Big 3 ETF managers continuing to push the ESG envelope in 2022

IN 2012, the world's largest investor, with close to US$4 trillion in assets under management then, sent out a letter to the world's largest public companies seeking engagement on issues of corporate governance.

That letter signed off by BlackRock's chief executive officer (CEO) Larry Fink was, by current standards, short and inconsequential.

Fast forward a decade, BlackRock has cemented its position as the world's largest asset manager with more than US$10 trillion under its management, and Fink's letter, now an annual affair, has even become feared among corporate bosses for its consistent foray into uncomfortable territories.

From just urging CEOs to consider how their companies contributed to society beyond making profits in 2018, Fink, in a 3,300-word edition sent out on Jan 17 this year, said failing key environmental, social and governance (ESG) tests could lead BlackRock to sell its holdings in a company.

"Capital markets have allowed companies and countries to flourish. But access to capital is not a right," he wrote. "It is a privilege. And the duty to attract that capital in a responsible and sustainable way lies with you."

The theme was echoed in pronouncements by other "Big 3" exchange-traded fund (ETF) managers, Vanguard and State Street Global Advisors, which had also, in recent years, spelt out the ESG considerations they would look at.

State Street Global Advisors CEO Cyrus Taraporevala does it by writing annual letters as well. His latest, issued on Jan 12, stated that State Street, with over US$4 trillion in assets under management, "expects" companies on major indices in the US, Canada, UK, Europe and Australia to align with climate-related disclosures requested by the Task Force on Climate-related Financial Disclosures (TCFD).

"With approximately one-third of the companies in the S&P 500 still not providing these TCFD disclosures, we will start taking voting action against directors across applicable indices should companies not meet these disclosure expectations," Taraporevala wrote.

All these words hold weight, especially against the backdrop of a "tectonic shift" of capital to sustainable investments, which pipped US$4 trillion last year and, as Fink reminded in his letter, is "still accelerating".

For corporations here, these present "a clear signal that ESG is not simply a regulatory issue, but also one related to access to international capital", Nneka Chike-Obi, director of ESG research and sustainable finance at Fitch Ratings, told The Business Times.

Brian Ho, climate & sustainability assurance leader, Deloitte Asia-Pacific and South-east Asia, noted that institutional investors appeared "less patient" with companies that do not disclose sufficient ESG management and performance.

"Increasing forthcoming mandatory ESG disclosure requirements are to be expected," he said.

Meanwhile, Cherine Fok, KPMG's director of sustainability services, noted that although many of Singapore's large cap companies are still going through a "discovery process" around ESG disclosure, they have made substantial progress.

They have started to implement more processes and controls to strengthen governance around ESG data, embed ESG considerations in resource decisions and goal setting, as well as to link ESG data to remuneration structures, asset valuation and financial reporting, she said.

As proxy voting season nears, BT collates what the top money managers have sounded out as their focuses for 2022, and how they intend to continue pushing the envelope in the years ahead.

State Street

More companies have made net-zero commitments, with over one-fifth of the world's 2,000 public companies having committed to meet a specific target, but few have provided a clear roadmap to achieve these goals. And fewer asset managers have provided details on what they expect these companies to disclose amid the transition to a low-carbon economy.

Laying this out, Taraporevala said what State Street is seeking from these transition plans is "not purity" - a blind chase of "green" distinctions" - but "pragmatic clarity" as to how and why a company can make meaningful progress through them.

Pointing out that it is far more meaningful transitioning an asset from "dark brown" to "light brown" than from "green" to a "darker shade of green", he stated his belief that the world may well need additional investments in some "light brown" fossil fuels in the near term.

This would guard against "brown-spinning" - public companies' efforts to appear more "green" by selling off their highest-emitting assets to private equity or other actors at a discount, which only reduces disclosure and shields polluters, Taraporevala pointed out.

Starting from the 2022 proxy season, State Street would therefore expect TCFD-aligned climate disclosure reports from companies in major indices in the US, Canada, UK, Europe and Australia, he said. This includes whether the company discloses board oversight of climate-related risks and opportunities, total direct and indirect greenhouse gas emissions, and targets for reducing such emissions.

The asset manager would also identify the most significant emitters in its portfolio and engage them to encourage disclosure aligned with its expectations for climate transition plans, which cover 10 areas, including decarbonisation strategy and capital allocation.

"Starting in 2023, we will be prepared to hold directors accountable if these companies fail to show adequate progress on meeting our disclosure expectations," State Street stated in a document detailing the expectations.

Taraporevala also set higher diversity targets.

From this year, State Street would expect all its portfolio companies worldwide to have at least one woman on their boards, while it begins taking voting action if companies in the S&P 500 and FTSE 100 do not have a person of colour on their board.

Come 2023, at least 30 per cent of board seats should be filled by women directors for companies in major indices in the US, Canada, UK, Europe and Australia, he added. This change is expected to put as many as 3,000 to 4,000 more female directors on boards.

"In each instance, we are prepared to vote against the chair of the board's nominating committee or the board leader should a company fail to meet these expectations," Taraporevala stressed.

BlackRock

Two years after announcing environmental sustainability as the core goal for BlackRock's future investment decisions, Fink underlined the importance of setting targets for reducing greenhouse gas emissions, and specifically asked for short, medium and long-term goals.

These targets, and the quality of the plans to meet them, are "critical to the long-term economic interests of your shareholders", he urged CEOs to see.

This is also why BlackRock is asking for reports consistent with the TCFD framework, he added. "We believe these are essential tools for understanding a company's ability to adapt for the future."

It takes this approach as Fink, like Taraporevala, also believes that divesting from entire sectors - or simply passing carbon-intensive assets from public markets to private markets - will not get the world to net zero.

Underlining that BlackRock does not pursue divestment from oil and gas companies as a policy, Fink, rather, asks "bold incumbents" to step up given their advantage in capital, market knowledge, and technical expertise on the global scale required.

"The next 1,000 unicorns won't be search engines or social media companies, they'll be sustainable scalable innovators - startups that help the world decarbonise and make the energy transition affordable for all consumers . . ." he wrote. "With the unprecedented amount of capital looking for new ideas, incumbents need to be clear about their pathway to succeeding in a net zero economy."

He continued: "Our question to these companies is: what are you doing to disrupt your business? How are you preparing for and participating in the net zero transition? As your industry gets transformed by the energy transition, will you go the way of the dodo, or will you be a phoenix?"

Specific goalposts were stated in its updated proxy voting guidelines for Asian securities, which were effective from January 2022. For Singapore in particular, BlackRock expects all listed companies to have at least one female board director.

In relation to environmental and social issues, it will advocate for continued improvement in the companies' reporting and will hold management or directors accountable where disclosures or the business practices underlying them are inadequate, it stated.

Reiterating that robust disclosure is "essential" for investors to gauge a company's business practices and strategic planning related to ESG-related risks and opportunities, it went on to say: "When a company's reporting is inadequate, investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk."

While Fink did not reference standards put forward by Sustainability Accounting Standards Board (SASB) in his letter, BlackRock's guidelines asked companies to publish SASB-aligned reporting with industry-specific, material metrics and rigorous targets as well.

In addressing climate risk, BlackRock said companies' short, medium and long-term targets for greenhouse gas reductions should be "science-based". And companies will have to demonstrate how the targets are consistent with long-term economic interests of their shareholders.

While companies may still require some continued investment to maintain a reliable, affordable supply of fossil fuels during the transition, they should disclose how their capital allocation across alternatives, transition technologies and fossil fuel production is consistent with their strategies and their emission reduction targets, it added.

Vanguard

In the case of climate risk, the stated approach of Vanguard is that it is better to "own, engage, and encourage" boards of companies with significant coal exposure to manage climate risks through the transition to a low-carbon economy, than to exclude and divest.

The money manager, with over US$7 trillion in assets under management, said in an Investment Stewardship Insights paper last December: "Investors who rid themselves of carbon-producing assets risk selling them to those who might not want to engage and encourage change.

"This may not help - and may frustrate - the just and orderly transition to a decarbonised economy that the investor hopes to achieve."

Notwithstanding that, Vanguard stressed that climate change is a "material risk", and stated an aim to understand the transition plan of companies with significant coal exposure and ensure value creation through business-model resilience.

With that, it believes that these companies should provide clear disclosures on board-level climate competence, including an explanation of how thermal coal remains relevant for the company's customer base and the market it serves over 10, 20 and 30 years.

The board should also present "compelling shareholder value proposition" in an environment where regulatory requirements and market activity support the implementation of the Paris Agreement, and how the company will deliver shareholder value through the transition.

It should demonstrate a deep understanding of the current and emerging policy and regulatory environment or framework for their companies in their key reference markets as well.

Companies should also disclose their risk mitigation methods, including how the business is resilient within a 1.5 deg C limit of global warming as the world progressively moves to net-zero emissions, such as by serving a specific market niche or through carbon capture and storage, Vanguard noted.

Risk mitigation should also consider responsible transition plans for coal mines and power stations, including site rehabilitation and workers' retraining, to minimise risks of liabilities and litigation and preserve social licence to operate within communities, governments and other stakeholders, it added.

"Outside of shareholder proposals, the Vanguard funds may vote against directors who, in our assessment, have failed to effectively identify, monitor, and manage material risks and business practices that fall under their purview based on committee responsibilities," it said.

READ MORE:

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