Ch. 6 Engagement

Question 1

Stewardship is the process of

Answer 1

f intervention to make sure that the value of the assets is enhanced over time, or
at least does not deteriorate through neglect or mismanagement. I

Question 2

engagement can

encompass the full range of issues that affect the long-term value

Answer 2

▶ strategy;
▶ capital structure;
▶ operational performance and delivery;
▶ risk management;
▶ pay; and
▶ corporate governance

Question 3

In a 2018 report,1

the PRI highlighted three ESG engagement dynamics that it believes create value:

Answer 3

▶ communicative dynamics (the exchange of information);
▶ learning dynamics (enhancing knowledge); and
▶ political dynamics (building relationships).

Question 4

One of the earliest articles to provide a detailed academic analysis of engagement impact
was Returns to shareholder activism: evidence from a clinical study of the Hermes UK Focus Fund”.

Answer 4

65% success rate overall, with greatest success in
restructuring and financial policies, and slightly less so with regard to board change. Ironically perhaps, the
lowest success rate was found in areas where shareholder engagement occurs more frequently, with only 25%
of the remuneration policy changes sought achieved and only 44% of the sought improvements to investor
relations.

was 4.9% net of fees a year in excess of the FTSE AllShare Performance, 90% of this excess return being estimated as due to activist outcome

Question 5

In Active ownership
a different (anonymous) fund manager’s engagement record was studied in depth, looking
at the years 1999–2009. This study considered less activist investing and more what would now be considered
standard ESG engagement and stewardship… success rate

Answer 5

it covered more than 2,000 engagements, involving over 600 investee companies, and had an overall
success rate of 18%. (vs 65% of activist stdy)

Question 6

The core finding of this study was clear: that successful engagement activity was followed by positive abnormal
financial returns.

Answer 6

Typically, the time between initial engagement and success was 1.5 years, with two
or three engagements being required. On average, ESG engagement generated an abnormal return of 2.3% in
the year after the initial engagement, rising to 7.1% for successful engagements and with NO adverse response
to unsuccessful engagement

Question 7

recent additional study finds that ESG engagement leads to a reduction

Answer 7

reduction in downside risk and that the
effect is stronger the more successful the engagement is. The effects are strongest in relation to governance (most engagement cases) then social

Question 8

Engagement also works, often, to further inform

Answer 8

investment analysis and fill out an investor’s understanding
of the potential for a business model to adapt to a changing business environment and evolving expectations,
and of the willingness of a particular management team and board to strategically address these challenges

Question 9

voting to receive the report and accounts, the issues considered at each meeting depend
on local law, but are often fundamental issues about the structure of the board, audit and oversight, executive
pay and the capital structure of the company. Not considering these issues would be …?

Answer 9

Not considering such issues with due care can clearly be seen
to be a failure of fiduciary duty, and due care will often require active dialogue with the company in order to
understand the issues and express any concerns and perspectives.

Question 10

in 2010 the FRC issued the UK’s first stewardship code – largely unchanged from the
existing Statement of Principles on the Responsibilities of Institutional Shareholders and Agents issued by the
Institutional Shareholders Committee (dated 2005, but itself built upon a 1991 document, The Responsibilities of
Institutional Shareholders in the UK).

Answer 10

▶ Global – ICGN Global Stewardship Principles.
10
▶ Europe – European Fund and Asset Management Association Stewardship Code 2018.11
▶ Hong Kong SAR, China – Securities and Futures Commission Principles of Responsible Ownership 2016.
12
▶ Japan – Financial Services Agency Principles for Responsible Institutional Investors 2017. 13
▶ USA – Investor Stewardship Group Stewardship Principles.
14

Question 11

The UK Stewardship Code went through a more fundamental redrafting to produce the 2020 version of the code,
published in late 2019

Answer 11

includes twelve principles
(plus an alternate six for service providers), where formerly there were seven, and a tripling of the number of
pages as compared with the 2012 code.

Question 12

Each of the new principles has an associated

Answer 12

outcome that must be reported as well as concrete examples of
what has been delivered

Question 13

The twelve new principles fall into four categories but cover two distinct functions

Answer 13

▶ principles 1 to 8 address the foundations for stewardship; 1-6 are structural investment factors, 7-8 and ESG factor while
▶ principles 9 to 12 focus on the practical discharge of engagement responsibilities.

Question 14

Perhaps the most challenging is principle 4

Answer 14

which charges signatories with identifying and responding to

market-wide and systemic risks

Question 15

engagement styles vary depending on the heritage of stewardship teams

Answer 15

There is a distinction in
mindset and approach between those teams with a history of governance-led engagement and those that have
worked more on the environmental and social side.

Question 16

The most obvious distinction is as material E and S issues arise from the nature of a company’s business
activities,

Answer 16

teams with this heritage tend to be organised by sector

The dialogue
would tend to start with investor relations or sustainability teams and then be escalated upwards, both to
senior management and to the board level

Question 17

whereas as G is determined more by

Answer 17

national
law and codes, such teams are usually split according to geography

Firms with a governance heritage tend to focus on individual
companies, starting with the chair (often with the assistance of the company secretary), and working through
the board and down to management from there.

Question 18

Passive investors typically start with an …., Active investors start with the ….. itself and
its business issues and develop a tailored engagement approach cutting across a range of issues, often with
the investment teams taking a leading role.

Answer 18

passive - issue

active - company

Question 19

effective enagement - goal setting

Answer 19

1) define Scope
2) frame engagement
3) articulate goals (SMART)
4) adapt to local context

Question 20

In many ways, this represents two different forms of necessary prioritisation:

Answer 20

1. identifying which company in a portfolio is most in need of engagement; and
2. determining which engagement issues should be prioritised in the dialogue between the investor and company

Question 21

both active and passive should look to stewardship as within the framework of the fund manager’s investment
approach,

Answer 21

an active manager may well find it easier to prioritise both the company and the issue as those
where most value is at risk within portfolios. The existence of risk means that if the manager is an active
manager, selling a holding in a company (or other investment asset) will always be an appropriate possible
action for a responsible fiduciary to take.

For passive investors, the same dynamic should be the driver, but may come less naturally to the decisionmaking teams: where in the portfolio is most value at risk. This will usually tend to mean a focus on the largest
companies and on the most material issues

Question 22

Practicality of effective engagement - goal setting

Answer 22

significant challenge - resourcing

1) define scope to ensure value adding
2) frame topic into broader discussion on strategy
3) clearly articulate realistic goals and milestones
4) adapted to local context

Question 23

two ways of prioritization

Answer 23

1. identifying which company in a portfolio is most in need of engagement; and
2. determining which engagement issues should be prioritised in the dialogue between the investor and company

Question 24

engagement objectives should have a ….

Answer 24

purpose, Having clear objectives helps set a clear agenda.

Clarity around objectives will also help to identify the right company representative to work with.

Outcomes matter more than activity and
given the impossibility of attributing share price movements to any individual engagement success

Question 25

Steps of escalation

Answer 25

holding additional meetings with management specifically to discuss concerns;
▶ expressing concerns through the company’s advisers;
▶ meeting with the chair or other board members;
▶ intervening jointly with other institutions on particular issues;
▶ making a public statement in advance of general meetings;
▶ submitting resolutions and speaking at general meetings; and
▶ requesting a general meeting, in some cases proposing to change board membership.

Question 26

Additional methods used by some as part of their escalation models might include:

Answer 26

▶ writing a formal letter setting out concerns, usually following one of the above meetings, and typically to the
chair; such letters are usually private, but may occasionally be leaked publicly if frustrations worsen;
▶ seeking dialogue with other stakeholders, including regulators, banks, creditors, customers, suppliers, the
workforce and NGOs (stakeholder dialogue is most typically a tool in European markets, but is increasingly
being used elsewhere as well);
▶ taking concerns public in the media or in some other form, not only as the code said in relation to AGMs or
EGMs;
▶ seeking governance improvements and/or damages through legal remedies or arbitration; and
▶ formally adding the company to an exclusion list, or otherwise exiting or threatening to exit from the
investment.

Question 27

way of collective engagement

Answer 27

This may be done
informally, through quiet and non-specific dialogue between individual fund managers’ stewardship teams. pooling those limited resources should enable greater efficiency

The challenges around collective engagement are perhaps the obvious ones of coordinating a potentially
disparate group of separate investors, and trying to maintain a consistent line

Question 28

The Investor Forum publishes ten key features of this private collective engagement framework:

Answer 28

1. Trusted facilitator, not an adviser:
2. Opt in/opt out:
3. Complementary to members’ direct engagement:
4. Confidentiality:
5. Nominated key engagement contact:
6. Hub and spoke model
7. No inside information
8. No-concert party and no-group:
9. Heightened procedures:
10. Conflict of interest avoidance

Question 29

special resolutions require support by…

Answer 29

by 75% of those voting, and there are unusual circumstances where
the number of votes cast must exceed a threshold in terms of the overall share capital (typically 25% impact to financials)

Question 30

Proxy voting forms are dominated by two:

Answer 30

▶ ISS, with around 80% of the market; and
▶ Glass Lewis, with the bulk of the remaining 20%; along with
▶ a few much smaller rivals, which have some market share, especially in a few localised markets

Question 31

If there are concerns about the capital structure and financial viability of the business, investors need to give
close consideration to votes

Answer 31

to dividends, share buybacks, share issuance or scope for further debt
burden.

Question 32

If there are concerns about the effectiveness or diversity of the board:

Answer 32

voting

decisions on director re-elections (and particularly in relation to the members of the nominations committee).

Question 33

Worries about the independence or effectiveness of the audit process

Answer 33

voting on the reappointment of the auditor, its pay and the reappointment of members of the audit committee

Question 34

Given the level of attention on executive pay

Answer 34

resolutions on remuneration. Currently, there are non-binding annual resolutions to approve pay in the year,
and often there are binding votes on forward-looking policies and any new pay schemes. These are in addition
to votes on the appointment of the members of the remuneration committee.

Question 35

Investors will also often reflect concerns about financial or sustainability reporting i

Answer 35

votes to approve the
report and accounts. In most markets this is a symbolic resolution, but the message sent by voting against it
can still be significant.

Question 36

Where the

view is not settled, but the investor does not wish to limit itself in a future engagement discussion, some will

Answer 36

choose to actively abstain from a resolution. The vote is rarely meaningful in itself because there may be a
range of reasons that an investor might have for voting in any particular way

Question 37

should investors communicate their rationale for voting to the company

Answer 37

YES - and insto will typically communicate in writing or engagement

Question 38

Corporate Governance Code

calls what % of board attendance?

Answer 38

Full Attendance

Question 39

Fixed income investors may ultimately be concerned with the likelihood of default

Answer 39

ESG factors can impact
credit ratings and affect spreads leading to short-term changes in value. Companies that regularly raise capital
in fixed income markets are becoming more conscious of investors’ interest in ESG as a material factor in their
pricing of debt.

Question 40

ESG engagement is also important to private debt, private equity and property and infrastructure investments.

Answer 40

These investments are often illiquid, relatively long-term and involve close partnership between the investor
and investee. As a consequence, there is both motive and opportunity for ESG engagement.

Question 41

In relation to fixed income, the PRI’s guide to ESG engagement for fixed income investors recommends that
investors should prioritise engagement based on:

Answer 41

▶ the size of a holding in the portfolio;
▶ lower credit quality issuers (with less balance sheet flexibility to absorb negative ESG impacts);
▶ key themes that are material to sectors; and
▶ issuers with low ESG scores.

Question 42

In FI, the greatest opportunity to push for conditions and disclosures around ESG is likely

Answer 42

ikely to be pre-issuance. This

can be difficult to implement in fast-moving public markets, but is easier to effect in private debt issuance.

Question 43

In FI communication is typically with corporate treasury rather
than more senior officials and is in relation to

Answer 43

relation to strategy, risk and
financial structure (especially where the proposed debt sits in the debt hierarchy) and also, the covenants and
protections for debt investors.

Question 44

While ther are cases with Eq and FI investors would oppose each other (select transactions and cap structure), they are much better aligned on

Answer 44

cases
relating to ESG matters at companies that are going concerns, the interests of long-term investors (whether
they are exposed to equity or debt) very much align and it will benefit all if the corporate effectively deals with
an ESG concern.v

Question 45

ESG on sovereign is more limited and typically approached by

Answer 45

ESG approach usually applied in this asset class is screening or an ESG tilt in the
investment process rather than engagement

Question 46

Within private equity investments, direct ESG engagement will be undertaken by

Answer 46

the general partner (GP)
rather than the limited partner (LP), though the LP may wish to engage with its GPs on the ways in which they
are monitoring and acting on ESG issues across their portfolios

Question 47

Infrastructure investors are exposed to ESG across the economic lifetime of their assets. These exposures
extend beyond issues related directly to a specific asset – ie

Answer 47

such as health and safety, supply chains and

environment – to factors such as climate change, bribery and corruption and the social licence to operate.

Question 48

investors consider eight potential mechanisms to act as engaged owners in
infrastructure:

Answer 48

1. undertaken during due diligence to prioritise attention to ESG considerations and
   and risk management.
2. Include material ESG risks and opportunities identified during due diligence into the post-acquisition plan activities.
3. Engage with management to act on the identified ESG risks
4. Define and communicate your expectations of ESG
5. Ensure ESG factors identified as material during due diligence are explicitly woven into asset-level policies.
6. Advocate a governance framework t
7. Set performance targets of ES and G
8. Where possible, make ESG information and expertise available to help with capacity

Question 49

Like fixed income, there is good evidence of the positive effect of ESG on returns to real estate investments.

Answer 49

Friede, Busch and Bassen’s 2015 study showed that 57% of equity studies showed a positive effect, but the
positive share for bond studies was 64%, rising to 71% for real estate.

and a 2.8% spread from top and bottom decile in Global RE sus BM

Question 50

in property, investors should engage

Answer 50

▶ engage, directly or indirectly, on public policy to manage risks;
▶ support research on ESG and climate risks; and
▶ support sector initiatives to develop resources to understand risks and integrate ESG.

Question 51

as investors in Funds the role is to

Answer 51

to hold to account the managers of the fund for their own investment
and stewardship efforts.

Closing the agency gap in these sorts of vehicles can be harder and take more effort,
but as long as the investor has this in mind, there is certainly a role for engagement to play.