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The Sustainability Story
Lindsey Stewart, CFA: Proxy Voting and Investor Engagement Practices
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In this episode of the Sustainability Story podcast, Nicole Gehrig, Director of Global Industry Standards at CFA Institute, is joined by Lindsey Stewart, CFA, Director of Stewardship Research and Policy at Morningstar Sustainalytics. Together, they...
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Hello everyone and welcome to the Sustain Sustainability Story Podcasts. This podcast focus on sustainability stories around the globe. I'm Nicole Garrig, Director of Global Industry Standards at CFA Institute and one of the three co hosts. I'm excited to have Lindsey Stewart from Morningstar with me today as my guest. Lindsey is Director of Stewardship Research and Policy at Morningstar sustainalytics. He works closely with Morningstar sustainalytics Engagement Services and ESG proxy voting specialists worldwide to deliver insights on how institutional investors, companies and regulators are approaching key sustainability and governance themes in global finance. Hi Lindsey, and thank you for joining us today.
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Hi Nicole, pleasure to be with you.
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In recent years we've seen a significant shift in how investors prioritize sustainability themes in their portfolios. The EU has implemented comprehensive regulations to promote sustainability in finance, such as the Sustainable Finance Disclosure Regulation or SFDR and the EU Taxonomy regulation, whereas the US has been less prescriptive with only proposed rules to enhance ESG related disclosures. Similarly, in Europe, fiduciary duty frameworks explicitly include sustainability considerations, where there's been much debate in the US as to whether ESG considerations are part of prudent investment practices. Given the differing regulatory environments and fiduciary duty frameworks in Europe and the U.S. i'm curious to understand how these factors have impacted the prioritization of sustainability themes by European and US Investors. Can you provide us some of your insights based on your research?
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Sure, Happy to talk about that Nicole. So perhaps taking it out of the Alphabet soup of regulations just for a bit, I think it is safe to say that in Europe, and certainly within the European Commission, the European Union, that framework, there is a lot more intentionality when it comes to climate and sustainability themes than there is in say, the United States or perhaps any other jurisdiction worldwide, to be fair. And so what you're seeing in that is there is double materiality regulation in the European Union which requires business actors to prioritize both financial returns, returns to providers of financial capital and the impacts on environment and society. And it's safe to say that in the US no such equivalent regulation exists, is very, very focused on a half century old definition of FIDUCIARY duty that is focused on financial returns to shareholders. Not to say that one is superior to the other, but they're certainly just different. And we see that difference very starkly when we start looking at the interactions between US Asset managers and European asset managers and the companies they invest in. And nowhere is that difference more clearly seen than when we look at proxy voting records. And I do a lot of research into proxy voting records, so let's dive into that. A research paper that we published back in January showed that there was a wide and broadening gap between the level of support for key shareholder resolutions on environmental and social topics, a gap between the United States managers. And we looked at 20 of the largest US managers and European managers, and we looked at 15 of the largest European managers. What we saw was that there was a peak in support for key SG resolutions in 2021. And I'll come back to the definition of key ESG resolutions in a minute, where US managers voted for around two thirds of the key ESG resolutions that we identified, that dropped to about 50% in 2023, whereas for the European managers that we studied, it was consistently very close to 100%. I think 98% of key resolutions were supported by the 15 European managers. What do I mean when I say key resolutions? Well, some of you may know that there have been many more shareholder resolutions going through the system at companies shareholder meetings in the last couple of years following some changes to SEC regulations. However, the level of support for those resolutions has not necessarily stayed that high, and it's dropped from 30% in 2022 down to about 20% in 2023. Overall, what we've done is because we've taken a very fiduciary focused view of the level of support for those resolutions and decided on a level on which a substantial number of institutional shareholders could agree that a proposal was worth considering. And so what we've done is we've taken a subset of all of those environmental and social resolutions, and There were over 300 in 2023 and over 200 in 2022. Taken a subset of those and we've said, okay, out of all of those resolutions, which one's got 40% support from independent shareholders? 40% or higher. And when we say independent shareholders, we mean those that are not directly connected to the company, not a founder, not an executive, not a board director. So if you take out the Zuckerbergs and Buffetts and Larry Pages and Sergey Brins from the equation, what percentage support was there from independent shareholders? We set a threshold at 40%. And we came up with 53 key resolutions in 2023 and 102 in 2022. That reflects the widening gap and the lower support from US Shareholders, in particular, over those two years. What we found was some of the US Managers in our sample had commented and said that they felt the shareholder proposals in latter years were not of the same quality as in previous years. And there are as many definitions of quality as there are shareholders. But what they meant was they felt that a lot of proposals were asking for very, very specific actions from managers, things that weren't necessarily in line with their definition of what meets a fiduciary duty standard, or that were too prescriptive in micromanaging, which is not an area that asset managers often want to go to, or that they simply asked for things that were already in progress at the company or the company already reported on. That is broadly a matter of opinion, and that's why we've got this wide range of support for proposals. But US Managers in particular felt that there were more of those quotes lower quality proposals than in previous years, and that helps to explain some of the tail off in support for resolutions in the latter years. What we have found is that European managers that have a lot more freedom to incorporate environmental and social priorities within their investment process have shown consistently high support for those key resolutions. So 98% in each of the last three years is certainly reflective of that.
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You mentioned the dip in proposals that received 40% or higher support might have been due to lower quality or redundant proposals. I understand that some managers are more transparent and provide their rationale for their voting records. For managers that do not provide that level of detail, do you engage with the managers to understand why they might have voted against key resolutions?
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Well, generally we like to keep our proxy voting research grounded in what is available publicly. So we are very grateful to asset managers that will publish rationales on why they voted. A certain way, we think is helpful to the investor, but we really want to get a feel for what's out there in the market rather than relying on what a particular manager is prepared to tell a Morningstar analyst. So generally we'll rely on public disclosure and encourage asset managers to make public disclosure on the kinds of decisions that they think are material so that the end investor can have a good idea of exactly what they're dealing with when it comes to aligning their own personal, environmental and social priorities and objectives and values with the way that they want to invest. But we do absolutely think it's helpful for Managers to provide their rationale. We know that a proxy vote can only be voted one of two ways or abstained from. And it's useful to understand the thinking that a manager has put into supporting or not supporting a resolution. And oftentimes you can see that different managers have supported or failed to support resolutions for different reasons. And there are different nuances. And understanding those nuances is becoming increasingly important as the landscape becomes more complex. There are a lot more socially focused proposals where it's a lot less agreement on what the right thing in quotes looks like. So that kind of disclosure closure, that kind of disclosure is really, really helpful.
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For audience that might not be familiar with the topic. Can you tell us what are say on climate votes and how have they been voted based on your research?
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So say on climate votes, they're an interesting new feature in the corporate governance landscape. And what they are is their management sponsored proposals at company shareholder meetings. They've proven popular in Europe and Australia in particular, but management will issue climate reporting, or in many cases an actual climate transition plan, and they'll ask shareholders for their advisory approval on that reporting and those plans. And we've had several dozen of those over the last three proxy years, and that's counting from 2021 to 2023. We'll be able to analyze the 2024 data. This year's proxy season is just about to end, and in a recent paper back in April, we looked at the results of 87 such resolutions, and we found that there was generally very high support for these resolutions among shareholders, which is not unusual among management sponsored resolutions. But there'd been a tail off in support from those resolutions, dropping from 93% down to 87% in 2022 before rising back up in 2023 to about 91%, which indicated that there was a bit of a dispersion of views around what sound climate votes were meant to represent and how asset managers were looking at them. And when we looked at 25 asset managers, records in particular tilted towards those exposed to the European market because those are where most of these sound climate votes are held. We saw a considerable dip in support for management sound climate proposals, peaking at 92% in 2021 and then falling to around 70% in the following two years. So there's certainly a development of those views over time among asset managers. What we saw that was really interesting is that even though there was lower support for sound climate resolutions, the reduction in support between different managers was not always for the same or even similar reasons. Some asset managers were clearly reducing their support as an indication of an expectation of higher ambition from companies. So the early votes in 2021, I think asset managers were generally just happy to have climate reporting and climate transition plans. This is all pre regulation that we have now. And so there was very high support for those. They wanted to encourage the practice. As 2022 and 2023 rolled on, they started applying a higher level of scrutiny and so they started withholding support and disclosing rationales on why they had withheld support. That's for sustainability focused managers. However, for other managers, usually more generalists, some of the United States based managers, there was a, a bit of a wider range of opinions on exactly what they were voting on and the views they were taking on it. Some of the larger managers were taking the view that they didn't feel it was their place to vote on the strategy being implemented, as in whether it was ambitious enough to meet certain climate targets, but more on the quality of disclosure that would allow an investor to make an informed decision on the risks and opportunities that the investor faced. Still others took the view that it was actually inappropriate to delegate this responsibility to shareholders to approve or reject a fundamental element of the overall corporate strategy which they felt was a job for management and the board. And so they decided to vote against or abstain from supporting those votes. So you've seen this drop in support over time, but it is not possible to know what message is being sent to each company or even to the market overall when you see that drop in support, knowing full well that there's this wide range of views out there. So we thought that was an interesting observation and it really does emphasize the thing we talked about earlier, the need for asset managers to clearly disclose and explain their decisions when they're dealing with material issues like this, either by disclosing what their policy is overall or by communicating the rationale behind their decisions on each vote.
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From your research, there's generally a high percentage of support for stay on climate. Have you seen a difference in support in say on climate votes from the European asset managers to Australian asset managers?
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Yeah, interesting question. Not in any particularly methodical way. The population of votes in Australia is much smaller than that in Europe. However, some of the strongest votes against say on climate plans have been in the Australian market. We saw that with Woodside Petroleum, forgive me, Woodside Energy, this year where they've had more than half of investors vote against their climate plan. But that was just a follow up from last year where almost half voted against it. And so we've seen Some pretty strong dissent from asset owners and asset managers in Australia who felt that the climate plans and climate reporting they were seeing was not nearly ambitious enough in their opinion.
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Companies in Europe and Australia have been the ones to put forth say on climate resolutions. Has there been an increase in say on climate votes in the US Generally?
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The largest US Managers have supported management on sound climate votes the same way that they generally support management on management proposals generally. And to be clear, say on climate votes have not taken off in the United States. I'm aware of two of them which were very early on in the three year period that we analyzed. I don't expect that will change anytime soon given the market and political environment in the United States. So I think that they're staying in Europe. How much longer they stay in Europe may well be a question given the wide range of views. Maybe it gets folded into general reporting and the vote that we have on financial reporting, maybe it evolves in a different way. It will be interesting to see.
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We saw earlier in the proxy voting season that five large US Asset managers exited or reduced their participation in the Climate Action 100 plus initiative. These exits might have been due in part to the accusations of collusion that breach antitrust laws for members involved in this initiative. Can you describe your view on this and the research that you have done within regards to this topic?
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Yes, happy to talk about the research. I'm going to be very, very careful about how we frame it. Certainly there have been accusations of collusion regarding climate action 100 plus. And certainly there have been exits from the initiative by four managers with one other manager reducing its participation. However, I don't think it's possible to draw a straight line between those collusion accusations. Between those collusion accusations and the exits. I would say, well, certainly the asset managers would say they've got various different reasons and some of them have come out and said that their, their processes have just moved on, they've skilled up in this area and they feel that they were putting more into the initiative than they were getting out of it. And we can certainly take them at their word when they say that. However, the political pressure that exists around collaborative initiatives like climate action 100 plus certainly cannot be ignored by investors. I'm certain that it isn't being ignored by any asset manager operating in that space right now and will have been certainly part of the calculus when coming up with that decision. So having said that, what we saw was having looked at the proxy voting record for flagged resolutions, that is the resolutions that are identified for Climate Action 100 plus signatories to consider when voting each proxy season. There wasn't really a lot of evidence or very little that I would call evidence of collusion. When we looked at those voting records, we'd seen that signatories were voting in very different ways. There were very, very different levels of support for the resolutions that were identified in 2023. And even among the five exited or amended signatories, BlackRock, State Street, Invesco, JP Morgan and Pimco, there was a very wide range of support levels even just within those five, those five institutions. So we think there is not a lot of evidence of collusion within the Climate Action 100 plus initiative, at least not when you look at voting results.
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It's interesting to see the variation in the voting records of the signatories across those flagged resolutions. It certainly is a clear signal that the accusations of collusions are unsupported. Numerous underlying circumstances could explain why a manager might not support those flag proposals as each one is assessed individually in accordance with their internal proxy voting policies as well. Another concern of investors is the role that proxy advisors play in stewardship activities. The proxy advisor market is concentrated with around 90% under the control of ISS and Glass Lewis. Based on your research, how has the use of proxy advisors impacted proxy voting outcomes?
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Yeah, interesting question and one that keeps coming back. I should probably start by saying that Morningstar sustainalytics does in fact own a proxy advisory service that issues advice aligned with the Sustainable Development Goals for those who are interested in investing along sustainable lines. But you're right, there are two dominant players in that market and they come into the headlines a lot. I would say they're more a feature, they feature more strongly within the concerns of listed companies than investors, in my opinion. But there is a perception that proxy advisors have too much say over how voting recommendations cast by investment fiduciaries. We looked into that in our research as well. And in February we published an article on Morningstar.com that assessed the level of alignment between several large asset managers in order to determine whether there was any evidence that proxy voting advisors had a disproportionate influence over voting outcomes. And we found that they didn't. What we saw was that the large asset managers and we looked at Basically the top 10 mutual fund advisors in the United States and they were voting very, very differently on the key resolutions that we spoke about. And there's a fancy graphic that we put on that article if you want to go and look at that. However, we still hear quite Frequently. We've heard pronouncements by several CEOs recently that I won't name, but you can google them who have said our proxy voting advisors have too much power and they need to be reined in. I think the fact remains that our study and several other studies have shown that proxy advisors do not have anything like the power that is being attributed to them when it comes to making voting decisions. Advisors advise, but investors decide and in any case proxy advisors recommendations are informed by the preferences of investors. Every year they put out a survey and they try to align their own in house policies with the investor feedback.
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Thank you Lindsey for your insights on proxy voting. I want to transition to more a discussion on engagements. So as you're aware there's a lot of sustainability conscious asset owners globally, especially in Europe. How do you think they're handling engagements and what would you say is a high quality engagement? What would that look like to you and what does your research show in regards to engagements?
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I think there's a wide range of approaches to engagement, certainly across European investors, across investors worldwide. And that shouldn't surprise us because each investor is different, their needs are different, their priorities are different, so you would expect them to have different engagement approaches. What I will say is that because there has been a very sort of foggy and amorphous concept of what actually constitutes engagement, it is very difficult to determine or make comparisons between one asset manager and another when it comes to what their engagement activity actually means. Is it just one off activities like phone calls or letter writing? Or does it describe continuous dialogue over a lengthy period with a specific objective? And I think it's that latter definition that most of us in the stewardship and governance community really want fiduciaries to focus on. The There's a document by the UK Investor Forum which is a collaborative corporate governance and investment stewardship organization here in the UK where I, where I live and work. And five years ago in 2019 they put out a document called Defining Stewardship and Engagement. Now a lot's changed in stewardship, governance and sustainability in the last five years, but this has definitely stood the test of time. In their document it says engagement is active dialogue with a specific and targeted objective. The underlying aim of the engagement dialogue should always be to preserve and enhance the value of assets on behalf of beneficiaries and clients. And so I think that active dialogue with a specific and targeted objective does really emphasise the need to be very clear about what the objective of engagement is. Maintaining that active dialogue, which implies a lengthy period of time with multiple conversations and actions and disclosure of progress toward those defined objectives. So I think that's certainly what investors are looking for in engagement. And I would hope that we can get to a point where we get consistent reporting that measures onto that standard.
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Right. I agree with you. I think that transparency on engagement is important too. And we're seeing more transparency in the marketplace. A lot more managers having their publicly available engagements where you're able to see reports on how they've engaged with certain issuers that they own in their portfolio, how effective they've been in developing different changes in those conditions as well. So I was wondering as a follow up, is engagement effective tool to help generate changes in environmental social conditions?
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That's a huge question. Is it an effective tool in generating changes? I think it's one of the tools in a very large toolbox and it really depends on whether you want to talk about affecting changes at a particular organization or even within an industry sector, or whether you're talking about affecting systemic changes. If we're talking about the latter systemic issues like climate change, like global human rights, like biodiversity and nature, it isn't the job of investors to effect those changes. This is why we have governments and elections and all of that political action. That's not to say that investors don't have a role in furthering and advising on that process, but it isn't their end responsibility. However, when it comes to bringing about changes at individual companies or perhaps even entire sectors, you can find that engagement and stewardship is an effective tool at bringing about those kinds of changes with a more limited scale and with that focus on preserving and increasing financial value that the investor forum talks about.
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So engagement versus divestment is a hot topic. And what is your take on it? There's a place for engagement, a place for divestment. Can you maybe provide your insights and knowledge on the topic?
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I knew this was coming. You're right, it is a hot topic. It has been for a very long time. It may stay hot for a few years more. Engagement versus Divestment. Well, divestment has to be in the toolbox for many investors. There are certainly a lot of purpose driven investors that have high environmental and social considerations, perhaps because of their origins in mutual societies in the labor movement, feel that they need to place a very high up high feel that they need to place a very high priority on those kinds of things. And so divestment is certainly in the toolbox for a lot of those. Some more diversified investors may take the view that divestment isn't an option that they want to pursue. They want to maintain their diversified portfolio to manage the investors risk. And of course if you're in passive portfolios, you don't even have that self discipline in your toolbox. So yeah, divestment is a tool that environmentally and socially conscious investors will often use. And we've certainly seen that with some large European asset owners that have felt that years of engagement in particular with the fossil fuel industry has not yielded the results that they intended to get. And they're switching to demand side engagement and exiting from fossil fuel investments entirely, which is their right to do as long as their beneficiaries are aware of the trade offs that that involves the risks and opportunities that they're taking on by shedding the particular risk of decarbonization within fossil fuel sectors. However, for other investors, they may take the view that they do have to invest in the economy as it currently exists and provide nudges to help companies transition from faster or at least to the speed that the economy is transitioning. They see themselves as a partner with companies in helping them get to that destination. And some investors, as is their right, will be completely agnostic and think we'll just take the economy as it is and as the economy transitions, we will transition with it in our portfolio. And they may well be inclined to respond to various policy interactions like the proposals and consultations we had for SEC Climate Rule, for the International Sustainability Standards Board, for European Sustainability Reporting Standards and engage in that manner. So there are a variety of ways to do it. But I think the thing with divestment, and because this is a CFA audience, we can go a little deeper here. There are also other considerations beyond just the act of divesting or investing in particular sectors that may have particular ESG focus risks. For example, if you divest from the fossil fuel industry at fair value, then you've really just realized the present value of the future cash flows from that industry, which still leaves you with a kind of exposure instead of just holding it for the long term. You still realize that cash and you've sold it to by definition an investor who cares less about that issue than you. So I think there's always a need to consider avoiding paper decarbonization that doesn't really impact the world and explaining the trade offs and the nuances to end investors as best you can.
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Great, thank you. That was a great summary of a divestment versus engagement. We talked a lot about proxy voting and the difference in European versus US proxy voting outcomes that you've seen and how regulation has influenced stewardship practices. I'd like to talk about now more about voluntary codes, specifically the UK Stewardship Code. What role does the UK Stewardship Code play in setting standards for stewardship practices? And what feedback have you received from institutional shareholders regarding the current version of the code?
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Yeah, the UK Stewardship Code is well known for being the first such code of its kind, helping guide asset owners, asset managers and even service providers towards defining what their sustainability and governance objectives are and explaining to stakeholders how they've acted on those objectives. The last iteration of the code was finalized in 2020 and in a previous role with the FOC, I was involved in the post implementation feedback for the first round of signatories for the first round of signatories reports. The code is now open for consultation or soon will be once again for a 2025 version of the code as it is reviewed regularly and it's a good time to take stock of what's gone well. And I think the focus on aligning activity with outcomes and measured against objectives is absolutely critical and should absolutely stay within the current version of the code, as are the principles that have been established and very well accepted. The Stewardship Code reports have become a valuable source of information, certainly for researchers like me who who look at sustainability and governance issues and want to draw conclusions. There's plenty of useful information in those reports. I think one thing that I've heard from a lot of preparers though, is that going through the process every single year, which often pulls in information that is published elsewhere, can sometimes be onerous and some review of reducing the burden of reporting the same information over and over. Perhaps moving to a model where reports are compiled less frequently or when there's new information might be worth considering, but that's one of several views that will be out there and it'll be interesting once the consultation opens, to hear a broad range of views, both from report preparers and report users, and from investors themselves, of course, because this is who all of that reporting is really for.
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I agree the UK Stewardship Code plays a significant role in setting standards for corporate governance and responsible investment. Although onerous, the reporting aspects allow for transparency and accountability for asset managers and owners regarding their stewardship activities and outcomes. I see that we are almost out of time. Can you let our audience know what's next in your research? What we can be expecting?
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We are coming up to the end of the 2024 proxy season. It's the end of June as we go on tape right now, so we'll continue to look at all of the relevant themes and disclosures and continue to published research that I hope is useful to the market in understanding which kinds of environmental and social priorities asset managers and other fiduciaries are prepared to prioritize and help investors align their environmental and social preferences in investing with the asset management choices that they make out there in the market. We hope it continues to be helpful so we'll start publishing that again probably towards the end of the summer, beginning of September, once the disclosures, once the annual disclosures are published.
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Lindsay, I thank you for sharing your research and perspectives with us today on stewardship and I hope we can collaborate with you again soon. Listeners, you can learn more about the research that Lindsay has described by subscribing to the Stewardship Snapshot newsletter from your LinkedIn page as well as reading his research on Morningstar.com's website. Thank you again, Lindsay, for being here today.
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Absolute pleasure, Nicole. Thank you for having me.