Dakota Access Pipeline: CalPERS on how DAPL has highlighted ‘junk equity’ and sustainability in bank finance (Part 2)

The second part of our look at CalPERS’ engagement on the controversial project

“This pipeline has been rerouted many times already, in the long, thousand-mile passage over private land. It just seems a very cruel irony, and a disappointment to the people who live there, that in the last several miles another detour couldn’t be made,” said Anne Simpson, CalPERS’ head of sustainable investment in an interview with RI.
Last month, at a CalPERS Investment Committee meeting, Simpson and others were directed to explore engagement options around the Dakota Access Pipeline (DAPL) controversy. Engagement options were not a simple matter in this case, however. “The whole situation poses an obvious dilemma as regards an engagement strategy, it means that we have to engage via the banks financing these partnerships and this should be encouraged,” said Simpson.
CalPERS is invested in both the debt and equity of Energy Transfer Partners (ETP) and Sunoco Logistics Partners, the two publicly-traded master limited partnerships (which are merging) that are building DAPL. Their MLP structure means investors don’t have voting rights. This does not prevent engagement, however. There have also been many calls for the fund to divest from ETP, but ETP is in an index and CalPERS, along with thousands of other investors, is invested in that index.
In the long-term, CalPERS would like to see MLPs excluded from indices. “MLPs are popping up like mushrooms in the pipeline industry, which in turn is being stimulated by the boom in shale oil. Pipeline building is going on at a hectic pace. There have been environmental protests against the pipelines, but I think these are misplaced.
“The issue is not simply about how you move oil around, it’s a bigger question about energy strategy, and we need to have the bigger conversation about the transition to low carbon.
“However,” she continued, “in this particular instance, we are faced with a company, ETP, that has a complex web of owners and that was set up as a master limited partnership. Pension funds buy this because it’s in their index. Now, we’re in the middle of a bigger push with the index constructors to change the way that indexes are constructed because we’re finding too many instances of ‘junk equity’.
“In other words, investors are providing equity capital, but not getting equity rights. You can’t just call something equity if there’s no equitable representation. This is not just an issue for Silicon Valley,” said Simpson, referring to the recent SnapChat IPO with its non-voting shares. “What we and others at the CII [Council of Institutional Investors] are arguing is that to be included in an index you should reflect the common features of common stock. That means equal voting rights attached to equity.”
Simpson favours simply excluding all such stocks, saying: “If you have deviations from normal practice, then that should be a disqualifying factor. This would mean that a company with non-voting shares would just not get that flood of unquestioning money, which flows through passive strategies attached to an index. Allowing non-voting shares into an equity index skews accountability. If investors want to buy companies with skewed or zero voting rights, that should be taken as an active bet, for which they have assessed the risk.”
We moved on to the Investor Statement that CalPERS and many others have signed. “Building on the good work of Boston Common, Calvert and others, we joined, and encouraged others to support, an Investor Statement to the banks financing DAPL,” said Simpson, “calling upon them to support the Sioux Tribe. Several [of the banks] said that they were unable to respond because the loan covenants did not allow them to intervene at this late stage in response to the Sioux Tribe’s concerns.”At the time of our interview, the statement had been supported by 130 global investors, representing c.$1.2trn in assets under management. There are now new signatories like Aviva, Hermes and other US pension funds like New York City and Oregon.
Steve Heim at Boston Common, which is coordinating the campaign, is keeping track of the signatory base, which is now up to 150. It’s being stressed that new signatories are still welcome.
Simpson noted that ING has announced it’s selling its investment in DAPL and that the banks have commissioned a review of their decisions under the Equator Principles by Foley Hoag.

In addition, banks have begun responding to the statement. Citi wrote to Heim saying that the project was reviewed under its Environmental and Social Risk Management (ESRM) Policy and the Equator Principles and “rated a Category A for high environmental and social risk”. However, steps taken by ETP allowed it to pass the policy review. In addition, Citi has hired Monkey Forest Consulting, the social performance management firm, to advise.
What other engagement actions have been taken by the signatories? “All the lead investors involved have had a range of face-to-face meetings,” said Simpson, “we’ve held an investor meeting with the leaders of the Sioux tribe that included many of the lead signatories, as well some of the banks who are invested. Other leads have had further written correspondence and/or phone conversations, so it’s been rippling out.”
CalPERS co-hosted an investor briefing with leaders of the Standing Rock Sioux tribe during the recent CII and ICGN conferences.
“The long-term issue is how sustainability is factored into bank finance, particularly at major projects like DAPL,” said Simpson, adding that 13 out of the 17 banks involved are signatories to the Equator Principles.
“So, for banks that have signed up to the Equator Principles, there are two very important elements: the requirement for an environmental impact assessment ahead of a project where there is a high risk; and there is a requirement for ‘free, prior and informed consent’ in line with UN human rights requirements relating to the treatment of indigenous peoples.”
“There are several issues raised for the banks financing DAPL,” continued Simpson. “The first is that it has opened up the vital question about how the rights of indigenous people in the US are being respected and protected. The United Nations Special Rapporteur on the rights of indigenous peoples has said that the US’s record on this is appalling.

“So, that’s an issue that has now been put solidly on the agenda for the sustainable investment community. The second issue is that it’s also put a spotlight on the structure of limited partnerships. If you want to invest in this ‘junk equity’ with no voting rights, then there are only two things you can do when trouble arises: you can sell or sue.

“However, it is not just the lack of voting rights which needs to be considered a governance risk. MLPs are allowed under Delaware Law to vary standard provisions of fiduciary duty to investors. And finally, it has also highlighted how we should be thinking about the flows of credit.

“This is an opportunity to galvanise the banking community around an important commitment that has been made to integrate environmental and social principles into the loan covenant and the lending process and to think how this has an influence on the commitments that have already been made.”
In addition, Simpson says the protests have highlighted the need for multi-stakeholder dialogue.
She said the “primary concern” of indigenous people’s rights was almost eclipsed by environmentalists’ protests and intimidation of pipeline workers.

“The ‘peaceful and prayerful’ protest called for by the Sioux leaders descended into an anarchic and very alarming situation. This potent mix became politically highly charged as the US Army Corps responded to a conflicting series of Executive Orders from the White House, following the election.”
And then there’s divestment, an issue that was top-of-mind at the recent CalPERS investment committee meeting.
It’s something that the fund’s members have called for, even the California legislature is asking for it.

So, how bad does a company have to be before you sell, I asked? “As far as calls for divestment are concerned, I think stakeholders rightly come to us when they have a concern over an issue that’s related to one of the companies or entities that we own; we welcome that. Stakeholders are our moral artery into wider society.”“That would mean selling shares worth about $6.5 billion, but that would also mean that we passed up on an opportunity to work with the banks on an agenda that could be more strategic” in terms of the Equator Principles and loan covenants. “Investors in banks to date have not paid much attention to this important issue.”
“However, ‘prior, free and informed consent’ should have been written into the loan covenants, as required under the Equator Principles. The Equator Principles have a huge reputation globally, it would be enormous progress to see them being implemented.

“We’ve got a choice between divestment or rolling your sleeves up in a dirty situation and weighing in and making progress on really important issues. I think that’s always the heart of the dilemma at CalPERS and one that our Board weighs with great care.”