The recent field assistance bulletin by the U.S. Department of Labor, which asserts that under ERISA “fiduciaries must not too readily treat ESG factors as economically relevant…” demonstrates a lack of awareness of what constitutes economic relevance. The bulletin does not rescind any portion of the 2015-2016 guidance, which we wrote about at the time, and thus has little practical impact. It appears to be simply an effort to chip away at progressive Obama-era policies.
In line with responses to similar efforts to dismantle or weaken public policy that supports widely accepted environmental, social and governance principles, leading organizations in both the corporate and financial sector will maintain momentum toward consideration of all material factors that contribute to sustainable long-term financial performance, including the environmental and social impacts of their business activities and investment decisions. Indeed, we believe that investment advisors that do not incorporate the discipline of ESG analysis into investment decisions are shirking their fiduciary responsibilities to their clients.
This is the text of a speech we prepared for the conference “Post-Carbon Finance: Fostering Low-Carbon Investment,” to be hosted by Ecologic Institute and the Consulate General of Germany in New York on June 15.
It is an auspicious time to be talking about climate finance. The US administration may be removing itself from the Paris accord, but as Cornerstone Capital wrote following the election of President Trump, we believe that the capital markets have the ability and responsibility to power the progress needed to solve the critical issues of our time, including climate change.
The US departure from the Paris Accord, together with the potential movement away from globalization in numerous countries, changes the medium-term climate investment catalysts, though will have less near-term effect. Earlier this year, we outlined three macro trends – regulatory, behavioral, and technological – whose intersection will drive climate change investing both in the near and medium term. Tonight, I want to talk through these trends, where their overlap creates the strongest catalysts, and how recent events create new climate investment risks and opportunities.
Regulatory: US sidestepping resistance, EMs linking to growth
Key US states and cities have driven policies addressing climate change, from renewable energy portfolio standards to feed-in tariffs (payments to ordinary energy users for the renewable electricity they generate), for decades. We see their role in climate action expanding further because of the current administration’s stance. The US government does not have a national energy policy, and, with the staying of the Clean Power Plan, it is not likely to adopt a plan soon. States and cities are now front and center, if they ever left, and leading states and cities have already increased climate response policies. California’s senate passed a bill mandating 100% clean energy by 2045 while Pittsburgh (not Paris) now aims to source 100% clean energy by 2035.
While states and cities will push climate change regulations in the US, national governments in emerging major emitting countries are taking a significant role. The clear co-benefits of climate action make the discussions for China and India different from even five years ago, as both countries have transitioned to incorporating climate action into other national policy goals. China sees the reduction in air pollution as well-aligned with the rollout of renewable energy, while India sees the necessary provision of electricity to all its citizens as linked to distributed energy sources, such as solar. This alignment between renewable energy, political stability, and economic growth provides significant hope for rapid progress.
Behavioral: Accelerating focus across sectors and consumer segments
We see behavioral trends becoming a more powerful force than regulatory trends. We consider behavioral trends in the broadest sense, from consumer trends to how companies are positioning themselves for changing markets. On the consumer side, we see a deeper focus on supply chain impacts. From food to beauty products to clothes, consumers are examining supply chains in a way we have not seen before. Some companies expressed their concern at the US’s shift on the Paris accord because they consider responding to climate change to be a market imperative (as well as a branding opportunity). Corporations are also acting to inspire their employees, who are increasingly demanding their organizations engage in climate action.
Technological: Relentlessly advancing
Technological advances to address climate change continue to meet and raise expectations. The question if solar and wind could reach grid parity has been answered, when it was a real concern less than nine years ago. The battery sector has also seen significant declines in price, with electric vehicle battery prices dropping by 80% from 2010 to 2016. If the decrease can continue, battery prices are poised to achieve grid parity in the coming years. This technology, which can support the decarbonization of transport and the mass storage of electricity, would be a significant boon to renewable energy.
Intersection of trends creates powerful investable opportunity
The intersection of regulatory, behavioral, and technology trends builds near- and medium-term momentum, which creates an investable opportunity that is more powerful than the sum of the individual trends. For instance, the intersection of trends has contributed to the increasing capacity of renewable energy, with solar capacity increasing from virtually zero at the turn of the millennium to 305GW in 2016. Over the same time, US regulation provided subsidies to consumers buying solar panels in the form of federal tax credits, minimizing the financial risks to buying solar panels while consumers became more interested in renewable energy sources for the climate benefits. China has also flooded the world marketplace with solar panels, rising from less than 1% of global production prior to 2000 to more than 60% in 2013. This supply growth, combined with technological advancement, has pushed solar prices to decrease 78% from 2000 to 2013, contributing to the relatively quick expansion of solar energy capacity.
These factors should cushion any near-term risks to climate investing from recent political events. In the near term, a slip in progress in one trend can be buoyed by the momentum created by other, overlapping trend. We believe that behavioral and technology trends can drive the investable thesis for renewable energy in the near term. In 2015, Kansas repealed its goal of 20% renewable energy by 2020, six years after adopting the goal. A year later, in 2016, Kansas achieved 30% of its electricity from wind power, speaking to the near-term momentum provided by the intersection of trends.
Looking to the medium term
The US departure from the Paris accord does, in my view, create medium-term implications. Regulation brings forward consumer and company action, which might take longer to manifest otherwise, and focuses technological development. Any further decrease of US regulation could weaken these trends, though there is the possibility that the retreat of leadership at the federal level will result in increasing state level regulation. California and China are already pledging to expand trade with an emphasis on renewable technologies. The potential for state action brings the possibility of companies looking to California as a leader in regulation instead of the federal government.
However, states will have difficulty filling the federal government’s role in international cooperation on climate change, which poses a risk for medium-term climate change investing. Consistent and transparent action across countries creates trust, enabling investors and companies to quickly adapt to new approaches and introduce technologies to new markets. A less trusting global marketplace hinders climate change mitigation and raises barriers to market access for investors.
We believe there are opportunities for creative investments to capitalize on and accelerate the behavioral and technological trends, which are aided by state action but not reliant on federal regulation. Given this change to medium-term regulatory momentum away from the US federal government, the areas of technological progress, behavioral trends, and the overlap of these two are becoming the more powerful catalysts.
On the behavioral side, we see companies that manage supply chain issues and integrate technological advances as well positioned to capture the increasing consumer concern around supply chain management. Specifically, an area that warrants more attention is the emissions reductions created for downstream companies by upstream companies. Coca Cola, for instance, says two-thirds of the carbon footprint of its products is caused by suppliers and is aiming to cut its carbon footprint by 25% between 2010 and 2020. While carbon emission trading schemes captures this value more explicitly, businesses that help other businesses within their supply chain be more efficient (i.e. sustainable) are well positioned.
Technologically, we are most interested in climate investing opportunities that align with broader technological trends, such as internet of things, and that respond to consumer demand for innovative energy products. While big data is mentioned in every conference on any topic, we do know that the availability of vast amounts of data, along with improvements in analytics, are likely to uncover critical insights that we would not be able to decipher through mere observation. We see the ability to gather and analyze big data as a necessary step for innovation in energy efficiency.
The public market support for large-scale energy innovation companies such as Tesla is a substantial vote of confidence for addressing climate change. Nearly 400,000 people have pre-ordered Tesla’s Model 3 car, highlighting the market demand for clean energy products. At the same time, we are looking for solutions to the sourcing of renewable energy raw materials so that the technology we use to address climate change doesn’t exacerbate environmental damage and income inequality issues in emerging markets. Technology companies that can source responsibly will be able to capture the demand for technology and benefit from the growing consumer concern around supply chain management.
The intersection of behavioral and technological trends opens creative opportunities for investors. For instance, we see a future for an ethical fish farming system that addresses the world’s protein requirements in a manner consistent with consumer supply chain concerns. Companies are starting to innovate in fish farming: a Danish company is building a high-efficiency salmon farm in the Gobi Desert in northwestern China, where there is no more rainfall than 50 to 100 millimeters a year, to address protein demand and consumer interest in sustainable protein supply chains. Companies that minimize energy use in this type of innovation are poised to satisfy consumer demand while benefiting from technological advances in efficiency.
We remain confident that technological and behavioral trends can continue to grow and catalyze climate investment, even as the US decreases its role in national and international regulation. However, there are several reasons we could be proven wrong in the future. Technology development or consumer technological demand for clean energy solutions could be more reliant on regulated subsidies than we understand, or changes in globalization could undermine the existing clean technology supply chains. We will continue to watch these trends and update our view on climate investing opportunities and risks.
In conclusion, I am buoyed by the progress over the last five years and hope that winning begets winning. As most people in the room can attest, shifting to an economy that decouples emissions and economic growth has had stops and starts before. Investors should remain focused on the bigger picture, utilize the growing global behavioral and technological trends, and nurture the capital markets to solve climate change.
Sebastian Vanderzeil is a Director and Global Thematic Analyst with Cornerstone Capital Group. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.
Emma Currier is a Research Associate at Cornerstone Capital Group. Emma graduated with a Bachelors of Arts degree in Economics from Brown University in May 2016. While at school, she worked with the Socially Responsible Investing Fund and as a teaching assistant for the Public Health and Economics departments. She spent her sophomore summer researching differences between American and Indian educational styles in Arunachal Pradesh, India, and completed a summer investment bank analyst position with Citi in the Media & Telecom group in 2015.
For over 40 years, some shareholders have been protecting the environment, improving working standards and increasing corporate accountability using a little-known but effective tool called a shareholder proposal. But now this tool is threatened by the legislative push to reform financial regulation.
Shareholder proposals allow investors to put questions related to a company’s environmental, social and governance (ESG) policies to a vote of all shareholders. But this right would be stripped away from most shareholders by Section 844 of Financial Choice Act, the bill authored by House Financial Services Committee Chairman Jeb Hensarling, R-Texas, to unwind much of the post-crisis regulatory regime.
As an advocate for corporate governance and sustainability, I strongly oppose this provision.
Shareholder proposals have long been an effective tool for promoting the interests of long-term investors. While most proposals do not receive majority support or result in immediate policy changes, the primary purpose of a shareholder proposal is to initiate a dialogue between companies and shareholders regarding long-term issues that may escape attention in a financial market primarily driven by quarter-by-quarter performance.
Shareholder dialogue does not coerce companies into action, but does offer corporate leadership the benefit of an independent and objective perspective of a group that, like the corporation itself, is focused on creating long-term value. These discussions may center on traditional corporate governance issues such as executive compensation or board structure and composition, or on material sustainability issues such as fair treatment of labor, climate change or equal employment opportunity.
Over the years, policies related to many of these issues have become a routine part of business planning for many companies, with benefits both for society as a whole and for the long-term performance of companies.
Today, many corporate dialogues proceed without shareholder proposals because companies seek out investor views on these issues. However, the right to file a shareholder proposal remains critical, particularly when companies prove reluctant to pay sufficient attention to issues of shareholder concern.
Section 844 arises from a white paper published earlier this year by the Business Roundtable, which represents corporate CEOs. The Business Roundtable professes that its proposal would improve the process for shareholder proposals but in fact it would stifle this important shareholder right.
The key provision would establish a minimum threshold of 1% ownership to file a shareholder proposal, replacing the current threshold, which is a nominal $2,000 worth of shares. Only the very largest institutional investors, such as my former employer, TIAA, would be able to meet this new proposed threshold. These shareholders typically already have access to management and rarely need to file resolutions.
By contrast, current law gives a voice to all of a company’s owners, even the smallest. These shareholders may not own a large percentage of a company, but their investment may be important to their own financial future. Their shareholder rights are part of the value of their share ownership.
Despite the openness of the shareholder proposal process, only about 25% of companies receive a proposal each year, and companies have incorporated shareholder proposals smoothly into annual meetings for many years. This contradicts the Business Roundtable’s claims that the current process is burdened by too many filings.
In the absence of this relatively collegial process, shareholders would be left only with more adversarial tools such as rejecting director nominees, opposing executive compensation plans, shareholder lawsuits, and books and records requests.
Regardless of what Section 844 is intended to achieve, it represents short-term thinking in corporate governance reform. Far from any visible benefits, all this provision would result in is less corporate accountability and more conflict between shareholders and companies.
This editorial originally appeared in American Banker’s “ThinkBank” blog: http://bit.ly/2qw8tjH.
John K.S. Wilson is the head of corporate governance, engagement and research at Cornerstone Capital Group. Prior to Cornerstone, he was the director of corporate governance at TIAA-CREF and the director of socially responsible investing at the Christian Brothers Investment Services. He is also an adjunct assistant professor at the Columbia University Graduate School of Business.
Today we contributed our opinion to the SEC regarding its move to reconsider the Pay Ratio Rule, which would require corporations to disclose the gap between CEO compensation and “median” worker pay. We reprint our letter below.
Dear Acting Chairman Piwowar:
Cornerstone Capital Inc. (“Cornerstone”) appreciates and welcomes the opportunity to submit comments in response to the Commission’s reconsideration of the Pay Ratio Rule (Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act).
Founded in 2013, Cornerstone is a financial services firm based in New York. The mission of the firm is to apply the principles of sustainable finance across the capital markets, enhancing investment processes through transparency and collaboration. In offering investment consulting and advising, investment banking, and strategic consulting services, Cornerstone works with asset owners, corporations and financial institutions, promoting new research in the field of Environmental, Social and Governance (ESG) analysis, and facilitating capital introductions for organizations around the world engaged in sustainable business practices.
The Commission has received numerous submissions in the years since this measure was initially passed by Congress outlining the rule’s potential benefits and costs. Reviewing this correspondence, we observe that investor groups have identified substantial material benefit, while representatives of issuers have raised concerns about whether they would be able to provide meaningful information in a cost-effective manner.
As an advisor both to corporations and investors, we would encourage a decision to go forward with the rule as mandated in the statute. Nevertheless, the Commission should take heed of the concerns of issuers that disclosures provide shareholders with accurate and reliable information.
Because our investor clients seek to invest for the long term, we have a strong interest in urging corporate disclosures that enable investors to evaluate risks and make decisions that will affect the long-term health of our clients’ portfolios. Our corporate clients believe that meaningful disclosure that communicates how they are managing environmental, social and governance matters helps them to attract long-term capital.
As a matter of good corporate governance, we believe that corporate disclosures should provide holistic information about the compensation strategies. As Charles Elison and Craig Ferrere have pointed out, current disclosure requirements focus entirely on executive compensation, ignoring the company’s governance strategy for compensation throughout the firm. Peer group comparisons provide useful but limited context for understanding CEO pay, since no two firms’ strategy or business model is perfectly comparable. Peer group comparisons also reinforce the notion that CEO pay should be treated as distinct from other forms of compensation, and may place upward pressure on pay levels.
By providing intra-firm context, pay ratio disclosure will shed light on the role compensation plays generally in its human capital strategy, including the strategic importance of top management relative to the rest of the firm’s talent. A consistent body of research has determined that compensation strategy has implications for firm strategy, talent retention and employee engagement. For example, Cornerstone Capital Group has published research demonstrating that quick serve restaurants that invest in both technology and human capital may enjoy higher margins and profitability.
We are sympathetic to concerns that such issues as outsourcing, foreign employment and part-time and seasonal workers may impact pay ratio figures. However, methodological choices may have a material impact on any accounting metric, and financial data may not be meaningful without context. Narrative descriptions accompanying pay ratio disclosures will help to provide necessary context to understanding these figures. Investors will find these disclosures particularly useful in comparison to other companies or as a measure of change over time.
We appreciate that for particularly large global companies, finding the “median” worker may be difficult. Nevertheless, statistical sampling techniques can be employed to reduce the burden of this research. Therefore, we are not supportive of allowing companies to exclude workers from the sample, which may distort the pay ratio and creates a moral hazard to manipulate the figures.
We are also sympathetic to the concern that the “median” worker is only one data point and may not fully represent the company’s human capital strategy. While we believe that the current disclosure represents a meaningful step forward, we recommend that the Commission also require companies to disclose total payroll, which will allow investors a fuller picture of the company’s compensation strategy, without creating additional substantial burden on companies.
We appreciate the opportunity to provide these comments and urge the Commission to move forward with final rulemaking on Section 953(b).
John K.S. Wilson
Head of Corporate Governance, Engagement and Research
Cornerstone Capital Inc.
 The Economics of Automation: Quick Serve Restaurant Industry, by Michael Shavel and Andy Zheng, March 2015 /2015/03/the-economics-of-automation-in-the-quick-serve-industry/
Corporate form has the power to effect significant and desperately needed change. The magnitude of the crises impacting our world, and particularly our country, is certainly not disputed — by liberals or conservatives, men or women, African Americans or White Anglo-Saxon Protestants, members of the 1% or the working poor. The nature of such crises is also not in doubt — the fact that the climate is changing and negatively impacting the environment, the fact that there is a wider gap between rich and poor in this country than at any time since 1929, the fact that there is a sweeping tide of gun violence and the fact that recurring overt and covert discrimination necessitates the “Black Lives Matter” movement and catalyzed the bathroom laws of my home state of North Carolina.
But I believe the contrived or real debate over the causes (e.g., is climate change man made? Does current tax policy exacerbate income disparity? Does increased violence argue for more or less access to fire arms? Is safety for children greater with birth-gender-imposed restroom legislation?) and potential solutions has stymied action. Our government is currently too divided and therefore ineffective at addressing the problems. And even if our government was more functional, the private sector can arguably be much more successful in effecting needed change.
Because I have been a corporate lawyer for 23 years, I turn to the corporate form. Sure, the term does not sound sexy or even remotely interesting to anyone outside of the world of lawyers, bankers and a few enlightened business people. But corporate form serves as the very backbone of our society, shaping the actions of the most powerful institutions of our time (corporations) and providing the functional framework for the behavior of virtually all men and women who work around the world. Therefore, I believe that corporate form can be a very effective extra‑governmental tool for solving the crises.
In describing the power of corporate form, let me start by debunking three myths from the world of corporate form perpetuated in the popular press (and even by reporters who typically check their facts at The Economist and New York Times).
- The existing primary corporate form — the corporation — is not “broken.” The corporation can serve in its current form as tool for change.
- The “B Corporation” is not a new corporate form. “B Corp” is a certification mark – and there are many others.
- The new corporate forms come in many shapes and sizes. There is no one form of “benefit corporation,” and advocates of other forms are really crap at marketing and promotion.
The Corporation Is Not “Broken”
From someone who has spent years studying and drafting new corporate forms, this smacks of sacrilege. But it is true. The current debate about form features Lynn Stout and others on one side claiming that shareholder primacy is a myth, with Adolph Berle, Merrick Dodd and others on the other side citing Milton Friedman and opining that corporations must consider shareholders’ primacy to the exclusion of almost all else. There are, of course, elements of truth to both arguments. Most corporate lawyers agree that the drive to maximize shareholder value is as much a reaction to legal and economic factors (e.g., quarterly reporting and heavy utilization of stock options in compensation for management) as it is a result of the corporate form itself. In normal operations (outside of sales, mergers or changes of control), boards and management can look to the long-term best interests of the corporation and its shareholders without enhanced risk. In general, their decisions are protected by the business judgment rules that provide an added layer of defense against liability (shifting the burden of proof in litigation) so long as they do not breach their fiduciary duties of care and loyalty.
However, I agree that the “extra-form” forces are powerful and entrenched. In fact, we all look to share price as the primary, if not sole, measure of a corporation’s worth and success. Every manager wants to “beat the Street,” and their compensation usually, in large part, depends on winning that battle. Further, board members are often correctly counseled that actions which do not yield stronger short-term profits or which are out of step with others in their industry can yield greater liability. While more corporations are at least considering environmental, social and governance (ESG) factors in decision-making, only events like the Enron debacle or the BP oil spill prompt significant shifts in corporate action.
In response to the focus on short-term profitability, prior to the advent of new corporate forms, proponents of “impact” or “double/triple/quadruple” bottom line approaches, including B Labs, advocated the use of constituency statutes for social enterprises. Many states adopted constituency statutes in the wake of the hostile takeovers in the 1980s. Such statutes stipulate that boards and management “may” or “shall” consider a laundry list of factors other than shareholder value when considering an offer by a third party to purchase the company.
While not designed for use by social enterprises, starting in the early 2000s, companies that wanted to promote mission relied on these statutes to include social and/or environmental purposes in their charters and to craft fiduciary duties of boards and management in favor of such purposes.
There are numerous flaws in this approach — but I believe that the primary concern is one of accountability. Constituency statutes provide no means of protecting shareholders from misuse by management of resources devoted to the articulated purposes. For example, I could form a corporation for the purpose of combating climate change and improving employee relations, raise money by selling shares to the students in my class at Berkeley Law, and hire Erika Karp as my CEO. If I took all of the profits and used them to pay for vacations for Erika and her team on Tahiti on an annual basis, leaving the company almost destitute, shareholders would have little way of learning about my actions until after the fact — and limited grounds to bring a claim to halt my actions or seek a refund for their investment.
Suffice it to say that the use of constituency statutes alone is a bad idea — they will not be effective in either improving shareholder profits or advancing social and environmental goals. But before examining the new corporate forms that are available, it is important to recognize and, for some companies, to adopt the low- (or no-) risk tools that traditional corporations have been employing for years to ensure a mission focus.
Tools for Impact with Traditional Forms
Both budding entrepreneurs and established enterprises can develop and retain an emphasis on positive social and environmental impact using the existing corporate forms, particularly corporations, limited liability companies and limited partnerships. For corporations in states without constituency statutes (e.g., Delaware and California), you would be ill-advised to draft social and/or environmental purposes into the charter itself given the established fiduciary duties. However, shareholders can execute agreements with management whereby the company will be contractually obligated to emphasize an agreed mission or public purpose. Classes of shareholders can require protective provisions in the charter to ensure that certain corporate actions, including change of business plan, change of mission and change of control, can’t be approved without the affirmative vote of a mission-focused class. Further, operating and partnership agreements for LLCs and LPs can include such contractual provisions in addition to waterfall rights (payouts for distributions and liquidation) that favor identified non-profits or mission-focused recipients. In fact, Delaware’s limited liability company statute allows for the possibility of an LLC where duties of the managers to contractually agreed social and/or environmental purposes are equal to — or trump — duties to generate economic returns.
It is also possible to draft limited partnership agreements where limited partners agree with fund managers to donate 1% of profits to a designated charity and/or to accept a lower financial ROI in favor of an “impact” ROI. I am encouraged by a growing trend in the fund world for carry or bonus payments to managers to be structured to pay out based on social/environmental as well as financial performance.
Tools for Impact in Change of Control
Notwithstanding these tools, there is an argument, supported by much precedent, that as enterprises scale and increase their intake of outside capital, they often, if not usually, lose their impact focus. First, this is not true for companies whose financial success is directly linked to its mission (e.g., Etsy, Revolution Foods, Sungevity or Bloom). For example, the more that Etsy provides training and support to its Etsy communities, the more members of those communities sell goods via their online platform and the greater the selection and sales to consumers. The more RevFoods educates children on the virtues of nutrition, the greater their sales of healthy, nutritious and delicious school lunches.
Second, for decades many corporations have established non-profits or “.orgs” to house their “impact first” programs and/or facilitate donations from the entity itself and its employees or partners to worthy causes. In recent years, corporations have donated or housed valuable intellectual property, not enough to impact valuation but critical for the business (e.g., a trademark, portion of software or code), in the related non-profit and then licensed the same back to the for-profit operating entity. The license agreement contains a “mission lock” such that if there is a material deviation from mission by the for-profit, the license resets with a higher royalty rate or eventually terminates. Including a mechanism to determine when there has been such a material deviation (usually involving a third-party mediator) is critical. Professor Eric Talley (formerly at Berkeley and now at Columbia Law School) refers to this as my “spurn-out” provision; however, I would argue that if there is financial value in the mission and the relationship with the “.org,” the license may not reduce valuation through sale.
The bottom line is that there are a number of mechanisms available to both public companies and private enterprises that can enable them to focus on long-term objectives as well as environmental, social and governance goals. Therefore, the need for new corporate forms arises because most of these tools are permissive for boards and management instead of mandatory. And it is not possible to underestimate the market forces which encourage, if not demand, short-term profit maximization.
A “B Corporation” Is Not a New Corporate Form
A “B Corporation” or “B Corp” is a certification mark — like a “Good Housekeeping” seal of approval or “LEED” certification. B Labs has done a very good job of creating a framework for companies to evaluate their business and operations on ESG factors and to then receive a score or ranking. To become a “B Corp,” such companies then enter into a license agreement with B Labs and pay a licensing fee of between $500 and more than $50,000 depending on the structure of the applicant.
B Labs does review the evaluations and often schedules calls for follow-up questions — but such reviews fall short of a full audit to ensure accuracy and completeness. This means that there have been — and will continue to be — companies that license the “B Corp” mark and are promoted as part of the B Corp community but whose operations do not live up to the standards espoused by B Labs. I believe that this is one of the reasons for the change in licensing requirements that I describe below.
When Should a Company Become B Certified?
Let me offer a few recommendations for companies that are deciding whether or not to become “B Corp” certified. First, you don’t need to hire a consultant or lawyer to help you fill out the questionnaire and become certified. The fact that there is now a cottage industry of “experts” willing to charge high fees to provide such assistance is a sign that B Corps are here to stay. But the B Labs folks have done a good job at making the certification process user-friendly.
The survey can be downloaded, you can use it to determine areas of improvement before submission, and their staff is available to help if and when questions arise.
Second, I strongly advise that management take and score the survey before deciding whether to pursue certification. While years of good work have gone into developing the survey and standards, one area of weakness is that the survey does not divide respondents by industry. This can yield unhelpful results — like a recycling company whose mission is to reduce waste having a lower score (because of carbon emissions among other factors associated with heavy manufacturing) than a developer of social media applications in SoMa, San Francisco (with little output of social value).
Also, the survey was not designed for public companies — so when Etsy went public, quite a bit of work had to be done (and improvements continue to be made) so that publicly listed companies can accurately respond to the questions. Further, acquired companies are not able to retain B Corp status post sale or merger unless the target remains a stand-alone subsidiary (e.g., Plum, New Chapter Vitamins, Ben & Jerry’s) or the acquiring company itself becomes B certified (e.g., Danone/WhiteWave). The issue with the former is obviously that both the survey process and compliance are in the hands of a corporate entity (e.g., Campbell’s, Procter & Gamble, Unilever) that does not have any legal requirement to retain the mission alignment associated with B certification.
Finally, as with any marketing campaign, it is very important to test with all constituents in your market to determine whether and how the B Corp brand will benefit your company.
The vast majority of B Corps are normal C Corporations or LLCs and are not legally required to advance their social and environmental goals. However, I believe that many of these companies (e.g., Etsy, Plum, RevFoods) are at least as mission-aligned as those that employ the new corporate forms (see below). Further, B Labs has, over time, changed the provisions of its license agreement and is now requiring B Corps to change (within a reasonable period of time) their underlying corporate form to the benefit corporation. Unfortunately, there appears to be a failure to recognize that there are effective mechanisms that can require corporations and LLCs to stay true to their impact goals — with enforcement measures that are just as (or more) effective as those afforded to the new corporate forms, including the benefit corporation.
Other Performance Metrics
In addition to B certification, there are many other methods for rating a company’s performance based on ESG factors. According to SustainAbility, there are over 110 such rating systems and many include both a description of the ESG factors that should be measured and data to provide a benchmark for measurement. In addition to B Corps, the Global Reporting Initiative (GRI), Sustainalytics and MSCI provide evaluations across the full environmental, social and governance spectrum, while CDP and CarbonTracker focus on measuring carbon emissions and risk.
Most public companies are suffering from disclosure “overload” related to ESG as they are continuously approached by new organizations asking them to complete surveys, provide data and help rate their performance on various social and environmental metrics. Fortunately, the rise of integrated reporting with public companies should, over time, bring needed standardization and rigor to the sector. Key leaders such as the Sustainable Accounting Standards Board, GRI and the International Integrated Reporting Council are identifying the ESG factors by industry that are material to operations and should therefore be disclosed in required reporting for public companies. The Bloomberg-Carney Task Force on Climate-Related Financial Disclosures is working to harmonize standards related to climate risk. All of the standard-setters are engaged with the Big 4 accounting firms to provide a framework for disclosure that can be audited or verified. In the United States, the Nasdaq and NYSE have indicated a willingness to follow other stock exchanges from around the world whose listing standards already include — or soon will — certain ESG factors.
The movement toward reporting on material social and environmental factors in a way that can be audited and included with financial reporting to shareholders will certainly represent a big step toward improving accountability for companies around the major environmental and social issues that we face today. Such reporting is also necessary for there to be a shift of the fiduciary duties of boards and management to include ESG goals, as contemplated by the new corporate forms.
The New Corporate Forms Come in Many Shapes and Sizes
The branding genius of B Labs has most people, including ESG practitioners and press, believing that there is only one new corporate form — the benefit corporation. However, in fact, there are several different forms that have been conceived to chart a new path between non-profits (focused exclusively on mission) and for-profits (focused primarily on shareholder value). Further, the benefit corporation form itself varies greatly from state to state; only a few states follow the “model” initially developed by B Labs, and that model itself has been modified substantially and improved over time.
There are two primary elements that are universal to the new forms. First, they all require boards and management to consider social and/or environmental goals in addition to financial returns. Second, at least as of this writing, none of the new forms receive special tax treatment; investments and/or donations to the new corporate forms are not deductible, and revenue earned by the entities is taxed at normal rates.
The Low-Profit Limited Liability Company (L3C)
The first new form to arrive on the scene — the Low-Profit Limited Liability Company or L3C — was written into law in Vermont in 2008. Since the Tax Reform Act of 1969, foundations have been permitted to make program-related investments (PRIs), which are investments in for-profit entities, so long as those investments are for the primary purpose of advancing the foundation’s charitable purpose and not generating financial returns. However, the originators of the L3C noticed that utilization rates for PRIs had remained very low over the four decades since their introduction. The L3C was conceived to address this failure and help non-profits, particularly foundations, deploy greater capital and have greater impact through investment in for-profit entities as an alternative to donations. Specifically, the L3C is a form of limited liability company that requires managers and owners to articulate social and environmental goals and then prioritize such goals over financial returns.
Unfortunately, L3Cs have not garnered widespread support from entrepreneurs or funding from foundations. This is in part because more significant IRS rule changes (anticipated at the time of original conception) have not come to pass to afford special tax treatment for the L3Cs or obviate the need for tax opinion letters. However, new regulations and guidance from the IRS as recently as 2016 have served to further de-risk PRIs (if they were ever in fact risky) and may spur further adoption of PRI investments if not L3Cs. In addition, the L3C form does provide a viable alternative to “mission first” enterprises in the eight states (and two Native American tribes) with L3C legislation. Further, for those of us who practice in states without L3C legislation (particularly California and Delaware), the forms offer good exemplars and ideas for incorporating social and environmental purpose into traditional LLCs.
Social Purpose and Public Benefit Corporations
Whereas the L3C can be viewed as an extension of the non-profit corporation, social benefit and public benefit corporations (SPCs/PBCs) were intended to introduce social and environmental focus to the traditional for-profit corporation. The Flexible Purpose Corporation (renamed Social Purpose Corporation in 2015) was drafted over a two-and-a-half-year period by a non-partisan group of corporate lawyers (of which I was a member) and was first introduced in 2009 in California. In general, the SPC provides a safe harbor — in addition to the business judgement rule — that requires boards and management to emphasize shareholder-agreed social and/or environmental purposes in the charter. In addition, the SPC differs from a traditional corporation because of the fiduciary duty to the mission (and additional protection to the board and management in promoting the entity’s social and environmental goals), mission protection (two-thirds class vote to change the agreed purpose), increased accountability via reporting, and detailed provisions for conversion, merger, sale and consolidation.
The Social Purpose Corporation, introduced in 2013 and adopted in Delaware in 2015, is substantially similar to the Public Benefit Corporation with only two material exceptions. The PBC requires a broad public purpose in addition to the specified social and/or environmental goals, while the SPC only requires at least one shareholder-agreed social or environmental goal. And the SPC requires greater accountability and reporting than the PBC. B Labs initially supported the SPC before deciding to introduce a second form in California in 2011. Ironically, when B Labs rejected the SPC in favor of the California benefit corporation, it provided an open letter with objections to five provisions of the SPC — and all five provisions are now incorporated into the Delaware PBC. Specifically, the Social Purpose Corporation and the Public Benefit Corporation:
- both have shareholder-agreed social and environmental goals that must be articulated in the charter of the corporation (instead of itemizing all goals in the state statute itself);
- do not require external validation or audit of the reporting to shareholders on the public benefit (the SPC requires that such reporting be in accordance with “best practices” while the PBC allows the board/management to simply describe the standards that have been used for reporting);
- do not have an identified “benefit director” (a feature of benefit corporations in other states) with fiduciary duties that arguably conflict with pre-existing fiduciary duties;
- do not have a “special proceeding” to enforce the social/environmental mission (both provide additional protection from liability for boards and management and rely on traditional corporate enforcement mechanisms, specifically the right of shareholder action for breach of duties and the right to remove directors); and
- both offer dissenters rights on conversion from an existing corporate entity to the new form (allowing shareholders the right to object to the conversion and take action to have their shares redeemed).
Ironically, given that the SPC is often referred to as the “benefit corporation light,” the SPC has more robust reporting requirements than the PBC — with annual reporting for the SPC (as opposed to biannual for the PBC), required reporting to the public as well as shareholders for the SPC (no public reporting for the PBC) and 8-K type reporting for the SPC if there are material changes in between annual reports (no reporting other than biannual for PBC).
Both the SPC and PBC have been designed for use by both small social enterprises and by larger public companies. The first PBC (Laureate Education) filed an S-1 with the SEC to go public in October 2015 (but has yet to list its shares and start trading). A second PBC will result from the closing of the $10.4 billion merger of Danone and WhiteWave Foods.
Finally, both the SPC and the PBC can garner support from liberals and conservatives as an “extra-governmental” solution to the current crises. They can be vehicles for economic growth and job creation in addition to advancing social and environmental goals that are approved by shareholders (as opposed to legislators) and can be in the best interests of the corporation’s long-term financial well-being. When introduced in California, the SPC was the only bill that year that received 100% support from both Democrats and Republicans in the Senate.
The Benefit Corporation
The first benefit corporation was written into the Maryland statute in 2010. Since that time, various versions of benefit corporation legislation have been adopted by 30 states plus the District of Columbia (according to B Labs as of August 2016). Note that many states use different names for the new form – including Benefit Corporation, Public Benefit Corporation (e.g. CO), Social Purpose Corporation (e.g. WA, FL) and Sustainable Business Corporation (e.g. HI). Further confusing the issue is that in some states, the benefit or public benefit corporation is a form of non-profit corporation while in others it is a form of for-profit corporation (and we are obviously discussing the latter in this article).
It is also important to note that benefit corporations vary greatly state by state and have evolved significantly since first introduced and advocated by B Labs in Maryland and Vermont six years ago. In fact, many are much more similar to the SPC and PBC than to either the first legislation or to the “model” statute promoted by B Labs. However, in general, unlike the PBC and SPC, these statutes bake “goodness” into the legislation — as a benefit corporation, a company’s board and management have a fiduciary duty to a long list of social, environmental and governance goals (borrowed from the “B Corp” certification survey) in addition to financial goals. The successful lobbying efforts of B Labs have made the benefit corporation approach far more prevalent when measured by state adoption (not by company incorporation) — although not in Delaware (or CO, WA, FL). However, it remains to be seen which policy approach will have greater positive impact on the world — companies that have affirmative fiduciary duties to selected social and environmental goals or those that are required to focus on a laundry list of objectives.
In most states, the benefit corporation provisions are an “add on” to the corporations code — not creating a new and distinct legal entity but fashioning a new designation for “normal” corporations. For many states, this has resulted in unintended conflicts between corporate law and benefit corporate law that apply to the same entity. For example, most state benefit corporations have a “benefit director” responsible for oversight and accountability with respect to the public purpose and a requirement of independent verification (which either by design or by default comes courtesy of B Labs for a fee). Corporate law experts often cite a recurring issue state-by-state between the conflicting duties of a benefit director whose new duties must be viewed in light of his or her pre-existing fiduciary duties of care and loyalty to the shareholders. They also point to issues with the “enforcement proceeding,” a feature of most benefit corporation laws, which can yield increased risk and liability for boards and management. It is therefore not a surprise that many benefit corporations have difficulty securing director and officer insurance.
Provided that you have waded through the detail on corporate form above — which is likely at odds with the articles and press releases written by biased advocates of one form or another (many of whom benefit financially from promotion of a certain form) — what does all of this mean for both private social enterprises and for public companies? Should boards and management consider either incorporating as — or converting into — one of the new corporate forms?
Let me stress that I believe requiring all corporations to change form — imposing fiduciary duties on boards and management in favor of shareholder-agreed social and environmental goals — is critical as a tool to address issues ranging from social inequality to climate change. However, we do not yet have an agreed form (much less an agreed name) for the new corporate form — although most experts (myself included) agree that the Delaware Public Benefit Corporation is currently the best model. Further, the weighting of fiduciary duties has not yet been tested in court. In other words, if a company is increasingly profitable in its operations and successful in emphasizing the agreed social or environmental goals, there is little risk of litigation. If, on the other hand, a company becomes unprofitable and therefore must make choices between adherence to the public purpose and financial stability, risks will increase.
So, some concrete advice on whether to adopt a new corporate form (to “B” or not to “B”):
- If the good or service that your company produces has a positive social or environmental impact in and of itself (e.g. solar, education, healthy school lunches), there is much less risk associated with the “weighting” issue above and therefore incorporation/conversion into a new form. For these companies, there is often no trade-off between high profits and high positive social/environmental impact.
- If the good or service that you produce is output-agnostic (e.g. social media application, coffee tables, baseball bats), then you must consider the interplay between the public purpose and your profitability before you convert. This does not necessarily mean there is a trade-off. Positive focus on ESG goals could increase profitability for the maker of baseball bats that emphasizes employee relations and contributes financially to the building of little league parks in underserved communities.
- If you are a start-up and introducing an innovative new product with a new management team, the new corporate form may be one “new” too many. If you and your board really want to try one of the new forms, I suggest waiting 6-18 months after incorporation, possibly asking your investors to agree to convert to a new form (conversion is easy) after certain milestones are met.
- In all of the cases above, it is critical that you not only get your board to embrace the new form, fully understanding the risks and rewards (not just the latest PR spin), but that your investors are fully comfortable as well. In the early stages, commitment to convert ahead of investor support can significantly increase the likelihood that your venture will fail.
- Your board and investors will need to understand not only the impact of the new fiduciary duties on daily operations but also exits — IPOs and sale transactions (although there are more alternative forms of exits being utilized by social enterprises). We do not yet know how the market will price these new entities (although we are waiting for two concrete examples — Laureate Education and Danone/WhiteWave). There is some evidence that the market will view the public purpose as a net positive, specifically for companies where the product or service produced is good for the environment, community or society. However, this belief faces strong headwinds from mainstream capital markets that have long held that “impact” or focus on social/environmental purpose will necessarily generate lower returns.
- Finally, if your company — with board and shareholder support — is serious about embracing a public purpose and having a positive impact, there are many very effective tools to implement such goals for traditional corporations.
The Power of the Corporate Form
So how can corporate form be such an effective tool for change? And why do we need the new forms? If you believe the statements that I made at the start of this article, then why can’t we just rely on existing forms of corporation, limited partnership and limited liability companies to solve the world’s problems? The short answer is that we can and should. Arguing that all corporations have to convert into new corporate forms in the short-term is essentially letting Corporate America off the hook. If we continue to stress that boards and management have a fiduciary duty solely to maximize short-term shareholder profits, we will miss out on enlisting the most powerful force (multinational corporations) to address the crises that are crippling our country and world. More importantly, we will be doing them a disservice. The combination of climate change, challenges with energy, water and other natural resources and population growth is leading to a world that in 10 or 20 years will be vastly different than it is today. Corporations will have to transform their operations to remain competitive. Ignoring these ESG factors — particularly the risks associated with climate change — is just plain bad business.
I often cite Bob Litterman, formerly of Goldman Sachs and now of Kepos Capital (who does not know that I am a groupie), in describing the intersection between climate risk and business. He explains that we are all in a car headed for a cliff. Most people recognize that the (or “a”) cliff is coming, but no one can confirm with certainty exactly when we will reach it or how precipitous the drop will be. The economic models underlying the operations of all of our corporations (and government policy) are premised on the theory that, if such cliff exists, we will be able to gradually apply the brakes before we commit suicide. However, in fact, because of the unknown variables, it is probable (if not a certainty) that we will need to slam on the brakes. The companies that start modeling the risk associated with the cliff will have a much better chance of avoiding or surviving the fall and thriving through the next several decades.
Unfortunately, for many reasons — including the difficulties associated with assessing the risk, the desire to maintain the status quo, compensation and tax structures — it is taking longer for corporations to appreciate how ESG factors will impact operations. And some of the issues that we are facing today, particularly those borne of climate change and social inequality, require solutions that can generate more immediate results.
We need the new corporate forms (and particularly agreement and promotion of one preferred form) so that we can require the major multinational corporations to identify and actively pursue social and environmental goals instead of merely considering material non-financial factors. We need the new forms so that the next BP oil spill is not just around the corner. We need the new forms so that shareholders can bring actions against large drug companies if they raise the prices of EpiPens, denying access to the general population.
We need the new forms so that “Black Lives Matter” can translate into educational opportunities for the underserved in our society. We need the new forms so that we can increase the number of women and minorities on boards and in management — and thereby improve productivity — of corporations (and law firms). We need the new forms so that we can hold the managers of privately owned prisons accountable for recidivism rates.And most of all, we need the new forms so that the managers of our corporations are required to look further into the future and take actions to plan for climate change and cybersecurity breaches and artificial intelligence and changes in the labor force — even if such actions are at the expense of short-term shareholder profitability.
Corporate form rocks. And, more importantly, it has the power to effect the change that we desperately need.
 Formerly named the Carbon Disclosure Project.
Susan Mac Cormac is a partner in the Corporate Department of Morrison & Foerster’s San Francisco office. She serves as co-chair of the Clean Technology + Alternative Energy Group and Private Equity and Venture Investment Practice. Susan has extensive experience representing start-up to late-stage private companies primarily in the clean technology or sustainable space.
A funny thing happened on the way to the Paris Agreement. On September 18, 2015, just six weeks before the most anticipated UN climate negotiations since Kyoto were slated to begin, the world’s most powerful environmental regulatory agency threw down the gauntlet to the world’s largest automaker. In a scathing Notice of Violation made immediately public, the US EPA detailed shocking allegations of blatant impropriety by Volkswagen, a company that had finally begun flourishing in the lucrative US market under the guise of being “green.” Just as 195 countries were finalizing their individualized commitments to address climate change by reducing emissions, the VW emissions scandal exploded. Environmentalists cheered as the sins of their chief nemesis, multinational corporations, were exposed. Free market proponents huddled up, ready to prove that inconsistent regulatory schemes were all that stood in the way of the innovations that would bring about global prosperity. The stage was set for an epic battle, and Paris was going to be one side’s Waterloo.
But as we mentioned, a funny thing happened. Globalization, environmentalism’s worst enemy, became the planet’s best hope.
Those of us who work at the intersection of environmental and economic policy have long tried to counter the perception that integrated capital markets and global trade are anathema to protecting Earth’s natural resources. Despite overwhelming evidence that interdependence leads to increased efficiencies, hyperbole and anecdotes have framed the debate, causing collaboration and compromise to be seen as Faustian deceptions. But Paris opened the door by linking the goals of environmentalism to international cooperation, and the VW scandal unexpectedly provided the blueprint.
For all the efforts by the EU and Germany over the years to develop strategies to combat climate change and promote sustainable development, companies, particularly large manufacturers, have benefited from inconsistent regulatory compliance mechanisms. In the name of consensus, certification by one EU Member State is certification by all, creating a loophole that critics refer to as the “Race to the Bottom.” Companies such as Volkswagen can build factories in countries that agree to relax standards without jeopardizing their ability to sell to customers in countries with rigid requirements. This form of roving protectionism makes enforcement of ambitious targets nearly impossible, especially when those targets conspicuously excepted the known contaminants emitted from “clean diesel” engines, VW’s revolutionary way of reducing the carbon and environmental footprint of their cars.
The US, however, has a different set of standards when it comes to regulating environmental impact. Yes, carbon emissions are important, but human health has always been the leading factor in turning environmental ambitions into political action. For that reason, the noxious fumes caused by diesel combustion are more tightly monitored, especially in California, where questions began to arise as to how clean VW’s diesel engines really were. When initial tests didn’t seem to match real-world experiences, the EPA contracted an independent research institute, the International Council on Clean Transport, to run a more exhaustive study. ICCT worked with a group of scientists from West Virginia University who uncovered the scandal.
It’s been one year since the scandal broke, and there has been no shortage of drama. Volkswagen agreed to a massive settlement with the US Department of Justice that could amount to $15 billion, a VW engineer has pleaded guilty to conspiracy to violate the Clean Air Act, and investigations continue both in the US and Germany to determine where the buck stops. From an environmental standpoint, VW has signaled it will drop its clean diesel program in favor of electric vehicles.
But the goal here is not to recount Volkswagen’s deceptions and determine if the punishments fit the crimes. Instead, we want to show that globalization enabled the discovery of VW’s crime. There are millions of clean diesel engines on the roads of Europe, and there likely would have been millions more, were it not for the variations in sovereign regulatory policies in the US and EU. Were it not for strong compliance and enforcement mechanisms at the EPA, the health of Americans and Europeans alike would have continued to suffer. It is the integrated global market that produced the transparency necessary to achieve this watershed moment for environmentalism.
Transparency and diversity, the hallmarks of sustainable globalization, are most easily observed as functions of corporate governance. Volkswagen’s position of privilege within Germany and the EU does not serve its investors well in the global marketplace. Questions have been raised as to whether VW will ever be able to be a leader in innovation as long as the national government’s priorities supersede the demands, and opportunities, of the global market. As investors look for companies prepared to meet those demands and take advantage of those opportunities, they will find that organizations which prioritize transparency and diversity, no matter the size, will be the innovators leading the way toward sustainable globalization.
Brendan O’Donnell is a Fellow at Ecologic Institute. His work focuses on sustainable urban development, especially the visibility and accessibility of diverse communities in the decision-making process; post-carbon finance, including the development of vehicles and policies to support sustainable investing; and the future of environmentalism, particularly how art and other cultural influences inform the concept of nature and inspire environmental policy.
Max Gruenig is the President of Ecologic Institute US and has been with the Institute since 2007. His work focuses on sustainable development in the energy and transport sector, as well as urban sustainability and resilient cities. Max Gruenig has lived and worked in Germany, the United States, Iceland, and Japan.
Mr. Brent J. Fields
Secretary Securities and Exchange Commission
100 F Street, NE Washington, DC 20549-1090
Re: Business and Financial Disclosure Required by Regulation S-K (File No. S7-06- 16)
Dear Mr. Secretary,
Cornerstone Capital Inc. (dba Cornerstone Capital Group [“Cornerstone”]) appreciates and welcomes the opportunity to submit comments in response to the Commission’s concept release “Business and Financial Disclosure Required by Regulation S-K” (“the Release”).
Founded in 2013, Cornerstone is a financial services firm based in New York. The mission of the firm is to apply the principles of sustainable finance across the capital markets and enhance investment processes through transparency and collaboration. In offering investment advisory, investment banking and corporate advisory services, Cornerstone works with asset owners, corporations and financial institutions to promote new research in the field of Environmental, Social and Governance (ESG) analysis, and facilitate capital introductions for organizations around the world engaged in sustainable business practices.
Because our clients are long-term investors, we have a strong interest in the quality of corporate disclosures, and how well they enable us to evaluate risks and make decisions that will affect the long-term health of our clients’ portfolios. We believe that although current disclosure standards require companies to report on all material issues, companies currently have insufficient guidance regarding disclosure of long-term issues, particularly those related to ESG concerns.
Voluntary sustainability reports separate from financial disclosures have been commonplace for several years. Standards for voluntary reporting have risen considerably, and these reports are valuable to many stakeholders such as employees, communities and customers. Yet current ESG disclosures fail the test of quality, comparability, consistency and materiality that would make them useful to investor decision-making.
Our comments reflect our views on how ESG disclosures could be incorporated into corporate disclosures in a manner consistent with existing disclosure standards and expectations.
Read the full text of the letter from John Wilson and the Cornerstone Capital Research team here.
John K.S. Wilson is the Head of Corporate Governance, Engagement & Research at Cornerstone Capital Group. He leads a multidisciplinary team that publishes investment research integrating Environmental, Social and Governance (ESG) issues into thematic equity research. He also writes and presents widely about the relevance of corporate governance and sustainability to investment performance for academic, foundations, corporate and investor audiences.
More than 2,000 people gathered in Vancouver last week for GLOBE 2016, North America’s Largest International Environmental Business Summit, to learn how businesses and investors are meeting the growing demand for innovations to move the world toward a low-carbon future. Business executives, government officials, investors, and delegates from 50 countries shared their views on the state of play on dozens of topics, most focused on the contributions the private sector is making and can make to adapt to climate change, meet the climate targets that 195 countries and the European Union committed to at COP21 (the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change) in Paris last December, and accelerate the shift toward a clean-energy and environmentally sustainable economy.
Scientists have warned for decades that global climate patterns are shifting in ways that are dangerously different from historical patterns, with some places getting stormier, others getting drier, some getting cooler, and others getting hotter. Along with those shifts has been a rise in the average global temperature that, above a certain point, would melt the planet’s permafrost, devastate small islands and coastal communities with rising sea levels, and permanently change weather and storm patterns in ways that would endanger agriculture, marine species, and the economies that depend on them. The scientific consensus has been that these changing patterns are a result of the growing volume of greenhouse gases being released into the atmosphere by certain carbon-heavy economic activities. And only by dramatically reducing the volume of such emissions, climate scientists have argued, will we be able to slow average warming to a point where risks to human lives and assets can still be understood, a level estimated at around 1.5° or 2°C above the current average. As pension actuary Karen Lockridge of Mercer put it, “A two-degree world might be insurable. A four-degree world would not be.”
Some damage has already been done. Droughts leading to urban migration and political instability have already contributed to outbreaks of war (followed by refugee crises). Some communities in the tiny islands of the Pacific and Indian oceans are preparing to relocate (one already has). Entire industries are at risk (how will changing temperatures in France affect the quality of its wine grapes?), and while some businesses, investors, and governments are preparing to mitigate those risks, the more entrepreneurial ones are recognizing that with such a large shift in economic forces comes the potential for large opportunities. For that reason, the theme of GLOBE 2016 was “innovation,” the search for opportunities to adapt, mitigate, profit from, or contribute to rapid changes in the global economy.
My three big takeaways from the week: Heading toward a low-carbon economy, demand is moving up, supply is catching up, and policy is lagging behind.
Demand: Moving On Up
The shift to a low-carbon economy did not begin with government regulations or international treaties. It began with consumers who demanded more and more environmentally friendly products and climate-friendly business operations, and who increasingly turned away from products and companies that did not meet the demand fast enough. Not all climate-friendly companies have succeeded, but many of the companies that predicted where social demand, environmental changes, and likely regulation were heading and got out in front of their competitors have turned out to do very well. Philips certainly has not regretted its move into LED light bulbs, BASF has profited nicely after reformulating some processes and products, and Boeing’s increasingly fuel-efficient planes are lowering its customers’ operating costs. In the mid-19th century, the whale-oil industry collapsed in a few short years as consumers turned to kerosene amid volatility in oil supply from declines in the whale population. As the Rocky Mountain Institute founder Amory Lovens put it, “Whalers were surprised that they ran out of customers before they ran out of whales.” It is likely that, as innovators meet the demand for clean technologies and materials, and industrial designers find more efficient uses of existing technologies and materials, peak oil might turn out to be a peak in demand rather than a peak in supply. It is market forces that will drive the low-carbon economy — if corporate boards and government regulators will let them.
Supply: Catching Up
Corporate social responsibility (CSR) came about in response to consumer divestment movements and investor activism, but CSR efforts were generally housed in public affairs offices rather than integrated into business operations. By contrast, a growing number of corporate directors and officers, as well as investment analysts, are recognizing the value of accounting for social, environmental, and governance (ESG) factors as part of their calculations of risk and opportunity. Some investment analysts are responding to investor demand for social impact and ESG performance with financial products based on simplistic screens. But more sophisticated analysts are digging deeper and encouraging more standardized reporting of ESG-relevant corporate reporting. More and more are recognizing, as Cornerstone’s Erika Karp has pointed out, that sustainability is just another term for “corporate excellence” or, according to the UN Global Compact’s Ingvlid Sørensen, “good corporate governance,” both of which demand that companies examine the real risks they face from climate change, climate adaptation, and the social disruptions that will emerge from both. But many boards still do not see it that way, instead simply waiting for policy makers to introduce the regulations they will need to follow.
Policy: Lagging Behind
Many companies are not waiting for policy makers. And many are not even looking for subsidies to support their innovations against dirty-energy products, although many did express a desire for a simplification of tax incentives and the removal of subsidies for their less climate-friendly competitors. What most businesses and investors are looking for is a predictable policy environment. It helps to know the commitments that most countries have now made to reducing their emissions, and at the Climate Action Summit in Washington DC in May, many of those countries will meet to begin developing an action plan. In the United States, the Labor Department ruling that allowed pension fund managers to account for ESG factors as part of their fiduciary duty was a welcome development, although there is still some confusion about how to interpret the ruling. But there is still a long way to go. Delegates to GLOBE 2016 wanted to see reforms in the financial sector to encourage more disclosure of risk and a policy framework that rewards longer-term investments, for example. And the policy change most speakers and delegates at the GLOBE conference wanted above all was a price on carbon pollution, a change that would give them a quantifiable way to incorporate climate considerations into their plans and reporting.
None of this will come easily. Corporations that are deeply concerned about climate change and spend a lot of money on policy advocacy for other issues are not asking their lobbyists to encourage policy changes on climate. That needs to change. In fact, it was clear from the talk on the panels and in the hallways of the convention center in Vancouver that adapting to and moving toward a two-degree world will require work at every level. Policy makers need to set a predictable framework. Corporations need to lobby them to do so, even while finding ways to create innovative new products and ways of doing business to reduce the carbon footprint in their operations and supply chains. Index, rating, and research agencies all will need to create the standardized data and tools that are needed to analyze climate risks and sustainability impacts. Social movements will need to advocate for communities and sectors who inevitably will be negatively affected by climate change and climate action alike, and businesses and policy makers will need to respond, both because it is the right thing to do and to reduce the social and political risks that could be associated with climate action. Consumers are going to need to shift their spending habits even more toward low-carbon products. And investors and investment managers are going to need to move billions and probably trillions of dollars into the companies that are best positioned to thrive in an economy that will see rapid changes in the next decades.
Robert Lamb, PhD, has been a strategist, policy adviser, public speaker, and collaborator in Washington, DC, for more than 20 years. Hi research focuses on hidden systems and barriers that affect strategic success in organizations and societies, from social dynamics in war zones to intangible factors in business relationships. This academic year he is a visiting research professor at the U.S. Army War College’s Strategic Studies Institute, working to improve U.S. and international policy in fragile and conflict environments.
In our July 2015 report Scenario: What if Electricity Prices Fell?, we outlined how radical changes in the US electricity market, including the then-draft Clean Power Plan (CPP) rule, could result in falling retail electricity prices. The CPP rule, finalized in October 2015, proposed state-specific, rate-based goals for carbon dioxide emissions from the power sector. The accompanying regulatory assessment released by the EPA stated the impact of the proposed rule would be a 1.1-3.2% increase in average electricity bills to 2020 but a 3.2-5.4% decrease by 2025 compared to current US Energy Information Agency forecasts.
On February 9, 2016, the US Supreme Court (SCOTUS) granted a stay to the implementation of the CPP rule by the US Environmental Protection Agency (EPA). Opponents of the rule, including 29 states and state agencies and several industry and trade groups, had appealed a decision by the D.C. Circuit Court not to stay the rule while litigation over it plays out. The stay application was approved by the Supreme Court along ideological lines – 5 to 4. D.C. Circuit oral arguments are scheduled for June 2.
Opponents of the rule point to the granted stay application as a sign that the majority of justices are likely to agree that the EPA doesn’t have the authority under the Clean Air Act (CAA) to craft the rule. The question of this authority, rather than whether the rule presents an unfair impact on different types of power generation (Figure 1), is the primary challenge from opponents. Yesterday’s ruling supported the opponents’ claim that the costs of implementing the CPP now could not be compensated for in the event that SCOTUS strikes down the EPA’s authority, and therefore, implementation should be halted until the case is adjudicated.
The ruling does not, in itself, change the likelihood of CPP being struck down by SCOTUS but indirectly recognizes the possible impacts of the plan. In our view, the intensity of the challenge from the states and certain industries, and the SCOTUS ruling that CPP should be halted while being litigated, demonstrates that the CPP has significant implications for the sector. Our view on possible falling retail electricity prices would change if the EPA’s ability to implement the CPP is struck down, but we note that ongoing declines in renewable energy costs, as shown in Figure 2, could still result in flat or falling prices.
The impact of the CPP rules are shown in Figure 1 in contrast to the US Energy Information Agency (EIA)’s AEO2015 reference case.
Figure 1: Projected US electric capacity additions and retirements, 2010-40
Source: US EPA, 2015
Key takeaways are higher renewable energy additions than currently forecast, lower forecast natural gas generation additions and major coal generation retirements. In addition, renewable energy prices continue to decline as shown in Figure 2.
Figure 2: Historical and forecast electricity prices, forecast levelized cost of energy and solar PPA announcements
Source: Cornerstone Capital Group, EIA, Lazard, SunEdison, and Berkshire Hathaway
*SunEdison and NV Energy PPA includes Investment Tax Credit benefits
For important disclosures, please click here.
Sebastian Vanderzeil is a research analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.
Interest in alternative nutritional feed additives is growing. As we discussed in our October 5, 2015 report Antibiotics and Animal Health: Value-Chain Implications in the US, a confluence of regulatory action and heightened consumer awareness is exerting pressure on livestock producers to reassess their usage of antibiotics.
Our optimistic view on specialty and nutritional feed additives is supported by Adisseo and Novozymes’ recent launch of a probiotics product.
- On January 25, 2016, Adisseo and Novozymes launched Alterion, their first probiotic for poultry. The product is meant to improve feed utilization and provide an alternative to antibiotic growth promoters on poultry farms. It will be released to the US market in addition to the Middle East and Southeast Asia.
- Developed from a strain of Bacillus subtilis, Alterion can be added to feed to affect the composition of intestinal microbiota, providing growth and health benefits to animals when ingested. In addition, it also optimizes feed conversion by 2-2.5%.
- Novozymes and Adisseo entered a partnership to develop probiotics in May 2015. Novozymes performs in-vitro testing and manages Alterion’s development and production. Adisseo performs in-vivo testing and manages the marketing and sales of Alterion.
Rapid growth of probiotics market. Our previous research indicated that the global feed additives market, which we estimate to be valued at approximately $15 billion, could experience mid-single-digit growth annually through 2020. Adisseo and Novozymes have also adopted a favorable outlook on the market, estimating the probiotics market alone to be at “EUR 200-300 million and 8-10% annual growth.”
Figure 1: Antibiotics and feed additives
Source: Cornerstone Capital Group
Figure 2: Feed additives outlook
Probiotics are forecast to grow rapidly and face less competitive pressure
Bubble size denotes the current size of each market; market growth outlook is estimated through 2020.
Source: DSM, Novozymes, DuPont, Grandview Research, Transparency Market Research, Cornerstone Capital Group
Michael Shavel is a Global Thematic Analyst at Cornerstone Capital Group. Prior to joining the firm, Michael was a Research Analyst on the Global Growth and Thematic team at Alliance Bernstein. He holds a B.S. in Finance from Rutgers University and is a CFA Charterholder.
Sebastian Vanderzeil is a Research Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.
Andy Zheng is a Research Associate at Cornerstone Capital Group. Andy graduated from Bowdoin College with an interdisciplinary major in Mathematics and Economics and a minor in Visual Arts. He spent his junior year studying abroad at the University of Oxford and the summer prior to that at the Sorbonne in Paris. Andy passed Level I of the CFA Program in January 2014.
Cornerstone Capital Group research intern Chanelle Qi contributed to this report.
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