Tony Featherstone speaks to AIRA about investor views on climate change risks.

Boards often view their organisation’s climate-related challenges as a “sustainability” or “risk-management” issue. But as financial markets demand more data in this area, climate risks are morphing into investor-relations, capital-management and corporate-reputation issues.

Ian Matheson, CEO of the Australasian Investor Relations Association (AIRA), says institutional investors are factoring Environmental, Social and Governance (ESG) issues into their investment decisions – a trend that is starting to influence company valuations. “Boards will consider ESG data in an entirely different light as it begins to affect their organisation’s market capitalisation and cost of capital,” says Matheson. “ESG reporting is rapidly transforming from a ‘soft’ issue into a ‘hard’ input in company-valuation models.”

Matheson, a leading investor relations expert in the Asia Pacific, says too many listed companies are yet to respond adequately to the market’s growing interest in climate-related issues.

“More companies are producing very good sustainability reports that contain data on carbon emissions and other climate-related issues, and providing data for the many ESG surveys each year. But there hasn’t been enough consideration of how this data is communicated to the market through the organisation’s investor-relations function and who has responsibility for it.”

That is a big issue for boards. Listed companies potentially risk breaching their continuous disclosure obligations if they do not report material ESG information to the market.

The rise of shareholder activism is another consideration for boards. Pressure from activists on mining, energy and finance companies – evident at more Annual General Meetings this year – is challenging boards, particularly as activist campaigns spill into the media and damage corporate reputations.

“The market’s focus on corporate carbon emissions and water usage will only get bigger,” says Matheson. “It’s a complex issue from an investor-relations perspective and not something that may be immediately apparent to boards. In time, ESG issues will have greater influence on board discussions and decisions.”

Here is an edited extract of Matheson’s interview with the Governance Leadership Centre:

Governance Leadership Centre (GLC): Are climate-change issues having greater impact on company valuations, reporting and market disclosures?

Ian Matheson: They are. Rising investor focus on Environmental, Social and Governance (ESG) issues, of which climate-change risks are a part, is a well-established trend for companies and boards. Investors have sought more data on ESG risks and larger listed companies have responded by publishing sustainability reports and other ESG data.

ESG data has become a growth industry and fund managers and superannuation funds are increasingly using that information in their investment decisions – often as part of a portfolio overlay or “filtering” system to incorporate ESG risks. Several larger funds now have internal ESG teams and a few of the larger sell-side broking firms have ESG analysts, each with their own speciality.

The big change is that ESG data and analysis is evolving from something that was mostly seen as qualitative information and useful to have, into something much more quantitative – hard data that can influence company valuations.

GLC: What are the implications of this trend for boards?

Ian Matheson: There are several implications. First, as climate-related and other ESG data increasingly affects company valuations, boards must consider their organisation’s ESG reporting and broader continuous disclosure policies and procedures.

Second, fund managers and analysts are seeking information on the company’s climate-change performance, which typically revolves around its carbon emissions and water usage. Chairmen who meet institutional investors, as part of the board’s investor-relations efforts, should be prepared to receive and answer more questions on their organisation’s climate risks and mitigation strategies in coming years.

Third, data and analysis on carbon emissions, water usage and other ESG risks will have greater influence on the listed company’s cost of capital. Organisations that have a poor record on carbon emissions or water usage will inevitably pay more for their debt and equity capital. As such, boards will need to consider the organisation’s climate-change risks and strategy as part of their broader oversight of capital management.

Fourth, ESG data and reporting will have more influence on corporate reputation-management strategies. Activists will be quick to pick up poor ESG performance on climate-related issues. Boards must ensure their organisation has processes to deal with adverse publicity that can damage its brand.

GLC: Some directors say they rarely receive questions on climate-change issues from the investment community. Is this only an issue for large listed companies in sectors such as mining, energy and finance?

Ian Matheson: Carbon-emission and water-usage reporting is clearly a growing issue for larger resource companies and organisations, such as the big banks, that provide capital for projects in coal and other higher carbon-emitting sectors. But as ESG data and analysis evolves, investors will focus more on the ESG performance of companies outside the ASX 100, so it’s something boards of all listed companies should think about.

Also, market interest in climate-change issues manifests in different ways and is not always obvious to directors. For example, sell-side analysts rarely ask questions about ESG issues in company results presentations because they have limited time and need to focus on earnings and other financial information. That does not mean they are not receiving ESG data or factoring it into their investment decisions and commentary.

Much ESG data collection and reporting goes on behind the scenes. Several ESG research houses ask companies to complete very detailed surveys each year on their ESG performance. That data is compiled and usually resold to financial-market participants.

GLC: Where do organisations go wrong with their reporting of climate-related ESG risks?

Ian Matheson: Some companies, particularly those that are small carbon emitters, see ESG surveys as a waste of time. However, it is important for organisations to allocate sufficient resources to the more important surveys that compile and resell ESG data to financial-market participants. Understanding the differences in ESG surveys is also useful because there is no standardised ESG survey among research houses.

Another risk is misunderstanding how climate change and other ESG data fit into the organisation’s broader investor-relations strategy. I’ve seen examples where a company’s sustainability team deals with market participants on some ESG issues; the investor-relations manager deals with analysts on another ESG issue; and the company secretary speaks to fund managers about another ESG matter. There is no co-ordination of the company’s broader ESG communication strategy or ownership of it.

AIRA’s strong view is that the organisation’s head of investor relations must have responsibility for all ESG communication to the market. As this data becomes more material to company valuations, it has significant implications for continuous disclosure obligations, making it a key issue for boards. Companies that persist with a haphazard approach to ESG communication run a risk.

GLC: Will we see even more shareholder activism around climate issues?

Ian Matheson: Without doubt. Every second question at AGMs, for companies that are higher carbon emitters or lend to such projects, seems to be carbon related these days. For example, a group of university students protested at the Commonwealth Bank’s AGM this year about its lending policies to carbon projects – a vocal objection that the CBA board handled well.

Climate-related shareholder activism is only going to increase for companies in the mining, energy and finance sectors, and will probably spread to other sectors in time.

GLC: Will more fund managers stop investing in companies with high carbon-emitting projects, such as coal mines?

Ian Matheson: Many superannuation funds already have well-established sustainability options that allow investors to choose funds that screen out companies with higher ESG risks. These options, and growth in sustainable or ethical investment funds, will become a bigger consideration for listed companies this decade.

GLC: From an investor-relations perspective, how do you see corporate reporting of climate-change risks evolving in the next five years?

Ian Matheson: Listed companies will become more proficient at understanding their climate-change risks and reporting on them. Organisations will be more proactive in this area; in some ways, corporates are already a lot more alive to climate-change issues than governments are, and doing a lot more about these risks. For boards, there will be heightened realisation about the importance of communicating the organisation’s climate-change risks, performance and mitigation strategies to the market. Boards will become more forward-looking in this area as investors ask them to identify the organisation’s ESG issues that most concern them, and what is being done about them – not only respond to questions the market asks.

Further out, we might see the organisation’s sustainability report incorporated into the annual report, as part of a broader push towards integrated financial reporting.

Overall, the biggest change will be ESG data evolving from something that, frankly, has been perceived as a “softer” governance issue, into something much more significant. It’s a trend boards should be well prepared for.

GLC: Are you seeing greater demand from the investor relations community for ESG skills?

Ian Matheson: Absolutely. AIRA ran a very successful course in July this year on ESG and investor relations that attracted 45 people. It’s an area that more IR professionals want to know about and a skill-set that could help other executives and directors.

Tony Featherstone is Consulting Editor of the Governance Leadership Centre.