The Pragmatic Case for ESG: Considerations for Investing in a Clean Energy Future
By Richard F. McMahon, Jr., Skytop Contributor / April 23rd, 2023
Richard McMahon, Senior Vice President, Energy Supply and Finance, and Chief ESG Officer and Aaron Cope, Director of Investor Relations, Edison Electric Institute/ April 23, 2023
Richard McMahon is Senior Vice President, Energy Supply & Finance, and Chief ESG Officer for the Edison Electric Institute. In this capacity, Mr. McMahon leads industry activities on energy supply including natural gas, renewable energy and energy storage. He also leads the industry’s Wall Street activities including the EEI ESG Template Initiative, the tax reform issue, accounting, governance and energy derivatives. In this role he has testified before the United States Congress as well as federal and state regulatory agencies and commissions. He has written extensively on electric generation, power markets, ESG and industry finance topics. He is a guest lecturer at Georgetown University on these topics. Mr. McMahon holds a M.B.A. degree in Finance from the George Washington University in 1987 and a B.A. degree from Duquesne University in 1983. He completed the Stanford University Graduate School of Business Executive Program in Leadership in 2007. He also completed the Center for Creative Leadership Program in 2013.
Aaron Cope is Director of Investor Relations, Finance, and ESG at the Edison Electric Institute. In this capacity, Aaron is responsible for managing EEI’s Finance-related executive advisory committees, including the Investor Relations, Treasury, and Chief Financial Officer committees, as well as the Wall Street Advisory Group. In this role, he is responsible for directing and facilitating the interactions between EEI’s member companies and the financial community. Aaron is also responsible for directing the advocacy efforts of the EEI-AGA ESG/Sustainability Committee and oversees EEI’s annual Financial Conference. Aaron holds a Bachelor of Science in Resource Economics from the University of Massachusetts Amherst. He later obtained a Master of Science in Management, Master of Business Administration, and graduate certificate in Cybersecurity Management and Policy at the University of Maryland Global Campus. Most recently, he earned an executive certificate in Sustainable Investment and Finance from Yale University.
ESG on the Rise
ESG investing, which takes into account environmental, social, and corporate governance (ESG) factors, has grown dramatically both domestically and internationally in recent years. The assets under management that emphasize these attributes are expected to reach $33 trillion in 2026 https://www.pwc.com/awm-revolution-2022. Investors, boards, management, employees, and customers all increasingly recognize that ESG provides a consideration of long-term value drivers that expand upon purely financial disclosures.
Although ESG investing is an emerging trend, evidence suggests that considering ESG factors contributes to, and does not hinder, positive long-term value and growth.
Anti-ESG and the Debate
With the rise of ESG investing, a parallel political debate has begun to polarize opinions.
Some say ESG consideration in investment decisions is “woke capitalism” and that consideration of ESG factors can lead investors to violate their fiduciary duty to be focused on pecuniary performance. Others believe ESG priorities should be equal to—or in some cases outweigh—financial performance.
The evidence suggests that neither extreme view is accurate. Instead, ESG should be considered an indicator of future financial performance and longer-term sustainable growth.
“ESG [investors] generally examine criteria within the environmental, social, and/or governance categories to analyze and select securities,” according to the U.S. Securities and Exchange Commission:
The environmental component might focus on a company’s impact on the environment—for example, its energy use or pollution output. It also might focus on the risks and opportunities associated with the impacts of climate change on the company, its assets, its business, and its industry.
The social component might focus on the company’s relationship with people and society—for example, issues that impact diversity and inclusion, human rights. This includes specific faith-based issues; the health and safety of employees, customers, and customers locally and/or globally. It may also address whether the company invests in its community, as well as how such issues are addressed by supply chain vendors or partners.
The governance component might focus on issues such as how the company is run. In 2021, an investor bulletin published by the SEC, the “G”, for governance in ESG might cover transparency and reporting, data security and privacy, ethics, compliance, shareholder rights, and the composition and role of the board of directors.”
In practice, examining ESG factors provides a valuable strategic window into a company’s non-financial risks and opportunities and provides insight into a company’s long-term goals
and activities for investors and other stakeholders. Therefore, pragmatic investors should consider ESG to be a tool more akin to a telescope than to a microscope.
The Case for ESG Is Supported by Applying the Right Lens
At its heart, consideration of ESG factors is intended to provide a more comprehensive view into how a company’s future goals will be achieved and a measure of progress against previously disclosed goals. This is especially important for analysis of electric companies because sound ESG practices are a fundamental part of the industry’s value proposition and electric companies’ business models.
For instance, EEI’s member companies have united around a vision that emphasizes delivering clean energy and demonstrating environmental stewardship. Core to this is addressing social impacts, such as by focusing on resilience and assisting low-income customers and the communities we serve, and on promoting good governance, as seen in the industry’s focus on implementing thorough cyber and physical security strategies.
ESG as an Indicator of Long-Term Growth
Taken together, these ESG factors all are key contributors to long-term success and sustainable growth and value creation.
Conversely, ESG should not be considered an instrument like a microscope, to be used to analyze a company’s near-term performance. Consideration of ESG factors certainly informs near-term investment decisions. However, ESG factors should not be considered a substitute for, or equal in importance to, sound financial performance. This remains the key criterion for most investors. ESG practices are, by definition, an indicator of the company’s future sustainable growth, which can only be measured in the longer term.
Greenwashing
Another emerging trend is greenwashing. This is the pivot by some activists who have long criticized companies for not disclosing enough ESG information. Or to labeling these companies that are making voluntary ESG disclosures as “greenwashing.” Noting here that greenwashing exists when aspirational ESG goals or targets are not met or do not align with the expectations of other outside interests.
Unlike most SEC disclosure, which is present or backward looking, ESG is inherently forward looking. Therefore, it is subject to significant uncertainties such as the evolving nature of strategic priorities against rapidly changing and dynamic world conditions. Furthermore, this pivot is unrealistic and unfair, because the ESG landscape constantly is evolving with the commercialization of breakthrough clean energy technologies and changing disclosure regulations for climate, cybersecurity, human capital management (HCM), regulatory influences, and expectations of the capital markets.
ESG is a Dynamic Concept
Our experience tells us that ESG itself is an evolving concept, with different emphasis on E, S, and G factors across industries and companies. As the ESG landscape evolves, so should the assessment of a company’s relevant ESG performance.
An evolving ESG strategy allows investors to understand how a company positions itself to be responsive to risks and opportunities that may not yet be financially material—but could be in the future. Even though ESG risk and opportunity factors often are not financially material when first identified, they still provide a deeper understanding of relevant business risks, as well as of potential pathways forward towards tomorrow’s value. ESG is a meaningful tool, though certainly not the only tool, to evaluate a company’s future operational viability and financial health, as well as risks on the horizon.
ESG as an Evolving Standard
Another erroneous view is that the ever-changing definition of ESG means it is volatile or ineffective. In fact, this flexibility is logical and fosters innovation and progress. As major risk factors around climate, human capital, equity, or cybersecurity evolve, ESG considerations also should evolve and be reflected throughout frameworks, regulations, and ratings. Since ESG provides a strategic window into a company’s risk profile, it makes sense that ESG is responsive and reflective of the current risks that are relevant to a particular company.
Since there is no clear statutory definition of ESG and prioritization between various ESG goals and metrics evolve, it simply is misguided to enforce arbitrary or all-encompassing standards on companies that have leaned into ESG early, especially if those companies have already been providing the appropriate information to support their ESG goals and to satisfy investor needs.
Different Sectors Have Different ESG Priorities and Focus
ESG should not be considered a one-size-fits-all approach.
ESG risks are sector-specific, so companies’ goals generally are tailor-made to their unique characteristics, such as business model, specific customer needs, geographic location, company size, etc. And they must evolve as these factors change over time.
For the electric power industry, environmental factors have long been a key priority. It is important for different sectors to tell their ESG story about how they are working strategically to position themselves for future risks and opportunities that could become financially material.
ESG Applied to Electric Companies
For electric companies, the EEI-AGA ESG Sustainability Template lends itself to telling the story of companies’ clean energy transitions, the risks and opportunities that lie ahead, and their plans to manage them.
Adopted by EEI and AGA member companies in 2018, the template currently is in its third iteration. The very first sector-wide ESG and sustainability voluntary reporting template, designed with and for investors, it provides a basis for comparing relative ESG performance, increases transparency, and it is a one-stop shop for information on a company’s relevant ESG risks and opportunities.
Template development is continuous, sustained by constantly engaging and gathering input from key investors, stakeholders, and policymakers. Maintaining ongoing dialogues with investors and other key stakeholders allows the EEI-AGA ESG/Sustainability Template to maintain its usability, credibility, relevance, and value. As ESG evolves, so has our template, to provide the most relevant information about ESG performance and a company’s strategy. Currently, EEI and AGA are working on the fourth version of our ESG template.
As new ESG risk factors become evident, ESG disclosure frameworks should reflect these new factors in an intentional manner, while still balancing investors’ need for data to be presented concisely, clearly, and comparably. This is where the EEI-AGA template, which provides a dashboard-like style of the most important data, differentiates itself from some or the other ESG reporting tools provided by groups that may have goals beyond providing investors and other stakeholders with relevant, impartial ESG information.
As an example of the evolution of ESG, until recently human capital and diversity, equity, and Inclusion (DEI) issues were not widely reported in ESG disclosures. Now, these workforce factors can impact a company’s ability to attract talent and innovate and be competitive, which in turn informs a company’s social and governance disclosures. HCM and DEI practices can significantly impact an organization’s brand equity, reputation, and ability to operate effectively in their communities.
For example, empirical studies have shown talent acquisition and retention are key drivers in achieving optimal organizational performance and serve as an indicator of an organization’s ability to attract a diverse talent pool. Both HCM and DEI practices are commitments to long-term, sustainable organizational growth and inform a company’s social and governance disclosures.
The Pragmatic Telescope
We believe that ESG is a pragmatic telescope for evaluating a company’s long-term sustainable growth and financial health. ESG should not be considered a substitute for, or equal in importance with, achieving required financial returns, which are table stakes for investors.
Consequently, ESG should be considered a pragmatic tool helpful to both investors and companies in assessing long-term risks and opportunities. We believe that is why the EEI-AGA Sustainability Reporting Template has been widely embraced by investors and key stakeholders and emulated by other sectors.