After years of getting little or no attention, ESG issues have not just become a priority for institutional investors, but are also beginning to drive several activist campaigns.

Last year, activist investors shook up oil majors including Exxon Mobil Corp., Chevron Corp. and Shell Plc, voting in higher numbers than ever before for climate-related resolutions.

While investment group Engine No.1 scored an unprecedented win for ESG activism by waging a battle to appoint several directors to Exxon Mobil’s board, Chevron suffered a similar rebellion when a majority of its shareholders went against the company’s board by voting 61% in favor of an activist proposal to curb emissions.

These high-profile cases present a cautionary tale for oil and gas companies who could become the target of similar ESG activism, which analysts expect, will continue to accelerate further this year. According to Bloomberg Intelligence, more than nine campaigns based on environmental or social issues are currently underway, impacting companies such as TotalEnergies SE.

So what can companies to do about it?

“The key is to be prepared, and to have a ‘Break Glass’ action plan in place,” said Christopher Drewry, partner at Latham & Watkins, speaking on the law firm’s podcast series.

“Activists move extraordinarily rapidly…so you need to have your advisor team and board prepared in advance so there can be rapid response if activist approaches the company,” he said.

“It all starts with being your own activist and then evaluating your vulnerabilities both on the commercial side, legal side and now, the ESG side,” he said, adding that it’s equally important for companies to stay aligned with their peer set.

“Activists monitor companies versus their peers,” Drewry noted.

“Their primary method of targeting companies is total shareholder return…So, if your shareholder return is lagging compared to your peer set, the activists get to pick your company as particularly vulnerable, which will be flagged in systems that activists use to monitor companies,” he said.

Another area that activists use to find targets is ESG, Drewry said, so companies must also critically evaluate themselves in terms of ESG rankings.

Companies can also prepare to respond to activist attacks by considering strategic alternatives across a broad range of metrics including M&A, capital allocation and governance matters, and work with financial advisers to demonstrate their work to the board.

Aligning interests

Since activists typically drive a wedge between management teams and the board of directors, it’s important for companies to understand their vulnerabilities to create an alignment between the board and management.

No matter how prepared they are, companies cannot fully prevent an activist from coming, Drewry cautioned.

Therefore, the best option to prepare against activism is to align support between the board and the corporate management. Once that is done, the management must openly communicate with the shareholders to ensure that they share the same vision for the company, he said.

If institutional shareholders are not happy with how the company is being managed or strategic decisions it is making, they have two options—they can either call the company if it maintains a strong relationship with them or they can call an activist group to instigate an activist campaign against the company.

“A well-prepared company should have a strong relationship with its institutional and other shareholders. So hopefully, the first call comes to the company and the management team rather than the activists,” Drewry said.

However, if activists do end up approaching a company, Drewry encourages engaging with them early in the process.

“Use those initial meetings to gather information and activists’ concerns and plans so [the company] can better respond to their attacks,” he said. “During the meetings, it should be emphasized that board and management are interested in their views and opinions and are committed to enhancing shareholder value.”

Evolving tactics

Over the past few years, there has been a sea change in what the investors are focusing on, noted Tiffany Campion, senior attorney at Latham & Watkins.

With increasing focus on climate risks, large institutional investors have become more attentive toward disclosure practices and commitment to reduce emissions so their businesses can thrive in a net-zero future.

As those investors become more assertive in trying to achieve their ESG goals, activists are able to obtain support for their campaigns by addressing those goals as a part of their own campaigns.

“Historically, ESG was not necessarily on top of mind. But now it is of main interest to institutional investors, and as a result, there is a lot of activism campaigns that have ESG elements,” she said.

Additionally, activists have evolved their tactics and their campaign strategies to widen their base and make their campaigns more attractive to investors.

“While activists previously utilized governance best practices as a way to gain wider base for their campaigns, exploit a target company’s vulnerabilities and weaken its defenses, they are now using environmental and social components in a similar way,” Campion said.

Additionally, she noted that even with a small investment in a company, activists are able to make large changes by leveraging the ownership of large institutional investors.

“We’ve seen activists with a little of one share trying to get involved and bring attention to ESG issues or push forward other strategies or tactics,” she said.

Getting educated

When the majority of board members are not fully aware of ESG risks, coupled with the looming possibility of mandatory ESG reporting, lays the groundwork for a significant increase in ESG activism.

According to a recent survey, although nearly 64% of companies are linking sustainability issues to corporate strategy, a whopping 75% of board members said they do not understand ESG risk or sustainability messaging very well.

Experts agree that adding one or two token climate “experts” isn’t enough to change board dynamics and decision-making, and shareholders are aware of this.

Activist attacks can be largely avoided if the board is educated about sustainability and climate issues, Campion noted.

The board needs to understand the company’s overall ESG strategy, the reporting frameworks it uses and identify how the company is managing and tracking ESG progress and publication of ESG disclosures.

“If the board is unaware of ESG issues, the company must think about expanding or changing and shuffling the board to make sure they have right expertise that is ready to handle ESG issues,” she said.

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