In a three-part series covering the engagement process, we provide views on evolving expectations and market practice for more effective investor stewardship.
The series covers phases of the engagement process as summarized below:
Objectives and Strategy: Establish, revise and provide transparency on engagement strategy to stakeholders
Prioritization: Observe portfolio companies to identify risks and opportunities to inform selection
Engagement and monitoring: Engage, review of progress and suggested actions
Escalation: Where unsuccessful or insufficient progress, escalate according to strategy
Reporting: Provide insight on activities and value creation to clients, beneficiaries and regulators
The first entry focused on Objectives, Strategy, and Prioritization - covering in part:
Building blocks for a successful program
Stewardship across asset classes
Mitigating systemic risks
Collaboration and advocacy
In this entry, we provide a spotlight on the initiation phase, monitoring, and escalation. See drop-down sections below for more information. The third entry will focus on Stewardship reporting and disclosures.
Investment stewardship encompass a variety of tools
Before we get going, let’s take a look at what the market expects from effective engagement, and some key factors influencing the ability to drive successful dialog.
In recent years, various soft and hard law initiatives have further tightened expectations of investors’ stewardship practices across asset classes. The PRI defines stewardship as: “the use of influence by institutional investors to maximise overall long-term value including the value of common economic, social and environmental assets, on which returns and clients’ and beneficiaries’ interests depend.”(1)
Commonly associated with activities towards investee companies, investment stewardship encompass a variety of tools, including exerting influence also over policy makers and other non-issuer stakeholders. So, while historically engagement might have been principally concerned with the use of formal shareholder powers, such as voting, there are a range of other ways investors can influence investee behaviour depending on the jurisdiction, type of enterprise and investment relationship.
Mind the gap…. in engagement practice
Still today, there are clear differences in what activities investors consider to be engagement, which is somewhat surprising given all the guidance that exists in this area. Take the UK Stewardship Code for example, it demands of signatories to explain how they have developed well-informed and precise objectives for engagement and to report on the outcomes. Then, in a first review of asset managers’ Stewardship code reporting, the FRC (Financial Reporting Council) concluded that “some relied heavily on examples of meetings with companies as part of general information-gathering and monitoring, rather than involving targeted engagement on specific issues.”(2) As many of these signatories can be expected to be PRI signatories as well, this probes an issue around responsible practices given that PRI essentially defines active ownership as “to influence the activities or behaviour of investee companies”.
The distinction is important because it influences our perception of what engagement is and thus what is to expected of investors. We find additional expectations of this change-oriented approach across the industry, take for example Larry Fink’s (CEO and Co-founder of BlackRock) recent 2022 letter to CEOs, he states that “Capital markets have allowed companies and countries to flourish. But access to capital is not a right. It is a privilege. And the duty to attract that capital in a responsible and sustainable way lies with you”(3), while Michael Jantzi (Founder of Sustainalytics), weighing in on the engagement vs divestment discussion, notes that “you need an array of tools, and the outcome depends on how seriously you wield those tools. Instead of simple letter-writing, those who engage with companies need to fundamentally challenge them on their underlying business models and call for significant change”(4)
Investors need therefore to be clear about their intentions and scope of practice. Purposeful engagement should be about setting expectations, understanding and helping companies develop strategies to manage important issues, and if progress is not satisfactory, there is consequence through escalation.
Enablers and barriers for effective engagement
PRI have identified enablers and barriers to effective engagement, as well as engagement dynamics that create distinct types of value for companies and investors(5):
communicative dynamics – engagement enables the exchange of information between corporations and investors, creating ‘communicative value’;
learning dynamics – engagement helps to produce and diffuse new ESG knowledge amongst companies and investors, creating ‘learning value’; and
political dynamics – engagement facilitates diverse internal and external relationships for companies and investors, creating ‘political value’.
A separate study (literature review) by academic researcher Dr Emma Sjöström, provides some great insights on success factors for corporate engagement(6). The study partly discusses the organization theory concept of Shareholder salience, which essentially helps to explain what factors influence companies’ willingness to listen to investor concerns. Theoretically, the factors - and the degree to which stakeholders possess these attributes according to corporate management - of Power, Legitimacy and Urgency are said to increase this stakeholder salience. Legitimacy has been found to be the most critical attribute. In this paper, she lists success factors for corporate dialogue, some of which speak to legitimacy. See examples below:
Presenting a strong business and societal case for engagement
Demonstrating a willingness to understand the company and its complexities
Providing the company with new information on emerging issues
Highlighting an established practice to follow
Having a credible engagement staff and good organisational reputation
Insights such as these can help investors develop a set of engagement standards or best practices.
Stage 1: Preparation
As identified, initiating an engagement dialogue with companies requires a well-developed business and societal case, which raises the need for preparation and doing your research right. Highlighted in the first entry in this series, we discussed quality over quantity in engagement prioritisation, which rings true here as well. Research is essential to develop an understanding around targeted issues and a strong case for outreach. As part of this process, investors should:
Collect background information from relevant sources such as corporate disclosures, open source databases and external benchmarks, esg research providers, academics, media, NGOs, and so forth
Establish best practice by considering e.g. global/industry specific frameworks and by peer analysis
Determine the objectives and asks – what are you looking for, including suggested actions for disclosure or step-wise achievement
In this stage, investors should also consider an appropriate framework for monitoring progress, i.e. would SMART milestones (Specific, Measurable, Attainable, Relevant, Timebound) or a KPI structure resonate better with your objectives? And over what timeframe do we want to see progress on suggested actions and targeted practices?
Stage 2: Dialogue
After acquiring enough information and knowledge about the target entity and the issues of concern, the next step is to initiate the actual dialogue or engagement activity.
To enhance the probability of a successful dialogue and to build trust, here are some additional factors for consideration:
Intentions and expectations: At the start of engagements, both parties will benefit from clarity around purpose and intentions. Providing clear guidance on those expectations as it regards both topic and timeline, together with information such as your investment or engagement beliefs is good practice. An investor that excels in the former is the work of Norges Bank Investment Management, NBIM, which provides clear expectation documents on different focus issues, aligned with the SDGs.(7)
Entry point: Do you utilize an influencer strategy finding your way through the organization or go straight to C-suite or the board? What about informing senior management either way at the start of an engagement? As circumstances will vary depending on company size, management structure, engagement topic and so forth, it is important to consider where it is appropriate to direct an issue, e.g. IR, operational management, sustainability departments, etc. One thing to remember though, identifying internal champions within companies who are willing to take ownership and influence for progress is crucial. It’s a recurring element in most engagement best practice resources.
Timing: Not surprisingly, there are busier periods during the year - in part governed by (regional) regulatory regimes - in which companies might be more or less inclined to engage. For example, the time before annual general meetings (AGMs) or earnings reports represent busy periods for management. Recognizing this, while taking advantage of sentiment, provides you with an opportunity to for example communicate vote intention or outcomes, some of which might have relevance to ongoing engagements.
Relationship aspects and regional considerations: Research suggests that building long-term relationships with companies is conducive to establishing trust. Regional differences also play into this, whereby for example in emerging markets it is especially important to understand socio-economic and cultural differences/customs. Activities such as taking time to translate requests into local language or visiting headquarters/site operations for face-to-face meetings can be important to show commitment and minimize risks of misunderstandings.
Follow-up: After meetings, make sure to provide meeting notes for approval of discussions and next steps. Good practice also includes asking for meeting feedback for future improvements.
For more information on what investors can do to ensure positive results, have a look at page 36 in PRIs guide to active ownership in listed equity, which aligns well with the referenced research of Emma Sjöström.
Responsible activity levels
Having established a foundation of what constitutes purposeful engagement, let us consider what activities (and commitment levels) it could encompass.
Different activities follow with different purposes and possible outcomes, and could be distributed across a resource intensity spectrum. In outlining an engagement strategy and objectives, investors should also reflect upon the engagement toolbox to determine what different forms of engagement are appropriate given organizational and corporate context. In terms of the latter,consider if you can identify other shareholders or groups that share your concerns, or if others are already engaging the entity on the issue in question. For additional suggestions here, consider the paper ‘21st Century Engagement - Investor Strategies’(9), which still provides relevance.
Here are some examples of activities:
(Public) letter writing
Proxy voting incl. vote intention/outcome letters (preferably aligned with potential engagement activity)
Individual dialog with companies
Collaborative dialogue, bilaterally or via initiatives
Voting campaigns, filing and building support for shareholder resolutions
Participation in networks, industry and policy advocacy
Sponsoring academic and industry research
Recognizing that engagements can take multiple years, a common practice to ensure timely follow ups and progress monitoring over the longer term is aiming to address company engagement objectives in two meetings per year with lower touch interactions in between. Depending on the development of internal and external factors such as overall engagement strategy and prioritization criteria, this might also encompass a review of goals over time, aside from any situation which may require escalation.
For the primary objectives of accurate recording, monitoring and reporting, there are certain areas you might want to consider structuring throughout the lifecycle of an engagement. Here are some examples:
Prioritization criteria/Engagement type: See previous post for examples.
Relevant background information and documentation.
Company, Engagement and Activity records: Given that objectives and timelines might vary, you may drive more than one engagement with a company, while certain activities might speak to one or more these.
Activity type: A list of engagement activities at your disposal.
Corporate representatives/counterparties: A list of counterparties for which different activities may be directed.
Monitoring improvements: Can regard progress against milestones or KPIs, as well as any other metric you might want to keep track of.
Capture sentiment: Performance scales for objective measures of e.g. dialogue progress (against change objectives) and response (willingness to consider investor concerns).
Feedback loop to investment decision-making: Aside from providing insight on policy level, from a process perspective, best practice include for example sharing active ownership data across teams, establishing mechanisms for rebalancing holdings or for pre-investment purposes depending on outcomes.
A technology resource perspective
When it comes to the infrastructure or database to assist with engagement tracking and reporting, we encounter a variety of solutions in discussions with investors. From utilizing Excel or Sharepoint, to different CRM/RMS softwares, or bespoke solutions, certain challenges become apparent, such as fragmentation (of data), version management unless fully cloud-based, implementation costs, or longer term service and innovation commitments.
Even if being biased here, there are a lot of advantages in using a dedicated, purpose-built system. Where some larger investors with extensive requirements and budgets will opt for custom builds, many would benefit from accessing a Software-as-a-Service model, which provides use case centric functionality, proof-of-concept, time-saving, lower IT costs, and continuous improvements
There is no one size fits all approach here. With different asset classes having different rights and influence, escalation strategies should be specified on a per fund or strategy basis. Investors should consider their own stance in regards to different issues and what the consequences are if there is inadequate progress by engaged entities. This includes developing well-informed objectives for escalation, including the factors considered most important in deciding to escalate and the approach in turn.
Several different activities can fit into an escalation strategy:
Use of external collaboration to increase influence and legitimacy
Sending formal letters to CEOs or boards of companies within reasonable time frames outlining your engagement expectations, escalation process and implications
Utilizing the AGM:
Asking questions during
(Co-)Filing or supporting a shareholder resolution
Voting against management on e.g. re-election of certain directors, against reports and accounts
Investment choices: Reweighting or divestment
Public statements: Using official position statements or blacklisting
From an industry perspective, there are some recommendations on what constitutes best practice. Take for example OECDs guidance on Responsible business conduct for institutional investors(10). In the report - on the consideration of divestment and exclusions - they note that investors should define what ‘extended engagement’ means in their particular circumstances, accounting for factors such as their scale and resources, size of the investment and severity of the adverse impact. Further, it is noted that the urgency for investors to see change - before taking a decision on divestment and ending potential other business relationships - grows with the severity of the adverse impact. Another example would be the Net Zero Investment Framework by the Paris Aligned Investment Initiative(11), which on escalation - where a company is not on track to achieve its transition plan or targets set for two years or more - note the use of different AGM routes, including voting against the board, remuneration policy, reports and accounts.
A reflection on Engagement vs Divestment This discussion has come to the fore again in industry discussions. Importantly, these approaches are not mutually exclusive as the debate sometimes suggests, but rather, divestment should be a viable tool as part of an escalation strategy. Take a look at Dutch pension fund ABP, which in October announced that it would divest from its direct fossil fuels exposures citing the main reason as “insufficient opportunity for us as a shareholder to push for the necessary, significant acceleration of the energy transition at these companies”.(12) Collectively, we should continue to develop best practice guidance also for escalation strategies, especially around expectations of reasonable timelines given the urgency of many ESG issues.
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