Reforming directors’ duties to encourage improvements in ESG behaviour may be “counter productive”, while investor-led pressure may be a better remedy to persuade companies to change their ways.

That view comes from Oxford and Hamburg university professor, Wolf Georg Ringe, as the world considers whether politicians at COP26 in Glasgow did enough to stave off the worst effects of global warming.

Writing in a new paper, Ringe explores the role of investors—not only the big asset managers, but hedge funds and other activists—and concludes they are better placed to correct the behaviour and decision-making of boards than rafts of new regulation. He says his work seeks to shift the “focus of ESG away from regulatory intervention to instead favour a market-led approach in ESG investments.” He adds that “investors’ initiatives and engagement are, and should be, the primary tool to promote sustainability orientations in the market.”

Ringe’s conclusion comes after examining recent events and developments involving investors and the way they have confronted companies and their need to make adjustments for climate change.

Several factors support the idea that investors are having an impact, he writes. Firstly, ESG funds, especially for big passive investors, have become more attractive because they attract bigger fees to manage and are, therefore, more lucrative. It’s a supply-side bonus.

Next, fund managers are responding to demand: millennials want their investments to work hard at sustainability and the share of wealth owned by millennials is only going to grow.

There’s a structural driver too. More and more of the share stock is under the control of fewer fund managers. Ringe calls this the “common ownership” argument. While the phenomenon has been criticised for being anti competitive it has “positive implications” because it does also appear to support ESG values, notwithstanding accusations of “greenwashing”.

Investors team up on ESG

But perhaps the most prominent issue he observes is the growing willingness of investors to “collaborate” or “team up” on engagement. This was under way on traditional issues, but has become “increasingly important in the context of green activism”, says Ringe.

There are some notable examples for boards to bear in mind. Ringe recalls the recent campaign against ExxonMobil, which saw a small activist, Engine No.1, take a $54m stake in the $284bn oil giant and then hound the company to cut capital spending and focus on accelerating its move to cleaner energy. But Engine No.1 may not have won out—which it did at an “epic” shareholder meeting in May—had it not been for big pension funds lending their support. That included CalSTRS (the California State Teachers’ Retirement System) and then even the Church of England’s investment arm. Some academics have written how the Exxon example provides a template for sustainability activism of the future.

Elsewhere, the Children’s Investment Fund (TCI), run by Chris Hohn, has led a successful campaign persuading many companies to offer investors a chance to vote—a “say on climate” vote—on their plans to cope with climate change. TCI has received support from other players, including BlackRock, the world’s largest asset manager, and UK asset manager Legal & General Investment Management.

This “teaming up”, Ringe writes, is then supported by the emergence of platforms, such as Climate Action 100+ or even the PRI (Principles for Responsible Investment), a body launched by the United Nations allowing investors to co-ordinate their investment efforts.

Ringe argues all this means that increasing regulatory intervention may not be needed, or may even be “counterproductive”. “For example, corporate management may hide behind the guise of protecting stakeholders’ interests by opposing institutional shareholders and their efforts, thereby becoming more entrenched.” Ringe argues the EU should even close its current efforts to reform directors’ duties.

Instead of doing that, Ringe says, “investor pressure, ideally filtered and vetted through the “teaming-up” model, will push firms to pursue sustainability initiatives out of intrinsic motivation.”

Politicians and policymakers are under pressure to accelerate measures to tackle change. Already, many argue COP26 failed to find enough agreement to keep global heating to 1.5 degrees above pre-industrial levels, while some argue even 2 degrees will be a hard target to meet. Given the volume of activity already under way it might be hard for policy makers to call a halt.