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A new paradigm

The recent EU Sustainable Finance Disclosure Regulation (SFDR) application and the upcoming implementation of the EU Taxonomy puts stewardship front and centre for sustainable investing. Last March, most investors had to (re-)publish their engagement and voting policies to integrate ESG considerations. These reporting requirements were already in place in France since 2019 with the Pacte Law and Europe through the Shareholder Rights Directive II.

In its attempt to curtail Greenwashing practices through its new regulatory framework, the EU is turning market participants demands, notably from non-governmental organisations (NGOs), of greater consistency between funds’ ESG claims and their engagement practice into a legal requirement. Now, funds categorised under articles 8 and 9 according to SFDR must integrate their ESG engagement policy into their investment strategy. The consistency between ESG claims, the investment strategy, and the stewardship approach (engagement & voting choices) should demonstrate the legitimacy of the responsible investment ambitions to regulators and institutional clients. In addition, one should expect that this reporting on funds’ ESG engagement activities will be scrutinized by NGOs to “name & shame” managers with inconsistent practices. Now through SFDR, the focus on investment stewardship continues to rise.

The recent report from Novethic: Engagement Actionnarial: Les investisseurs responsables face aux dilemmes des AG 2020¹demonstrates that on ESG issues, there is sometimes a gap between investment management and voting decisions. This gap was apparent for some North American investors who did not support climate- and diversity-related resolutions during the last proxy voting season. With SFDR requirements acting as another driver for leveraging engagement to support the ESG strategy, the scrutiny of investor practices will advance, growing the reputational risks for investors failing to provide a holistic and aligned approach from ESG integration through to engagement and voting. Some of the unprecedented ESG voting outcomes in the 2021 proxy voting season have been encouraging thus far, and we hope to see increased commitment and alignment from investors as we advance.

Evolution of investing styles and tools

From a market perspective, engagement and voting on governance issues have been used as levers for influence for a long time. On the other hand, environmental and social issues were historically addressed from a values-based perspective (e.g. meeting international global norms and standards) or primarily for fact-finding purposes. Today, many responsible investors leverage corporate dialogue as a tool to influence and drive meaningful change and impact, e.g., through global initiatives such as Climate Action 100+. When engaging in such dialogue, it is important that the investor define short-, mid- and long-term engagement objectives and a process for tracking progress, irrespective of the means to conduct this dialogue (individually, collectively, or via a service provider like Sustainalytics), acknowledging each corporate specific ESG characteristic to identify “most impactful” changes. For instance, incentivizing an industrial company to stop lobbying against more stringent environmental regulations could be a step prior to defining a transition strategy to a less polluting activity.

The rise of passive investing

Amongst recent market trends, we identified the growth of ETF and passive investors’ interest for engagement. For such investments, dialogue and voting are concrete levers to support the transition to a more just and low carbon economy. As the choice of issuers is closely related to the composition of the replicated index, there are limits to active ownership options for the ETF or passive portfolio managers. Since it is unlikely that the issuer exits the index, the investor is therefore exposed to potentially controversial investments for the long term. However, the passive investor can incentivize the company to implement changes on specific ESG topics through long-term dialogue. Alternatively, voting can sanction a lack of progress on the issue or the non-responsiveness of the issuer vis-à-vis the dialogue. We believe that recent European regulation will also drive new stewardship practices for passive investors.

Available stewardship solutions

With more than 25 years of experience in ESG research and ratings, Sustainalytics supports investors in implementing holistic approaches to investment stewardship, including norms-based, materiality-based, or thematic engagements and ESG voting recommendations. With access to the firm’s comprehensive ESG research, which underpins the stewardship process lead by our Engagement Managers, we help investors establish an authentic alignment between investment management, engagement, and voting. Many investors partner with Sustainalytics to complement their in-house efforts or involvements in collaborative global initiatives such as the FAIRR initiative (Farm Animal Investment Risk & Return).

For example, from a regulatory perspective, investors utilise our engagement activity to address Principle Adverse Impacts. For instance, our engagement theme on Tomorrow’s Board addresses gender diversity at the board level. Sustainalytics’ Thematic Engagement program, covering a range of different systemic ESG risk exposures and opportunities, can also support the need for investors to develop expertise and sector expectations, which can assist in ensuring regulatory compliance. For instance, developing impact reporting on biodiversity to comply with Article 29 of the new French Energy & Climate Law (replacing Article 173 of Energy Transition Law).

Outsourcing active ownership or having it complement an existing strategy provides many advantages. It enables investors to grow their impact through the number of companies engaged and outcomes achieved from a robust engagement process facilitated by dedicated ESG dialogue experts. Sustainalytics’ clients have access to engagement results, case studies and regular reports through our client platform to enhance the investors’ capacity to address novel regulations, including the SFDR and EU Taxonomy.

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