” she said.

This 12 months, Norway’s wealth fund didn’t back Exxon Corp. CEO Darren Woods continuing as chairman, and demanded that the oil giant be transparent around political contributions, in an effort to stop the type of corporate lobbying that results in dubious climate policies.

The investor also backed a successful proposal that Chevron Corp.’s emissions targets include Scope 3, which is the broadest definition and covers the carbon footprint of its customers. And Ihenacho says the fund is now stepping up pressure on firms that may’t explain their taxation models.

It’s a method the fund says is more powerful than outright divestment. “If we just sold out straight away, it wouldn’t solve the issue of getting towards 1.5 degrees,” Ihenacho said, referring to the critical planetary warming limit identified by scientists.

The fund’s governance structure means it’s also guided by recommendations from a Council on Ethics regarding firms to blacklist, regardless of any financial considerations. Inside that framework, the investor has excluded scores of firms comparable to Canadian Natural Resources Ltd., as a consequence of its “unacceptable greenhouse gas emissions,” BAE Systems Plc, due to its involvement within the “production of nuclear weapons,” and Vale SA, based on the “severe environmental damage” brought on by the corporate.

But beyond that framework, Tangen characterizes divestment as a cop-out. “You’ve two camps,” he said. “One sees an issue, and just runs away. We predict that approach doesn’t make much sense, since you don’t solve any problems. Any individual must own these firms. We predict it’s higher that we attempt to constructively move them in the correct direction.”

Divestment vs Engagement

The controversy around ESG divestment versus engagement is increasingly attracting academic research. A study earlier this 12 months showed that funding costs for firms that pollute hardly change once they’re divested, indicating that portfolio allocation ultimately does little to correct unethical behavior in the company world.

Authors Jonathan Berk (Stanford Graduate School of Business) and Jules Van Binsbergen (Wharton School) wrote that “given the present levels of socially conscious capital, a more practical technique to put that capital to make use of is to follow a policy of engagement.”

Other studies suggest that each strategies can go hand in hand. Divestment in addition to thematic and integrated strategies “have potential to assist in their very own way,” in accordance with research by Jonathan Harris, director of Total Portfolio Project and an associate researcher at EDHEC-Risk.

Tangen says engagement works more often than not. “There are only a few firms that don’t respond,” he said. And people who resist change face a bleak future, he said.

“You’re not going to get any financing since the banks are under increasing pressure to be very careful; you’re not going to get any insurance, because insurance firms are under pressure as well,” Tangen said. “No one’s actually going to be just right for you because for young people, it’s really, really essential that their values are aligned along with your values.”

After which there’s the impact of social media, which has the ability to sway customer behavior, he said. “You’re not going to get any clients…in case you should not sustainable.”

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