EU offering better ways to engage companies

European investors are set to get better tools to engage with companies whose debt and equity they own, thanks to the European Union's enhanced standards and requirements for evaluating ESG investments.

Investors said that most of them have been more reactive than proactive about engaging when it comes to reaching their sustainability objectives. But a series of upcoming European regulatory amendments is set to help change that by giving them more transformational tools, such as disclosure requirements and bond standards, to deepen their portfolio analysis. Investors said their investment choices also could change because portfolio decisions will become better informed by broader engagement work.

Among these regulatory initiatives, to be available to investors before the end of this year, the European Commission is enhancing:

• Classification, or taxonomy, of business activities to include social standards and definitions of harmful activities.

• A renewed Sustainable Finance Strategy, which aims to accelerate transition to a low-carbon economy through increased private investments in sustainable projects.
• Sustainability programs that underpin the post-pandemic recovery, such as pushing for employment security.
• Requirements on how green bond issuers invest proceeds in order to qualify under the Green Bond Standard.
• Voting requirements on investors under the Shareholder Rights Directive II.

The commission's efforts are set to increase disclosure demands on bond and stock issuers, while helping investors obtain data on corporate activities that were not attainable to them before, sources said.

Ole Buhl, vice president and head of environmental, social and governance at the 889.5 billion Danish kroner ($139.3 billion) ATP, Hilleroed, Denmark, said that without the enhanced data that will come from the new tools, investors would engage by reacting to poor corporate operations on the part of portfolio companies. Mr. Buhl added that the upcoming changes, specifically the taxonomy, will help investors be more specific in engaging with portfolio companies on, for example, why company practices are not in line with their competitors in terms of the green transition of supply chains.

Noting climate change mitigation, Mr. Buhl said that investors to some extent know the activities of portfolio companies, but they need more details on social issues in supply chains and corporate strategies on employee management. With initiatives like the taxonomy, investors will have clearer, non-environmental information in regard to different aspects of climate change, such as data on worker turnover, he said.

Addressing current disclosure challenges that limit engagement efforts, Stephanie Mooij, senior engagement associate, at Aegon Asset Management in Frankfurt, noted that data on the livestock industry, for example, has been distorted. Once companies start to measure, they can better manage reducing their greenhouse gas emissions, she said. Every company is disclosing in a different way, so it is not comparable, she said. The taxonomy will make comparisons across companies easier and more accurate, she added.

Still, Ms. Mooij noted that more standards are needed beyond what are coming online this year. Ms. Mooij thinks more detailed industry-specific data disclosure, including indirect carbon emissions from supply chains, is needed for investors to do a thorough analysis.

Sources added that the initial scope of the taxonomy has increased since the outbreak of the coronavirus pandemic.

The commission currently is working on aligning its budget spending with taxonomy objectives while incorporating additional focus on social standards on how companies operate. It's also working on new classification of harmful activities alongside low carbon economy transitional activities, sources said.

Nathan Fabian, chief responsible investment officer at Principles for Responsible Investment in London, said that with green and harmful criteria, it will be easier to make comparisons between companies. Such criteria could show that automaker A's operations, for example, are 70% harmful, 20% neutral and 10% green, but automaker B's operations are 60% green, 30% neutral and 10% harmful. That would make it clearer for an investor to determine which company to invest in, he said.

Mr. Fabian added that the commission is planning to formalize the new emission targets with a goal to reduce carbon emissions by at least 50% by 2030 under the renewed Sustainable Finance Strategy that would see corporations pay more in emission payments. That would affect companies' financial performance, he added.

Addressing current challenges faced by investors who engage with companies, ATP's Mr. Buhl added that climate-specific issues are not the only important issue relative to sustainability that investors need information on to evaluate when it comes to the sustainability of the businesses.

"It's extremely important how portfolio companies are retaining expert workers," he said. "When we have that benchmark in place, we will be able to lead our engagement efforts on different social metrics."

ATP is currently allocating more resources to engagement, Mr. Buhl noted, adding that more information on portfolio companies could determine future investment choices.

The European Commission is also gearing up to impose harsher requirements on bond issuers to limit the issuance of low-quality green bonds, sources said. The lack of transparency over how proceeds are invested currently stops many investors from investing in green bonds that do not meet the international frameworks backed by organizations such as the European Investment Bank or the World Bank, sources said.

Enhanced green bond standards will help investors who are looking to increase their green and social bond exposures in the coming years. For example, the €420 billion ($489.4 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands, intends to have social and green bond investments constitute 20% of all assets by 2025.

Claudia Kruse, managing director and head of responsible investment and governance at APG Asset Management NV, the in-house manager of ABP, said in a telephone interview: "The more clarity there is on standards for both green and social bonds the more this helps to ensure the proceeds are being put to a good use."

"Standards will support us in our own due diligence," she added. To date, APG has invested €9 billion in green and social bonds on behalf of ABP and its other clients.

Brussels-based Johan Barnard, head of international public affairs also at APG Asset Management, noted that the EU's recovery plan in response to the pandemic, agreed to on July 21, could facilitate further transformational tools for investors.

Under that recovery plan, the commission will issue up €100 billion in EU standards-compliant social bonds and COVID-19- linked bonds. The bonds will be guaranteed by EU countries and will finance programs that will pay the salary of workers to keep their jobs, Mr. Barnard said.

For Carola van Lamoen, head of active ownership at Robeco in Rotterdam, the Netherlands, the EU's renewed Sustainable Finance Strategy and Shareholder Rights Directive II are also a big push toward more communication between investors and executives at portfolio companies, including a focus on outcomes and actual achievements resulting from engagement.

Under SRD II, investors across Europe are required to vote annually on remuneration of chief executives of European companies and give evidence they are actively participating in the voting rather than outsourcing it to external providers.

Stewardship will become more demanding, she said, adding that shareholder proposals are already increasing in volume. "Also, the quality of the (shareholder) proposals is improving," she said.

EU offering better ways to engage companies