ESG's next challenge: engagement or exclusion?

There is growing accord among global investors that, when it comes to effective ESG investing, it’s good to talk. 

 

The idea is that investors act as active owners and stewards and regularly engage with each other and the companies they invest into. By doing so in a coordinated fashion, the argument goes, they can successfully push these investees to change their behaviour to better meet pressing issues such as climate change or diversity and inclusion.

 

That is easier said than done. While many companies boast of their desire to become more environmentally sound, it can be hard to sort through those with genuine commitments versus those covering inaction with loud claims. 

 

The challenge for asset owners and ESG-focused fund managers is to work out how best to engage with their portfolio firms, in order to persuade them to clean up their acts (often literally). They also need to work out when to start raising the pressure on uncooperative companies, and when it is time to divest. 

 

A rising number of Asian asset owners explicitly state that engagement is part of their ESG agenda. Singapore state fund Temasek is one: “[Our ESG framework] doesn’t mean that we don’t invest in companies that have more of a carbon positive trajectory, but the question is, can we help them change and be better and have a better carbon outcome?” Dilhan Pillay, chief executive of Temasek International, told a media conference in 2019.

 

Similarly, Singapore’s sovereign wealth fund GIC noted in a thought leadership piece on its website that “engagement to improve companies’ sustainability practices and focus them on a transition pathway will ultimately create long-term value.”

 

GIC has made several investments that might appear to misalign with its stated focus on ESG. These include it taking a 19.9% minority stake in Duke Energy in January, which it said was done to help the company accelerate its clean energy transition plan. GIC also acquired a 17.5% stake in Philippines’s AC Energy in March and backed India’s Greenko Energy alongside Abu Dhabi Investment Authority in 2019; both companies have used recent funds from GIC to finance renewable energy projects.

 

ESG BEST PRACTICES

 

For many asset owners and investors, stewardship codes have set the bedrock for their engagement activities. 

 

These codes have become increasingly prevalent in the region. Japan was the first country in Asia to adopt one in 2014, but it has been followed by Malaysia (in 2014), Singapore (2016), South Korea (2016), Taiwan (2016) and Hong Kong (2016). However, each one is a bit different; there is no unified course of action about how often investors should engage, or the best means to do so. 

 

“I don’t necessarily think that there is a right number of meetings that you should have. It depends on the issue that you’re trying to deal with,” said Fiona Reynolds, managing director of the Principles for Responsible Investing (PRI), a United Nations-supported initiative promoting sustainable investment.

 

“Investors can also be overwhelmed by the number of company stocks they hold and the number of issues that that there are,” said Reynolds. 

 

She told AsianInvestor that asset owners need to have defined goals when engaging with investee companies and have a clear escalation process in place for when a company is not being receptive or sufficiently proactive. In addition, she advocates investors focus on ESG issues important to them, suggesting that they select a few to focus on in any given year.

 

Dutch pension fund manager APG considers ESG monitoring and encouragement to be an integral part of its everyday corporate engagement. Its ESG team often sits with portfolio managers on quarterly business update calls with investees and requests that they share progress updates on ESG matters.

 

“We roughly know, per company, what we don’t like and where we see improvement. Once we complete the ESG analysis, we know where the shortcomings and areas of improvement are, then start the engagement,” Park Yoo-Kyung, head of Asia Pacific responsible investing and governance at the €570 billion ($688 billion) pension fund, told AsianInvestor.

 

Building longstanding corporate relationship allows asset owners direct access to relevant senior executives, which eliminates the first barrier to engagement. However, establishing close relationships can be a double-edged sword according to Dan Gocher, director of climate and environment at shareholder advocacy group Australasian Centre for Corporate Responsibility. 

 

“Most investors we speak to will have standing engagements with companies. While that’s good, it creates a sense of inertia; you’re less likely to be critical,” he told AsianInvestor. “We have had investors tell us that they won’t vote for a resolution, or they won’t vote against a director because they don’t want to jeopardise the [corporate] relationship.”

 

OUTSOURCING ENGAGEMENT

 

Many asset owners also face the challenge of capacity constraints. 

 

To effectively engage, they need in-depth knowledge across complicated ESG and climate issues, which often differ by asset class and sector. Added to that, foreign investments often require local country knowledge and language skills. 

 

For this reason, several larger global institutional investors have been building out their ESG teams. In January Abu Dhabi sovereign wealth fund Mubadala named its first head of responsible investing, Derek Rozycki, and assigned him to hire a team. Temasek last year formalised a dedicated ESG investment team to work with portfolio managers on ESG engagements.

 

However, relatively few asset owners can internally establish such resources. Smaller investors may consider outsourcing to external stewardship services providers. One example is EOS, by US fund manager Federated Hermes. 

 

As of April 2020, EOS was engaging with 96 emerging market companies on behalf of 50 institutional clients. Michael Viehs, head of ESG integration at Federated Hermes, says EOS’s level of engagement with each company varies, depending on the type and volume of the engagement objectives, the importance of the issues and the size of its client’s stake.

 

When they do outsource, investors must clearly communicate their objectives and expectations and ensure they understand the manager’s process for engagement and reporting, Reynolds told AsianInvestor. 

 

“Otherwise, your managers could be going in a completely different direction to what you’re expecting.”

 

Another is the potential for greenwashing. Asset owners need to be careful to appoint stewardship service providers that demonstrate how and when they engage, rather than those that claim to do so but don’t follow through.

 

TO DIVEST OR NOT? 

 

There is one step that asset owners can take against the most recalcitrant of investee companies: divestment. 

 

Selling out of a company is the ultimate expression of dissatisfaction. However, there are arguments against it. Critics note that while divesting might cleanse the asset owner’s portfolio (and conscience), it does not remedy the issue at hand. Plus, a less conscientious investor may simply replace the ESG-conscious divestor.

 

“GIC believes it is more constructive to engage and support companies in their transition towards sustainability, rather than adopt a blunt divestment approach,” wrote the sovereign wealth fund’s executives in an article on its insights page.

 

While divestment does not always guarantee results, some experts believe the possibility needs to

exist and be credible. 

“With some companies, the threat of divestment is very helpful; it puts everything into very sharp focus,” said Rebecca Mikula-Wright, executive director of the Asia Investor Group on Climate Change (AIGCC), an initiative to create awareness among asset owners about climate risks.

 

AIGCC is dominated by European institutions, but it includes prominent Asian names like regional life insurer AIA, Korea’s Hanwha Group and the Asian Infrastructure Investment Bank (AIIB). “I think we’re seeing more divestment from investors in Europe because they have been having these conversations for a longer period of time,” said Mikula-Wright.

 

Aviva Investors is also prepared to consider divestment when companies that it targets for change refuse to even acknowledge the issue. 

 

“Sometimes we reach out to companies who come back and say they’re not prepared to engage on this topic, full stop,” said Mirza Baig, global head of ESG corporate research and stewardship at the UK-headquartered asset manager. 

 

On whether this is common, he tells AsianInvestor, “I would be surprised if every investor hasn’t had at least some experience of that.” 

 

Korea Electric Power Company (Kepco) offers an example of investors using the threat of divestment to try to drive change. 

 

In 2020, APG publicly condemned the state utility and warned it would divest its shares if the company did not take more action on reducing carbon emissions. BlackRock, the world’s largest fund manager by assets, later wrote to Kepco’s board and called for greater disclosure of the company’s interests in overseas coal projects. Then other major shareholders such as the Church of England also pledged to do the same unless the firm abandoned plans to invest in coal-fired power plants in Vietnam and Indonesia. 

 

APG ultimately divested from Kepco after the firm went ahead with the acquisitions. In addition, last year it dumped eight investees because of their plans to build or enlarge coal-fired power plants, the company said.

 

Kepco seemed initially oblivious to the upset of APG and others, forging ahead with the planned Vietnam and Indonesia coal projects. However, the pressure appears to have affected it. 

 

Company president Kim Jong-gap said in October 2020 the electricity producer would transition two other pipeline coal projects in the Philippines and South Africa, and stop pursuing overseas coal energy investments.

 

APG is not the only investor becoming pickier over its exposure to carbon-intensive entities. Over 1,300 investors representing $14.1 trillion assets have divested from fossil fuel-linked companies, according to global investor network DivestInvest. 

 

Within these, the Institute for Energy Economics and Financial Analysis has identified over 100 “significant” insurers and banks and development finance institutions that have eliminated or cut their exposure to coal.