The SRI research arm of Novethic, the French ESG ratings and media company, has published a major study on shareholder engagement practices, following a debate it hosted in Paris earlier this month featuring Karina Litvack, Head of Governance and Responsible investment at F&C, the UK fund manager, Geneviève Guénard, CFO at CCFD – Terre Solidaire, and Manuel Domeon, Head of SRI and European Mid Caps management at La Compagnie Financière Edmond de Rothschild. The study defines shareholder engagement as ‘investors taking a stance on ESG issues’ and requiring companies in which they invest to improve practices. These requirements, it says, mostly take the form of structured dialogue with the company and long-term monitoring. However, investors can use more intense pressure tactics if dialogue is ineffective. These might include public disclosure on the progress of engagement, the company’s shortcomings on extra-financial issues, impact on management if investors divest, or the exercise of shareholder rights, i.e. questions in general meetings, voting against proposed resolutions, support or filing external resolutions. Similarly, the report says objectives behind engagement can be manifold. Many institutional investors and asset management firms link it to the preservation of long term company value, which explains why a fund like CalPERS targets underperforming companies for engagement. For some institutional investors such as France’s FRR, engagement is a way to protect its reputation by requiring companies to improve reprehensible behaviours. For other players, mostly NGOs, engagement reflects their core mission: human rightsdefence, environment protection, poverty reduction, etc. But there is increasing overlap between investor and NGO missions. Amnesty International’s campaign against FTSE 100-listed mining group, Vedanta, over indigenous rights in India is a case in point: after slamming Vedanta’s violations of local population rights in India in a detailed report, the NGO then contacted several investors to encourage them to pressure the company and ask questions during its annual general meeting (AGM). Engagement is usually a long-term process, however, and can involve several steps, some private and some public. It usually starts with the identification of engagement themes based on existing SRI analysis or dedicated research; some extra-financial rating agencies even offer specific engagement services. Once the issues are identified, a dialogue is initiated with companies and a follow-up is usually ensured to trace the compliance of the company with the investor’s requests. While some investors are very private on their engagement practices, the report says publishing an engagement policy and a reporting on engagement practices can boost investors’ credibility and objectiveness. Such transparency is both a pledge of clear intentions when initiating the engagement process, and a supporting argument in case of unsuccessful dialogue. The involvement of investors in AGMs, beyond the exercise of voting rights, is also a potential element of engagement. While private dialogue often occurs with company management in charge of the specific issues pointed out by the investors, questions asked in AGMs puts these issues forward for the board of directors and other shareholders. Another way to do so is
to file shareholder resolutions, a deed whose ease of execution varies according to the regulations (simpler but non-binding in the USA, for example). Some investors see the filing of resolutions as a last resort when all other means of engagement have failed, whereas others such as Australia’s Climate Advocacy Fund use it as a way to initiate their engagement process. Finally, some investors end unsuccessful engagements by selling their shares. Such practices are rare, however, partly because of the long horizon of engagement practices. In theory, both investors and companies should benefit from engagement strategies, since the improvement of ESG corporate practices is supposed to improve the company’s Financial, image and relations with its stakeholders. Still, many hurdles remain for the development of engagement approaches, not the least of which is companies’ dissent towards them. Not yet used to being challenged on these issues, especially in France, corporates sometimes see advanced engagement steps as confrontation. Still, the report says, time should allow these practices to settle in the corporate landscape. Faced with reluctant companies, investors need to muster sufficient support for engagement. While this is straightforward for independent asset management firms, some investors exposed to conflicts of interests prefer to stick with private dialogue, even if it proves inefficient; this is sometimes the case for firms that are part of a banking group. In this context, having a detailed and published engagement policy can help investors justify their actions. Other obstacles to engagement are cost and the difficulty of measuring its results. Gathering extra-financial research, ensuring regular contacts with a large number of companies and analysing andcasting hundreds or thousands of votes in AGMs all require resources that can deter investors. The use of external service providers or mutualised engagement with other investors can be a solution. As for measuring results, a regular follow-up of ongoing engagements can show investors the link with improvement of company practices. Financially speaking, CalPERS has recorded a positive effect of its engagement on the market performance of targeted companies. Finally, costa can be lower and impact higher when investors act locally and engage with domestic companies.
Engagement has not yet reached a level of recognition and diffusion comparable with that of SRI in general. Interest and practices vary between countries. France’s reluctance for example, contrasts with an enthusiasm for engagement by investors from the USA, UK or Northern Europe.
The Novethic study seeks to clarify the concepts associated with engagement, and encourage interested investors to structure their practices. We believe engagement complements other SRI strategies such as best-in-class selection, which is the most common SRI strategy in France, but sometimes criticised for its limited impact on corporate practice.
Engagement still has much room for improvement. However, the exercise of voting rights is seriously gaining in importance for investors and dialogue with companies on ESG issues is rapidly becoming part of the mainstream shareholder toolbox.
Samer Hobeika is SRI project manager at Novethic in Paris, France