Europe

Reading Between the Lines of Managers’ Stewardship Reports

Consistency a challenge for asset owners attempting to get to grips with managers’ engagement policies via the UK’s updated Stewardship Code.

In late summer 2021, the UK Financial Reporting Council (FRC) is scheduled to publish the first list of signatories to its Stewardship Code 2020. The Code, which took effect from 1 January 2020, is an update of the 2012 version, reflecting the growth in investments such as bonds, real estate and infrastructure and also the increasing importance of ESG factors for investors. To become a signatory, applicants need to submit a stewardship report that explains how they have applied all the principles and responded to the reporting expectations for the period in question.

Comprising 12 principles for investment institutions and six principles for service providers, the Code “recognises that asset owners and asset managers play an important role as guardians of market integrity and in working to minimise systemic risks as well as being stewards of the investments in their portfolios”. The signatories listed will be those organisations that have, in the FRC’s judgment, effectively evidenced adherence to its principles.

The Code applies to asset owners, asset managers and service providers on a voluntary basis. Where an organisation elects to apply to the Code, it must adopt the principles on an ‘apply and explain’ basis. There is no minimum AUM threshold, but there is a requirement that organisations managing investments for professional clients disclose on their website the nature of their commitment to the Code, or where they do not commit to it, their alternative investment strategy.

The ‘official’ list will not include organisations that wish to explain their alternative investment strategy or those that have produced a policy statement but do not wish to be listed. Just under 200 asset owners and managers met the initial deadline to become the first signatories of the Code.

The FRC published a progress report in September 2020 that assessed around 25 ‘early’ reports to the Code where organisations submitted their 2019 reporting in alignment with the new principles. These organisations received written feedback. Despite good examples and case studies evidencing stewardship activity, the progress report also found that few reports “consistently demonstrate the application of all the principles or address all the reporting expectations.” For all the principles, it said, reporting needed to improve by reflecting on effectiveness of approach, demonstrating continuous improvement and disclosing outcomes. Statements should be supported with specific evidence from the reporting period, and the rationale rather than just a general statement of approach.

During the past few months, a large number of asset managers have issued stewardship reports based on FRC guidance. But how useful are these reports for asset owners? The asset owner will find that consistency of approach remains an issue. The plethora of reports that have been issued display a diverse approach by asset managers to not only how information is presented, but also the content itself. Some managers have reported on a principle-by-principle basis, dividing their reports into separate sections relating to each of the 12 principles in turn, while others have not. Moreover, some firms focused on policy rather than on activity and outcomes for the reporting period.

Engagement and escalation

To assess adherence of the recently submitted reports, ESG Investor has focused on engagement and escalation – an area that asset owners have long complained lacks transparency and impact, in assessing the stewardship reports. This area is covered by principles 9-11. In its review of early reports, the FRC said principle 9 – which requires signatories to engage with issuers to maintain or enhance the value of assets – was “among the better reported principles in the reports that we reviewed”. In their reports, asset managers should show:

  • how they have selected and prioritised engagement;
  • how they have developed well-informed and precise objectives for engagement with examples;
  • what methods of engagement and the extent to which they have been used; and
  • the reasons for their chosen approach.

Principle 10 requires signatories, where necessary, to participate in collaborative engagement to influence issuers. In reporting, signatories should the collaborative engagement they have participated in and why, and should describe any action taken, how the outcomes informed investment decisions, and whether their stated objectives had been achieved.

Principle 11 covers escalation, requiring signatories to explain how they have selected and prioritised issues, when they have chosen to escalate their engagement, including the issue(s) and the reasons for their chosen approach and how escalation has differed for funds, assets or geographies. The reporting requirements for outcome are the same as for principle 10.

Patrick Peura, ESG Engagement Manager at Allianz Investment Management and asset manager engagement track co-lead of the UN Net Zero Asset Owners Alliance (AOA), says the UK Code aligns with what the Alliance is seeking from asset managers on engagement and escalation. “We want asset managers to make their escalation tactics clear. Since we believe that voting on resolutions at AGMs is not an escalation tool,” he says, “asset managers need to demonstrate how they hold company leadership accountable, including through director votes, when it is determined they are not properly addressing ESG or climate concerns.”

Demonstrating a consistency of approach on engagement is also important, says Peura. “We want to see how an asset manager is setting engagement priorities and assessing outcomes. This will help us, as asset owners, determine if an asset manager is sufficiently stewarding our long-term interests.”

Striving toward consistency

Although only a small sample, the stewardship reports examined by ESG Investor don’t always deliver on these requirements. While they generally provide a summary and metrics of their overall engagement activity, supported by case studies outlining different aspects of their approach, it is not always clear what escalation strategies are. Neuberger Berman, a private investment manager with US$356 billion AUM, however, does outline its escalation strategy: “We believe escalation should not be a top-down dictated approach, but rather investment-driven, taking into consideration matters such as investment objectives, issuer-specific circumstances, and our history of engagement.”

Inevitably, drawing conclusions about managers’ approaches to engagement is a case of qualitative rather than quantitative analysis, requiring the asset owner to read between the lines. UK-based M&G, which manages £284 billion in equities, multi-asset, fixed income, real estate and cash, states in its Stewardship Report (a weighty tome at 84 pages) that as a “general approach” as an active fund manager it is supportive of the management of the companies in which it invests. However, when companies “consistently fail” to achieve the firm’s expectations “we will actively promote change”. This could be via the formation of a new strategy or the appointment of new directors.

Invesco says when it finds itself in a position where management are “digressing from where we, as shareholders, feel they should be, we will engage directly with the board and other board members”. Engagement at board level will depend on the individual case, however the firm says in many instances, it will reach a “satisfactory position” in advance of voting.

On engagement, the stewardship reports vary as to how case studies are presented. M&G addresses each of the 12 Code principles in detail in an appendix, while the main body of the report is driven by themes and narratives. In the appendix, the firm details how it prioritises engagement, develops objectives, its categories of engagement, and its engagement framework.

In the main body, M&G presents case studies based on its thematic engagement approach – as opposed to its ‘reactive’, company-specific engagement – to environmental and social issues. These case studies are presented under the subheadings of objective, action and outcome.

Neuberger Berman presents engagement case studies under subheadings of background, scope and progress, and outcome and outlook. In its 2020 ESG Investment Stewardship Report, Invesco provides case studies across disclosure and policy, climate change and social equity. The companies are not named (unlike in M&G and NB) and the case studies provide a summary and outcome.

BMO Global Asset Management’s stewardship report presents two named case studies one on the theme of climate change and the other on corporate governance under the headings of background, action and verdict. BMO Global’s 2020 report is not designed specifically for the UK market, but the firm says it may be used by the FRC to assess compliance.

High expectations

It is early days for the revised Stewardship Code and prospective signatories are to an extent feeling their way around the Code. The expectations of the FRC, and of asset owners, for asset managers to fully explain the structures and processes that underpin stewardship decision making and the rationale for approaches taken are high.

Asset owners are likely to keep pushing for greater transparency, particularly on escalation around ESG issues in order to bring discussions out from behind ‘closed doors’. The stewardship reports are a step along the way.

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