chapter 6 Flashcards
ENGAGEMENT AND STEWARDSHIP IN ESG INVESTING
Definition of Stewardship
Stewardship refers to the responsibility of investors to act as proactive and engaged owners, ensuring that the companies they invest in are managed effectively and ethically to enhance long-term value
Definition of Engagement
Engagement is the process by which investors communicate with company management and boards to influence decisions and encourage better practices, particularly in the areas of corporate governance, social responsibility, and environmental sustainability.
Historical Context
The concept of stewardship has its roots in the idea of fiduciary duty, where stewards are obligated to care for and protect the assets they manage on behalf of others.
Key Components
Effective stewardship and
engagement involve active dialogue, voting at shareholder meetings, and working towards specific goals that align with long-term value creation
Why is Engagement Important?
Enhancing Shareholder Value: Engagement helps investors protect and enhance the value of their investments by influencing corporate behavior and promoting better governance, risk management, and ESG practices.
Fulfilling Fiduciary Duty: Investors have a fiduciary responsibility to act in the best interests of their clients and beneficiaries, which includes engaging with companies to ensure they are managed in a way that supports long-term value creation. Promoting Transparency and
Accountability: Engagement fosters better communication and information flow between investors and companies, allowing for more informed decision-making and greater transparency.
Criticisms of Engagement: Some criticisms include the potential for conflicts of interest, the time and resource intensity of effective engagement, and the challenge of measuring its impact on financial performance.
Understanding Global Stewardship Codes - UK Stewardship Code (2020)
Overview: The UK Stewardship Code is a set of principles and guidelines for institutional investors that emphasize the importance of engagement, transparency, and accountability in investment practices.
Key Principles: The 2020 revision introduced 12 principles, focusing on practical delivery, the integration of ESG factors, and the requirement for signatories to report on the outcomes of their stewardship activities.
Understanding Global Stewardship Codes - US ERISA Guidelines
Overview: The Employee Retirement Income Security Act (ERISA) sets out fiduciary responsibilities for fund managers, including the duty to vote proxies and engage with companies where it enhances the economic value of investments.
Interpretation: Recent interpretations of ERISA have become more supportive of ESG engagement, provided it is grounded in enhancing value for beneficiaries.
Understanding Global Stewardship Codes - EU EFAMA Stewardship Code
Overview: The EFAMA Code provides guidance for asset managers in Europe on best practices for stewardship, emphasizing the importance of engagement, transparency, and managing conflicts of interest.
Comparison: The EFAMA Code shares similarities with the UK Code but places less emphasis on conflicts of interest, reflecting regional regulatory differences.
Different Approaches to Engagement: Top-Down Approach
Typically governance-focused,
starting with the board and senior management to address strategic issues and corporate governance.
Different Approaches to Engagement: Bottom-Up Approach
Often driven by environmental and social concerns, beginning with specific issues at the operational level and escalating to senior management as needed.
Different Approaches to Engagement: Issue-Based
Engagement initiated around a specific issue, such as climate change or labor practices, affecting multiple companies or an entire sector.
Different Approaches to Engagement: Company-Focused
Tailored engagement with individual
companies to address various ESG issues, often driven by active investment strategies.
Different Approaches to Engagement: Engagement in Practice
Examples of successful engagements, such as Larry Fink’s annual letters from BlackRock outlining engagement priorities, demonstrate how different approaches can be applied effectively.
Methods and Techniques of Engagement - Individual Engagement
Generic Letters: Broad communications sent to multiple companies, often as a first step in engagement.
Tailored Letters: More specific and detailed communications addressing particular issues or concerns.
Active Private Engagement: Direct, focused engagement with a company to achieve specific goals, often involving multiple meetings and in depth discussions.
Methods and Techniques of Engagement - Collaborative Engagement
Informal Discussions: Sharing views and coordinating strategies with other investors to influence corporate behavior collectively. Group Meetings and Collective Campaigns: Joint efforts by multiple investors to address issues across companies or sectors, enhancing the impact of engagement.
Formal Collective Engagement: Coordinated by organizations like the Investor Forum, where investors pool resources to engage with companies on specific issues.
Strategy and Tactics for Successful Engagement
Goal-Setting: Establishing clear, specific objectives for engagement, aligned with long-term value creation and linked to material strategic or governance issues Identifying Key
Stakeholders: Determining the appropriate company representatives to engage with, such as the CEO, CFO, board members, or sustainability teams, based on the nature of the issues.
Communication and Tone: Engaging in a constructive dialogue that emphasizes mutual understanding, respects the company’s context, and promotes positive change. Escalation
Techniques: When initial engagement efforts are not successful, employing escalation methods such as additional meetings, public statements, shareholder resolutions, or collective engagement.
Case Studies: Examples of effective engagement strategies, such as the Investor Forum’s work with Imperial Brands, which led to significant changes in the company’s strategic direction and communication practices
Challenges and Obstacles in Engagement
Resource Constraints: The significant time and expertise required for effective engagement can be a challenge, especially for smaller investors with limited resources.
Conflicts of Interest: Potential conflicts arise when investment managers have business relationships with the companies they engage with, or when their interests diverge from those of their clients or beneficiaries.
Cultural and Behavioral Barriers: Differences in corporate culture, resistance to change, and varying levels of willingness to engage can hinder effective dialogue.
Competition Among Investors: As stewardship becomes more competitive, the collaborative spirit that drives successful collective engagement may be challenged by individual investors seeking to differentiate themselves.
Proxy Voting as a Tool for Stewardship
Importance of Voting: Proxy voting is a key aspect of stewardship, allowing investors to influence corporate decisions on issues such as board structure, executive remuneration, and ESG policies.
Challenges of Proxy Voting: Voting at AGMs is resource-intensive, especially for large portfolios, and requires careful consideration of the issues at stake.
Role of Proxy Advisers: Proxy advisers like ISS and Glass Lewis provide analysis and voting recommendations, helping investors navigate complex voting decisions. Impact of Voting Decisions: Voting outcomes can have significant implications for corporate governance and are often scrutinized by the media and other stakeholders.
Applying Stewardship Across Different Asset Classes - Corporate Fixed Income
ESG in Debt Investing: Fixed income investors engage with corporate debt issuers on ESG issues that affect credit ratings and spreads, influencing debt pricing and issuer behavior.
Pre-Issuance Engagement: The best time to advocate for ESG conditions is before debt issuance, allowing investors to influence terms and disclosures.
Applying Stewardship Across Different Asset Classes - Sovereign Debt
Challenges in Engagement: Engaging with sovereign issuers is challenging, with limited opportunities for direct influence. Strategies often focus on screening and ESG tilts rather than direct engagement.
Case Study: The investor coalition urging Brazil to curb Amazon deforestation is an example of collective engagement in sovereign debt, though the impact remains uncertain.
Applying Stewardship Across Different Asset Classes - Private Equity and Infrastructure
ESG Monitoring: In private equity, GPs are responsible for monitoring ESG issues across portfolios, with LPs engaging to ensure ESG practices are upheld.
Long-Term Risks: Infrastructure investments face long-term ESG risks, including health and safety, environmental factors, and corruption, requiring ongoing engagement and monitoring.
Applying Stewardship Across Different Asset Classes - Real Estate
ESG in Real Estate: Evidence shows a positive impact of ESG on real estate returns, with investors engaging on issues like energy efficiency, sustainability, and regulatory compliance.
