The new paradigm
Historically, activists have sought to drive financial performance. Activists with purely financial motivations have often been seen as adversaries by boards of listed companies, especially if they have pushed for short term financial outcomes such as paying out excess cash as dividends.
However, in much the same way that private equity funds were once derided as asset strippers but are now seen as good custodians of businesses they own, some activists are increasingly seen as playing a valuable role in delivering lasting changes to businesses. Some activists now call themselves constructivists and boards increasingly take note of their suggestions and often welcome their nominees to the board. Similarly, short sellers once derided as the ultimate opportunists, have played a valuable role in unearthing fraud or creative accounting practices in businesses where governance has failed (e.g. Wirecard).
In a more recent trend, ESG shareholder activists have emerged and are shaping the corporate landscape. At risk of simplification, they can be divided into:
- Activists (or even traditional long only investors such as pension funds) who have material shareholdings and combine suggestions for lasting change in business with improvements in ESG. Often these activists focus more on improving governance (and alignment of remuneration with performance), the “G” in ESG but many also look at the environmental and social aspects of ESG – the focus of this article; and
- Pressure groups who may have a smaller, perhaps even a nominal shareholding, which has been acquired purely as a way of having locus to take action as a shareholder and improve environmental standards in listed businesses. In some instances, the campaigns by these types of ESG activists have acquired the support of other shareholders, thereby acting as a catalyst for ESG changes that might never have been effected without their involvement (e.g. Engine No.1’s campaign against Exxon – see case study below).
How can ESG activists effect change?
In my post on shareholder activism here, I explained what techniques activists can use to pressure companies to take action in relation to their businesses.
These techniques by traditional activists or constructivists can also be used to hold listed companies accountable for ESG commitments.
To take action ESG activists first need to understand:
- What ESG legal and regulatory standards are applicable to companies;
- The disclosures they are required to make in relation to these standards;
- What commitments they have given and whether they are binding upon them;
- Whether the disclosures or commitments are adequate; and
- If they are not adequate, what pressure can be put upon them improve their disclosures or commitments.
In my ESG post here, I examined the environmental reporting requirements for listed companies in the context of the voluntary carbon market. Although many of these reporting and disclosure standards are voluntary, they are increasingly akin to mandatory standards given the pressure being exerted upon investors to be responsible custodians of businesses who then put pressure on the listed companies they are invested in.
In other words, ESG activists need to consider the following approach:
- Review who the major shareholders are and what ESG objectives they have set for themselves (or agreed to as members of the PRI) as owners of the listed companies they invest in; and
- Review the ESG performance of the listed companies themselves.
ESG activists can therefore pressure both the owner/shareholders and the underlying listed companies.
If the asset owners are failing to ensure their investee companies are meeting the ESG standards they say they should meet, that can be a point of leverage, especially if media and public relations are used to highlight the fact that they are not acting as good custodians. Big pension funds do not like being called out for being absentee landlords.
If the ESG activist can then garner support from the asset owners when the ESG activists take the fight to the listed company they may be able to get shareholder support for the ESG resolution being proposed at an EGM or AGM.
In the case of major UK listed companies, many institutional investors choose to work through the Investor Forum on ESG concerns, esp. on governance issues. This provides a less confrontational way to put pressure on UK listed companies whereby the forum can collate concerns of investors and then intermediate between asset owners and listed companies. The Investor Forum 2021 report, lists achievements at HSBC on environmental standards and at BT Group on its Chair succession.
Case studies
Engine No.1 -v- Exxon
In 2021, Engine No. 1 GP LLC, an ESG activist investor (which held a $50m 1% stake) successfully led a campaign to replace three directors of Exxon’s 12-person board with the support of Blackrock, Exxon’s second largest shareholder. The campaign focussed on the Exxon board’s failure to pursue a strategy addressing climate change which Engine No.1 argued would impede Exxon’s ability to deliver long-term economic value. What is noteworthy about this approach is that Engine No.1 successfully linked ESG to value.
Third Point -v- Royal Dutch Shell
Third Point LLC is advocating the break-up of Shell into multiple standalone companies. Specifically, its letter to investors in October 2021 suggested a split into: (1) a standalone legacy energy business (upstream, refining and chemicals) which would freeze capex, sell assets, and prioritize return of cash to shareholders (for reallocation by the shareholders into low-carbon areas of the economy); and (2) a standalone LNG/Renewables/Marketing business could increase investment in renewables and other carbon reduction technologies. Third Point argues that this could accelerate CO2 reduction and deliver increased returns for shareholders. It remains to be seen how successful this campaign will be.
Follow This -v- BP
BP has a history of collaborating with climate activists over net zero targets but advised shareholders to vote against a special resolution at its 2021 AGM which was proposed by the climate activists Follow This. Although the resolution did not pass, it garnered support from shareholders holding approximately 20% of its shares. Although similar proposals by Follow This failed at Equinor, Shell and Total these actions show how environmental activists are making headway with the big energy companies.
Conclusions
There is no question that pressure from investors is driving change at major companies. However, environmental activism is most likely to be successful where there is a demonstrable link between environmental change and longer term value as these are mostly likely to garner support from institutional investors.
Engine No.1’s campaign highlighted Exxon’s lack of ambition on addressing its legacy business model (relative to the other oil majors) and attracted mainstream investor support as a result. The campaign showed that obtaining board representation and using that to influence change can be successful.
By contrast, the experience at BP, Equinor, Shell, and Total show that seeking to micro-manage how a company should operate its business, e.g. to meet greenhouse gas emission reduction targets is unlikely to succeed. In a UK listed company, the activist seeking to impose such direction has to get a special resolution passed which requires a 75% majority in favour which is an exceptionally high threshold to meet. Even traditional activists rarely deploy such a tactic.
