Timing and influencing the market are vital considerations for asset owners when divesting ESG assets.
Since the success of the South African apartheid divestment campaign in the 1980s, investors must contend with similar pressure on other ESG issues, such as the growth of campaigns encouraging them to exit fossil fuels or tobacco.
Divestment has also shot up the agenda for investors as ESG risks, such as climate change or biodiversity loss, become not just moral, but also financial risks. But exiting a position is complex business, with multiple factors to consider.
Dutch public sector pension fund ABP is in the process of selling €15 billion (US$16 billion) in fossil fuel investments after deciding the industry is not transitioning quickly enough towards decarbonisation.
Asha Khoenkhoen, spokesperson for ABP, tells ESG Investor its process starts with a clear definition: “What kind of companies are covered by this exactly? When is a company part of the chain and when is it not?”
ABP has distinguished two types of companies within the group of fossil energy, companies directly involved in the exploration and production of fossil energy from coal, oil and gas and those indirectly involved such as a company that supplies parts for oil rigs. On the latter it will reduce investments if they derive 20% or more of their costs from fossil energy activities.
But it also makes exceptions if companies are working hard to make the transition to sustainable energy. This includes investment in utilities, investments that contribute more than 50% of its income to SDG7 (sustainable and affordable energy) or SDG13 (taking action for the climate) or companies that derive less than 50% of revenue from fossil energy activities and that are recognised by independent scientific agencies as operating in line with the aim of limiting global warming to 1.5°C.
By April, ABP had sold all its liquid investments in fossil energy producers in developed economies, amounting to around €9 million. This included equities and corporate bonds in developed economies such as the US, Australia and Singapore. There is a remaining €1 billion in emerging countries to sell and the reduction of illiquid investments.
When ABP formally announced its divestment plans in 2021, it wanted to make a statement, making the move in the run-up to a climate summit that year.
Khoenkhoen explains: “As a large investor, we also wanted to seize the moment and send a public signal in the run up to the summit. With the announcement we also indicated about the divesting process from the start that it entails carefully phasing out fossil investments, step by step.”
Usually, when an investor divests it avoids telling the market beforehand to avoid extra trading losses, which can be incurred as a result of market participants knowing its intentions, which is a particular risk in the liquid secondary markets for the securities of oil and gas majors. But in ABP’s case its divestments can run for up to ten years as some holdings are attached to pooled funds to which the pension fund is bound by contracts.
ABP is one of Europe’s largest pension funds with €470 billion in assets under management.
Openness and transparency on divestments
Extended divestment periods are not an issue for Norwegian pension fund KLP which manages its divestments in-house.
Kiran Aziz, Head of Responsible Investments at KLP, says: “It will depend on the number of shares we hold and what kind of company it is, but normally it takes one to two days. Two years back, we excluded 16 companies due to links to Israeli settlements on the West Bank. The settlements are considered to be in violation of international law. KLP held investments totalling NOK 275 million (US$24.9 million) in the companies at the time of the decision. There were some big names, such as Motorola, so in total we used 3-4 days to sell.”
KLP’s strategy for ESG investment decisions starts with “positive change”, explains Aziz.
“Active ownership via stewardship, engagement and exclusions as an ultimate measure allows a large passive allocator such as us to integrate ESG.”
The strategy is also based on openness and transparency, with KLP publishing exclusion documents to show how it assesses the risks in a company.
“It is designed to build global attention around ‘high risk industries’ and the ‘worst offenders’ as well as put new issues in centre stage. For us, it is important to draw a line between what is acceptable and what is not.”
KLP has three categories of exclusions: a behaviour-based, a product-based and a due diligence-based exclusion.
The behaviour-based exclusion criteria are companies that are associated with gross and/or systematic violations of generally accepted standards of business conduct such as human rights violations or environmental damage. The product-based exclusion criteria, are certain sectors that are excluded such as coal, oil sands, alcohol, non-medical cannabis, gambling services or pornography. Lastly, the due diligence-based exclusions are to enhance due diligence assessments in the investments and where KLP can exclude based on a combination of country, sector and company risk.
Aziz notes that its main tool to influence the company towards responsible behaviour is through dialogue, but if this isn’t sufficient, it will escalate to exclusion.
Like ABP, it can time its exclusions to influence the market.
“We aim to make divestments as effective as possible so timing can be one important factor to put pressure on the company so they can change their practices,” Aziz says.
“The purpose is to put the pressure on a stage so other investors can take similar actions or media coverage of the exclusions can put some additional pressure on the companies, similar to when we divested early on from Adani Green Energy earlier this year after the report by Hindenburg Research.”
Adani came under investor pressure of February this year after US short seller Hindenburg Research accused it of improper use of offshore tax havens and stock manipulation.
Divestment data gap
For an asset manager like AllianceBernstein there is the extra complexity of managing the divestment wishes of clients. Jodie Tapscott, Director of Responsible Investing Strategy, says it applies exclusionary screens in a variety of ways, depending on the investment strategy’s objective or whether the screening is client-driven or determined by country or regional regulation.
For some of its exclusions, such as controversial weapons in some products, it engages with ISS-Ethix to provide it with data. But in other areas it struggles with a lack of reliable information such as monitoring companies for UN Global Compact breaches.
“Instead of relying on third-party data in this regard, we believe that the risk of breaching international norms is best understood and addressed through ongoing in-depth fundamental research, which enables us to fully analyse a wide range of information and properly assess the risk at an issuer specific level,” Tapscott says.
On the top of this, AllianceBernstein has a Controversial Investments Advisory Council that oversees divestment decisions.
But Tapscott is also keen to stress that shareholder engagement is AllianceBernstein’s primary tool for influencing companies. While divestment is always possible, she says, it is rarely used by the asset manager, and only as a last resort.
In some cases, divestment isn’t always the final word from a shareholder. KLP’s Aziz’s says it will continue dialogue with the company to push them in the right direction so they can be re-included.