The issue

In a recent article, Fiona Reynolds, CEO of The Principles of Responsible Investment (PRI), the United Nations-supported international network of investors working together to implement its six aspirational principles, announced that it will be introducing new minimum requirements around voting and engagement practices for signatories. The action follows recent research by specialists at Dutch investment manager, Robeco, and the Erasmus School of Economics, which found that US-based PRI signatories “consistently” supported fewer ESG proposals at US companies than their non-signatory peers. As pressure mounts on the PRI to counter greenwashing in the investor community, other stakeholder groups are calling more effective engagement with companies to bring about real change [i].

What does increased investor engagement mean for companies?

Rising corporate scrutiny, particularly on ESG matters, is a growing trend. Shareholder activism – previously associated with a relatively niche group of socially responsible investors – has moved to the mainstream. Responsible Investor recently reported (ii) on a record year for environmental and social investor petitions in 2020. Sixteen investor petitions concerning social or environmental issues were passed at US companies in 2020, according to corporate governance data providers, suggesting that large asset managers have become more willing to back dissident shareholders over management [ii].

This increased investor action, coupled with momentum to reach net zero CO2 emissions targets, means companies must work with shareholders to enable an orderly transition to a low carbon economy. This direction of travel has become important even to the largest global index fund shareholders, as they must transition themselves by de-carbonising their global investment portfolios [iii].

In 2021, both investors and companies want to be on the right side of ESG risk, valuation and wider societal sentiment. Shareholder engagement has moved from a “nice-to-have” to a mainstream and important game-changer.

The background

Shareholder engagement used to consist of attending analyst conference calls, quarterly earnings calls and the Annual General Meeting (AGM) of shareholders to vote on proposals and resolutions [iv]. However, a plethora of ESG issues as well as major societal shifts, including the global financial crisis in 2007 and the current COVID-19 pandemic, have led to a reimagining of shareholder engagement; a trend which is certain to continue. Corporate governance and shareholder engagement are now two sides of the same coin.

For example, the UK Stewardship Code 2020 – a corporate governance code written for asset owners and asset managers – prioritises sustainable value for beneficiaries, the economy and society – including making explicit reference to ESG factors. It requires signatories to integrate this approach to stewardship into their investment approach; effectively necessitating engagement [v]. In addition to voluntary codes, regional and global bodies are also playing their part. Recent reform of the European Shareholder Rights Directive (SRD II) promotes similar long-term engagement policies.

What is the business/strategic rationale?

A recent award-winning study: “ESG Shareholder Engagement and Downside Risk”, which used data from Hermes Equity Ownership Services (EOS) came to the following conclusions:

  • A constructive dialogue with companies at a senior level is most effective in promoting change and financial benefits.
  • Companies with better ESG credentials have on average a lower chance of going bankrupt, more stable cash flows, and are more resilient to external ESG shocks, such as tightened regulation on pollution and climate change[vi].

Corporate ‘change’ and good risk management are recognised as the main potential drivers for shareholder engagement[vii]. And their ambit has gone beyond bad press for poor corporate behaviour or high executive remuneration to the wider arenas of questionable balance sheet intangibles and potential financial externalities. ESG related incidents now regularly negatively affect corporate reputation/strategy and/or the share price.

Some recent examples are below:

  • Rio Tinto – CEO, Jean-Sébastien Jacques, stepped down following criticism after the mining giant’s destruction of sacred Aboriginal sites [vii].
  • The Australian Fires – Over 18 million hectares burned in the Australian bushfire season 2019–2020 as of mid-January according to media reports, destroying over 5,900 buildings, including over 2,800 home [viii].
  • PG&E – California power firm paid US$13.5bn to wildfire victims from fires from 2015 to 2018[x].

Companies focus on the sustainability factors which are most likely to affect company financial performance. The materiality of ESG issues and their relationship to the investment business case is an area which needs closer observation. In August 2020, the World Economic Forum published a report, titled: Embracing the New Age of Materiality, Harnessing the Change in Pace of ESG. The paper explains that: “In greater numbers and at greater speed, ESG issues are becoming financially material.” For investors, greater capability in understanding companies is necessary. Engagement that unlocks siloed corporate issuer ESG information and embeds it in mainstream research analysis will be key in the investment process, specialists say[xi].

But does engagement work?

In a 2018 survey asking investors questions around the Fossil Fuel Free movement, survey respondents were asked whether they thought it was more effective to divest or engage: 45% said engagement was more effective (compared to 8% of respondents who preferred divestment).

Investors favour engaging in dialogue with companies rather than selling their share[xii]. This approach has been borne out by successful shareholder engagement examples within the oil and gas industry to secure net zero targets: Repsol, Shell and BP.

Considering trends post the COVID-19 pandemic, the Edelman Trust Barometer survey reveals an expectation that shareholder activism will become more critical to supporting alignment of companies, asset managers and investors, and that boards must get ready for direct engagement on ESG matters. It says: “the great majority of investors believe that a multi-stakeholder approach will deliver enhanced returns and say that companies that do this well will have a competitive advantage in building trust[xiii]

The Rise of Shareholder Activism

In the last decade, a sharpened focus on shareholder engagement with company boards has become an integral part of investment strategy. Climate change and ESG-related resolutions are gathering attention for the 2021 AGM season, and the diversity of type of activist investor putting forward resolutions is expanding, and now include hedge funds and large investor coalitions, alongside the more traditional NGO-led and individual shareholder campaigns.
And the issues are becoming more targeted, especially around environmental accountability against the Paris Agreement. Common examples of related shareholder resolutions over the past few years have included[xiv]:

  • Setting out transition plans and publishing Scope 1, 2 and 3 targets aligned with the Paris Agreement;
  • Presenting a strategy for business transformation from the use of fossil fuels to renewable energy;
  • Discouragement of exploration and drilling for fossil fuels;
  • Discouragement of oil and gas exploration and production activities in certain areas;
  • Publishing a strategy consistent with the Paris Agreement, including capital expenditure and targets.

Other issues such as global health, antimicrobial resistance, diversity and inclusion, biodiversity and resource use, and human rights are also now regularly on the board AGM agenda.

There is still much debate over what form of shareholder engagement is most effective at driving change, and sometimes the engagement is amongst asset managers themselves. In March 2020, US boutique SRI fund managers Mercy Investments and Boston Trust Walden challenged fund manager giant BlackRock’s voting record on climate change shareholder resolution, against its public statements on climate change. They claimed the two were inconsistent[xv]. The claim was backed up by a report issued by research house, Morningstar, that showed that BlackRock had voted against 80% of climate-related resolutions in 2020[xvi], despite its CEO, Larry Fink’s annual letter to companies articulating the company’s commitment to ESG issues. Conflicting asset manager commitment to ESG issues has also been levelled against US funds giants JPMorgan and Vanguard[xvii].

Who does the investor engaging, and what is collaboration?

A fund managers’ corporate governance or stewardship team usually carries out the engagement with companies on the issues that have been identified as material to its investment strategy. It also votes on behalf of clients and funds that have delegated voting authority to it. As an example, Blackrock, the largest global asset manager with US$8.6 trillion assets under management, says it engages with companies for four main reasons[xviii]:

  • Preparation to vote at the company’s shareholder meeting and the need to clarify information in company disclosures;
  • An event at the company that has impacted its performance or may impact long-term company value;
  • The company is in a sector or market where there is a thematic governance issue material to shareholder value;
  • Corporate governance risk analysis has identified the company as lagging its peers on ESG matters that may materially impact economic value.

Collaboration and engagement forums

Collaboration and engagement forums such as the UNPRI and Climate Action 100+ (CA100+) hold an important role in the shareholder engagement sphere. The effectiveness of individual asset managers to hold companies to account has been overshadowed by recent successes from CA100+, for example.

Through intense engagement, CA100+ has delivered results, including:

  • An agreement with Shell, the Dutch oil and gas company, to reduce Scope 3 emissions intensity with targets plus leadership on US methane regulation[xix].
  • A management-backed resolution at BP plc, a UK oil and gas company, to align business strategy with Paris goals (which did not include Scope 3 emissions), was also achieved[xx].
  • Rio Tinto management agreement with shareholders to put its Taskforce for Climate-related Financial Disclosure to a vote in 2022 AGM.
  • Glencore has agreed to align its business and investments with the goals of the Paris Agreement[xxi].

Climate Action 100+ has revealed its intention to create a benchmark tracking corporate alignment with the transition to net-zero by 2050. The benchmark will assess progress and commitments across more than 30 indicators, including internal and external engagement, action on Scope 3 (indirect) emissions, and whether the businesses have interim targets and credible roadmaps. This will enable targeted shareholder engagement as laggards become more visible[xxii].

The role of asset owners in the collaboration-engagement space is an important contribution. The UN-convened Net-Zero Asset Owner Alliance shows united investor action to align portfolios with a 1.5°C scenario, addressing Article 2.1c of the Paris Agreement. The international group of 34 institutional investors with asset under management of US$5.5 trillion has a commitment to transition its investment portfolios to net-zero GHG emissions by 2050[xxiii]. The alliance seeks to engage on, corporate and industry action, as well as public policy. In January 2021, the Net-Zero Asset Owner Alliance released guidance on how investors should calculate and set targets on climate in their portfolios, and allocate capital to support decarbonisation[xxiv].

What are companies doing?

Effective shareholder engagement mechanisms can yield valuable sources of for intelligence for risk management, strategy and stakeholder engagement for companies[xxv]. With increasing pressure on investors, companies can expect more engagement and more scrutiny. But what do they need to communicate, what are the issues, how should they engage and who should be doing the engaging?

How companies choose to engage makes all the difference

There are different forms of engagement for different shareholders. It is important to tailor an engagement to the audience. Research shows that companies should consider the concentration of the investor base involved in an engagement, their familiarity with it, and the levels of activism being deployed. Companies may take a portfolio approach to working with their shareholders, combining methods that focus on mass investment community outreach, targeted investor communication, and individual investor conversation. As noted earlier, large passive/index investors do conduct stewardship engagement programmes with companies despite being “passive”. Creative approaches in building investor relationships are key.

Ongoing shareholder engagement throughout the year

Companies typically conduct shareholder engagement programmes around AGM proxy seasons. But as a result of new regulations and expectations, companies are increasingly engaging with investors throughout the year on financial and ESG focused themes. Keeping abreast of institutional shareholders’ ESG policies and briefing on sensitive issues can give higher comfort levels which are more likely to convert to shareholder resolution support[xxvi].

Board participation
The expansion of the board’s oversight responsibilities has come from an uptick in global legislation; for example from the Sarbanes-Oxley and Dodd-Frank legislations in the US and the UK’s Companies Act[xxvii]. In PwC’s 2019 “Annual Corporate Directors Survey,” 51% of directors reported that a member of their board, apart from the CEO, engaged directly with a shareholder in the past year[xxviii]. Board involvement is expected particularly on topics of strategy, performance, boardroom independence, executive compensation, shareholder rights and other corporate governance matters.

What are the new focus areas of Shareholder Engagement?

Mid and small cap companies

These may not yet have engagement programs that are fully developed, given they do not have the same resources that larger companies do, and because sometimes it can be more difficult for them to get an audience with shareholders. Smaller companies might be advised to focus on first developing relationships with portfolio managers or analysts, who are a separate audience from proxy voting groups at shareholders. Small cap companies are often forced to decipher shareholder engagement quickly and ‘get up the learning curve’. Engagement can happen at all levels and through various channels from the investor side, including via data providers, ESG raters and proxy firms) in order to form an opinion of a whether a company engages proactively, or reactively[xxix].

Where do we see shareholder engagement in three years time?

As investors start to look more closely at the wider value chain, companies can expect a cross-sectoral perspective from investors up and down supply chains. For example, in order for industries such as oil and gas to transition to a low carbon economy, companies in the value chain, such as in aviation, will need to participate to help achieve net zero ambitions. This will demand greater investor-company-industry collaboration frameworks as the basis to shareholder engagement. Global legislation is moving in a direction that will encourage more engagement[xxx]. Companies that are willing to continually revise their views of investor engagement will be ahead of the curve[xxxi]. Both investors and companies know that in order to make significant strategy changes and ensure that ESG ambitions are reachable, companies will need effective shareholder engagement and strong investor support.

related webinars

ESG Investor Insights series – A Teach-in with investors: Part 1 – Investor Engagement

March 2021 | The direction of society is changing. Responsible investing is a minimum for investors. But how can you keep track of all the ESG investment styles in the market, what they are and what they mean?
This webinar will teach you what you need to know.

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