Chapter 6 - Engagement and Stewardship

Question 1

Stewardship

(3 Points)

Answer 1

• broad term for the approach investors take as active and involved owners through voting and engagement
• process of intervention to make sure that the value of assets is enhanced over time, or at least does not deteriorate through neglect or mismanagement
• aspect of the delivery of fiduciary duty

Question 2

Engagement

(3 Points)

Answer 2

• active process of purposeful dialogue with specific objectives in mind, improving companies business practices, usually with management and board of investee companies
• way in which investors put into effect their stewardship responsibilities under the PRI principle 2 (“…active owner and incorporate ESG issues into ownership policies and practice”)
• voting is most visible form of engagement as AGMs are public events and institutions make their voting actions public

Question 3

Long-term Governance Issues covered under Engagement

(6 Issues)

Answer 3

• strategy
• capital structure
• operational performance and delivery
• risk management
• pay
• corporate governance

Question 4

Non-Financial Areas relevant to Company’s Stakeholders

(4 Points)

Answer 4

• highlighting the long-term health of the business, such as relations with the workforce
• establishing a culture that favors long-term value creation
• dealing openly and fairly with suppliers and customers
• having proper and effective environmental controls in place

Question 5

PRIs 3 ESG Engagement Dynamics

(3 Dynamics)

Answer 5

• communicative dynamics: exchange information
• learning dynamics: enhancing knowledge
• political dynamics: building relationships

Question 6

Benefits of Engagement

(3 Benefits)

Answer 6

• helps investee companies to understand their investors’ expectations, allowing them to shape their long-term strategies
• investors can work closely with an investee over time on specific ESG issues
• growing body of evidence that engagement adds value to portfolios, e.g. positive abnormal financial returns, reduction in downside risk

Question 7

Criticisms of Engagement

(2 Criticisms)

Answer 7

• for companies that are unlikely to change, it may be considered an excuse to continue holding onto a company that’s otherwise unsuitable
• “knee-jerk engagement” may happen after a stock price fall, which is less likely to be effective than long-standing consistent engagement

Question 8

Dialogue

(5 Points)

Answer 8

• active discussion between companies and investors
• must be consistent, direct and honest
• respectful and seeks to build mutual trust
• delivered professionally in the context of full understanding of an individual company
• two principal forms of dialogue: monitoring and engagement

Question 9

Monitoring Dialogue

(4 Points)

Answer 9

• one-way dialogue for investment purpose to understand the company, its stakeholders and performance
• informs about incremental buy/sell/hold decisions
• detailed and specific questioning for investors to seek insights
• insights lead to better informed decisions by investors

Question 10

Engagement Dialogue

(4 Points)

Answer 10

• two-way dialogue with investors expressing opinions
• purposeful dialogue with specific and targeted objective to achieve change
• individual or collective engagement, as appropriate
• clear and specific objectives lead to better company behaviors

Question 11

Walker Review

(4 Points)

Answer 11

• report on 2008 financial crisis
• issued 2009 in UK by Sir David Walker
• review of corporate governance in UK banks and other financial industry entities
• formally called for the issuance of a stewardship code to provide framework for shareholder engagement

Question 12

2010 UK Stewardship Code 7 Principles

(7 Principles)

Answer 12

• publicly disclose their policy on how they will discharge their stewardship responsibilities
• have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed
• monitor their investee companies
• establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value
• be willing to act collectively with other investors where appropriate
• have a clear policy on voting and disclosure of voting activity
• report periodically on their stewardship and voting activities

Question 13

UK Stewardship Code

(7 Points)

Answer 13

• in 2010 Financial Conduct Authority (FCA) issued the worlds first stewardship code in UK
• followed around the world with such codes in now 20 markets
• originally 7 principles
• 2012 revision: clarifying distinction between roles of asset owners and their fund managers and other agents
• 2020 revision: increased to 12 principles, plus alternate 6 for service providers:
  1. inverstors now expected to report annually on activity and outcomes from that activity
  2. must state concrete examples of what has been delivered practically for clients and beneficiaries

Question 14

Japanese Stewardship Code
(Proposed Changes to UK Code)

(4 Points)

Answer 14

• extend coverage to all asset classes, not only equity
• incorporate sustainability and ESG
• add encouragement for asset owners to become involved in stewardship and provide a little more clarity on their role in the stewardship hierachy
• clarify the position of service providers in the hierachy and add expectations of proxy advisers

Question 15

Common Principles across Stewardship Codes worldwide

(3 Principles)

Answer 15

• regular monitoring of investee companies
• active engagement where relevant (sometimes termed “escalation”)
• thoughtfully intelligent voting

Question 16

Employee Retirement Income Security Act (ERISA)

(2 Points)

Answer 16

• US legislation from 1974
• advisors (including fund managers) should act as fiduciaries in relation to the beneficiaries, e.g. vote at investee company general meetings and engage with companies

Question 17

Engagement Styles

(6 Styles)

Answer 17

• direct
• external/outsourced
• top-down
• bottom-up
• issue-based
• company-focused

Question 18

Direct Engagement

(1 Point)

Answer 18

• asset owners engage with companies directly

Question 19

External/Outsourced Engagement

(2 Points)

Answer 19

• engagement by external fund managers, e.g. portfolio managers or stewardship specialists
• outsourced to service providers, e.g. proxy voting firms or specialist stewardship service providers

Question 20

Top-Down Engagement

(4 Points)

Answer 20

• applies a perspective on particular issues (e.g., climate change) across all companies in a sector or market as a whole
• environmental and social issues arise from nature of business activities and tend to be organized by sector
• issue-based, top-down engagement tends to align more closely with passive or otherwise broadly diversified investment portfolios
• starting engagement with investor relations or sustainability teams and then escalated upwards

Question 21

Bottom-Up Engagement

(3 Points)

Answer 21

• governance issues arise from national laws and codes and tend to be organized by geography
• company-focused, bottom-up engagement fits most naturally with active investment approaches
• starting engagement with chair and working through the board down to management

Question 22

Issue-Based Engagement

(4 Points)

Answer 22

• often for passive investors or those with broadly diversified portfolios
• start with an issue
• seek to engage with all companies impacted by that issue
• usually letter to all impacted companies, followed by dialogue

Question 23

Company-Based Engagement

(4 Points)

Answer 23

• often for active investors
• starts with company and its business issues
• tailored engagement approach with direct discussion with senior management and then the board
• companies selected are often identified as underperformers or trigger other financial and ESG metrics

Question 24

Individual Engagement Forms

(5 Forms)

Answer 24

• generic letter: broad communications across a swathe of investment holdings
• tailored letter: more targeted and can cover range of topics at varied level of detail
• “housekeeping” engagement: annual dialogue to maintain relationship, but only limited objectives
• active private engagement: targeted and specific engagement
• active public engagement: engagement delibaretly made public by the institution

Question 25

Collaberative Engagement Forms

(7 Forms)

Answer 25

• informal discussion: institutions discuss views of particular coporate situations
• collaborative campaigns: collaborative letter-writing or market/sector wide campaigns
• follow-on dialogue: engagement dialogue led by one or more investors following a broader group letter or expression of views
• soliciting supports: asking broader support for formal publicly stated targets, e.g. “vote no”
• group meeting: group meeting with a company followed by individual investor reflections or co-signed letter
• collective engagement: formal coalition of investors with clear objective
• concert party: any form of formal agreement with concrete objectives and agreed steps, e.g. collective proposal of shareholders resolutions, agreeing how to vote an particular matter

Question 26

Success Factors of Individual Engagement

(3 Factors)

Answer 26

• specific and targeted objectives to enable clarity around delivery
• strategic or governance-led objectives, or linked to material strategic and/or governance issues
• tailored engagement approach for the target company

Question 27

Success Factors of Collaborative Engagement

(3 Factors)

Answer 27

• clear leadership of participants with appropriate relationships, skill and knowledge
• meaningful scale of coalition (both scale of shareholding and overall assets under management of the group)
• coalition should have prior relationship and/or cultural awareness of target company

Question 28

Investor Forum White Paper “Collective Engagement”

(4 Points)

Answer 28

Investor Forum White Paper “Collective Engagement: An Essential Stewardship Capability”:
* published in November 2019
* identifies 12 different forms of individual and collaborative engagement
* identifies 6 key success factors for effective engagement
* provides matrix to show how likely the 12 forms of engagement fulfil the 6 success factors

Question 29

Goal-Setting for Cost- and Time-Effective Engagement

(5 Goals)

Answer 29

• investors need to define scope of engagement and prioritize their activities to ensure it’s value-adding and impactful for improved corporate practices
• investors need to frame engagement topic (e.g. climate risk, supply chain risk) into broader discussion around strategy and long-term financial performance
• investors must develop a clear process that articulates realistic goals and milestones for clear indicators to measure expectations and effectiveness of engagement strategies
• engagement process needs to be adapted to the local context, language, and cultural approaches of doing business
• investors need to have clear escalation measures in case engagement fails

Question 30

Prioritisation Forms of Engagement

(2 Forms)

Answer 30

• identify which company in a portfolio most needs engagement
• determine which engagement issue should be prioritized in dialogue between investor and company

Question 31

Relational Barriers to Engagement Success from Corporate Perspective

(2 Barriers)

Answer 31

• language barriers and communication issues
• lack of continuity in interactions

Question 32

Corporate Barriers to Engagement Success from Corporate Perspective

(3 Barriers)

Answer 32

• company bureaucracy preventing changes in internal practices and/or external reporting on practices
• lack of resources, insufficient knowledge to meet investor demands
• lack of actual ESG policies, practices and/or results that can be reported externally

Question 33

Investor Barriers to Engagement Success from Corporate Perspective

(4 Barriers)

Answer 33

• lack of investor preparation, overly generic questions/requests
• lack of knowledge about the company (e.g. ESG policy, track record)
• lack of sufficient investor tracking process to determine whether engagement requests have been met
• changing engagement objectives and targets

Question 34

Relational Barriers to Engagement Success from Investor Perspective

(1 Barrier)

Answer 34

• language barriers and cultural differences can hamper dialogue

Question 35

Corporate Barriers to Engagement Success from Investor Perspective

(4 Barriers)

Answer 35

• refusal by top executives to be engaged on ESG issues
• functional/sustainability manager struggles to advance ESG related issues
• too small a shareholding to attract sufficient attention
• corporate inability to meet (on-going) objectives and targets

Question 36

Investor Barriers to Engagement Success from Investor Perspective

(6 Barriers)

Answer 36

• lack of buy-in from clients and/or top management for ESG-related investment activities
• small, under-resourced ESG team
• lack of clear engagement policies, objectives and monitoring systems
• underdeveloped relationships with key corporate actors
• difficulty demonstrating materiality of engagement
• insufficient mechanisms to guarantee asset managers conduct successful engagements

Question 37

Other Barriers to Engagement Success from Investor Perspective

(2 Barries)

Answer 37

Conflicts of Interest:
* investment managers have business relationships with some companies thay engage with
* company that is selected for engagement or voting might be related to a parent company or subsidiary of the investor

Question 38

First Step of Engagement

Answer 38

Set clear objectives in form of a milestore measure or set of KPIs

Question 39

Setting Engagement Objectives

(3 Points)

Answer 39

• first key step in engagement
• as engagement outcomes are difficult to quantify, having some mechanism to test whether objectives have ben achieved is best way to evidence success
• will help to identify right company representative to work with, e.g. sustainability or investor relations teams for ESG operational matters, CEO/CFO for business strategy or operational matters

Question 40

Escalation of Engagement

(13 Points)

Answer 40

UK Stewardship Code:
* holding additional meeting with management specifically to discuss concerns
* expressing conerns through the company’s advisers
* meeting with the chair or other board members
* intervening jointly with other institutions on particular issues
* making a public statement in advance of general meeting
* submitting resolutions and speaking at general meetings
* requesting a general meeting, in some cases proposing to change board membership

Additional Methods:
* writing a formal letter setting out concerns, typically to the board chair
* seeking dialogue with other shareholders, e.g. regulators, banks, ceditors, etc.
* formally requesting a special audit of the company
* taking concerns public in the media or in some other form
* seeking governance improvements and damages through legal action, other legal remedies or arbitration
* formally adding the company to an exclusion list, or otherwise exiting or threatening to exit from investment

Question 41

Collective Engagement

(5 Points)

Answer 41

• often most resource-efficient method for engagement
• maintain a consistent perspective across investors can be challenging
• need to be mindful of rules around anti-competitive behaviour - Investor Forum has detailed collective engagement framework to not fall foul of such rules
• noteable ESG investor coalitions: Climate Action 100+ (targets most polluting companies), Collaboration Platform (PRIs own service for ESG investor coalition)
• commercial approaches include “overlay service providers” predominantly offered by fund managers

Question 42

Organizations which support Asset Owners in Stewardship Work

(7 Organizations)

Answer 42

• Asian Corporate Governance Association (ACGA)
• Associação de Investidores no Mercado de Capitais (AMEC) - Brazil
• Assogestioni - Italy
• Australian Council of Superannuation Investors (ACSI)
• Council of Institutional Investors (CII) - USA
• Eumedion - Netherlands
• Pensions and Lifetime Savings Association (PLSA) - UK

Question 43

Investor Forum Collective Engagement Framework

(10 Key Features)

Answer 43

10 key features through which collective engagements avoid falling foul of the rules around acting in concert and market abuse:
* trusted facilitator, not an adviser: members retain full voting and other investment rights in respect of their shareholdings, no control is ceded to the forum or other members
* opt in/opt out: member actively chooses to participate in an engagement for a shareholder company, it can also choose to opt out at any time
* complementary to members’ direct engagement: members are encouraged to continue their direct interaction with companies outside the forum
* confidentiality: members agree to comply with confidentiality obligations during engagement, disclosure of identities and statements must be agreed by participants
* nominated key engagement contact:. members retain full control as to whether or not they receive information and who receives that information
* hub and spoke model: bilateral model is the usual method of communication between the executive and members involved in engagements
* no inside information: forum is not intended to exchange inside information, participation in engagement doesn’t exempt from any law or regulation governing use of inside information
* no-concert party and no-group: while participating in a forum engagement members will not form concert party control-seeking resolution or seeking to obtain control of the company
* heightened procedures: at various points in engagement heightened procedures may be deemed necessary, including seeking specialist advice
* conflict of interest avoidance: forum maintains control procedures to avoid conflicts of interest, members are reminded of their own obligations

Question 44

Voting

(4 Points)

Answer 44

• also called “proxy voting” as investors often vote via an appointed proxy, e.g. chair of the company, anyone physically at the meeting
• attendance of AGMs in person can give investors direct access to company directors with much scope for informal dialogue
• proxy voting is often advised by proxy advisors, e.g. ISS, Glass Lewis
• voting is a key tool for active investors to influence key issues like financial/capital structure, board membership, audit and remuneration

Question 45

Voting on Key Concerns

(3 Points)

Answer 45

• capital structure and financial viability of the business: pay attention to votes in relation to dividends, share buybacks, share issuance or scope for further debt burden
• effectiveness or diversity of the board: reflected in voting decisions on director reelections
• independence or effectiveness of the audit process: taken into account when voting on reappointment of the auditor, its pay and reappointment of members of audit committee

Question 46

Engagement for different Asset Classes

(7 Asset Classes)

Answer 46

• Public Equity: stewardship codes focus heavily on public equity
• Corporate Fixed Income: companies becoming more conscious of investor interest in ESG issues
• Sovereign Debt: very limited stewardship interaction possible
• Private Equity: normally undertaken by general partner (fund manager) instead of limited partner (asset owner)
• Infrastructure: investors will monitor and engage with specialist managers
• Property: investor required their managers to report on frameworks and metrics to monitor holdings
• Fund Investments: typically fund board which should represent investor interests and can be subject to engagement

Question 47

Engagement for Corporate Fixed Income

(9 Points)

Answer 47

• ESG factors can impact credit rating and affect spreads
• PRI recommends corporate fixed income investors to priotize engagement on:
  1. size of holdings
  2. lower credit quality issuers (less balance sheet flexibility to absorb negative ESG impacts)
  3. key themes that are material to sectors
  4. issuers with low ESG scores
• easier to push for ESG-related conditions and disclosures while pre-issuance, which is difficult to implement in fast-moving public markets but is easier to effect in private debt issuance
• possibly more scope for influence where debt investors engage alongside equity investors, but in certain situations - like insolvency - the two investor types may be rivals
• engagement is also important to private debt, private equity and property/infrastructure investments, as they are illiquid, relatively long term and involve close partnership between the investor and investee

Question 48

Engagement for Sovereign Debt

(2 Points)

Answer 48

• very limited stewardship interaction possible
• only largest investors have any scope to influence stance of nation states

Question 49

Engagement for Private Equity

(2 Points)

Answer 49

• normally undertaken by general partner (GP) instead of limited partner (LP) - GP-private equity fund, LP-asset owner
• individual LPs may wish to engage with their GPs

Question 50

Engagement for Infrastructure

(11 Points)

Answer 50

• investors are exposed to ESG across the economic lifetime of their assets
• investor will monitor and engage with specialist managers
• PRI recommends 8 mechanism for engaged asset owners in infrastructure:
  1. use ESG assessments during due diligence for attention on ESG and improving profitability, efficiency, and risk management
  2. include material ESG risks and opportunities into the post-acquisition plan and integrate this into asset management activities
  3. engage and encourage with management of business to act on ESG risks and opportunities
  4. define and communicate expectations of ESG operations and maintenance to infrastructure business managers
  5. ensure material ESG factors are woven into asset-level policies
  6. advocate governance framework that states who has responsibility for ESG and sustainability
  7. set performance targets for environmental and social impacts, including regular reports to the board and investors
  8. make ESG information and expertise available to the asset or project company to help it develop capacity

Question 51

Engagement for Fund Investments

(3 Points)

Answer 51

• typically fund board which should represent investor interest and can be subject to engagement
• hold managers of the fund accountable to stewardship efforts as investor are distanced form underlying assets
• agency gap may be harder to close for engagement in funds

Question 52

Engagement for Property

(2 Points)

Answer 52

• good evidence of positive effect of ESG on real estate investment returns
• investors engage indirectly by requiring their managers to report on frameworks and metrics they use to monitor holdings

Question 53

Concert Party

Answer 53

A concert party is a groups of investors acting in concert as part of a takeover bid, which are subject to regulatory oversight.

Question 54

Stewardship Overlay Services

Answer 54

Overlay service providers (such as Columbia Threadneedle Investments [REO] and Sustainalytics) provide stewardship overlay services, such as voting advice and direct engagement activities.

Question 55

Origins of Term “Stewardship”

Answer 55

The word “steward” is derived from two Old English words (“stig” and “weard”) describing a guardian of a home—to protect the owner’s assets.

Question 56

2020 Revision of UK Stewardship Code

(3 Points)

Answer 56

Increased to 12 principles, plus alternate 6 for service providers:
* inverstors now expected to report annually on activity and outcomes from that activity
* must state concrete examples of what has been delivered practically for clients and beneficiaries

Question 57

Shareholder Resolution

Answer 57

A shareholder resolution is a proposal submitted by shareholders for a vote at a company’s annual meeting. It is a non-binding recommendation to the board of directors of a public corporation.