What Happens When Companies are Receptive to Investor Feedback on ESG?

Keiyau Sin

Associate Director and Product Manager, Material Risk Engagement

Palle Ellemann

Director Engagement Services

Nearly two years ago, Sustainalytics launched its Material Risk Engagement program on the premise that if we engaged with high and severe risk companies focusing on key unmanaged ESG risks, we could drive meaningful real-world change. With 22 months of data and results, we observe that our proactive approach generates better risk management systems (such as safety training or tailings management) and reduces the exposure to negative impacts for ESG and brand reputation. What’s more, these results are measurable using our ESG Risk Ratings research. When companies are receptive to investor feedback, there are often clear real-world impacts and positive changes. Such engagement outcomes vary and are directly tied to the company and its company-specific exposure to material ESG issues.

A Unique Approach for Every Company

At its core, the value of a company-by-company engagement approach is that it is indeed very close to real-world impact. For instance, when a company implements better safety procedures and practices based on our recommendations, fewer people get hurt on the job. When we conduct engagement, we engage with change agents (people) within the company. We seek to raise ESG awareness and increase commitment to sound ESG risk management. To ensure long-term corporate sustainability and value creation, we focus our recommendations on ESG risk management structures as well as specific ESG performance (outcomes). Following every engagement meeting, our team delivers a set of specific Suggested Actions, catering to the maturity of the company’s sustainability journey and providing guidance on what the company should do to improve ESG risk management. To the extent that companies follow these Suggested Actions, they will lead to company-level impacts that will collectively lead to system-level impacts.

Assessing and Tracking Engagement

We systematically track engagement outcomes in various ways. First, we track Positive Developments, defined as new initiatives that engaged companies have implemented with reference to our Suggested Actions. These are tangible results improving ESG risk management and/or performance. Second, the Sustainalytics Research Team conducts regular reviews of the ESG Risk Rating, reflecting the changes in the quality of management of material ESG issues.

A concrete example of how MRE drove impact in 2021 is climate change, a recurring theme in about three out of four MRE dialogues with companies. All industries and companies can be exposed to this systemic risk to various degree and through different parts of their value chains. By referencing the recommendations of the Task Force on Climate-related Financial Disclosure (TCFD), our Suggested Actions address first and foremost companies’ approaches to managing climate risk – for example, risk assessment and disclosure, carbon emissions monitoring etc. As the commitment to addressing climate risks and risk governance structures mature, we would then emphasize the importance of developing measurable targets to improve performance. While MRE is a relatively young product, only officially launched in early 2020, we already see companies advancing their climate risk management and performances with numerous Positive Developments.

During 2021, 225 Positive Developments were recorded. As shown in the below chart, of the 51 climate-related ones, 29 pertain to developing climate targets, ten on corporate initiatives to address climate change (e.g., energy efficiency programs), eight on the commitment to aligning disclosure with TCFD or enhanced risks disclosure and four on better transparency on carbon emission and capex data.

The ESG Issues in Focus

For the first time, Petrobras has highlighted a new initiative in its five-year strategic plan relating to renewable energy development among its three key issues. This is directly followed by specific carbon emission reduction targets for 2025 and 2030 and a public commitment to end routine flaring. For target setting, Korean Air Lines has committed to energy efficiency targets in Korea above the general sector targets (2% versus 1.5%), and it is so far meeting this well above the target, which also means avoiding any cost in the Korean carbon exchange trading system. Companies improving disclosure on carbon emissions and developing relevant reduction targets will lead to improved scoring in the applicable management indicators of the ESG Risk Rating.

^{Source: Sustainalytics}

Impact as an outcome may sound abstract, but Material Risk Engagement is a tangible method to illustrate the ability to reduce negative impacts and generate positive ones. The engagement strategy focuses on sound and robust risk management at the company level. MRE is designed to raise companies’ awareness of their material ESG issues and that they should respond proactively. By doing so, a company will be much better positioned to manage its real-world impacts—for its stakeholders, the environment, or the community—on its own and in collective terms, thus becoming part of the solution to the sustainability challenges that urgently need corporate contribution. With more than 200 Positive Developments in the past year, our engagement is making a difference, guiding companies to address sustainability challenges and ESG-related risks. We continue to drive ESG impact—one company at a time.

Material Risk Engagement is part of Sustainalytics' Engagement 360—an integrative stewardship solution that combines all of Sustainalytics’ engagement programs in one bundle. This service offers institutional investors a comprehensive approach to address systemic risks and underlying ESG issues in their portfolios. Click here to learn more.

_{*All information is sourced from 2021 Material Risk Engagement activities.}

Recent Content

Taking a Forward Look on Climate Investing

83% of US-based issuers have some real estate at high physical risk in worst climate scenario, Morningstar Sustainalytics finds.

Biodiversity in the Balance Revisited | Sustainalytics

Biodiversity in the Balance: Revisiting Portfolio Risks

On the occasion of COP16, this article updates previous research from Morningstar Sustainalytics showing how investing in companies facing high levels of risk associated with biodiversity loss can have a material effect on long-term portfolio performance.

Green Buildings on the Rise | Morningstar Sustainalytcs

Green Buildings on the Rise: Why Building Products Matter

This article explains the role of building products companies in the global green building transition and why investors should consider them as part of their sustainable portfolios.

The Current State of EU Taxonomy Alignment in 2024

This article summarizes the findings from our first EU Taxonomy Reporting Review, examining alignment to KPIs on revenue, opex, and capex on more than 1,300 non-financial companies over the last two years.