Chapter 6: Stewardship and Engagement

Question 1

Stewardship

Answer 1

The broad term for an investor operating as a good long-term owner of assets, standing in the shoes of their underlying clients to ensure that value is added or preserved over time.

Question 2

Engagement

Answer 2

The active process of dialogue with a company where the investor is seeking specific change. This can often be a lengthy process and involve many iterations of contact with senior representatives of the company.

Question 3

Origin of the word steward

Answer 3

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 4

Fiduciary duty

Answer 4

Fiduciary duty is an obligation by the person (fiduciary) to look after another person’s assets; a person with a fiduciary duty must seek to protect and enhance the value of the assets with which they have been charged so that they are able to return them in good order to their owner.

Question 5

Provide examples on issues on which investors should engage companies

Answer 5

Engagement can encompass the full range of issues that affect the long-term value of a business, including: strategy, capital structure, operational performance and delivery, risk management, pay, corporate governance.

Question 6

Engagement dialogues according to the 2019 white paper, Defining Stewardship and Engagement, published by the Investor Forum

Answer 6

Engagement dialogues are conversations between investors and any level of the investee entity (including non-executive directors) featuring a two-way sharing of perspectives, such that the investors express their position on key issues and, in particular, highlight any concerns that they may have

Question 7

List the seven principles issued in the 2010 Stewardship Code

Answer 7

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

Question 8

Success factor characteristics of engagement approach

Answer 8

1. Objective should be specific and targeted to enable clarity around delivery
2. Objectives should be strategic or governance-led, or linked to material strategic and/or governance issues
3. The engagement approach should be bespoke to the target company

Question 9

Success factor characteristics of investor collaboration

Answer 9

1. The participants should have clear leadership with appropriate relationships, skills and knowledge
2. The scale of coalition gathered (both scale of shareholding and overall assets under management of the group) should be meaningful
3. The coalition should have prior relationship and/or cultural awareness of the target company

Question 10

Describe the four steps of effective engagement

Answer 10

They are:
1. Setting engagement objectives
2. Practicalities of dialogue
3. Escalation
4. Collective strategies

Question 11

Provide an example of public and influential divestment process

Answer 11

The Norwegian Government Pension Fund relies on an ethics council which considers whether companies should be excluded from the fund because of business activities or breaches of behavioural norms. The manager of the fund (Norges Bank Investment Management) makes the full list of its exclusions public and publicizes its decisions to exclude individual companies. The list is observed by a number of other investors.

Question 12

Engagement dynamics

Answer 12

In a 2018 report, the PRI highlighted three ESG engagement dynamics that it believes create value: (i) communicative dynamics (the exchange of information); (ii) learning dynamics (enhancing knowledge); and (iii) political dynamics (building relationships)

Question 13

Concert parties

Answer 13

Concert parties are groups of investors acting in concert as part of a takeover bid and are subject to regulatory oversight. Even though a takeover is not the intention of collective ESG engagement activities, formalized agreements between investors to act in concert to achieve ESG objectives can raise concerns with regulators and other market participants.

Question 14

Overlay service provider

Answer 14

Overlay service providers (such as Columbia Threadneedle Investments [REO] and Sustainalytics) provide stewardship overlay services, such as voting advice and direct engagement activities, for clients regardless of whether they invest funds on the client’s behalf. Proxy advisers (such as ISS and Glass Lewis) provide voting advice and assist with processing votes, but don’t directly advance engagement on their clients’ behalf. ESG investment consultants (such as Mercer) typically rate the ESG expertise of fund managers.

Question 15

Situations where engagement is required

Answer 15

There are also situations where engagement (or at least some form of stewardship) is required and when an investor must take a view. These could be corporate actions, such as share issuances in which the investor can choose to participate or not, or proposed takeovers where the investor must decide whether to sell up or, if it is permitted, to hold on to their shares. For most investors, some dialogue with the company will be needed before reaching the relevant conclusion.

Question 16

The 12 new principles of the UK Governance Code

Answer 16

The 12 new principles fall into four categories but cover two distinct functions: (i) Principles 1 through 8 address the foundations for stewardship. (ii) Principles 9 through 12 focus on the practical discharge of engagement responsibilities

Question 17

Effect of SRD II

Answer 17

Among other things, SRD II, as it is known, will raise expectations in each country about the level of stewardship carried out by local investors. This is likely to supersede such initiatives as the voluntary EFAMA Code and may move European markets towards expanding expectations that have regulatory backing. While by name, it is about shareholder rights, the directive in reality is more about shareholder responsibilities.

Question 18

Issue-based approaches to engagement

Answer 18

Issue-based approaches to engagement are often accompanied by examples of what best practice in a particular area looks like. These may be developed in advance of the first engagement dialogues but usually come out of the engagement process with those companies that are deemed to have leading practices. By expecting all companies in a given sector to adopt these best practices, investors may over time move sector or industry practice forward overall.

Question 19

Company-focused engagement

Answer 19

Company-focused engagement seeks to improve practice across a number of relevant ESG issues at an individual company; the aim is to enhance performance of the portfolio overall, in terms of both ESG and investment performance.

Question 20

Prioritization of engagement in Fixed Income

Answer 20

In relation to fixed income, the PRI recommends that investors should prioritize engagement based on the following: (i) the size of a holding in the portfolio; (ii) lower credit quality issuers (with less balance sheet flexibility to absorb negative ESG impacts); (iii) key themes that are material to sectors; and (iv) issuers with low ESG scores.

Question 21

PRI investment principles

Answer 21

1. Incorporate ESG into investment analysis decision making; 2. active ownership incorporates ESG issues into ownership policies; 3. seeking appropriate disclosure; 4. promote acceptance of principles within industry; 5. work together to enhance effectiveness in implementing principles; and 6. report on progress

Question 22

Walker report

Answer 22

Post financial crisis, led to the creation of the first stewardship code in the UK

Question 23

2010 UK Stewardship code; 7 principles

Answer 23

1. Publicly disclose policy on how they will discharge responsibilities; 2. Robust policy on managing conflicts of interest; 3. Monitor investment company; 4. Establish a escalation guidelines for protecting shareholder value; 5. Act collectively where appropriate; 6. Voting policy and disclosure of voting; and 7. Report periodically on stewardship and voting activities

Question 24

Successful investor engagement tends to have most positive impact on …

Answer 24

abnormal financial returns. Academic studies have consistently shown that, on average, successful engagement activity has been followed by positive abnormal financial returns. The same studies showed that of the engagement objectives investigated, those related to changes in remuneration policies were least likely to be successful. Finally, the studies showed that successful engagement is time consuming, as the average timeframe for success was 1.5 years.

Question 25

Most significant change in the 2020 version of the UK Stewardship Code is …

Answer 25

the requirement to report on the practical effects of engagement activities.

Question 26

Which principle, more typical in regulatory codes, is frequently neglected in codes developed by investor groups?

Answer 26

Conflict of interest

Question 27

Which principle in the PRI is the “engagement principle”?

Answer 27

Principle 2

Question 28

The six principles of the PRI are…

Answer 28

Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
Principle 6: We will each report on our activities and progress towards implementing the Principles

Question 29

Which form of collaborative engagement is most likely to require greater formality in approach?

Answer 29

An Investor Forum white paper rated 12 forms of engagement in terms of the need for formality in approach. Of the three options listed, direct engagement between groups of investors and the company was considered most likely to require an organized, formal approach and clear engagement objectives.

Question 30

For fixed income investors, why is the opportunity to engage with companies the largest in private debt?

Answer 30

Private debt is typically less liquid than public or sovereign debt, resulting in closer, longer-term relationships between investors and issuers of private debt. Opportunities to engage on ESG issues are enhanced because of these relationships