European investors sharpening tactics around engagement efforts with rise in reporting rules

European investors are under pressure to enhance their activities when it comes to engaging with companies on ESG issues, but the pandemic added an additional burden and prompted them to redouble their efforts as well as adopt new strategies.

While the list of growing reporting requirements in the U.K. and Europe mean a natural progression in the types and intensity of dialogue with portfolio companies is underway, the COVID-19-induced move to an online operating model has made such discussions more difficult, industry experts said.

After many annual general meetings moved online due to COVID-19 lockdowns across the U.K. and Europe, it became easier for companies to "control" these meetings and stifle dissent, said Caroline Escott, senior investment manager and stewardship lead at Railpen, London, in a telephone interview. The firm is the in-house manager of the £37 billion ($45.2 billion) Railways Pension Scheme, London.

In an online format, investors aren't able to discuss with companies issues such as climate or diversity to the extent that they would have liked, she said. It also was easier for companies to cherry-pick the questions they wanted to answer at virtual AGMs, she added.

As a result, some investors are improving engagement outside of annual general meetings to convey what is important to them.

"We regularly engage with our largest holdings, or companies where we think there is a particular ESG risk, throughout the year. The vast majority of companies are responsive to our requests for a meeting, as well as our follow-up letters and thoughts," she said.

"However, where we have been unsuccessful in obtaining a meeting — either in our own right, or as part of a coalition — and we think there are key ESG issues which need to be addressed, we will seek to ask a question at an AGM or consider other escalation tactics," she added.

For example, in 2023 Railpen will pre-declare its voting intentions, Ms. Escott said.

Another U.K. investor, Border to Coast Pensions Partnership, Leeds, England, said in February that it planned — for the first time — to vote against chairmen of banks who fail to make climate progress. The pool is responsible for £38.3 billion in assets for 11 local government pension funds.

Colin Baines, stewardship manager at Border to Coast, said that the banking sector will be key to the low-carbon transition given its size and influence and role in the allocation of capital.

Mr. Baines said that to date banks have not received the same level of investor attention as other climate risk sectors such as oil and gas. "This is changing and banks will find they are subject to increasing attention and higher expectations," he said.

"A key challenge in the banking sector is that most banks' climate targets are intensity-based. These require complementing with absolute emission reduction targets and commitments to halve emissions across the banks' financing activities, thus ensuring real emission reductions are achieved in the real economy," he said.

Investors are also revisiting their engagement efforts due to European Union and U.K. regulatory requirements to provide more specific information on what they have achieved with companies through engagement. Sofia Bartholdy, net-zero lead for U.K. endowment fund Church Commissioners for England, London, which has £10 billion in assets, said that engagement is evolving because the regulators want more information from investors every year.

"The focus is increasing on the outcome of engagement rather than the quantity of engagement," Ms. Bartholdy said.

Adam Gillett, head of sustainable investment at Willis Towers Watson PLC in London, agreed with Ms. Bartholdy that there is a "big shift" in regulatory style, which moved to seeking specifics about the outcomes of investors' engagement efforts from setting policies, following the introduction of the new U.K. Stewardship Code in 2020.

"Activities are now focused on the 12-month period so that kind of discipline is forcing people into being much more tight about examples — of what they have been doing, tracking what they have been doing, change and progress," he said.

The annual reporting under the new code changed the tone and the urgency of some of what investors are doing, he added. Mr. Gillett said there was a big engagement push a few years ago and companies were given time to improve and meet investors' targets.

"But it's getting to the stage when the time is up," he added.

As part of a big push, investors are forming coalitions and setting decarbonization deadlines to put pressure on companies.

Also, money managers are bound by the same rules of the U.K. code and are presenting engagement outcomes rather than only listing their policies.

Managers are running into issues with portfolio companies as they attempt to sell climate change strategies to investors.

"Escalation is needed if a company with whom we've engaged is diverging materially from their stated path to ESG improvements," said Mike Zelouf, managing director Europe and Middle East at Western Asset Management Co., which is owned by Franklin Resources Inc.

For example, he said there are companies that had previously stated they want to transition over time from high carbon footprint assets to a greater level of renewable energy, but end up buying companies that are heavily reliant on coal power.

"It's the polar opposite" of what should be happening, he said.

Mr. Zelouf added that the firm then considers the ESG rating it assigns to the portfolio company and could end up demanding a higher risk premium to participate in new bond issues or reducing the weighting to that issuer in client portfolios.

In Europe, Dutch pension fund Stichting Pensioenfonds ABP, Heerlen, saw its engagement efforts lead to some improvements, but challenges remain, according to a spokeswoman. ABP, which has €480 billion ($519.9 billion) in assets, used a mix of strategies including voting and discussions with companies. The fund would set interim goals and monitor whether companies meet them.

But there are businesses with products and services that inherently involve damage to the planet and present a serious obstacle to achieving the Paris Agreement's goals, the spokeswoman said. ABP is now working on further renewing its requirements for including companies in its portfolio and excluding investments that don't meet the fund's requirements.

A new tactic for ABP is decreasing the number of companies in its portfolio. "With our sharper selection on companies we will invest in a smaller number of companies and therefore have a higher stake in these companies. That is essential to effective engagement," the spokeswoman said, noting that it gives the fund more influence.

ABP already decided to stop investing in fossil fuel producers in 2021, and at the beginning of 2022 it aligned its climate voting policy with carbon emission targets.

Other large investors in Europe, such as Norway's sovereign wealth fund, Government Pension Fund Global, Oslo, are also enhancing their engagement practices. The 13.8 trillion Norwegian kroner ($1.4 trillion) fund is planning to vote more actively to hold boards accountable and to promote its investor expectations, it said in a strategy report in December.

"Some of the new elements in this strategy are that we will vote against boards if they are not doing enough on climate, CEO pay and diversity at board level. Another new element is to consider filing shareholder proposals if companies fail to meet our expectations," the fund's spokesman said in an email about the new strategy. "We believe in being an active owner and our starting point is to work with companies over time, to convey our expectations, and to follow up through dialogue," he added.

Also, investors that did not have robust engagement programs before the onslaught of the pandemic are making meaningful changes. Mikael Bek, head of ESG at PenSam, the 171 billion Danish kroner ($24.9 billion) multiemployer plan for elder-care, technical service and education workers based in Farum, Denmark, said that in an effort "to put more pressure on companies" the fund is launching its own engagement efforts for the first time. These activities include co-filing shareholder resolutions and joining other pension funds in voicing concerns directly to portfolio companies. Its first focus is labor rights and tax transparency. For example, Mr. Bek said that companies are not required to report on taxes country by country, and PenSam wants to see the information on an individual country basis for its own reporting.

PenSam previously solely relied on external providers such as Morningstar Sustainalytics and Institutional Shareholder Services Inc. to engage with companies.

In Italy, the €13 billion Fondo Pensione Cometa, Milan, is also enhancing its voting policy, said fund President Riccardo Realfonzo in an emailed comment. Starting in 2023, Cometa will vote at meetings of 200 listed companies to support workers' rights, environmental protection and transparency in corporate governance. In 2022, before the new "advanced" policy was adopted, it participated in shareholders' meetings of six important companies, voting in favor of increasing female representation on boards.

This year, Cometa also intends to initiate engagement with its portfolio companies that are involved in controversies due to greenwashing, he said.