Asset owners and managers were not always fully aligned in 2020, but escalating ‘active ownership’ requires plugging the ESG skills gap.
Although environmental issues have remained front and centre of ESG priorities for many investors during 2020, strong governance remains critically importance to asset owners, often providing the focus of their stewardship activities.
Particularly in such unprecedented times, investors want corporates to demonstrate that they have comprehensive and resilient governance structures that can effectively manage resource allocation and long-term strategic planning. This often requires asset managers to coordinate with investee companies on behalf of institutional clients, balancing a range of priorities, covering matters from director independence, board decision-making and risk management to policies on executive versus employee compensation and dividends.
Louise Schreiber, SRI Analyst at French asset management firm Mirova, emphasises that companies also need “a strong governance structure” to help better address environmental and social challenges, too. “Having a strong governance structure incentivises a sound sustainability approach at a group level,” she says.
However, going into 2021, there is still room for improvement. Governance structures and policies are in need of regular review, including those related to oversight of ESG risks, opportunities and metrics. Both asset managers and owners have a big part to play to ensure that happens.
Covid-19: Executive pay and compensation
In 2020, governance has largely been centred around the impact of Covid-19, with investors scrutinising decision-making on dividends and pay in particular. With the pandemic rocking the global economy, company boards are having to weigh the importance of providing shareholders with fair returns while employees are either laid off or furloughed.
Rupert Krefting, Head of Corporate Finance and Stewardship at M&G Investments, says the economic impact of Covid-19 hasn’t always been shared fairly across all stakeholders this year. “For example, where companies have cut or reduced dividends, made significant staff cuts or accepted furlough cash, we have engaged with companies on how executive pay should be adjusted to reflect this,” he says.
“Although the 2021 proxy season is still some way off, many investors called for the top brass to take meaningful pay cuts where shareholders or employees are suffering,” surmised Proxy Insight, a global research firm focused on providing data surrounding shareholder voting, in its ‘2020 Global Shareholder Voting Review’.
Big corporates have been called to account for missteps, including Walt Disney, which saw shareholder support for executive compensation packages fall from 59% in 2019 to 53% at its March 11 annual meeting. “Disney faced further criticism over salary cuts for top executives amid unpaid furloughs for theme park employees,” the report noted.
Krefting expects this to be an ongoing theme in 2021 “as the economic impact of Covid-19 is increasingly felt”.
“Whether the 2020 proxy season signalled greater forbearance or progress in the field of compensation will likely be revealed next year,” Proxy Insight added. “Pandemic-inspired layoffs, combined with fresh highs for some stocks, will present new challenges for compensation committees to show they have been listening to investors’ concerns.”
“Business resilience will need to be a central priority of boards, while issues related to ‘fairness’, such as remuneration and taxation, will also be high on the agenda in the UK and globally,” Krefting continues.
Pensions policies have not escaped attention, according to the Investment Association (IA). The vast majority of FTSE 100 companies (98%) claim to have either aligned their pension contributions of new directors with that of the workforce or have committed to doing so, said the IA. A total of 14 FTSE 100 constituents reduced pension contributions for existing directors during the year, with a further 43 committing to reduce contributions in future years.
However, 10 FTSE 100 companies were issued a ‘red-top’ warning by the IA’s Institutional Voting Information Service (IVIS) for having at least one existing director receiving a pension contribution of 25% or more with no commitment to align this with the rest of the workforce by the end of 2022.
Empowering asset owners
One of the key tools at the disposal of asset managers and their clients is the ability to weigh in on corporate decisions by exercising their rights to vote at annual general meetings. In 2020, it was not always clear that asset managers and owners were on the same page. But there were signs that structural weaknesses in the processes designed to ensure corporate accountability are being addressed.
UK Pensions Minister Guy Opperman launched a new Taskforce on Pension Scheme Voting Implementation, in response to concerns that asset managers of pooled pension funds are not voting in line with asset owner policies. The taskforce was initially proposed by the Association of Member Nominated Trustees (AMNT) in its ‘Bringing Shareholder Voting into the 21st Century’ report.
Janice Turner, AMNT Co-Chair, pointed out that the existing structure means that trustees are left feeling “disenfranchised”, with fund managers taking “weak or contrary positions”. By empowering trustees and giving them more control over voting, trustees can better force funds to align with their ESG-aligned strategies.
Evidence that asset managers were not always reflecting the priorities of clients was global. “Some of the world’s largest asset managers are still failing to use their proxy voting rights to support sustainable progress in their investee companies,” ShareAction said in its ‘Voting Matters 2020’ report.
The pressure for greater coordination led to an increased focus on stewardship and active engagement. In January 2020, the Financial Reporting Council (FRC) published its updated UK Stewardship Code, following a consultation in 2019. It calls for asset management firms to better implement a “comprehensive integration of stewardship within and across investment firms” across different funds, products and asset classes, which it notes will require “a shift in culture”.
“This emphasis needs to be reinforced through governance and incentivisation approaches – the purpose of the [asset management firm] should support and guide their stewardship activities,” the report said.
The UK’s HM Treasury-led Asset Management Taskforce, backed by the IA, launched a stewardship initiative that provides an overview of expected stewardship standards to UK institutional investors. The report calls for the implementation of a Council of UK Pensions Schemes to oversee the implementation of higher standards of pension stewardship, too.
Serving the clients’ best interests?
However, progress remains inconsistent. In BlackRock’s Q3 stewardship report, the asset management firm revealed it had taken voting action against just 53 companies for “insufficient progress” in the adoption of ESG targets. BlackRock voted against 55 directors at 49 companies and put directors at 191 other companies “‘on watch’ or at risk for voting action during the 2021 annual general meeting season absent further progress”.
This year, 55.8% of Goldman Sachs Asset Management (GSAM) voting decisions were “director-related”, according to its ‘2020 Global Shareholder Voting Review’. The majority of these director-focused votes (37%) were related to governance problems, such as lack of disclosure, compensation issues and unsatisfactory risk oversight.
“Asset managers are there to serve the best interests of their clients, particularly on issues in which asset owners are particularly vocal – such as voting on a governance-related issue,” says Rhodri Preece, Senior Head of Industry Research for the CFA Institute. “Ultimately the responsibility of the asset manager is to listen to what their client wants and to take that into account when interacting with investee companies.”
Encouraging more stakeholder engagement remains an active area of discussion between regulators and policymakers. In the US, recent shareholder proposal rule changes were passed in a 3-2 vote by the US Securities and Exchange Commission (SEC). Furthermore, The EU Shareholder Rights Directive (SRD II), initially introduced in 2017, was updated this year with a new requirement for institutional investors and asset managers to develop and publicly disclose how their engagement policy integrates within their investment strategy.
On a practical level, Schreiber notes that a lack of transparency makes it difficult for the asset manager to make an informed decision. “For example, if we don’t have sufficient transparency on tax practices, it will be difficult for us to determine whether the distribution of value is fair to the stakeholders, which makes it harder for us to vote,” she explains.
Asset managers such as Mirova are pushing companies to increase engagement and provide more transparency around issues such as board management, pay and compensation.
Schreiber says asset owners can take a more active position in investee company interactions, to better “open a dialogue around securing the information [asset managers] need to inform voting”.
“Actively engaging with companies“
Although the responsibility to engage with investee companies largely sits with asset managers, asset owners are increasingly prepared to take matters into their own hands. The Institutional Shareholder Services (ISS) Governance team has highlighted that asset owners are increasingly looking to conduct in-house ESG assessments.
In the ISS ‘2020 Asset Owner Stewardship Survey’, 22% of respondents said they intend to bring assessments of ESG risks and opportunities in-house, with 29% noting their intention is to do this “in conjunction with either voting proxies or company engagement”.
Currently just 8% of asset owners do not vote in proxies or ask their managers to do so, compared to 57% that vote their own proxies or provide voting instructions to their investment managers.
“If you’re a large asset owner, the best way in which you can protect the value of your investments, and potentially enhance returns, is through actively engaging with the companies you invest in. Asset owners should have a very receptive audience in those meetings with corporate management,” Preece says.
“We’re still seeing a lot of investors and asset managers relying on proxy policies, as opposed to determining their own voting guidelines or internal voting policy,” Schreiber agrees.
Plugging the ESG skills gap
Holding investee companies to account, either through voting or active ownership, requires resources at both the asset manager and owner level. According to Preece, the ESG skills gap in the investment industry can be improved in 2021 by introducing widespread training and education for asset owners, as well as within asset management firms and investee companies.
Research conducted by the CFA Institute this year revealed that, while 90% of investment professionals expect and increased commitment to ESG research by their organisations, just 26% of respondents said they have “sustainability expertise”, revealing an obvious discrepancy between supply and demand of ESG analysts and researchers.
Now more than ever “new skills are needed to stay current and relevant”, he says. Being trained to better identify and analyse the relevant ESG data will help both shareholders and asset managers to resolve governance issues within investee companies.
“There is a lot of existing inconsistency across the industry – some firms have dedicated sustainability analysts and others don’t. There is no one size fits all solution, but [the CFA Institute] does think this is an area that needs improvement next year,” Preece says.