By Lawrence Elbaum, Patrick Gadson, and Margaret Peloso
For activist investors pursuing environmental, social, or governance (ESG) goals, 2022 has not exactly gone according to plan. Indeed, the success of activist campaigns involving demands on environmental and social issues has fallen nearly 50 percent,[*] and support for these proposals from the two dominant proxy advisory firms has sharply declined as well.
Meanwhile, newly lifted restrictions on international travel—along with rising inflation and the escalating war in Ukraine—sent oil prices to record highs this summer, driving up conventional-energy stocks and causing ESG-focused funds to underperform. And following years of growing interest and optimism, the broader ESG movement is suddenly facing strong pushback, as state governments challenge financial institutions they see as hostile to conventional energy and “anti-woke” proposals promote an alternative view.
Yet if you think we’ve reached Peak ESG, as some financial analysts claim, think again. As shown in a thoughtful new report from Insightia, the environment for ESG activism remains quite rich, with ample opportunity for activists to strike in both new and familiar ways.
A Rich Environment
The raw data bear out this rich environment. Through July, U.S. activist investors had engaged in 607 ESG- and remuneration-led campaigns in 2022, a 25 percent increase over the 484 launched all of last year. For environmental- and social-led campaigns, the numbers are even more striking: U.S. activist investors had engaged in 310 through July 2022, nearly twice the 168 launched in all of 2021.
The takeaway here is that, even as the success of ESG-oriented campaigns has taken a hit, investor interest in ESG issues has surged, and today stands well above its previous all-time high. Just as important, the declining success of environmental and social proposals doesn’t indicate some sea change in investor sentiment; rather, it reflects a shift in the substance of the proposals brought to a vote.
This proxy season, many environmental and social proposals were settled before coming to a vote, suggesting that companies at times hedged their bets to protect against the possibility of activist victories, and that the activists managed to extract some concessions in the process. Plus, the proposals that did go to a vote were more demanding—and more constraining—than those in 2021, making it more difficult for them to win support.
None of this is to say that investors’ ESG-related views aren’t evolving. Of course they are. As the Insightia reportmakes clear, institutional investors—the electorate whose support activists need to win any proxy contest—no longer line up behind any and every environmental or social activist campaign. Instead, they’re working to become more knowledgeable on the issues, growing more selective in the issues they support, and administering greater scrutiny to the proposals themselves.
The upshot has been a sharper focus on materiality, with a view to basing support for ESG-oriented proposals on their ability to create shareholder value. For this reason, we expect ESG activist investors to be thinking more about the economic arguments in their proposals, and crafting them to ensure that the sustainability reforms they advance don’t lose all sight of the bottom line.
With this in mind, companies that have seen substantial drops in market value can expect to become more tempting targets for activists, and to face more campaigns centered on mergers and acquisitions. As activists aim to highlight companies’ economics in these campaigns, ESG-related issues may well become less visible in them. But make no mistake: these issues will continue to be a key driver of activist campaigns behind the scenes.
The regulatory landscape is another area to watch. The SEC’s new universal proxy rules should lower the cost to run campaigns seeking minority board representation, and thus encourage first-time activists—particularly those with small or ESG-focused funds—to put forth their own nominees. And should the Commission’s climate disclosure rule turn out similar to the proposal, the new requirements it imposes will likely play a role in shaping activists’ demands in climate-related campaigns next year.
Looking ahead, companies and their boards will have plenty of ESG-oriented activist campaigns to contend with, and both will need to be prepared to protect themselves.
This means consulting with key players on their team—lawyers, investment bankers, boutique advisors, communication firms, and proxy solicitors—long before an activist begins raising concerns. It means getting up to speed on leading activism trends and defense techniques. And it means closely monitoring and processing shareholder feedback, whether through routine quarterly engagements, annual meeting voting results, or proxy advisory firm recommendations and ESG scores.
Companies and boards that take this preparation seriously—and that are proactive in making board, governance, and business changes where appropriate—will be positioning themselves to mount a stout defense when an ESG-oriented campaign arises.
Lawrence Elbaum and Patrick Gadson are Partners at Vinson & Elkins, serving as co-heads of the firm’s Shareholder Activism practice. Margaret Peloso is the firm’s Lead Sustainability Partner.
[*] Only 33 percent of environmental and social activist campaigns have seen even partial success in 2022, down from 62 percent in 2021. ESG Activism 2022. Insightia.