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Beyond a Governance-led Approach to Stewardship

Jessye Waxman, Senior Campaign Strategist at Sierra Club, argues that investors are failing to adapt to a new era of risk ahead of the 2024 AGM season.

April marks the start of AGM season, the time of year when global investors are preparing to vote on critical matters at companies in their portfolios that have a significant impact on the climate. Despite climate goals, years of engagement, and considerable risk exposure, the majority of institutional investors are coming to AGM season ill-prepared to weigh in on these risks in order to protect their clients’ investments.

The emissions pathways of the majority of companies are still misaligned with the goals of the Paris Agreement. Therefore, meaningfully reducing climate-related financial risks, requires companies to reorient business strategy to achieving climate goals and meaningful decarbonisation. Responsible fiduciaries should be voting in a way that works to minimise these risks. However, most fund managers’ proxy voting guidelines, the principles which guide their votes at companies’ annual meetings, do not encompass provisions that would allow them to vote to meaningfully reduce climate-related risk.

Significant shortcomings

In reviewing fund managers’ proxy voting guidelines, two significant shortcomings emerge for the 2024 AGM season. The first is an overreliance on working to increase corporate climate disclosures as a risk management tool. Corporate climate disclosures are critical for investors to have decision-useful information, but, as the UN Principles for Responsible Investment notes, corporate disclosures are not sufficient to deliver outcomes, especially on systemic issues, such as climate change. In fact, several studies have found zero-to-negative correlation between a company’s disclosure and its actual environmental performance and that disclosure does not necessarily lead to changes beyond disclosure itself.

Furthermore, improved disclosure does little to shield passive investors from risk as most buy securities based on index fund tracking, rather than risk characteristics. For context, BlackRock has 90% of its equity portfolio in index-tracking passive funds. Improving disclosure, while both necessary and important, is not sufficient to shield long-term, diversified, and largely passive investors from climate-related risks.

The second shortcoming is a ‘governance first’ approach to stewardship and proxy voting, which leans more on assessing corporate governance practices than on actual corporate outcomes to evaluate a company’s preparedness for risk. For example, BlackRock, a champion of this approach, writes in the climate section of its Investment Stewardship Global Principles that “well-managed companies will effectively evaluate and manage material sustainability-related risks”.

But that strategy has failed in the wake of the unique risks posed by climate change. The vast majority of companies in Climate Action 100+, the world’s largest investor engagement initiative on climate, are still misaligned with the goals of the Paris Agreement. Similarly, disclosure platform CDP found that the oil and gas sector has made “almost no progress toward the Paris Agreement goals”. This is the state of progress after years of investor engagement, where too few have focused on holding polluting companies accountable to actually implementing transition strategies.

Improved disclosure and strong corporate governance are important, but neither strategy necessarily encourages companies to incorporate science-based decarbonisation strategies into their business plans, which is critical to combat growing risk to peoples’ investment portfolios.

Necessary, but insufficient

So, while necessary, they alone are no longer sufficient in the face of new kinds of emerging risks. Climate change, ecosystem decline, and biodiversity loss are all systematic risks, risks that cannot be diversified or hedged against and that create instability across the entire economy. Leading financial institutions estimate that unmitigated climate change will lead to up to 25% of losses in global economic output, an unprecedented level of economic decline. The financial risks posed by these looming ecological disasters are fundamentally different from more established financial risks and need to be managed with new approaches.

Unfortunately, very few investors are prepared for this new era of risk. Most of the biggest fund managers in the world have not taken the steps necessary to shield their clients’ portfolios from climate-related risks, including in the proxy voting arena. BlackRock, for example, has asserted a position of excusing itself from encouraging decarbonisation strategies, instead insisting that such risk mitigation work falls to governments. These institutions manage the savings of millions of Americans, and are putting client’s savings at risk because they refuse to move away from the status quo.

Failing to adapt to modern times is not just unwise but irresponsible for those entrusted with managing investments, savings, and retirement funds. Fund managers have the opportunity to update their guidelines annually. To manage climate-risk responsibly for their clients, they must set clear expectations for high-emitting and high-impact companies to align with the goals of the Paris Agreement goals across all of their portfolios. Failure to do so risks breaching their fiduciary duty.

It’s crucial for investors to update proxy voting guidelines to responsibly manage evolving risks, especially amid escalating (systemic) climate concerns. It’s time for proxy voting guidelines to reflect a responsible risk management approach appropriate for the 21st century.

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