Growing regulatory pressure and rising member awareness are not the only reasons schemes should engage with the companies they are exposed to, says Shade Duffy from Axa Investment Managers.
Key points
• Many countries are reviewing the scope of fiduciary duty with regard to ESG requirements
• In the recent past, single ESG tail events have made headlines and cost investors significant sums
• Effective engagement with ESG concerns could lead to better long-term management of companies and support risk mitigation
However, transparency depends on the level of disclosure offered by companies. It is the role of good stewards to ensure there is enough transparency on key investment issues for investors to be able to price risk better.
The fallout from mispricing or ignoring ESG risks has been clearly demonstrated by specific events
It is becoming increasingly clear that both scheme members and regulators are concerned with ensuring that businesses contribute to the societies and environments in which they operate.
To that end, many countries are currently reviewing the scope of fiduciary duty with an eye to environmental, social and governance requirements, including a recent effort from the OECD in conjunction with China to make the expanded definition explicit.
The importance of full consideration of ESG risks
The fallout from mispricing or ignoring ESG risks has also been clearly demonstrated by specific events.
In the recent past, single ESG tail events have made headlines and cost investors significant sums – for example, BP’s Deepwater Horizon and, more recently, the Volkswagen emissions debacle.
But there are a number of risks lurking on the horizon: global warming and climate change-related risks, and the impact on long-term company value and the financial interests of pension beneficiaries are a key agenda item for many investors.
The proper consideration of relevant ESG factors affects the long-term sustainable performance of companies and benefits the investors of such companies. Through active shareholder engagement, asset managers can use their influence as investors to encourage companies to mitigate key environmental and social risks relevant to their sectors.
Climate change is increasingly on the engagement agenda
Climate change has become a key stewardship topic. The systemic nature of climate change requires investors to aggregate collective influence to bring about necessary change, as regulatory and political pressure worldwide around the topic of global warming continues to increase.
Initiatives such as ‘Aiming for A’ – which saw a number of large investors co-file shareholder resolutions at extractives and utilities companies with significant exposure to climate change risks in order to influence change – are a good example of shareholder engagement in action.
The objective of this particular initiative is to support companies in their preparation for the low-carbon transition that is imperative to meet the below 2C objectives of COP21.
It also aims to improve the information provided by these companies to their shareholders, so that shareholders can have a better understanding of how relevant companies are adapting their strategies around climate change issues.
Ultimately, the objective of this kind of necessary engagement is to ensure protection for the pension assets of beneficiaries.
Regulation and members increase pressure
The 2010 UK Stewardship Code sets a standard for engagement, removing barriers between shareholders and companies; it is making investors responsible in holding the board to account.
Are we engaged enough?
Active ownership; shareholder engagement; shareholder activism; stewardship – the language varies, depending on which market you are in, but the fundamental logic is the same.
A few years later, the UK also became the first country to make it compulsory for companies to include greenhouse gas emissions data for their entire organisation in their annual reports. In 2014, with the Pensions Act, the fiduciary duty and reporting requirements of pension funds were expanded to include ESG factors.
Besides these regulatory pressures, which have clearly been rising, the general awareness around sustainability issues through the media means pension funds have come under pressure from members in both defined benefit and defined contribution, especially with millennials, and corporate sponsors are also more actively engaging on the subject – usually starting with formalising the beliefs of the trustees.
Ultimately it is for pension scheme trustees to decide how their views may affect asset allocation. However, effective engagement could lead to better long-term management of companies and support risk mitigation.
Shade Duffy is head of corporate governance at Axa Investment Managers
