A new paradigm
The recent adoption of the EU Sustainable Finance Disclosure Regulation (SFDR) and the upcoming implementation of the EU taxonomy place stewardship at the heart of sustainable investing. Last March, most investors had to (re)publish their engagement and voting policies to integrate ESG considerations. These reporting requirements had already been in force in France since 2019 with the Pacte law and in Europe via the Shareholder Rights Directive II.
In its bid to curb greenwashing practices through its new regulatory framework, the EU is addressing demands from market participants, especially non-governmental organizations (NGOs), for greater consistency between funds’ ESG claims and their engagement practices, into a legal requirement. Now, funds that fall under Articles 8 and 9 according to the SFDR must integrate their ESG engagement policy into their investment strategy. The consistency between ESG claims, the investment strategy and the stewardship approach (engagement and voting choices) should demonstrate the legitimacy of the responsible investment ambitions to regulators and institutional clients. Furthermore, one would expect this reporting on funds’ ESG engagement activities to be scrutinized by NGOs to ‘name and shame’ managers with inconsistent practices. Thanks to SFDR, the focus on investment management continues to increase.
Novethic’s recent report: Engagement Actionnarial: The responsible investors face the dilemmas of AG 20201shows that when it comes to ESG issues, there is sometimes a gap between investment management and voting decisions. This divide was clearly visible to some North American investors who did not support climate and diversity-related resolutions during the last proxy voting season. With SFDR requirements acting as an additional driver for deploying engagement in support of ESG strategy, scrutiny of investor practices will increase, increasing reputational risks for investors who fail to take a holistic and aligned approach from ESG integration to engagement and voting. Some of the unprecedented ESG voting results in the 2021 proxy voting season have been encouraging thus far, and we hope to see greater investor engagement and alignment over time.
Evolution of investment styles and instruments
From a market perspective, engagement and voting on governance issues have long been used as leverage for influence. On the other hand, environmental and social issues have historically been approached from a values-based perspective (for example, meeting international global norms and standards) or mainly for fact-finding. Today, many responsible investors use corporate dialogue as a tool to influence and achieve meaningful change and impact, for example through global initiatives such as Climate Action 100+. When entering into such a dialogue, it is important that the investor defines short-, medium- and long-term engagement objectives and a process for monitoring progress, regardless of the means to conduct this dialogue (individually, collectively or through a service provider such as Sustainalytics), where each company-specific ESG characteristic is recognized to identify the ‘most impactful’ changes. For example, encouraging an industrial company to stop lobbying against stricter environmental regulations could be a step before defining a transition strategy to a less polluting activity.
The rise of passive investing
Among recent market trends, we have identified the growth of ETFs and passive investors’ interest in engagement. For such investments, dialogue and voting are concrete levers to support the transition to a fairer and lower-carbon economy. Because the choice of issuers is closely tied to the composition of the replicated index, there are limits to the active ownership options for the ETF or passive portfolio managers. Because the issuer is unlikely to exit the index, the investor is therefore exposed to potentially controversial investments for the long term. However, the passive investor can encourage the company to make changes on specific ESG topics through a long-term dialogue. Alternatively, voting may sanction a lack of progress in this area or the issuer’s failure to respond to the dialogue. We believe that recent European regulations will also encourage new stewardship practices for passive investors.
Available stewardship solutions
With more than 25 years of experience in ESG research and ratings, Sustainalytics supports investors in implementing holistic approaches to investment management, including standards-based, materiality-based or thematic engagements and ESG voting recommendations. With access to the firm’s extensive ESG research, which supports the stewardship process led by our Engagement Managers, we help investors create authentic alignment between investment management, engagement and voting. Many investors partner with Sustainalytics to complement their internal efforts or involvement in joint global initiatives such as the FAIRR (Farm Animal Investment Risk & Return) initiative.
For example, from a regulatory perspective, investors are using our engagement activities to address key negative impacts. For example, our engagement theme on The management of tomorrow focuses on gender diversity at board level. Sustainability analysis Thematic involvement programme, which covers a range of different exposures and opportunities to systemically important ESG risks, can also support investors’ need to develop expertise and sector expectations, which can help ensure regulatory compliance. For example, developing impact reporting on biodiversity to comply with Article 29 of the new French Energy and Climate Law (replacing Article 173 of the Energy Transition Law).
Outsourcing active share ownership or complementing it with an existing strategy offers many advantages. It enables investors to increase their impact through the number of companies involved and the results achieved through a robust engagement process, facilitated by dedicated ESG dialogue experts. Sustainalytics’ customers can access engagement results, case studies and regular reports through our customer platform to increase investors’ ability to address emerging regulations, including the SFDR and the EU Taxonomy.
 The Novethic report was published in July 2020, it looks at global ESG results and can be downloaded only in French via the following link: https://www.novethic.fr/fileadmin//user_upload/tx_ausynovethicetudes/pdf_complets/ Novethic_Engagement_actionnnarial_Juillet_2020.pdf#_ga =2,95518360,525523156,1630315890-937489899,1630315890