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On October 12, DPAM hosted its 6th Sustainable Seminar. The first panel of experts discussed and delivered their insights on the role of engagement and voting policy by investment managers towards corporates. The second panel discussed engagement towards sovereign bond issuers or debt management offices. At stake is a proper strategic alignment of ambitions and (investment) projects that can tackle urgent climate and societal issues.
The conclusion was obvious yet merits a lot more attention: active engagement and voting are essential components required to achieve societal objectives across ESG challenges. ESG integration without active engagement and voting lacks credibility. Moreover, investment managers are bound, over time, to measure and generate impact across meaningful and measurable sustainable development goals. That requires a reorientation of the debate away from simplified exclusion frameworks towards active ownership engagement with clear escalation paths. First, we reveal corporate engagement success factors. Second, we summarise challenges encountered in sovereign engagement.
Investment managers should direct efforts towards active ownership engagement and apply the divestment option with care. Whilst exclusion is a clear and direct outcome within ESG screening methodologies, blacklists might not help the required acceleration towards environmental and societal objectives. The very existence of indexed, passive equity, corporate bond or aggregate investment solutions guarantees public funding to companies. Divestment decisions of active managers still leave plenty of funding options through captive investments by owners of passive solutions or bank balance sheets. Fair enough, at best, voting power attached to shares in passive instruments can be geared towards change, as they can provide support to shareholder resolutions. Yet, most of the time, it requires active ownership and collaborative engagement (via initiatives like Climate 100+, UN PRI on human rights or with peers) to influence and alter board decisions for the better. For instance, and shareholder resolutions can impact Articles of Associations when pushing for improved governance, lead to adherence to the Scientific Based Target Initiative (SBTi) that pushes companies to set environmental targets by steering capital investments or raising awareness on litigation risks.
Engagement starts with continuous dialogue by analysts and fund managers with management teams and investor relation officers. Questioning executives on their ESG ambitions and their choice of metrics and targets sets the tone. The moment formal individual or collaborative engagement processes are launched, with well-defined calls for action towards boards of directors, specific shareholder resolutions can take shape. Open communication on these actions informs other shareholders but also companies active in the same sector. Activist engagement can direct sector psychology towards an intended behavioural change followed by an effective change in strategy. Successful engagement processes take time, require time. Progress comes in a ‘step and click’ fashion. Shareholder resolution adoption rates might start at a disappointingly low % level but can grow over the years. Moreover, engagement relates also to the willingness of shareholders working behind the scenes and goes well beyond the months around the proxy voting season.
The engagement versus divestment debate deserves more attention. Of course, the threat of being blacklisted versus the eagerness to belong to (best-in-class) whitelists become determinants in the formation of risk premia. Blacklisted or companies becoming victim of divestment behaviour will incur higher funding costs, a higher weighted average cost of capital and fall victim to a higher volatility profile from which investors shy away. Regulators focus on the importance of exclusions but should advocate the necessity of engagement with a similar zeal. Engagement and exclusion should reinforce each other. That is why divesting in credit whilst engaging through equity holdings or vice versa might be overcomplicating methodologies and sending mixed signals to respective boards and management teams.
Engagement within sovereigns is often perceived as political interference defined as lobbying and advocacy. However, an active engagement policy towards government institutions in general and debt management offices in particular can encourage governments to support the greening of finance. Engagement with institutions in order to improve the quality of data gathering and promote transparency in domains such as education, healthcare, social security…are part of proper due diligence work towards government policy. Engagement is not about criticising governments rather it is asking the right questions that make the distinction between pledges and real actions. Climate targets and pledges over various conferences, should be discussed over credible and budgeted plans to achieve those.
The human impact of climate change is high and broadening in intensity and frequency. Governments that lead the transition by adopting economic policies geared towards decarbonisation and lower dependency on fossil fuel energy sources, will benefit from lower funding costs and easy refinancing. Debt management offices will have to expand their ability to issue green and social bonds whilst administrations will allow for proper structures that can monitor and control public investments. It will be important for instance to promote urban sustainable city projects that unlock prosperity and a higher quality of life for all. Again, as it is key to engage with corporates seeking capex alignment with net zero ambitions and targets, a similar capex alignment in the public investment space is required.
Tackling climate change will be a main driver to obtain peace and security as well as better control over purchasing power. Behavioural change is not enough, and governments should track a credible policy (investment) path through sovereign funding on top of their participation in blended finance projects. The collaboration between public and private funding sources will accelerate the transition. As politicians come and go, sovereign engagement has to raise government accountability. Making use of a climate log that can track emission reduction targets versus remaining carbon budgets should become mainstream. Sovereigns should be put to the test even as government coalitions change. Sustainable investment managers will have to engage with the same intensity towards governments as they do towards corporates.
Effectively, engagement and active ownership are essential foundations upon which functional and effective ESG methodologies are built. Avoiding greenwashing risks requires strong, dynamic engagement and voting frameworks to support and enable transitioning companies and countries.
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