The role of proxy advisors - ISS/GL, Asset managers, etc.

Proxy voting has long been one of the most critical parts of a company's AGM cycle. Shareholder resolutions are meted out and voted on. Proxy voters thus serve as a mode for shareholders to communicate preferences to the board. In the ihe ideal scenario, every shareholder would scrutinize the resolutions and vote based on what they feel should be right to advance and grow the company they have a stake in. However, in reality, shareholder voting is dominated by institutional investors. Many asset owners and shareholders also just lack the time and resources necessary to review the countless companies they have a stake in as a shareholder. 

Institutions thus own up to 70% of outstanding shares of traded companies in the US (PWC, 2017). The percentage may vary from then, but it is still largely dominated. That said, institutional investors and their influence over voting outcomes is tremendously huge as compared to simple retail investors. This also brings about the question on how an institutional investor would vote on the shareholder resolutions of the countless portfolio companies at every AGM. In comes proxy voting and robovoting - where these companies would tend to follow an advisors' recommendations. Proxy voting helps relieve the resources required by institutional investors in sourcing for investor sentiment to vote on these AGMs. Based on a harvard research paper, overall, 114 institutional investors voted in lockstep alignment with either ISS or Glass Lewis in 2020: 86% of robovoting investors used ISS and 14% used Glass Lewis, reflecting the dominant market position of ISS.

Because of this phenomenon, A major concern raised by previous research on the role of proxy advisors relates to the potential overreliance of asset managers on “proxy advisors’ recommendations, with studies indicating they can sway anywhere in the range of 13-30% of shareholder votes for various corporate governance issues.” However, most of the practitioner and academic research on proxy advisors to date has focused on their impact on ‘traditional’ corporate governance topics—for example, appointments to the board of directors, and whether executive pay levels are appropriate. 

That's a very brief overview of proxy advisors and their voting influence. So what does it all mean for ESG? 

Well, the answer is it depends. It really boils down to what the proxy advisor believes in, commits to, and values. On a good note, ISS has shown that it is more supportive of environmental and social resolutions than the largest asset managers. When examining why traditional active managers such as JPMorgan Asset Management, were less likely to support environmental, social and political lobbying proposals than their proxy advisers. Research from the harvard paper showed that only 35% of asset managers voted “For” these resolutions more or equally often than they were recommended to, with 65% showing less support than their proxy advisor. This is concerning as it shows that asset managers, including those commonly used by charities, have implemented voting policies which are less progressive than ISS.

Inevitably, the focus on short-mid term returns will still weigh heavily on these asset managers mind. Despite the benefits that ESG friendly companies and stocks bring. They are a definitely a longer term play. Hence, there will be a conflict between priorities for these managers that proves difficult to balance.  Rakhi Kumar, head of ESG investments and asset stewardship at State Street Global Advisors, said the $3.1tn asset manager took a “case-by-case approach” to voting on proposals related to sustainability topics. She added that it would consider issues such as the materiality of the topic and whether the adoption of the proposal would promote long-term shareholder value.

Another surprising point is between the proxy adivsors themselves. There exists quite a significant difference between voting recommendations of the two largest proxy advisors, ISS and Glass Lewis. Another harvard paper preesnts that ISS recommended that investors vote “For” an ESG related shareholder resolution 79% of the time, way higher the 53% of votes supported by Glass Lewis. That said, given that ISS is estimated to have a 24% larger market share than Glass Lewis, this level of support is generally positive for fostering a financial system that takes into consideration environmental and social issues. 

Corporate Resolutions - Proxy advisors VS Fund managers VS Investors

As mentioend above, asset managers, fund managers and large investment comapneis tend to vote differently on ESG issues as compared to their proxy advisors. Specifally those that have the resources and manpower required to delve into their portfolio company analyses.

An analysis by responsible investment charity ShareAction, on behalf of the Charities Responsible Investment Network, found that the world’s largest fund managers voted differently to their proxy advisers’ recommendations about three-quarters of the time on environmental, social and political lobbying proposals. The ‘Big Three’ asset managers (BlackRock, Vanguard, and State Street) who collectively control an average of around 25% of the votes cast at S&P 500 firms. The direct power of these asset managers is at the upper end of the estimated scale of 13-30% indirect influence attributed to proxy advisors.

So what does this mean for investors and asset owners who care deeply about ESG, and have holdings with these large asset managers? Despite the strength of proxy advisors, the worry is that these asset managesr are regularly ignoring recommendations to support ESG resolutions and voting against them. Investors that truly have a strong view on ESG resolutions ought to scrutinize and empahsize their views to their asset managers, or do so on their behalf - such that there will be pressure and there will be further support on ESG resolutions.

All links to the related Harvard papers and FT articles are listed below.

 

https://corpgov.law.harvard.edu/2020/03/05/another-link-in-the-chain-uncovering-the-role-of-proxy-advisors-in-investor-esg-voting/ 

https://corpgov.law.harvard.edu/2019/06/25/proxy-advisory-firms-governance-failure-and-regulation/

https://corpgov.law.harvard.edu/2021/05/27/proxy-advisors-and-market-power-a-review-of-institutional-investor-robovoting/ 

https://www.ft.com/content/fd275eff-39b9-438d-bf15-31bb242a1924

 https://www.ft.com/content/bcbedfb1-383e-46c8-89a8-1f3ae1db9cea 

IWAF - Impact Weighted Accounts Framework

To sideline a little from my prior post, I came across an initiative celebrated by Singapore's Green Finance Centre - the IWAF, which I thought was worth mentioning and taking a look at. This was a framework not entirely foreign to me as there had been prior Impact measurement frameworks proposed by Impact Institute, which I think now brands itself as the IEF, Impact Economy Foundation.

What actually drew me to it was because one of the contributors to this framework was someone that taught me in University, and was one of the key figures that exposed me to this whole world of ESG, Sustainaible investing and the sorts. Prof Hao from SMU. 

More about that (my motivations and fascination when I first learnt about these topics) another time. To discuss the IWAF, the Impact Weighted Accounts Framework. It sets up a another layer for companies to disclose their ESG related metrics. This time it provides actual monetized Impact a company has on 6 different capitals (related to ESG) based off its operations and efforts towards ESG/Sustainability. It also encompasses data used by other frameworks, and captures the significant ones which can translate to actual impact on ESG factors. The framework, thus, sets out not as a competition to existing frameworks, but to supplement and give a more cenetralised baseline for companies and investors to use. 

Impact has always been substantially more rigorous compared to ordinary disclosure frameworks where companies simply disclose the efforts/invesmtent amount/emission amount/etc, which leaves actual effects or impacts of these efforts to the interpretation or judgement of the investor. They might serve as possible basis of comparisons, but with countless frameworks and varying levels of disclosure, it might be difficult for someone to even compare simply based off voluntary disclosures. That said, regulators have a part to play in  this field, and steps have been made in the right direction, such as the SEC and MAS (Singapore) proposing frameworks from TCFD as the baseline standard for reporting. 

However, the narrative of these frameworks from the regulator standpoint comes with a large emphasis on risk mitigation and management. To have safeguards for investors, the economy and to ensure the companies themselves are not taking on too much esg risk in a sense. That is not enough. IWAF contributes by going beyond the risk measuring and mitigation efforts toward measuring positive or negative impact to society, environment. The data provided also enables corporates to make better decision making, something that mere disclosures might not be as effective in. The monetization of impacts gives corporates and leaders something familiar to work with, and as such, they can make decisions more easily regarding their operations and impacts to the 6 capitals laid out by IWAF. 

How does the monetization actually work? According to the reports and webinar, well cited and credible academic research is used as a foundation to convert disclosures and data from a company into monetary value. Data is also only taken from credible and reputable sources such as those compiled by the World Bank. 

With all that said, impact measurement is definitely a key area that will contribute heavily towards cneetralizing existing frameworks, while providing key useful and comparable data for investors and corpoartes. The project is still in the midst of refining, but I certainly hope to see further developments of it soon. 

Another note: A presenter from the IWAF Launch talked about an interesting point - the narrative of the economy of the past was all about pricing and profits. That brought the emphasis in accounting toward these key figures. In a way, the 'scarcity' of that era was about growth/development/industrialization/speed/etc. these were the limitations in the past, with lots of room for corpoartes to grow and innovate without any major consequence. Today, the 'scarcity' relates to environmental resources, impacts on climate, society, etc. Yet the accounting methodology for corporates remain fixated and without major changes from the emaphsis on profits. It is about time to relook at this foundational issue and crucial for regulators to also enact changes to it. 

Links to the IWAF Launch and their website: 

https://www.youtube.com/watch?v=yYqaqPnfNyY&ab_channel=ImpactEconomyFoundation 

https://impacteconomyfoundation.org/impactweightedaccountsframework/iwaf-public-consultation/iwaf-public-consultation-updates/

A New York University professor, Aswath Damodaran’s view on ESG.

Unhedged from the Financial Times is, to me, one of the most entertaining columns in the newspaper. Armstrong would vehemently argue against the concepts of ESG finance - regularly quoting Damodaran and his research insights. 

I've linked two Damodaran's articles here, which I would summarize and give my take on them at a later date. I believe both are good reads with valid points raised. If you noticed, Damodaran's blog style is what prompted me to adopt this similar theme.  

In both, Damodaran talks about how Russia's invasion proved to be a major misdirection by ESG factors, and how he believes the ESG movement is just not worth pursuing.  

- To be updated - 

 https://aswathdamodaran.blogspot.com/2022/03/esgs-russia-test-moment-to-shine-or.html

 https://aswathdamodaran.blogspot.com/2021/09/the-esg-movement-goodness-gravy-train.html 

Can ESG claims be trusted?

ESG, typically known as Environmental, Social, Governance is a hallmark of any company these years. Perpetuated by the inevitable warming of the globe and the growing unrest of social issues across many developed nations, the focus on ESG is stronger than ever. Companies, especially public ones, have undoubtedly placed an increased emphasis on this valued indicator of social good/environmental friendliness/etc.

ESG Investing is one of the branches that was birthed from the increased scrutiny of investors and managed funds on their portfolio companies. Specifically targeting companies that aim to do good, and do well (financially). It incentives both the companies with promises of perhaps greater capital allocation and favourable business conditions from governments, while providing investors with seemingly great benefits of investing in the future and the social good of the world.

Today, the ESG investing landscape is awash with billions of dollars worth of funds. Yet, more is demanded and required as quoted. To promote further efforts and enact greater ESG benefits to really help the world. However, in this inaugural article, I explore 3 different instances where it might seem that ESG investing is not as glorious and well-meaning as it claims to be.

'The ESG Mirage' was an article written by remarkable journalists over at Bloomberg - documenting how an institutional finance company can mislead investors about a company's ESG ratings. MSCI, the company in question, is best known for its index business - crafting and combining companies into a portfolio of stocks for investors to buy into. Given its exposure and business model - it also provides ratings too. Through the millions of datapoints it gathers and uses when creating said indexes. Of course, it provides ratings for a company's ESG practices. To cut to the chase, their ESG rating methodology does not even consider a company's impact on the environment/social factors - it instead measures how likely environmental issues would harm a company's bottom line. A total flip on what is supposedly meant for a company that does good for the E in ESG well. The authors also found that only one of the 155 upgrades in environmental scores were due to an actual cut in emissions. Companies with massive emissions like McDonalds (up to a 7% increase in emissions in four years) still managed to get an upgrade due to environmental factors. These are just some cursory points raised by the article, but it does poignantly puts into question, who will hold these rating companies accountable for their practices, and how trustworthy or reliable are their rating methodologies.

Divestments or engagement. Another key arguing point among investors - to divest and disincentivise ESG poor companies? Or to continue investing while engaging them to improve their ESG standards. This is a whole other debate for another time.

However, it leads me to discuss the idea that divestment by publically owned funds on ESG poor companies/assets only leads to funds being raised or having their assets owned by private companies (without heavy ESG obligations/commitments). The Environmental Defense Fund (EDF) study exposes this idea https://www.edf.org/media/report-oil-majors-take-climate-goals-data-shows-billions-worth-their-polluting-assets-are. The authors tracked M&A deals from 2017 to 2021, and found that almost 300 deals worth close to $140 billion have transferred assets from companies with ESG commitments to those without. 150 deals worth close to $90 billion moved assets away from companies which had net-zero goals. All this does, is showcase the shadier, gray area of these corporate commitments and obligations, and the way some companies might manoeuvre their assets and subsidiaries to fulfil these commitments. In this case, there seems to always be a willing buyer, and someone to adopt these less ESG friendly assets.

Finally, we have an example of a leading asset manager adjusting itself on its espoused ESG values. BlackRock is by far, the world's largest fund manager. And to its merit, it has close to 150 sustainability-focused exchange-traded funds. It also aims to increase its sustainable assets to $1tn within a decade. Clearly, BlackRock has an iron fist towards ESG related issues in its business model. That said, reports by the Financial Times mentioned that it may not support as many shareholder climate-related resolutions this year due to too extreme or too prescriptive measures proposed. The group also commented that it might not be 'consistent with our clients' long term financial interests'. That said, to give BlackRock credit where it is due, its emphasis on ESG and sustainability is something that many more firms can emulate. Prescriptive or over-the-top claims are about just as effective as the world pushing towards a net-zero standard so far. Talk is easy. More actionable directives are needed. Here's to hoping that BlackRock will continue its push toward the ESG field and continue supporting this treasured planet with financial institutions and investors.

These are just 3 very recent instances of ESG-related grey areas within the financial industry. That said, there are definitely good initiatives and efforts from institutions that truly seek a net-zero and ESG friendly world. There are more issues to be discussed, and an ocean of information out there.

Here are just some topics off the top of my head -

The existence of over 400 ESG related frameworks - is at worst confusing, at best misleading. Though, we have institutions like ISSB and EUFRA helping out.

The economics of corporate responsibility - stakeholder responsibility.

Economic reporting - the old reporting standards were based largely on scarcity in the past/ the purpose of a business. But today, should we think about how the scarcity of the now and future can influence corporate reporting

Till next time,

Johann