In a three-part series covering the engagement process, we provide views on evolving expectations and market practice for more effective investor stewardship.
The first entry focused on Objectives, Strategy, and Prioritization.
The second entry covered the Initiation phase, Monitoring, and Escalation.
In this third entry, we provide a spotlight on what voluntary and statutory initiatives require in terms of active ownership reporting and disclosures, outlining expectations and best practices. See drop-down sections below for more information.
In most jurisdictions, investors are expected to report on their engagement and voting activities to their stakeholders. The information should be easy to access and understand, and provided on a regular basis (at least annually, increasingly so bi-annually or quarterly). Best practice would also have investors provide some disclosures on both entity and product-level.
Stewardship reporting address different stakeholder groups and objectives:
Internal stakeholders: It enhances internal accountability and coordination, for example in terms of a feedback-loop to investment decision-making.
Clients, beneficiaries, regulators and others: It facilitates for increased transparency and validation of activities, promotes competition, and support standards development.
Issuers: It provides opportunity to set expectations to engaged entities, and hold them accountable by rewarding positive progress and punishing poor performance.
Information use & intent
Recognizing that trust is an essential part of relationships with companies, and that dialogues sometimes include sensitive information, some investors will perceive reporting as a limiting factor. Therefore, it is important to have a structure in place and get it right from the start. Good practice include explaining:
Expectations: Transparency around e.g. engagement purpose and process, frequency of interactions, and potential activities.
Information collection: Information type and how it will be handled, such as public disclosures, confidential information or accessible upon request, and Inside/MNPI.
Information sharing: Internally vs externally. Certain disclosures can be more detailed than others. Information intended to be shared with clients should preferably be publicly available.
For examples of best practice, check-out Sustainalytics’ Engagement Guidance and Information Types site
With the globalization and consolidation of the asset management industry, many managers need to follow different regional considerations, for example as it regards their stewardship activities. Nearly all stewardship codes encourage disclosure of active ownership policies, management of conflicts of interest and regular reporting to clients and beneficiaries. Let’s take a look at a couple of examples here:
International Corporate Governance Network (ICGN)
In 2016, the ICGN Global Stewardship Principles came into force(1). Principle No. 7, ‘Enhancing transparency, disclosure and reporting’, highlights that Investors should publicly disclose their stewardship policies and activities and report to beneficiaries or clients on how they have been implemented. On a more detailed level, the underlying indicators cover areas such as; signifying commitment by becoming a signatory to a relevant national code; maintaining records and summaries of stewardship activities; transparency and accountability in terms of key internal governance arrangements for exercising stewardship duties; client reporting of stewardship priorities and forward-looking engagement strategy, activities and performance.
UK Stewardship Code
While most codes set requirements on investors’ reporting, primarily around performed activities such as publishing of voting records, and providing engagement case examples, the updated UK Stewardship Code (since 2020) goes further:
Using a balance of both qualitative and quantitative information, reporting should provide insight into how investors practice stewardship and allow stakeholders to understand the scope and scale of activities. Effective reporting in this regard means presenting data that provides a clear cause and effect relationship between ESG research and tools, investment beliefs and engagement with issuers, and where applicable, investment-decision outcomes. The use of case studies is important to exemplify process and activities, in which objectives, methods, and details of the investor’s role, contribution and next steps should be explained.(2)
UN PRI & general best practices
PRI reporting is the largest global reporting project on responsible investments. The implementation of the new reporting framework has been delayed, with the next reporting cycle in January 2023. Information on the new framework can be found here.
Their stewardship guidance incorporates some of their latest work, including the practical guides to active ownership and engagement in listed equity and fixed income respectively(3, 4), and their framework on SDG outcomes(5). Here are some best practices from noted reports to guide reporting:
Outline of engagement strategy, due diligence and monitoring approach
Detail on engagement prioritization and definition of objectives
Number of engagements during reporting period, with breakdown by type, topic, region, and so forth
Assessment of progress and outcomes achieved
Details on escalation strategies and activities
You will find relevant perspectives on the former two bullets in our first post on the engagement process. For additional best practices, some investors would highlight for example:
Number of companies and issues/objectives engaged respectively, and activities performed (shows that you might engage companies on more than one issue, with separate change objectives and timelines).
ESG category, SDG attribution, Topics (often aggregated to broader categories), and PAIs (increasingly so)
Milestones and or KPI progress
Outcome type and investment implication, such as improvements in disclosure, changes in company practice, reweighting of exposure.
Activitity type, such meetings, site visits and emails.
Participation and role, i.e. internal or collaborative, leading or supporting.
Public policy advocacy and involvement in global initiatives.
Year over year statistics to highlight change and momentum in practices.
Spotlight: Reporting on escalation activities
The importance of accountability across the engagement chain is growing, both in terms of holding companies and directors accountable for performance, as well as scrutiny of investors’ activities. Highlighted in the FRC’s review of stewardship reporting, they state that reporting on escalation was weaker in comparison with other Principles, with fewer effective examples of escalation in other asset classes. Reporting should explain how investors selected and prioritised issues and developed well-informed objectives for escalation, including factors most important in deciding to escalate, the choice of approach, and description of outcomes. This should also be reflected in situations where escalation is performed on someones behalf, take asset owners for example.
Spotlight: Reporting on outcomes
Pressures on investor resources call for due weight to be placed on quality, evidence-based engagement focusing on clear outcomes. Historically, what has been primarily measured and emphasized in ESG has been activities, or inputs such as policies, principles, management systems and targets, and not outcomes, which is what we really need. Now, it needs to be recognized that we still have lengths to go in terms implementing transparent and comparable frameworks of environmental and social impacts that can support outcome-focused reporting.
George Serafeim provide some relevant comments on this in a working paper, where he notes that reporting and transparency can be effective at changing behavior and outcomes in general and in ESG areas in particular. However, while reporting is likely a necessary condition, it is unlikely to generate significantly different outcomes, unless also strong incentives are tied to those metrics(6).
Regional Insights: Europe (SFDR & Taxonomy)
The Shareholder Rights Directive (SRD II) requires institutional investors and asset managers in the EU to disclose their engagement policies and the implementation of these policies on a comply-or-explain basis.
SFDR Investors engage with investees and companies on sustainability risks and factors, the 'do no significant harm' principle and the principal adverse impacts (PAIs).
On entity level, SRD II requirements apply with associated obligations to disclose an engagement policy and annual updates on its implementation, and how material votes were cast. For entity and product-level PAI statements and periodic reporting, engagement policies should be included, with activities applicable as ‘Actions taken’ to address specific PAIs. There is no obligatory requirement however to report on PAI indicators on fund/portfolio/product level in the regulation.
Engagement is not part of the Taxonomy’s objective. Even so, over the long-term, engagement is seen as an important tool by investors to ensure compliance with the criteria and increase alignment among investees and potential investments. As such, investors engage with issuers both around specific economic activities and thresholds, as well as on non-compliance or risks of breaching Do No Significant Harm (DNSH) and Minimum Standards (MS) criteria.
The Taxonomy itself apply for companies currently under NFRD, and the coming CSRD. For fund reporting, Financial Market Participants (FMPs) must exclude companies that voluntarily report their Taxonomy alignment in calculations. Even if this is seen as a huge downfall for the potential impact of the Taxonomy, which will clearly decrease the level of engagement with non-NFRD firms, it still helps set standards in the market with many possible voluntary uses. Investors can for example use the taxonomy and its science-based performance thresholds (for most criteria right..) in due diligence and engagement activities with other companies to help achieve positive environmental and social (yet to be implemented in the Taxonomy) impacts.
Regional Insights: United States
The US is by far the biggest market globally in terms of assets. You have some of the largest investors based out of the US with the big three - BlackRock, State Street Global Advisors, and Vanguard Group - wielding most power in terms of stewardship influence. In meeting their fiduciary responsibilities, as many others, they have to respond to requirements not just within the US, but across regions, some of which come with higher stewardship expectations.
If advocating for sustainability impacts, the applicable legal framework in the US indicates that using engagement for such could be consistent with the duty to seek financial objectives if, in their discretion, the financial benefit analysis of such engagement outweighs its relevant cost(7). In other words, regulation requires it to be linked to long-term financial performance at risk. BlackRock, as an example, has been clear about their view that engagement efforts do form part of their role as a fiduciary because prioritised issues drive long-term sustainable performance.
Whether using investment powers, stewardship or undertaking policy engagement, investors pursuing sustainability impact goals need to address these challenges of defining and assessing progress against identified objectives and their potential financial implications, while establishing a robust understanding of how they best can exert their influence. A project that seems extra relevant for this undertaking is the year-long collaboration between the Investor Forum and London Business School’s Centre for Corporate Governance, which culminated in the recently published report 'What does stakeholder capitalism mean for investors?'. The report is well worth a read. It offers practical insights to guide investors in how to best evaluate and address stakeholder considerations. Building on a framework developed by Alex Edmans to help companies prioritise stakeholder-oriented actions, the authors have developed a ‘triple test’ for investors to use in turn, based on a combination of assessing Materiality, Efficacy and Comparative Advantage. The report highlights that if a disciplined approach to stakeholder issues and mandates is in place, issue-specific engagement dialogues can be rooted in matters of direct relevance to the company, and to investor interests, rather than being seen as indiscriminate, which is sometimes the case today.
In recent years we have seen regulators stepping in to scrutinize claims from the investment industry, for example through the EU Action Plan with the implementation of SFDR and the Taxonomy, with similar initiatives underway on a global scale. More recently, the European Securities and Markets Authority’s (ESMA) launched their Sustainable Finance Roadmap, in which a top concern is addressing the risk of greenwashing(8).
Investors today are expected to demonstrate an aligned responsible investment strategy with consistency across esg integration or investment-decision making, to engagement and voting activities. Misalignment between investment beliefs and headline statements with subsequent activities will hurt investors’ asset stewardship, as well as business and reputation.
Disclosure is important. It increases transparency and promotes well-functioning, competitive markets. And, perhaps most importantly, it enables greater accountability to stakeholders. We should all be prepared that expectations of investors’ stewardship commitments, activities and reporting thereof will continue to increase.
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