ESG Activism: Coming Soon to a Boardroom Near You

Authors: MLT Aikins ESG practice group

Creative investor and social activism in environmental, social and corporate governance (“ESG”) could be bad news for business as usual.

The unprecedented success of ESG activist group, Engine No. 1, in forcing management of Exxon Mobil Corporation (“Exxon”) to become more aggressive in tackling climate change could signal a new form of highly effective and innovative ESG activism. In a similar fashion, Royal Dutch Shell (“Shell”) has very recently become the target of similar pressure from the activist Wall Street hedge fund Third Point LLC. For companies operating in the energy sector and beyond, this means that boards of directors need to quickly up their ESG game or face the risk of activist scrutiny and action.

For the purposes of this article, the term “activist” is outlined below and does not include Indigenous communities and businesses, as these organizations are important players and will factor prominently in ESG strategy and business opportunities going forward.

In this article we define an “activist” as an individual or group of shareholders in a corporation that are motivated primarily by ideological reasons, with little or no consideration of any other perspectives or rationale. Activists become shareholders and take certain actions in these roles to achieve a singular political goal. “Activists” are distinguished from other shareholders who have a diversity of perspectives and views and are not motivated to become a shareholder and exert the powers of being a shareholder primarily for ideological or political reasons.

The Perfect Storm is Brewing

Boards Do Not Understand ESG Risks Well

According to Price Waterhouse Cooper’s 2021 Corporate Director survey, although nearly 64% of companies are linking sustainability issues to corporate strategy, a whopping 75% of boards reported that they do not understand ESG risk very well, nor do they have a good understanding of their company’s sustainability messaging.

Mandatory ESG Reporting is Coming

To date, ESG reporting has been largely voluntary, with companies having wide discretion in terms of the selection of the ESG frameworks and standards they choose to rely on for reporting guidance, as well as in terms of what ESG metrics they use, the data they rely on, and ultimately how they decide to communicate ESG information to investors and stakeholders.

However, the days of voluntary ESG disclosure and wide discretion being afforded to companies are likely soon coming to an end. Significant momentum is growing and many jurisdictions are actively moving towards mandatory ESG reporting including the European Union, the United Kingdom and the United States, among others. In Canada, there are also strong signals that mandatory ESG reporting will likely not be a question of “if”, but “when.”

ESG Risks Not Well Understood + Mandatory ESG Reporting = Fertile Ground for ESG Activism

With the majority of boards not fully understanding ESG risk, coupled with the looming likelihood of mandatory ESG reporting, the grounds are fertile for a significant increase in ESG activism. A recent case in the US, that of Engine No. 1 and its battle with Exxon, provides a cautionary tale for companies who may also soon become the target of similar ESG activism.

The Exxon and Engine No.1 Example

In May of 2021, an ESG activist investor group named Engine No.1 scored an unprecedented win for ESG activism by successfully waging a battle to install several directors on Exxon’s Board of Directors with the intent of forcing Exxon to tackle climate change in a more meaningful way.

Engine No 1.’s strategy resembled what academics refer to as “the market for corporate control,” i.e. the buying and selling of shares of a targeted corporation to acquire voting control. However, rather than seeking control of a public company, a shareholder or group of shareholders can seek to correct managerial inefficiencies by acquiring enough shares in a target company to gain a significant (but not controlling) share in the company. Unfortunately for Exxon, Engine No. 1’s strategy proved highly successful.

On May 26, 2021, with less than $40 million worth of common shares in Exxon (approximately 0.02% of Exxon’s shares), Engine No. 1 executed a proxy fight that resulted in its winning seats on the board of Exxon for three out of its four nominations.

It is extremely noteworthy that significant institutional investor support was given to Engine No. 1 by several of Exxon’s largest institutional investors including BlackRock, Vanguard and State Street, who all voted against Exxon’s leadership and in favour of Engine No. 1. Up until the case of Engine No. 1, these huge investment companies rarely provided such support to ESG activists.[5]

Prior to these events, Exxon faced significant shareholder dissatisfaction regarding the company’s climate change strategy. In fact, Exxon executives hit the snooze button on numerous activist proposals, resisting calls for investment into alternative energy such as solar and wind that were thought to offer less profit potential. Activist attention and scrutiny only intensified when ExxonMobil posted a $22 billion loss.

On top of the significant reputational costs associated with being the target of ESG activism, defending against a proxy fight can be extremely costly from a monetary perspective as well. Exxon spent an estimated $35 million, not including the cost of management time, to defend against the proxy fight instigated by Engine No. 1. Accordingly, the cost of ESG activism can be very high for target companies.

Shell/First Point LLC

Following the success of Engine No. 1, an activist hedge fund called First Point LLC appears to be employing a similar strategy and has very recently purchased approximately $750 million worth of Shell’s shares (approximately 0.4% of Shell’s shares). Although it remains to be seen how this emerging situation will unfold, First Point LLC has written letters to Shell calling on the energy giant to split into two companies, reduce fossil fuel investments and pivot to renewable energy amid concerns about climate change.

Being the target of ESG activism is not new to Shell, as in May of 2021, it was on the losing end of a landmark ruling by the Hague District Court which ordered the company to significantly accelerate cuts to carbon-dioxide emissions, with the Court concluding that Shell’s plan to reduce pollution was insufficient.

How to Avoid Being Targeted by ESG Activism

A company’s failure to adapt to mounting ESG pressure could create big opportunities for activists and leave the company vulnerable. Importantly, this risk will only increase in the wake of Engine No. 1’s successful strategy, which could result in an influx of activists seeking to exploit growing gaps between corporate management and societal expectations in the field of ESG. It is also important to note that ESG activism is not limited to Engine No. 1’s strategy.

With companies under increasing scrutiny across many industries, there is the potential for numerous forms of ESG investor activism which could affect public and private companies of all sizes.  For instance, it is not difficult to imagine a scenario where an investor or investor group in a private company become dissatisfied with management’s ESG decisions. Numerous avenues exist for such investors to take action which could result in significant pain and disruption for a company’s management team and its board of directors.  Likewise, although climate change has historically been the primary focus of ESG activism, many other aspects of ESG (e.g. water use, biodiversity, racial and gender equality, among others) are rapidly garnering comparable attention and could soon become the focus of ESG activists.

Although Engine No. 1’s success is likely immediately relevant to companies operating in the energy (i.e. oil and gas) sector, it is important for several industries in Western Canada to have a strong focus on ESG. Although it is difficult to predict precisely what industries or companies will become the next target(s) for ESG scrutiny and activism, it is reasonable to assume that companies and industries with perceived higher ESG impacts will be targeted.

One source of guidance to identify potential next targets may be found in relation to the development of the Global Reporting Initiative (GRI) Sector Standards. The GRI recently developed the GRI Sector Standard for the oil and gas industry and is currently working on similar standards for the following sectors with the highest perceived impacts including:

  • Coal
  • Agriculture
  • Aquaculture
  • Fishing
  • Mining
  • Food
  • Textiles and apparel
  • Banking
  • Insurance
  • Asset management
  • Utilities
  • Renewable energy
  • Forestry
  • Metal processing

To ensure ESG activists do not capitalize on shareholder dissatisfaction in respect of ESG, companies should consider:

  • Assessing the company against established ESG frameworks, standards and metrics to proactively identify material ESG risks and opportunities
  • Thoughtfully communicating and reporting (both internally to boards and externally to stakeholders) on ESG issues
  • Focusing on improving ESG strategy and performance by adapting operations to address key and material ESG issues
  • Embedding ESG strategy into the organization at all levels to ensure that material and meaningful progress is made in improving the company’s ESG strategy and addressing ESG issues
  • Keeping an eye on future trends and critically analyze the company’s performance relative to other industries and peer groups

With an experienced team of energy lawyers in offices across Western Canada having significant experience in ESG-related matters, MLT Aikins is well-positioned to assist clients as they develop and implement their ESG strategies. Please contact a member of our energy team to discuss the opportunities.

Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.