In the relentless face of our planet’s escalating challenges, the urgency to embrace environmental, social and governance (ESG) stewardship has never been more crucial.
Last year was the hottest on record – a refrain we will likely see on a recurring basis in the future. Once an alarming outlier only concerning the most visionary insurance firms, extreme weather events have now become a daily reality, leading the Financial Times to ominously predict the advent of an “uninsurable world.”
Time is running out fast before the damage done is irreversible – but not all hope is lost.
The landmark Paris Agreement of 2015 cemented the private sector’s role in driving forward the decarbonisation of the global economy. Since then, ESG principles have become part and parcel of the business world, with the financial sector not exempt.
By virtue of the sheer size of the assets it manages and the financial flows it encounters every day, the asset and wealth management industry is a pivotal player in propelling the green transition. This can be achieved not only by channelling investments towards assets that implement and promote ESG principles, but also by steering investee companies towards decarbonisation. ESG stewardship is thus a core tool to drive the sustainable transformation of the global economy.
But is it being used to its fullest extent?
Asset managers have significant influence…
As per the Principles for Responsible Investment, stewardship is defined as “the use of influence by institutional investors to maximise overall long-term value including the value of common economic, social and environmental assets, on which returns and clients’ and beneficiaries’ interests depend.” In other words, it entails asset managers actively engaging with their investee companies to set, among others, the business strategy, the risk management policies and procedures, or ESG considerations in the long-term interests of their clients.
With global assets under management (AuM) standing at USD 115.1tn in end-2022, asset managers theoretically have considerable influence over how companies carry out their operations. This also applies to alternative managers, whose AuM stood at USD 18tn – a figure poised to grow as alternative investments increasingly gain favour from retail and institutional investors alike.
As of 2021, the three largest asset managers in the United States – BlackRock, Vanguard and State Street Global Advisors – were estimated to own 21.9% of companies on the S&P 500, with recent academic research showing that the ‘Big Three’ have “substantial voting power” which is “likely to persist” and “grow.”
In Europe, the landmark Sustainable Finance Disclosure Regulation (SFDR) requires financial market participants – including traditional and alternative investment fund managers – to “publish and maintain on their websites […] brief summaries of engagement policies in accordance with [the EU Shareholder Rights directive].” Frédéric Vonner, sustainable finance and sustainability leader at PwC Luxembourg, states that “in theory, the SFDR’s transparency disclosure requirements on engagement policies could encourage asset managers, particularly those who strengthen their sustainability credentials, to adopt more active ESG stewardship in their investee companies.”
Within Luxembourg, a pioneering international hub of sustainable finance in the heart of Europe, “the local regulatory authority regularly checks on management companies (ManCos) to ensure they design and enforce stewardship policy,” Vonner adds.
While traditional asset managers do have influence over their investee companies through general assembly votes and shareholder proposals, alternative managers active in private markets tend to have a much more substantial influence over their portfolio companies.
Jean-Florent Richard, ESG Regulatory Lead at BNP Paribas’ securities services business, underscores that “hedge funds and private equity firms, compared to traditional asset managers, are more inclined to employ active ownership for decarbonisation initiatives within their portfolio companies”.
Echoing the findings of BNP Paribas’ ESG Global Survey 2023, Richard emphasises that “alternative asset managers, with their substantial stakes and board representation, wield significant influence in shaping the business strategy of portfolio companies.” This could entail “setting a climate transition plan with clear net zero targets alongside overarching ESG principles across the business, hence making active ownership work.”
…but the potential remains untapped
Proxy voting provides a formal avenue for asset managers to express their view on crucial matters and can indicate their commitment to ESG. However, it appears that ESG stewardship is not being implemented sufficiently in a way that reflects investors’ long-term interests.
For instance, in November 2023 the UK Asset Owner Roundtable found “significant” misalignment between investor preferences and proxy votes on oil and gas companies. Not long after, ShareAction, a London-based civil society group that advocates for ESG principles in corporate decision making, published its Voting Matters 2023 report which found that the largest asset managers have “regressed” when it comes to supporting ‘E’ and ‘S’ shareholder resolutions in their investee companies.
Nonetheless, according to Jane Wilkinson, a Luxembourg-based non-executive director and founder of Ripple Effect, “asset managers in Europe tend to be more active in ESG stewardship than their peers in other jurisdictions.” This view is echoed by the aforementioned ShareAction’s report which highlighted how the sustainable finance regulatory developments in Europe “appear to have improved the voting performance of European asset managers” on ESG issues.
Towards responsible ESG stewardship
Part of the recent anti-ESG backlash is rooted in the notion that financial performance and ESG are mutually exclusive, with the latter supposedly having an adverse impact on the former and hence leading to a breach of asset managers’ fiduciary duties.
But given the deleterious impacts that climate change and biodiversity loss are having on firms’ bottom lines, alongside changing stakeholder expectations and the very serious reputational and legal risks posed by poor ESG track records and compliance, this argument cannot hold unless one adopts a narrow short-term perspective.
“Many asset managers ignore biodiversity loss and climate change at their own peril,” Vonner stated. “We are already seeing how whole sectors – from insurance and real estate, to manufacturing and trade, to name a few – are being upended by extreme weather events rendered worse by the collapse of ecosystems.”
The investment approach adopted by Nikko Asset Management illustrates how ESG and financial performance go hand in hand. According to Natalia Rajewska, Global Head of Sustainable Investment, the firm strongly believes “that stewardship, including fiduciary and ESG considerations, are inherent to long-term corporate value creation and contribute to the realisation of sustainable economic growth.” In addition, the firm incorporates “ESG principles in its investment processes” as it sees “ESG issues as an integral part of fiduciary duty to clients.”
ESG stewardship thus cannot be relegated to a mere box-ticking exercise. From engaging directly with investee companies’ board and management to proxy voting on key resolutions, it can bring forth enhanced risk management capabilities and processes, improved returns and meaningful impacts on sustainability factors when carried out adequately.
Based on her extensive experience in the asset management industry in Luxembourg, Wilkinson advocates for a two-pronged approach whereby “asset managers and fund boards would proactively and clearly communicate what their ESG targets and challenges are” whilst also “regularly inviting dialogue with their investors to obtain any necessary guidance and expectations and thus better understand how to embark on an ESG transition. Such a dialogue with, generally, institutional investors will also contribute to inform investment strategies adopted in retail financial products.”
“Ultimately,” Wilkinson adds, “boards need to keep the big picture in mind – namely, how crucial it is to seriously consider and reflect on the ESG risks and opportunities ahead – view proactive asset managers as partners to drive value creation and work with less active managers to push forward necessary actions.”
Furthermore, PwC Luxembourg’s Vonner highlights that “proactive and transparent ESG stewardship could help sustainability-focused asset managers differentiate themselves from their competitors and stay ahead of emerging trends in the industry.” Successful asset managers in the future will likely exhibit full ESG integration across their product suite, with a clear responsible investment policy which includes robust stewardship strategies that drive investee firms’ ESG transformation.
And there is no shortage of ESG-related topics which require active collaboration between investee companies and asset managers.
The aforementioned BNP Paribas survey highlights that among “the 50% of respondents who plan to use active ownership as part of their ESG investing approach” in the next two years, they will prioritise climate change and decarbonisation, as well as biodiversity and health – two topics which are also becoming important in the minds of investors.
It is more efficient to transform already existing companies than to wait for a Schumpeterian process of ‘creative destruction’ whereby companies ill-equipped for the decarbonised future go extinct and get replaced by a dazzling array of green-focused startups whose success and survival is far from assured.
Rather than punishing firms by divesting, asset managers in public and private markets should make the best use of their shareholder rights to help steer companies towards ESG territory. “Even if the primary liability remains with the companies whose operations could have adverse impacts on environmental and social matters, asset managers – like all the other financial institutions – are essentially intermediaries in the process by distributing capital and underwriting risk,” says BNP Paribas’s Richard. “Their fundamental purpose is to provide funding and resources to the economy.”
As Rajewska states, Nikko Asset Management recognises its “wider role as guardians of market integrity and responsibility to minimise systemic risks to ensure that markets continue to be run for the benefit of the whole of society.” Such an overarching view should inform the rest of the industry when it comes to ESG stewardship.