Engagement and Stewardship Flashcards
Stewardship
• Stewardship:
o Process of intervention to make sure assets are enhanced over time
o Or to ensure assets don’t deteriorate though mismanagement
o Involves:
Buying and selling of assets to maintain value within fund as a whole
Acting as a good owner
Engagement
o Aspect of good stewardship
o Individual interventions in specific assets to preserve or enhance value
o Dialogue with management and boards of investee companies
o Structural issues:
Strategy
Capital structure
Operational performance and delivery
Risk management
Pay
Corporate governance
o Operational issues:
Relations with the workforce
Establishing culture for long-term value creation
Dealing openly and fairly with suppliers and customers
Effective environmental controls
• Role:
o Enhance shareholder value and support investors in fiduciary duty
Benefits of engagement
• Company side:
o Help investee companies understand investors
o Allows them to explain their approach to sustainability and how it relates to broader business strategy
o Allows them to comment on ratings or scores that don’t represent complexity
• Investor side:
o Work more closely with investee on specific ESG issue
o Influence better ESG practices, less downside risk
o Preserve and enhance the value of assets
Relation to fiduciary duty
• The Investor Frum (UK group to facilitate dialogue between investors and investees)
o Define stewardship in terms of assets which organisation has been entrusted
o Therefore, relates to fiduciary duty – duty held by party holding assets for another
o Stewardship is an aspect on delivering fiduciary duty
• Types of dialogue:
o Monitoring dialogue: conversations between investors and management to more fully understand performance and opportunity
o Engagement dialogue: investors and any level investee discussing two-way perspectives on key issues
• Characteristics of high-quality delivery
o Set out context of long-term ownership, value preservation and creation
o Close understanding of nature of company and business model
o Recognise that change is a process and shouldn’t be inappropriately rushed
o Employs consistent, direct and honest dialogue
o Use resources efficiently so engagement coverage is broad
o Appropriately resourced so that it can be delivered professionally in the context of a full understanding of a company
o Involves reflection so that lessons are learnt
Walker Report
- Issued by Financial Reporting Council (FRC)
- Stewardship code to provide framework to shareholder engagement
- Reinforced by the FCA requirement for fund manager to make statement as to whether and how it approached its principles
UK Stewardship Code
• 2010 FRC issued first UK stewardship code
• Iteration in 2012:
o Clarifying distinction between asset owners and fund managers roles
o Role of asset owners: overseeing, challenging and assessing stewardship role of service providers
o Copied by 20 markets such as:
Global: ICGN Global Stewardship Principles
Europe: European Fund and Asset Management Association Stewardship Code 2018
• Code revisions (2020)
o Tripling of pages
o New code with 12 principles (plus 6 for service providers):
1-8: foundations of stewardship
9-12: practical discharge of engagement responsibilities
o Increased ambition for delivery by signatures:
1 to 3 and 5 to 6 – report on concrete examples of structural issues within investment institution such as governance, culture and conflicts
4 – signatories must respond to market-wide and systemic risks - “disclose an assessment of their effectiveness in identifying and responding to”
7 and 8 – integrate ESG into investment process and effective oversight of service providers
9 to 12 – regard engagement and voting activities
o Model for changes in Japanese Code:
Extend all coverage to all asset classes (not only ESG)
Incorporate ESG and sustainability
Add encouragement to asset owners to be involved with stewardship
European Fund and Asset Management Association (EFAMA)
• Stewardship codes likely to increase in EU following Shareholder Rights Directive II (2019)
• SRD II:
o Raise expectations about stewardship from investors
o Supersede the voluntary EFAMA code
o More about shareholders responsibilities
US Employee Retirement Income Security Act (ERISA)
• Stewardship also set by legislation as well as codes
• Employee Retirement Income Security Act (1974):
o Advisors should act as fiduciaries to beneficiaries
o In fiduciary duty, fund is required to vote in meetings and engage with company
• Field Assistance Bulletin 2018-01:
o Previously engagement on environment and social issues rare
o Engagement might be prudent for indexed portfolios where ESG represents significant operational risks and costs
o ESG forms firm basis in value for beneficiaries, therefore not permissible to achieve purely social policy goals
Engagement Styles
• Internal or external engagement from asset owners:
o Internal: through team members who act as stewards to portfolio
o External: expect external fund managers who either:
Take stewardship responsibility
Outsource to specialist stewardship service providers
• Types of specialist stewardship service providers:
o Proxy voting advisory firms: Hired to ensure voting decisions are delivered and provide advice
o Engagement through service firm: aggregate interests of clients to build scale and engage with company (collective engagement) – can take place through PRI or Investor Forum UK
• Engagement styles depend on E and S or G-only heritage of engager:
o E and S arise from nature of company’s business activity (sector split)
Tend to pursue through sectors or markets
Example: establishing better practice to show leaders and laggards
Start with IR and go to management (bottom-up)
o G determined by national law and codes (geography split)
Focus on individual companies
Start with chair and then work through board up to management
• Active vs. Passive investors:
o Passive investors:
Start with issue identified by broader analysis
Engage with sector as whole or broader
Start with letter, follow with dialogue
o Active investors:
Start with the company itself
Tailored engagement approach cutting across range of issues
Companies identified as investment underperformers or ESG underperformers
Start with management and then board
• Issues-based vs. company-focused:
o Issued-based:
Accompanied by examples of best practice looks like
Developed from companies that have leading practices
Encourage given sector to adopt these best practices
o Company-focused:
Improve number of ESG issues at particular company
Overall portfolio performance of company
Goal Setting
• Define:
Define the scope of engagement and prioritise their engagement activities carefully to add value to beneficiaries and improve corporate practices
• Frame:
Frame engagement topic into discussion around strategy and long-term financial performance
• Clear:
Develop clear process articulates goals and milestones so companies can measure their expectations and effectiveness
• Local:
Adapted to local context and cultural approach to business. Beyond this, need to have clear engagement measures
Prioritization
• Identify company in portfolio that is in most need of engagement
o Active managers: prioritise company where most value is at risk within the portfolio and have the option to sell holding
o Passive investors: prioritise where in portfolio is most at risk, tend to focus on largest companies with material risks
o Other resources to help prioritisation:
Stewardship teams
External collective vehicles: such as investor groups who have specialities internally in issues such as water use
• Determine engagement issues that should be prioritised between the investor and company
Behavioural challenges
• Challenge of reaching a consensus
o What needs to change to address issue
o Individual engagements can be time-consuming and costly, and from many investors, therefore trade-offs required
• Conflicts of interest
o When investment managers have business relations with same companies
o Interests beneficiaries differ from each other
• Emergence of competition
o Stewardship professionals usually work together on specific issues
o Collaboration might be transient in both a formal and informal sense
Setting engagement objectives
• Apply milestones to engagement activity – difficult to measure outcomes of individual engagement to stock price or corporate governance
• Clear objectives – handful of issues that are probed – share agenda so there are no surprises – allows engagement with correct party: chair, CEO, CFO, company secretary (voting)
• Listening more important than speaking – good engagement understands constructive dialogue
• The meeting:
o Usually one hour
o Demonstrate knowledge of company or sector to build relations
o Identify reasons why the company may not want to adopt a measure
o Privately without media interest
Escalation of engagement (Principle 11 in UK Stewardship Code)
- Holding additional meeting with management to specifically discus concerns
- Expressing concerns through company’s advisors
- Meeting with chair or other board members
- Intervening with other institutions on particular issues
- Making a public statement in advance of general meetings
- Submitting resolutions and speaking at general meetings – don’t enter public domain until AGM published – company can take to SEC and be
- Request general meeting to change board membership
Collective engagement
• Advantages:
o Resource-efficient method for engagement due to pooling – for both investor and company
o Increases weight of investor concerns
• Disadvantages:
o Co-ordinating separate investors and maintaining constant line
o Concerns about anti-competitive behaviour or exploiting the market
• Asset owner organisations who offer stewardship include:
o the Pensions and Lifetime Savings Association ((PLSA), formerly the National Association of Pension Funds (NAPF)) in the UK
o the Council of Institutional Investors (CII) in the USA
• Investor Coalitions who offer stewardship:
o CDP and Climate Action
o Asia Investor Group on Climate Change (AIGCC)
o European Investor Group on Climate Change (IIGCC)
o Ceres
• PRI collective engagement service
o Collaboration Platform
