Is ESG relevant to managing long-term corporate performance, in light of today's key risks?

When it comes to the global economy, policy and markets, hotly debated contradictions have emerged that are hard to reconcile—from low inflation and interest rates to waning productivity, rising labor costs and risks from climate events. 

It’s up to corporate decision makers to take charge of their environmental risks because we are seeing change in consumer behavior and investor attitudes.

These and other topics drove discussions among panelists, presenters and attendees at Morgan Stanley’s recent third annual Financial Decision Makers Conference in New York. A year ago, a similar group of Chief Financial Officers, Treasurers and investors mainly wondered how they might make the most of strong markets, the windfall from U.S. fiscal stimulus and the upbeat outlook for synchronized global growth. Now, amid heightened volatility, they looked farther out for guidance and ideas.

The key recurring theme this year: ESG, or Environmental, Social and Governance, as a way to future-proof against the uncertainties of today. It turns out that thinking about and managing what used to be considered unquantifiable inputs and risks, such as extreme weather, gender diversity and multiculturalism, ethical vendor supply chains, and the right balance of boardroom personalities, may be exactly what many companies need to set the best course for the future.

“It is important to strategize and plan ahead when navigating during volatile times,” says Melissa James, Morgan Stanley’s Vice Chairman of Global Capital Markets who opened the conference. “Events like the conference provide a useful backdrop for clients to forge new perspectives and formulate ideas.” 

Focus on Environment

One of the key issues that corporates can’t ignore: environmental sustainability, according to Tomer Regev, a Managing Director in Investment Banking and Co-Head of Corporate Finance and Transaction Strategies. Regev, who says he approached the question of measuring the impact of sustainability and climate change on company performance and valuations with some skepticism initially, presented some provocative findings and conclusions during the conference.

“There’s some evidence for equity outperformance from strong environmental factor governance, but it’s statistically fragile,” he says. “The really interesting thing is when you start to look at volatility and tail risk—the data shows significant divergence between stocks that are consistently highly rated for environmental factors and those that are not.”

In short: Investors, at least, may see companies that are managing their businesses with a perspective toward environmental stewardship as better able to weather volatile markets, while demanding a higher risk premium to hold equity in those that don’t. “This makes sense,” says Regev. “It doesn’t matter what you believe in terms of climate change, what matters is that the market has assigned a value for companies that manage their climate risks. This means that it’s up to corporate decision makers to take charge of their environmental risks because we are seeing change in consumer behavior and investor attitudes. Even among employees, an environmentally conscious and responsible employer is more attractive to younger candidates,” Regev says.

Long-Term Perspective

The same holds true for issues such as managing human capital. “It used to be fairly simple for a company to talk about the numbers around human resources. That’s not the case anymore,” said James during a panel discussion on board membership that touched on corporate governance. “Now, we’re talking about the right mix of people who can bring you a diverse set of perspectives, because that’s how leadership arrives at important decisions.”

These are among the ESG factors that more companies are either voluntarily reporting to shareholders and investors as part of their performance metrics, or filing with regulators in markets, such as Europe, where ESG has become an integral requirement in managing brand and reputational risk.

The ESG approach couldn’t be more timely, amid the forces of fragmentation at work today in global economies, politics and cultures. Growing inequality, populism, climate-related disasters and migration, and so on, which have given rise to policy uncertainty, ranging from Brexit and global trade disputes to fiscal and monetary policy, could all benefit from the kind of proactive long-term risk management that ESG seeks to standardize, measure and reward.

Indeed, “The data is mostly reflective of what companies and investors have been saying and doing over the past three to four years,” says Regev. “It’s far from conclusive, but we can’t ignore it.”

For the CFOs, Treasurers and others at the conference responsible for figuring out where to best invest in the future of their firms and portfolios, the message was clear: At a moment when uncertainty is rife, take the long view and manage the kinds of ESG risks that will drive better performance in similarly volatile times still to come.