Investors Pushing Environmental and Social Proposals

Compliance

Investors Pushing Environmental and Social Proposals

By Hannah Orowitz

Environmental and social (E&S) considerations have dominated the shareholder proposal landscape for several years.

Historically, many of the largest asset managers declined to vote in support of such proposals, preferring instead to attempt to influence corporations’ actions by engaging shareholders and the board through ongoing dialogue.

Now, an increasing number of institutional investors have begun to include E&S considerations within their established risk-return analysis framework. Additionally, evolving expectations placed upon the more than 2,600 investors that are signatory to the UN Principles for Responsible Investment, and pressure from asset owners such as pension funds and special interest groups, looks to be reshaping this landscape.

In January of this year, pledges by two of the three largest U.S. asset managers, State Street Global Advisors (SSGA) and BlackRock, indicate that these firms have reached an inflection point. These two funds may diversify their practices of using assessment and engagement as the primary tools to influence portfolio companies, and focus more efforts towards taking voting action in favor of shareholder proposals that address material E&S issues. In all but the most egregious cases in the past few years, E&S considerations — even if they did lead an investor to vote in favor of a shareholder proposal — did not factor into most asset managers’ and owners’ broader voting decisions surrounding director elections. That, too, now appears to be ripe for change. We expect investors will likely articulate their concerns much more often by voting against specific directors, committee members or entire boards.

Covid-19 has brought to the forefront certain E&S topics such as human capital and supply chain management.

Concerns surrounding the evolving Covid-19 pandemic that have developed subsequent to investors’ articulation of expectations and priorities may mean that some investors are more likely to be more lenient on E&S topics this season. Glass Lewis, one of the two leading proxy advisors in the United States, recently noted this possibility in a statement to its clients regarding the current corporate governance environment. However, to the extent this leniency occurs in 2020, companies would be well advised to understand that any reprieve is temporary and unlikely to carry into 2021.

Covid-19 has also brought to the forefront certain E&S topics such as human capital and supply chain management, and has illustrated the all-encompassing andimmediate shocks that systemic risks, albeit from a black swan event, can have on asset valuations. Ultimately, the global pandemic may increase investors’ sense of conviction about the urgent need for companies to address risks like climate change.

Vanguard, which manages the second greatest volume of assets in the United States, has generally been less vocal on E&S topics, but on April 1 it released an update on the 2020 Proxy Season, recognizing the impact of Covid-19 on corporate decision making. At the same time, it reminded companies to keep long-term shareholder interests in mind, noting in particular that “climate change presents a pressing and concerning risk to long-term shareholder value.” Vanguard’s statement does not specify any policy change, but it articulates an intention to continue to address climate risk through voting and engagement, and states that Vanguard “will raise [its] expectations for the companies that our funds invest in.”

Accordingly, to avoid adverse voting activity in the future, companies should view 2020 as a year of preparation and an opportunity to engage with investors regarding their expectations. Companies can be positioned to act on feedback received to improve E&S disclosures and practices.

SUSTAINABILITY-RELATED DISCLOSURE

In January 2020, BlackRock CEO Larry Fink released his annual letter to portfolio companies’ CEOs, predicting a near-term reallocation of capital as investors broadly incorporate the impact of sustainability on investment returns. In conjunction with those expectations, BlackRock published updates to its global and U.S. proxy voting guidelines in February. They significantly expand the E&S section to call upon companies to improve their sustainability-related disclosures in compliance with industryspecific Sustainability Accounting Standards Board (SASB) standards applicable to companies, and the Task Force for Climate-Related Financial Disclosure’s (TCFD) recommendations.

To the extent that companies do not effectively disclose and manage material sustainability matters, BlackRock warns that it will be “increasingly disposed to vote against management and board directors” and in favor of sustainabilityrelated proposals. The guidelines also say that even if BlackRock declines to support a given climate-focused proposal, if it believes that a portfolio company has not made sufficient progress in its disclosures, it may vote against the election of relevant directors. These policy changes follow on the heels of BlackRock’s January 2020 announcement that it has signed on to Climate Action 100+.

In January, SSGA’s CEO, Cyrus Taraporevala, announced to directors in his annual letter that the company intends to use proxy voting to press companies to improve E&S disclosure and practices. Specifically, for 2020, SSGA will be taking action against board members at companies within the S&P 500 that are categorized as laggards under its proprietary R-Factor analysis and cannot articulate how they plan to improve their score.

R-Factor is SSGA’s environmental, social and governance (ESG) rating system, which leverages SASB standards. R-Factor scores classify companies as laggards based on their percentile ranking compared to industry peers as defined by the Sustainable Industry Classification System designed by SASB. Currently, laggards appear to be companies within the bottom 10th percentile of their industry.

Beginning on January 1, 2022, SSGA will likely expand this approach beyond the S&P 500 to its entire portfolio. Accordingly, it could vote against directors at all companies that have consistently underperformed peers on their R-Factor score unless SSGA sees “meaningful change.”

Following the release of his letter amid the development of the Covid-19 pandemic, Taraporevala issued a letter on March 31 recognizing that engagement conversations in 2020 may shift to immediate ESG issues raised by the pandemic. However, he urged that companies “refrain from undertaking undue risks that are beneficial in the short term but harm longer-term financial stability.” There was no indication that SSGA would be delaying the voting actions regarding “laggards,” as previously announced.

Data regarding investors’ voting decisions for the current proxy season, including SSGA’s and Vanguard’s, are generally not available until August 31. However, recent voting bulletins released by BlackRock on select annual meetings illustrate how these E&S convictions are beginning to play out in its voting process. For example, at National Fuel Gas Company’s March 11, 2020, annual meeting, BlackRock voted against a director’s re-election in light of what it viewed to be insufficient progress on the company’s climate-related reporting. In reaching this decision, the bulletin explained that BlackRock assessed both the company’s current disclosure as well as its engagements with the company on climate-related issues over time.

In BlackRock’s view, climate change poses significant material operational, physical, reputation and regulatory risks. On that basis, BlackRock would have expected the company to have developed more robust reporting. In particular, the BlackRock bulletin noted that National Fuel provides limited disclosure that aligns with neither SASB nor TCFD and has not set any greenhouse gas or methane-related reduction targets. Although BlackRock views climate as an oversight responsibility of the full board, National Fuel maintains a staggered board. Accordingly, BlackRock elected to hold the audit committee chair accountable as the longest tenured director up for election. Separately, BlackRock also voted in favor of a shareholder proposal requesting the declassification of National Fuel’s board.

On the other hand, BlackRock’s engagements with Sanderson Farms, Inc., leading up to that company’s February 2020 annual shareholder meeting, swayed BlackRock to vote in accordance with management’s recommendations on two E&S-related shareholder proposals. BlackRock indicated that it discussed a range of E&S issues with the company, including energy conservation efforts, waste management, greenhouse gas emissions management, water stewardship and human rights.

Although Sanderson Farms’ existing disclosure addresses a range of E&S matters, it does not provide SASB-aligned disclosure. Ultimately, BlackRock determined not to support the shareholder proposals that addressed water resource risks and human rights concerns, respectively, citing the company’s “willingness to improve its reporting by aligning reporting with the SASB framework, as discussed in our engagement with the company prior to the annual meeting.”

These examples reveal that companies should make meaningful and concrete commitments to improve their management of material E&S matters, including producing disclosures aligned with SASB and/or TCFD, to avoid negative voting consequences from BlackRock. Fink’s letter indicates that it expects companies to develop this disclosure by year’s end. SSGA’s Taraporevala indicates that E&S-driven voting action in United States 2020 annual meetings will be limited to roughly 50 “laggards” within the S&P 500.

For most companies, shifts in voting behavior will likely not begin to be felt in earnest until 2021. Companies can use the remainder of 2020 to improve their oversight and communication of E&S matters.

CONSIDERATIONS FOR RIGHT NOW

If a company has not yet assembled an ESG task force, it may now want to consider its creation, as well as which colleagues and external advisors will form its membership. Oversight structures and disclosure are best developed when companies break through existing silos to involve all relevant subject matter experts across the organization. While this may vary from company to company, common participants include individuals across the legal, human resources, risk management, investor relations, finance, facilities — and, if applicable, health and safety — and sustainability functions.

Once the task force is assembled, companies may want to invest time in understanding the company’s shareholder composition, including which reporting standards and frameworks, as well as data providers and ESG rating organizations, their investors use. Consider prior engagement feedback, as well as potentially engaging in additional off-season outreach, to specifically discuss ESG matters with significant investors or other key stakeholders. With this information in hand, the ESG task force can then be in a position to develop investor-focused ESG disclosure and appropriately embed oversight of ESG matters within the board and committee agendas.

Hannah Orowitz is a managing director on Georgeson’s corporate governance advisory team. A former in-house counsel, she is a member of the National Investor Relations Institute, the Sustainability Accounting Standards Board, and the Society for Corporate Governance and its Sustainability Practices Committee. horowitz@georgeson.com