Effective Corporate Persuasion
To be successful, engagement must be a two-way street, says Gillian Secrett, Research Director at the Cambridge Institute for Sustainability Leadership.
Direct engagement with investee companies has emerged as the preferred way for institutional investors to influence corporate decision making. Exerting influence means being useful to companies and their boards, rather than confrontational.
According to research recently published by the Cambridge Institute for Sustainability Leadership (CISL) and global law firm DLA Piper, the world’s largest asset management companies increased their ESG-specific engagement by 39% between 2020 and 2023, driven in no small part by the sustainability objectives of their asset owner clients.
ESG engagements peaked in 2022 before declining by 20.3% in 2023, which the report says is likely due to the backlash in the US.
More broadly, annual private engagements reported by asset managers have increased by approximately 36%, from approximately 50,000 engagements in 2020 to around 68,000 in 2023.
The CISL report acknowledges that there is “no universal definition of what constitutes an engagement”. It says that the research was conducted by analysing the annual stewardship reports of 40 of the world’s largest asset managers from the US, Europe, Asia, Africa and Australia.
“Whereas voting [at AGMs] focuses on specific areas, private engagement focuses on building a much deeper and comprehensive relationship between asset managers and investee companies,” said Gillian Secrett, Director of Leadership and Culture and Future of Boards Research Director at CISL.
“Private engagement allows asset managers and board directors to work together so that they can align their targets and ambitions. The voting route, on the other hand, feels more controversial and provocative.”
This is not to say that casting votes at company meetings doesn’t have some value. Secrett said that it is helpful in “raising awareness and making a statement” about certain issues. However, according to the report’s findings, only 6% of environmental and social proposals are successful, suggesting that shareholder voting has only limited influence in the pivot towards sustainable investment.
But the volume of engagements makes it hard to be heard above the noise. To be successful in their overtures, investors have to make sure that they work out where the value lies – both for the future of the planet, and for the future of the company.
Beyond compliance
While the CISL report doesn’t specifically indicate the extent to which investors are embracing direct engagement, it does give some clues about where such dialogue is most impactful.
“Investors need to make sure that companies know what their sustainability focus is and how they see sustainable value creation, with a clear expectation communicated to the asset manager,” said Secrett.
She added that the asset manager needs to build a relationship with the board, focusing on “key material topics” that deliver long-term value creation rather than becoming weighed down by short-term goals.
“During our research we noticed that many asset managers are stress-testing their cashflows and their portfolios under various scenarios, and we felt strongly that this is important,” said Secrett.
For instance, asset managers should be looking at the cost of carbon in their portfolios, so that they can see what is going to happen to the companies they invest in, and where both risks and opportunities lie, said Secrett.
“This is about making sure that funds are invested wisely, being mindful of the risks down the line and that these are dealt with in a strategic way, rather than parachuting in on specific issues,” said Secrett. “Some of the asset managers we looked at are really focused on this and doing extremely well, but it’s difficult to say whether everyone is.”
Being useful
The world’s largest companies are increasingly recognising the risks and opportunities presented by climate changes, according to several studies.
Out of more than 500 chief financial officers surveyed by global consultancy Kearney, 92% say they will increase their current investments in sustainability, with more than half saying they will “significantly increase” them.
A separate study by another consultancy, Bain & Company, showed that 30% of companies disclosing their progress via the CDP platform were behind on their Scope 1 and 2 emissions reduction goals.
Moving from box-ticking to sustainable value creation requires focusing greater effort on the use of data and wider information needed for strategic decision making, said Secrett. Asset managers need to support companies in reaching this goal.
“Those boards who want to move beyond compliance and take advantage of the sustainable-investment opportunity are asking important questions about what information they need to shape their business, where they can get this information and how they can make sure it is verified,” said Secrett.
Of course, having that information on its own is not enough to drive a firm’s sustainability efforts. Such data also needs to be actionable, meaning that it must be integrated into a firm’s core strategic planning.
“It was generally found to be better when full boards were engaged with the process rather than having the sustainability focus managed by separate committees,” said Secrett. “Sometimes they had developed governance and ownership structures that would help with this.”
Direct engagement with asset managers can help move things in the right direction.
“Our research showed that collaboration across the supply chain helps firms get hold of the data that they need. Such information is also important for scenario planning and ‘blue sky thinking’,” said Secrett, referring to out-of-the-box brainstorming that doesn’t consider whether an idea is realistic or not.
A lot of firms have had to find new ways to gather this data, making sure that there is a dedicated channel, so that it can be properly collated and verified. Secrett said that AI could also help, allowing firms to improve their modelling and to test what the impact of a strategic decision might be before it is executed.
From their point of view, asset managers need to make sure that the companies they invest in are sufficiently on top of their data to know that the strategic decisions they are taking have a meaningful difference.
“Effective engagement hinges on those asset managers having the market intelligence and the influence to use that knowledge in a constructive and helpful way,” said Secrett. “Private engagement is about the quality of board governance, the expansion of corporate disclosures and the operationalisation of sustainability targets,” said Secrett.
Conflicting ambitions
It can be very difficult, however, to reconcile the two often-conflicting goals of staying competitive in the short-term while looking at longer-term risks and opportunities. This applies equally to corporates, investors and policymakers.
“There needs to be the necessary frameworks and incentives in place to make sure that the market aligns with sustainability imperatives,” she said. “The incentives need to be there to support the right kind of behaviour and, if they are not there, this can make companies feel less competitive in the short-term.”
This is why the simplification of the EU’s sustainability rules, as part of the new omnibus package, is so worrying for investors.
“It’s really important that the EU legislation doesn’t get dumbed down and simplified, because the legislation that has already been put in place to tackle these long-term risks and opportunities is really important for market stability across the entire system,” said Secrett.
She added that “there’s some scope for simplification and refining, so that the legislation is easier to apply, but not to remove the benefit of the legislation altogether”.
It’s about finding the right balance and not losing sight of the bigger picture, she said.
Companies and investors need to “work out where their long-term value creation is coming from, and then lobby to make sure markets support this transition,” said Secrett.
This is even more important against the current backdrop, where both the US and the EU seem to be wavering on key pieces of ESG legislation, prompting sustainability-focused investors to fight back.
“There is increased weaponization of ESG factors as a tool for pursuing political and social causes,” said Secrett.
“Boards need to continue to do what’s right for them as a company, but also think about what impact on sustainability their decisions are having: how they invest, how they strategically align themselves, and ultimately how they create their value for their shareholders.”
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