A Missed Opportunity
The Financial Conduct Authority’s decision to halt the development of an effectiveness metric undermines systemic stewardship, says Gustave Loriot-Boserup, Founder of Compass Insights.
In an update published on 5 September, the UK’s Financial Conduct Authority (FCA) said it will “discontinue” the development of a metric measuring stewardship effectiveness, highlighting the complexity of isolating the effect of engagement activities on companies’ sustainability strategies.
The concept of assessing what effective stewardship should look like was first introduced by the FCA in 2019 in a joint effort with the Financial Reporting Council (FRC), setting the groundwork which helped define what the minimum expectations should be for financial services firms investing on behalf of clients and beneficiaries. Following this work, the UK Stewardship Code 2020, which we still use today, was published.
Back in 2019, stewardship was often seen as an elusive concept. Yes, we all understood that ‘good stewardship’, and the active oversight of assets in which our managers invest, could help mitigate downside risk and possibly enhance the quality and integrity of those investments, which in turn would also contribute to well-functioning capital markets. But this understanding lacked focus. It was largely driven by formalities, and for many investment managers was probably viewed as just another box-ticking exercise.
False dawn
Things started to change in 2021.
By the end of that year, over 370 organisations had signed up to the Institutional Investors Group on Climate Change, including both asset owners and asset managers, representing around US$40 trillion in assets under management.
Many also signed up to the Net Zero Investment Managers Initiative and the Net Zero Asset Owner Alliance. Many investment managers and asset owners – which at that time committed to net zero – didn’t fully appreciate how they were going to meet their objectives. As a result, most organisations pointed to ‘stewardship’ as the primary mechanism through which they would pursue their net zero goals.
In fact, over the course of the past few years, many institutional investors have probably faced several conversations with their investment managers during which they’ve challenged them on this exact issue.
Q – You’ve signed up to the Net Zero Asset Managers initiative. Can you explain how you plan on meeting those objectives?
A – Stewardship.
Q – You have recently increased your exposure to several oil and gas companies. How does that align with your climate policy?
A – Stewardship. We pursue a strategy of engagement rather than divestment.
Q – We observe that you’ve also voted against shareholder resolutions supporting Paris-aligned climate transition plans.
A – These resolutions are overly prescriptive. Stewardship and continued dialogue are our preferred approach.
Q – Can you please explain how you plan on staying accountable for your new year’s resolution?
A – Stewardship. Oh, sorry what’s the question again?
Investors have a duty of care to hold their investment managers accountable. Stewardship was of course already recognised as a critical lever for achieving net zero and other sustainability objectives.
Unfortunately, in many cases, it was used as an evasive answer, which often lacked substance and demonstrated outcomes.
Rise and fall
Fast forward to September 2021. The FCA publishes a discussion paper on Sustainability Disclosure Requirements (SDR) and investment labels, introducing a tiered product classification for sustainable investment products which includes the ‘Sustainable Transitioning’ category, designed to shift the alignment of underlying holdings to be consistent with net zero and improved sustainability criteria over time, supported by active and targeted investor stewardship. This introduction was hailed as a significant positive development by practitioners at the time, as it addressed the gaps and issues present in the EU Sustainable Finance Disclosure Regulation framework.
The consultation paper, published in October 2022, later introduced some concepts to support the assessment of the effectiveness of the stewardship approach pursued, specifying that investors must establish credible, rigorous, and evidence-based KPIs focused on outcomes achieved and matters escalated. The product label was updated from ‘Sustainable Transitioning’ to ‘Sustainable Improvers’. Any funds falling in that category were also expected to monitor and disclose the impact of their stewardship on the profile of fund assets.
Unfortunately, the final SDR policy statement, published in November 2023, completely discarded references to metrics demonstrating stewardship effectiveness. Over the course of that year, stakeholders expressed concerns that it was challenging to demonstrate a causal link between their stewardship activities and improvements in an asset’s performance.
This decision by the FCA one year ago had already hinted that the investment industry was not prepared to provide evidence on the effectiveness of their engagement efforts. Therefore, the FCA’s recent announcement a couple of weeks ago should perhaps not come as a surprise. It should however come as a disappointment.
‘Sustainable Improvers’ funds, powered by effective stewardship, have a clear potential to reorient capital flows towards investment managers that prioritise long-term value creation, actively engage with companies on sustainability issues, and as a result demonstrate real-world measurable progress towards environmental and social objectives.
The bigger picture
Institutional investors will now find themselves in a difficult position. Many have self-declared net zero targets and expect their fund managers to drive their voting and engagement activity in line with those objectives. Unfortunately, as this voting season suggests, many managers continue to support Shell, Exxon, and other oil and gas companies, citing prescriptive shareholder resolutions as justification. The backlash against ESG in the US has also prompted several managers to leave the Net Zero Asset Managers Initiative and Climate Action 100+.
Maybe the FCA missed the point when concluding that isolating the effect of engagement activities would be “challenging” and choosing to discard any measure of stewardship effectiveness because of this. The focus should not be on assessing the effectiveness of individual stewardship approaches, but rather on evaluating whether it aligns with the product and the firm’s broader responsible investment objectives.
From an investor’s perspective, the emphasis should be on implementing systematic stewardship and the overall improvement journey, rather than identifying individual contributions to sustainability outcomes. Further, any metric that attempts to quantify individual stewardship contributions overlooks the vital role and value of collaborative stewardship activities.
While no single metric can ever fully capture stewardship impact, it has now become clear that investors asking a few questions to managers once or twice a year is no longer sufficient. In order to implement systematic stewardship, investors must pinpoint who they need to target, understand how they currently engage, and establish escalation measures when companies do not meet expectations. Failure to do so will result in continued exposure to systemic risks.
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