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Passive Houses Feel the Heat on Stewardship

Asset owners’ appetite for customised engagement and voting solutions to accelerate.

As engagement rises up the agenda of responsible asset owners, they are increasingly in need of passive managers who are able to adapt to their engagement and voting policies.

It might once have been acceptable for passive managers offering ESG vehicles to duck out on stewardship activities, but that no longer cuts the mustard.

BlackRock came under the spotlight for its weak support of proposals and has since vowed to make headway.

A 2020 report by NGO ShareAction highlighted that BlackRock, together with Vanguard, were among those supporting the fewest ESG shareholder proposals, with just 12% and 14% respectively for a total of 102 resolutions.

BlackRock’s Global Executive Committee wrote in a 2020 client letter: “As a long-term investor, BlackRock has historically engaged to explain our views on an issue and given management ample time to address it.

“However, given the need for urgent action on many business-relevant sustainability issues, we will be more likely to support a shareholder proposal without waiting.”

At the end of last year, BlackRock voted for climate resolutions at Australia & New Zealand Banking Group and National Australia Bank. And in February this year, pension fund clients called on the largest asset manager in the world to vote for a climate resolution at HSBC, the Financial Times reported.

Stewardship plays a crucial role in the transition to net zero greenhouse gas emissions, and many responsible asset owners already consider this in their manager selection.

A 2019 CREATE-Research report surveyed 127 pension plans in 20 countries, with combined assets under management of €2.2 trillion.

It found that 56% of respondents currently use a manager’s track record on stewardship as a criterion in manager selection to a large extent and 27% to a medium extent.

Customised stewardship policies

The type of ESG support asset owners require from passive managers differs largely.

Swedish state pension fund AP7, with SEK670 billion (€65 billion) in assets under management at the end of 2019, has a long track record for holding its investee companies accountable on ESG issues.

As a universal and active owner, it seeks to influence the entire market towards sustainability over the long term.

Despite being a passive asset owner with over 3,000 companies in its portfolio, CEO Richard Gröttheim explains that the fund applies a range of tools to change investee companies’ behaviour.

These include dialogue via its own in-house engagement team, which includes collaborative engagements as part of investor initiative Climate Action 100+, voting at annual general meetings (AGMs) through its proxy voting service provider, and excluding firms from their passive investments via public blacklistings.

Engaging on corporate lobbying activities is one of its focus themes. In 2019, six companies published lobbying reviews following dialogue with AP7, including Anglo American, Royal Dutch Shell, Rio Tinto and BASF, according to the fund’s sustainability report.

The fund elevates engagement in steps when it can’t reach agreement with a firm.

As a last resort, AP7 also takes legal action to criticise and discourage companies from fraudulent conduct. At the end of 2019, AP7 was involved in 14 ongoing legal processes.

The fund has picked the proxy voting provider Institutional Shareholder Services (ISS) for its voting activity, because of its ability to create flexible solutions compared to passive asset managers.

“We are a very demanding investor,” Gröttheim notes, adding that proxy voting is one of the fund’s most important fields.

Lorraine Kelly, Head of Governance Solutions at ISS, comments that, rather than having to monitor multiple asset managers, some asset owners prefer to opt for one proxy voting provider, as this allows them to apply their stewardship strategy consistently.

“For instance, the ability to develop a custom voting policy with ISS provides the asset owner with a tool to build their own specific objectives into their stewardship strategy and ensures that this is represented across their entire holdings,” she says.

AP7 specifically requires from its passive asset managers, BlackRock, State Street Corporation and Northern Trust Asset Management, the ability to exclude holdings according to its stewardship policy.

Gröttheim says, “When we decide to exclude the company, we want to be sure that it is in fact excluded from the investments.”

The fund has currently more than 80 companies excluded based on its norms-based screening, due to for example involvement in nuclear weapons and the violation of labour rights.

The fund also “names and shames” excluded firms by publishing their names and reasons for exclusions twice a year to increase the pressure to change. Meanwhile, it continues the dialogue with these firms and reincludes them in their portfolio once they have changed, Gröttheim explains.

ESG voting track record counts

Katharina Lindmeier, Responsible Investment Manager at UK pension scheme NEST, £16.4 billion assets under management as at March 2021, explains that stewardship and proxy voting have become increasingly important to address any ESG risks in the fund’s passive portfolios.

“We expect all of our managers to combine ESG integration with strong stewardship capabilities to ensure that any ESG risks can be addressed and escalated,” she says.

NEST meets with its managers every year ahead of the proxy voting season to discuss any changes to its respective stewardship policies and emerging themes.

Identifying a good passive manager on proxy voting requires resources, Lindmeier explains, but their services don’t necessarily differ from active managers.

“Most asset managers have centralised proxy voting teams who vote across all [active and passive] funds and similarly, engagement activity is often carried out across different mandates, so we do not see a difference in quality between active and passive management,” she explains.

Both voting policies and voting record matter in the fund’s manager selection process.

NEST sets its expectations for managers according to global voting principles, such as the International Corporate Governance Network’s (ICGN) Global Governance Principles, and UK voting standards, which are broadly aligned with UK Corporate Governance Code and the Pensions and Lifetime Savings Association voting guidelines.

“What we like to see is a strong policy that articulates the guiding principles on key governance and sustainability topics,” Lindmeier says.

“When looking at voting track record, we consider the proportion of votes against management as well as the manager’s stance on high-profile votes. We then have the ability to interrogate them on their track record in due diligence sessions during the selection process,” she notes.

More progress on data needed

Among the barriers to progress on stewardship in index funds are the lack of clear definitions and metrics for corporate engagement (cited by 62%) and the number of companies listed in indices (60%), according to CREATE-Research.

The report also cites as an issue that shareholder voting is overly influenced by ‘unaccountable’ proxy advisors (64%), which constrains passive managers.

Passive asset managers also seem to be hesitant about how much of their engagement and voting data they wish to disclose.

Out of 43 passive and active asset managers contacted, only one third (33%) were able to provide details of how they had used their influence in voting as investors, according to a survey by Minerva Analytics, a UK independent proxy voting agency, assigned by Dalriada Trustees.

Sarah Wilson, CEO of Minerva Analytics, explains that the industry has had a long lead time to address the EU Shareholder Rights Directive II (SRD II) and UK Pensions Act changes, including taking care of technical issues in regard to stewardship data.

“We are at a loss to understand why, given the voting platforms that managers use, [ie. they] have this information in very easily downloadable formats, the businesses were not able or willing to support their clients.

“By not being prepared, the managers are not helping their clients comply with the law, which is extremely concerning,” she says.

SRD II aims to encourage long-term shareholder engagement in listed companies and to improve transparency on shareholder engagement.

Raza Naeem, Counsel at Linklaters, says the comply-or-explain approach of SRD II leads to asset managers applying it with a “goodwill gesture”.

While legislators may hope that the approach will shame managers into disclosing their policy on shareholder engagement and voting, most passive managers have chosen not to comply, Naeem says.

Yet, given the rising need for engagement to achieve net zero goals, change seems unavoidable. ShareAction’s report points to an accelerating trend going forward.

Northern Trust Asset Management significantly improved its voting record this year, for example, voting for 79% of resolutions on climate change, up from 21.3% last year, whereas JP Morgan Asset Management voted for 51% of all climate change resolutions this year, as opposed to 6.7% the year before, the 2020 report says.

At the same time, more than a fifth of 79 asset owners polled said they intend to bring assessments of ESG risks and opportunities in-house as a single task, whereas 29% said they have looked at combining in-house work with either voting proxies or company engagement, according to a 2020 ISS survey.

Wilson believes that index managers are no less able to be good stewards than any other type of investor.

Rather, she notes, it is “a question of them stepping up and getting involved – which many are”.

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