Charlotta Dawidowski Sydstrand, Head of ESG at AP7, explains how universal owners can exert collaborative pressure to drive sustainable outcomes in the global economy.
Swedish government pension fund AP7 is a universal owner that manages around SEK1 trillion (US$968 billion) in AuM, with 90% of its assets invested in a diversified equities portfolio across more than 3,000 companies. In its annual sustainability report, it details how its universal owner status means its stewardship framework must manage risks related to climate change, biodiversity loss, and human rights.
Charlotta Dawidowski Sydstrand, Head of ESG at AP7, stresses the importance of using its “privilege” as a universal owner to encourage investee companies to develop sustainable strategies to ensure their profitability over the long term.
“Our mission is to generate long-term returns for our five million pension savers,” Sydstrand tells ESG Investor. “To do this, the global economy must function properly and be developed sustainably – therefore we must focus on systemic risks.”
AP7 has focused on identifying systemic risks to its entire portfolio and undertaking effective action to influence established processes and practices in its engagement with investee firms. This, says Sydstrand, creates a “ripple effect” in the global economy.
Sydstrand also stresses that collaboration with other investors is key in driving sustainable outcomes via its engagements as it allows for the pooling of resources and sector-specific expertise.
“We are a universal owner, so were not overly sentimental about any of the companies we own. We are aware that in 40 years’ time our portfolio will consist of totally different companies, with some no longer relevant in a low-carbon economy,” she says.
“Pooling together with other investors who might have a more concentrated portfolio and a deeper, local knowledge of every company in that portfolio is often complemented by a universal owner possessing more assertive active ownership methods.”
In March, the Principles for Responsible Investments (PRI) released its implementation guidance for policymakers with recommendations for creating an “enabling environment” for stewardship activity.
Sydstrand welcomes the new guidance, citing the challenges of collaborating with US-based investors due to their fears of being sued for violation of antitrust laws amid the backdrop of rising anti-ESG rhetoric on the other side of the Atlantic.
“Asset managers in the US are more careful in how they communicate and collaborate on ESG-related issues,” she says. “The anti-ESG movement in the US is really worrying, I hope it does not spread to European shores.”
While AP7 acknowledges it must take a systemic view of stewardship to address climate and nature-related risks, modelling the impact of ever-evolving and overlapping issues that impact corporate profits and the wider economy is a near impossible task.
“Once you realise you are a universal owner, you also realise how difficult it is to specifically model that impact in basis points return to your fund,” Maria Nazarova-Doyle, Head of Pension Investments and Responsible Investment at Scottish Widows, told ESG Investor recently. “A lot of pension funds are stuck, saying we know it’s really important, but I can’t easily put numbers on the page to prove it.”
From a portfolio returns perspective, Sydstrand accepts the inherent challenges. But notes that from a stewardship perspective AP7 attempts to mitigate risks via active engagement with investee firms.
“We are constantly thinking about how to mitigate climate risks in the real economy, and that won’t happen through tilting our portfolio or shifting our shares in different companies or selling shares on a secondary market, but by working with the companies to develop norms and standards that they can adhere to,” she says.
She cites the Global Standard on Corporate Climate Lobbying, a project instigated by AP7, BNP Paribas Asset Management and the Church of England Pensions Board, which was launched last year as an example of the development of new norms and standards to drive change. The standard aims to solidify investors’ and companies’ commitment to responsible climate lobbying and the impact of their advocacy to ensure alignment with the goals of the Paris Agreement.
“Companies have a huge impact on the climate through their greenhouse gas (GHG) emissions, but they also have a major impact over climate policy,” she says. “In order to manage the pensions of our savers sustainably over the next 50 years, we need a strong, robust climate policy response and companies have a lot of influence over policymakers.”
Collective engagement has served to raise awareness among companies about how their lobbying activity risks “hindering, watering down or delaying” necessary climate policy, according to Sydstrand.
Lessons from climate action
AP7 is also a member of both the Task Force on Climate-related Financial Disclosures (TNFD) and the Task Force for Nature-related Financial Disclosures (TNFD), with the latter framework set to be finalised in September.
The TNFD was established to develop and deliver a risk management and disclosure framework for organisations to report and act on evolving nature-related risks and opportunities, with the objective of supporting a shift in global financial flows towards nature-positive outcomes.
“Nature is the next big systemic risk– companies need to get on board with the framework and map the influence of their operations on global ecosystems,” she says.
“Nature-related engagement and stewardship has a lot to learn from ongoing climate action,” she says, noting that investor network Climate Action 100+ (CA100+) has been criticised for not being effective enough in getting companies to form comprehensive net zero plans vital in curbing their carbon emissions.
Sydstrand is quick to point out that prior to CA100+ there was no infrastructure to enable investors to collaboratively engage with investee firms to mitigate climate-related risks, with the initiative laying strong foundations for nature-related discussions and the formation of Nature Action 100.
The new initiative seeks to engage with companies in key sectors that are deemed to be systemically important in reversing nature and biodiversity loss by 2030. Its secretariat and Corporate Engagement Working Group is co-led by Ceres and the Institutional Investors Group on Climate Change (IIGCC), and the initiative’s Technical Advisory Group is co-led by the Finance for Biodiversity Foundation and Planet Tracker.
As a universal owner AP7 is “not afraid to go beyond polite dialogues”, says Sydstrand, with the pension fund willing to use “assertive tools” in its engagements with investee firms if its investment criteria are not fulfilled.
AP7 has conducted collective, escalated engagement, up to and including litigation with a number of companies. In October last year, the pension fund, alongside Danish AkademikerPension and the Church of England Pensions Board, took legal action against German carmaker Volkswagen after it refused repeated attempts to disclose information on its corporate climate lobbying.
“We have a lot of different tools in our toolbox to use in order to create real world effects,” says Sydstrand. “We are not afraid to be quite assertive towards companies – we see that as our role in the market.”
This no-nonsense approach to engagement is not limited to environmental risks. In January 2019, AP7 sued Alphabet, the parent company of Google, based on information regarding sexual harassment within the company.
“[Alphabet] had covered up a systematic pattern of sexual harassment and paid generous separation payments to executive managers involved in these activities which led to large-scale protests and walkouts,” she says.
“On that basis, the company were in breach of their fiduciary duty to their investors, wasting corporate assets, mismanaging their employees and ultimately eroding shareholder value.”
After a settlement, Alphabet has undergone extensive governance reforms and set aside US$310 million to invest in programmes aimed at improving diversity and inclusion within the group.
In December last year, AP7 updated its ‘blacklist’ which identifies companies in breach of international conventions signed by Sweden. These are expressed in the UN Global Compact’s ten principles on human rights, labour, the environment and anti-corruption.
“Companies acting in breach of one of these norms will be publicly blacklisted and divested from our portfolio,” she says. “We have a clear dialogue with a company before they are blacklisted but will continue to engage because we want to be able to invest in them again.”
AP7 is a member of the Paris Aligned Asset Owners Initiative, a global group of 56 asset owners with over US$3.3 trillion in AuM that have committed to transitioning their investment to achieve net zero portfolio GHG emissions by 2050 and drawing on the Net Zero Investment Framework to deliver on that commitment.
The road to net zero is inextricably linked to the phasing out of fossil fuels, with some investors prioritising engagement with oil and gas companies to transition to renewables, while others, such as the Dutch pension fund ABP, opting for a strategy of divestment in the sector to accelerate the energy transition.
For Sydstrand, the energy transition is too complex and multifaceted to simply divest its holdings in the oil and gas sector, but acknowledges that a fundamental question remains: What do we do with these assets that are likely to become stranded?
AP7 remains committed to its role as a responsible owner.
“We need to be there,” she says. “We need sustainable investors to stay with these companies. Going forward, I think the power of collaborative engagement will become clearer and enable sustainable investors to drive real change, rather than leaving these companies in the hands of investors that lack climate ambitions.”
According to Sydstrand, AP7 plans to launch a new transition portfolio in collaboration with its external asset managers in 2H 2023 that will combine active ownership with active investment to find “synergies between returns and transition”.
Over the past 12 months, the Swedish pension fund has also tightened its requirements on fossil fuel companies and has blacklisted coal companies that cannot demonstrate credible transition plans, as well as oil and gas companies that do not plan to wind down their oil sands operations.
AP7 also continues to toughen its voting policy and is prepared to vote against board members at companies with large GHG emissions and fail to effectively manage their climate risks.
“This year, we will focus more on high emitting companies’ short- and medium-term emissions targets and if they fail to align with the Paris Agreement, and we consider them climate laggards, we will file resolutions and vote against directors this upcoming AGM season,” she says.