Engagement and voting practices

Engagement activities 

Research and prioritisation 

This due diligence process can be based on internal desk research on raw company data, information and scoring provided by specialised ESG research service providers/brokers and any other resources investors may use to verify or triangulate potential controversies (i.e. reports from national authorities, NGOs, media coverage, statements from National Contact Points). Participating in multi-stakeholder forums on specific ESG issues can also help refine research methodologies and evaluations. This research phase can partially overlap or coincide with ESG monitoring systems set up to support incorporation practices (i.e. screening, integration and thematic investment). The same research used to identify cases of engagement will be continuously integrated with the insights gained during the dialogue with companies following a circular rather than linear process (see figure 3 below).

“As an index investor we have to prioritise. We do not want to replicate efforts so we may consult with other investors about their engagement work and consider whether to collaborate on issues being led by them. We consciously focus on sectors and themes that are largely ignored.” Diandra Soobia, Head of Responsible Investment, NEST, Asset Owner, UK

As institutional investors would usually hold thousands of companies in their portfolios and only be able to meaningfully engage with a small number of investees, setting up criteria for prioritisation is required. Prioritisation defines how company due diligence resources are targeted and recognises that not all ESG risks and opportunities can be identified and addressed.

Typical criteria of prioritisation for further analysis would include:

• the largest holdings as they would pose the biggest risk to portfolio performance;
• specific markets considered, particularly those that are exposed to ESG-related risks and opportunities, or local markets the investor might be more familiar with and more exposed to;
• specific sectors considered that are particularly exposed to ESG-related risks and opportunities;
• companies in the lowest ranks of several ESG benchmarks to best mitigate risks;
• companies in the highest ranks of several ESG benchmarks to raise the bar of industry performance;
• companies in breach of international norms (i.e. conventions or the UNGC principles);
• companies exposed to controversies on specific ESG issues over a long to medium period of time using external sources of information;
• specific ESG themes representing the highest value at risk or the highest potential of impact; and
• specific issues considered a priority for the investor based on input from clients and beneficiaries.

Based on an organisation’s approach, this prioritisation process could be centralised through an ESG team or decentralised through independent investment teams. In the latter case, communication and coordination will be necessary to ensure synergies and alignment.

Following further investigation, investors would need to assess: the severity/opportunities of the cases; the potential to effect change with available resources and expertise; past interactions; time constraints; the impact on long-term shareholder value; and existing efforts by other investors. This would ultimately be a cost-benefit analysis which might culminate in a decision not to engage. Such analysis should be done by ESG teams in collaboration with portfolio managers.

Engagement cases usually fall into two categories:

• Proactive engagements: When investors seek dialogue with priority companies based on their preventive analysis of material ESG issues and megatrends.
• Reactive engagements: When investors initiate dialogue with companies in reaction to a controversy or scandal which is presenting a financial and reputational risk.

Defining objectives and tracking results

Once the list of target companies has been defined, setting objectives and tracking results will be necessary to assess achievements and next steps. These objectives should be developed by ESG teams in consultation and collaboration with investment teams to ensure robustness and consistency of messages to companies. Examples of objectives for target companies include:

• developing a human rights policy;
• setting up a whistleblowing monitoring system;
• defining emissions reduction targets;
• improving skillset balance at the board level;
• joining a multi-stakeholder initiative tackling a specific issue; and/or
• increasing information provided to the market on ESG matters.

Measuring performance on specific ESG KPIs and scores could be another way to assess success. Investors might find it useful to define milestones and timelines at the start of engagement, although these will need to be continuously reviewed to reflect internal and external developments during the multi-year dialogue with target companies. Tracking systems would facilitate record keeping, on a progressive basis, in the following areas: interactions (i.e. letters/emails/meetings/on-site visits); corporate representatives met; information/documentation received; commitments from management; and regular assessments of ESG performance. While this information is usually kept internal and confidential, such systems are useful for preparing reports for clients and the public on the progress and results of engagements.

Engagement dialogue can be tracked through tailored, preferably cloud-based, IT systems or customer relationship management (CRM) tools, available across the organisation, from ESG analysts to portfolio managers (see table below for examples). While setting milestones to measure objectives is useful, this might not always be possible for each engagement dialogue and success should always be contextualised; having all milestones covered does not necessarily mean that dialogue cannot be improved. On the other hand, missing milestones might lead to perceived failure and a reluctance by investors to take on difficult issues where progress is not guaranteed or measurable. As a matter of fact, recording the details of an unsuccessful dialogue with a company could be extremely insightful from an ESG integration perspective. Investors also need to be openminded about how companies can address a problem, and management should have as much as or more to say about finding the solutions than investors.

Examples of systems to monitor engagement results

ORGANISATION	BRIEF DESCRIPTION OF SYSTEMS
Æquo Shareholder Engagement Services, Service Provider, Canada	Æquo defines measurable objectives at the beginning of each new engagement. Different objectives can address one issue/topic and they can also be set during dialogue. Objectives include: the adoption of a SMART (specific/measurable/agreed upon/realistic/time-based) target, an internal process, a policy or a specific disclosure. A rigorous tracking system is used to measure committed and realised changes in the organisations they interact with. This system is based on a series of defined objectives for each engagement (be it collaborative or individual) and grades progress on a defined scale of zero (objective not yet communicated) to four (objective met). The assessment of these formal objectives are combined with other evaluations (such as general dialogue appreciation, the quality of management or other aspects difficult to measure) that allow them to monitor change.
BMO Global Asset Management, Investment Manager, Canada	BMO tracks milestones on all engagement aspects. It also captures the narrative around materiality and impact of the progress made by the company (indicated by a number of stars). In addition to milestones and qualitative analysis of engagement track record, BMO is increasingly quantitatively documenting the engagement journey and insights gained throughout the process. The SDGs are also able to provide another language to categorise and define specific outcomes. Existing engagement categories have been mapped against the goals as a starting point.
Boston Trust/ Walden Asset Management, Investment Manager, US	Boston Trust/Walden maintains a database of companies included in the engagement programme and updates it quarterly. At the end of each calendar year, progress is assessed for all engagement activities and reports are prepared for clients and consultants. To evaluate progress, it periodically assesses company engagement as follows: 1) Progress was observed: engagement contributed to new or amended policies; engagement contributed to more sustainable business practices; and/or engagement led to greater transparency and accountability. 2) No significant progress; engagement is ongoing. 3) No additional follow-up is planned.
British Columbia Investment Management Corporation, Investment Manager, Canada	bcIMC has developed a set of KPIs for its engagement themes so it can track overall progress that it has made. Its KPIs measure progress over five or more years and link to the many methods bcIMC has contributed to each theme including individual and collaborative engagement, proxy voting, filing shareholder proposals and making public policy submissions to advance broad market change.
Hermes EOS, Service Provider, UK	Hermes EOS’ proprietary milestone system allows it to track progress in its engagements relative to objectives set prior to or following interactions with companies. The milestones used to measure progress in an engagement vary depending on each concern and its related objective. They are broadly defined as: 1) concern raised with company; 2) acknowledgement of the issue; 3) development of a credible strategy to address the concern; and 4) implementation of a strategy or measures to address the concern. In addition, Hermes EOS will track when an engagement objective has failed or has been discontinued having become obsolete. Each year, Hermes EOS reports on the number of engaged companies, number of issues raised and objectives, and progress made in achieving milestones set for each engagement by categories of topics covered (E, S, G and strategy/risk).
PGGM, Investment Manager, Netherlands	PGGM’s database tracks all the necessary documentation and progress of engagement conducted by both RI and investment teams. The system includes all the activities that have contributed to an engagement result. Assessments are discussed by a results committee within the RI team to challenge each other and define if a real contribution has been made. Subsequently, the head of the RI team reviews the process and adds their opinion. Finally, the auditors will decide if the results can be reported or not.
Regnan, Service Provider, Australia	Regnan starts with detailed research into a company’s individual risks. It uses this to prioritise and develop objectives for change to see these problems addressed. Engagement success is measured in terms of whether these changes happened and the extent to which this was due its engagement.

Key factors for successful dialogue 

Evidence shows that engagement quality is more important than quantity to achieve results. As good engagement is time and resource-consuming, investors have to decide where to focus their efforts to achieve the biggest impact. Recent academic research commissioned by the PRI analysed the perceived barriers and enablers to good engagement dialogue from both a company and investor perspective (see table 8 for more detail).

Based on insight from research and interviews with signatories, investors can do the following to ensure that engagement generates positive results:

• Arrive prepared and provide feedback. Investors should enter an engagement with a clear agenda, having reviewed financial and sustainability performance data in depth and having talked to experts beforehand. Bringing ideas and expertise to how a problem can be solved provides value for the organisation in question. After the meeting, investors and corporate management should jointly approve a confidential summary of the discussion and commitments made. Investors should also seek feedback on the quality of the meeting and improve it accordingly.
• Demonstrate a holistic understanding of the company’s performance and strategy. Investors need to understand how the company fs business operates; a holistic evaluation can clarify how companies and investors are focused on attaining similar goals.
• Understand the corporate culture. Investors can grasp corporate culture and human dynamics by considering a series of red flags/indicators that could signal a shift, including: high turnover; discussions with board members and operational staff; results of employee surveys; customer satisfaction; fines and penalties; and incentives/remuneration.
• Be sensitive of cultural differences. Communication and engagement strategies need to be adapted to the local market. Whenever possible, speaking the local language is an advantage.
• Visit site operations. Opportunities to visit company sites enable investors to gain a deeper understanding of the company’s operations, which can complement engagement activities. Visits also give investors the opportunity to collect feedback from local experts, government representatives and other stakeholders.
• Praise positive practice. Positive engagement is very cost-effective as it helps ensure processes are maintained without needing to start again.
• Focus on the business case and materiality. Managers are more likely to incorporate ESG strategies into their organisations when doing so is clearly associated with greater economic opportunities, increased competitiveness and improved long-term prospects for the firm. Materiality could also be related to ESG issues that are particularly relevant to a company’s stakeholders. The dialogue can then focus on the issues that may affect the company fs bottom line if not adequately addressed. Recent academic research shows that firms with good performance on ESG material issues and concurrently poor performance on immaterial ESG issues perform the best.
• Present a consistent and integrated message. Companies want to hear consistent and integrated messages from ESG analysts and portfolio managers who should both join meetings with companies. When this is not feasible, sharing of information and alignment is crucial. Companies would also benefit from understanding how the information collected during dialogue will be used to inform investment decisions.
• Make connections. Companies are usually contacted by numerous investors, and groups of investors, on similar issues simultaneously. Investors should reference other efforts they are aware of and express support for requests from other shareholders aligned with their objectives for dialogue. Similarly, investors should share with other peers the focus of their engagement programme.
• Align requests with international standards, where possible. Simplifying requests and referencing international sustainability frameworks can address companies’ concerns about receiving varying and detailed questions from ESG specialists.
• Time your requests accurately. Investors should keep in mind the company’s position in the business cycle and its current focus on certain issues when defining their requests.
• Share best practices. Investors benefit from having a dialogue with lead companies to identify best practices they can refer to and share with laggard companies.
• Build on and foster ongoing and trustworthy relationships. Fruitful meetings stem from a long history of engagement and productive relationships with corporate management. Dialogue is not just about one meeting but a long-term process where investors show persistence and consistency in their approach and respect for an agreed level of confidentiality/publicity. Engagement is also about listening and being open to what management is saying, beyond asking questions and monitoring.

Depending on the topic, shareholders might want to speak with different corporate representatives, including: investor relations (IR); CSR/sustainability departments; heads of departments (i.e. supply chain or HR); company secretary/general counsel; and the board (CEO, chairman and independent non-executive directors or the lead independent director). Access to the board is fundamental to understand the strategic direction of a company and cover issues such as leadership, board composition and management performance and succession, while discussions with operational staff can help to gain deeper insights on specific environmental and social issues. Contact with members of the board can be sought as an escalation strategy if issues of concern or initial questions cannot be resolved through first conversations with IR or sustainability departments.

Escalation strategies 

If dialogue does not bring the desired outcomes after a certain period of time, investors can consider different escalation strategies to trigger corporate reaction. Depending on the jurisdiction they belong to, these strategies might follow different orders. Possible next steps after an unsuccessful engagement include: 

• communicating with the board: expressing concerns to corporate representatives or non-executive directors, either directly or in a shareholders’ meeting;
• collaborating with other investors to increase pressure on the company;
• issuing a public statement and organising a media campaign;
• submitting shareholder resolutions in relation to the ESG issues of concern;
• voting against the re-election directors who are responsible for the topic of engagement (i.e. risk and audit committee members);
• voting against the board of directors or the annual financial report;
• submitting one or more nominations for election to the board;
• seeking legal remedies or arbitration; and
• threatening to reduce exposure or divest.

Litigation usually takes place through class actions and is considered a measure of last resort to receive financial compensation and trigger remedial action. While some can argue that it causes shareholders to pay other shareholders and lawyers to take a big proportion of money recovered, litigation can also be seen as an investor fs fiduciary duty to recover clients f financial resources and help institutionalise necessary corporate changes including new governance structures.

Voting practices 

Engagement and voting practices are interlinked and feed into each other. Investors might start a dialogue with companies before the voting season in relation to particularly contentious items on remuneration, board structure or shareholder rights, and then start a more in-depth engagement to achieve a required change in corporate governance. In some markets, where engagement capacity is more limited, voting might be the only tool available to communicate with companies and raise concerns. In other circumstances, investors might vote against a management resolution as an escalation strategy and express dissatisfaction following unsuccessful engagement on ESG issues. More generally, engagement activities provide an opportunity to apply timely and nuanced factors within the voting decision-making process. This is also why engagement and voting policies are often highly related or combined in one document.

While voting is an essential tool for investors to express their voice and should be widely used by any responsible shareholder, its exercise might not always be possible. As outlined in the overview on current barriers to active ownership (see introduction), share blocking, necessary power of attorney or onerous bureaucratic procedures might prevent investors from voting all the shares on which they are entitled to vote. In these situations, investors will apply a cost/benefit analysis and decide whether to vote or not. Many investors prefer to bear the short-term costs of voting to protect long-term value creation.

Without direct vote confirmation from issuers, investors cannot guarantee that their votes reached the final destination either. Several investors consider this a concern for the industry and responsible investment and have piloted projects to understand the underlying causes of lost votes in key markets for their holdings. Ideally, each investor would analyse a small sample of stocks after the voting season to ascertain the frequency of the problem and engage with the various actors of the chain (i.e. proxy agent, custodians, sub-custodian, registrars etc.).

Different models to exercise voting

As institutional investors have the right and responsibility to vote on thousands of companies in a very concentrated period of time each year, the use of third-party research and services is almost essential. Proxy advisors are hired to recommend and sometimes cast proxy statement votes on behalf of investors, while proxy analysts look at the issues raised by resolutions to be voted on at company general meetings. When contracting these advisors, responsible investors do not automatically take on board their voting recommendations and make informed decisions based on a triangulation of sources, including internal research and engagement. Such analysis requires time and resources; investors will therefore have to define their criteria for prioritisation (i.e. domestic markets, controversial or key topics, large shareholdings, current engagements etc.). Engaging with proxy advisors and providing them with periodic feedback on their analysis and recommendations through surveys, questionnaires or one-to-one meetings is also part of being an active owner. Asset owners and investment managers can exercise voting in several ways. Each option involves a combination of in-house activities, outsourcing and decisions based on centralisation versus decentralisation, and customised versus standard services.

Asset owners with segregated accounts could:

• Centralise voting activities and carry them out internally even when assets are totally or partially managed externally. Proxy advisors can be hired to provide recommendations based on a tailored voting policy or an agreed standard policy and investment managers can also be consulted, while internal staff will review these recommendations following defined criteria. This option ensures full ownership of the process and ensures that all shares are voted in a consistent way as defined by the investor according to its investment beliefs.
• Delegate voting activities to investment managers following a customised voting policy, when possible. This option safeguards consistency but asset owners will have to ensure that investment managers follow their policy accurately and consistently across several mandates.
• Delegate voting activities to investment managers or service providers following their own voting policy. This option would entail in-depth due diligence work by asset owners during the selection process to ensure that the third party fs voting policies are consistent with their investment beliefs and responsible investment strategy. Consistency would be more challenging to achieve as each mandate would potentially follow a different voting policy.

Asset owners with investments in pooled funds could:

• Make sure that voting considerations are an intrinsic part of the investment manager’s selection process so that they are satisfied with the third party fs voting policy and how their shares will be voted.
• Supply research to the investment manager on priority ESG issues or concerns to influence the development/review of their voting policies and their voting decisions, although the investment manager will retain full freedom to make the final decision.
• Agree with the investment manager to vote proportionally on the shares held (i.e. pro-rata voting) following their tailored voting policy and try to garner support from other asset owners with similar views. Many investment managers believe this option is unfeasible when funds are pooled at the custodian level in an omnibus account.

Investment managers could:

• Outsource all voting activities to third-party providers following either a tailored or standard voting policy with various degrees of monitoring and selection. This approach would not require as extensive resources as other approaches, but would give less control and ownership of the voting process.
• Keep voting activities in-house and allow each portfolio manager to execute their votes with support from internal specialists and third-party research. While this option allows portfolio managers to have more flexibility and take into consideration the risk appetite and economic interests of their clients, there is a high risk that the same organisation votes inconsistently for the same stock. This can only be avoided by facilitating robust internal communication.
• Keep voting activities in-house and centralise them in an ESG/voting unit that is responsible to vote for the entire organisation. This model makes use of proxy advisors f recommendations but internal staff are responsible to review and finalise decisions. Consistency is guaranteed by this approach but the organisation will have to make efforts to involve portfolio managers in the decision-making process.

How to make voting decisions

While voting policies can help to guide investors’ decision-making process, research and discretion will always be necessary to ensure meaningful voting. Lead investors would use a combination of internal and external resources and would involve ESG experts as much as portfolio managers. An active shareholder would also benchmark its voting decisions against those of its peers to understand new trends and evolving thinking in the industry. The diagrams below show best practice examples of the steps taken to execute final votes by an asset owner and investment manager respectively.

Filing and voting on resolutions

A component of exercising shareholder rights is the option of filing shareholder resolutions to put ESG issues to vote during an AGM. In some countries (such as the US), this is more common practice than in others and it is regarded as a possible way to contact the board of a company and initiate a discussion. Initial openness and responsiveness by corporate management could result in the proposal being withdrawn. Alternatively, the dialogue would continue after the vote, particularly if the resolution gains meaningful support from shareholders.

In other countries, where filing resolutions is more cumbersome and votes are binding and not advisory, shareholder proposals are more widely considered as a rare escalation strategy after private dialogue has been unsuccessful. Regardless of the approach, there has been an increase in the number of ESG resolutions filed by investors in recent years, especially in the US, as well as higher interest among asset owners in monitoring how investment managers have voted these resolutions. Investors might decide to file or co-file a resolution directly or simply consider how to vote on ESG resolutions filed by peers. The former practice is not as broadly applied by investors as the latter. When considering how to vote on ESG resolutions, investors’ individual voting policies are the first point of reference.

However, there are other useful criteria investors can use to assess the quality of ESG proposals, including:

• The topic: Good shareholder proposals show that the issue is financially material for the company in the long run and that changes can be made with no harm.
• Leadership: Resolutions are often filed with the largest companies as they pose the highest value at risk. Smaller companies from the same sector with similar risks may not be targeted. Effective resolutions invite the target company to be an industry leader without giving management the impression that they have been singled out.
• The evidence: Adequate research and documentation should support the aim of the resolution.
• Current performance: Good resolutions should be based on a strong understanding of what the company is currently doing well in and what needs to be improved.
• Previous engagement: The proposal should provide evidence that the company has already been engaged on the topic with no results to date.
• The tone: The resolution should not be prescriptive and leave it to management to propose a strategy to tackle the issue without giving a sense of investors micromanaging the company; more general proposals are usually easier to support than very detailed and specific requests.
• The suggested timeline: The proposal should be realistic and give sufficient time for management to react (without imposing an hard deadline).
• External pressure: Effective resolutions make the case for action based on peer positions, regulation and stakeholder pressure.
• Disclosure: Resolutions asking for more information and transparency on issues of concern are usually aligned with the responsible investment strategy of many institutional investors.

In 2016, the PRI piloted a system for investors to declare their voting intentions on ESG resolutions filed by PRI signatories to increase awareness and information sharing on these resolutions.

Director nomination

As included in the OECD Principles of Corporate Governance, a fundamental ownership right is the ability of shareholders to vote at shareholder meetings and to elect and remove directors from the board. While individual country codes of governance may differ with regard to their specific approach to director nominations, it is generally accepted, at least in major markets, that shareholders should be able to participate in and influence the director nominations process3. Putting forward specific board member candidates to be considered in the nomination process requires research and resources which cannot be allocated for every investee company in large portfolios. However, when used and available, this practice allows investors to actively contribute to the composition of the board in cases where a company has not been able to propose a group of candidates with the appropriate mix of skills, competences and background for the long-term success of the business. Some countries (e.g. Brazil and Italy) allow minority shareholders to present their candidates for election. 

Communicating with companies

Beyond research and casting votes, voting involves communicating with investee companies before and after the AGM. Where possible, investors should raise concerns with companies before voting against or abstain to initiate dialogue, receive additional information and then start shaping corporate behaviour. When this is not feasible, investors should publicly share the rationale for their votes against management or abstentions and explain their view with interested companies directly, either voluntarily or following a company’s request.

Relation to investment decisions

Integrating active ownership practices into investment decisions is one of the most difficult yet necessary tasks to achieve a holistic investment strategy. One of the challenges is that engagement and voting practices are often carried out by ESG teams, service providers or investment managers who are not responsible for the investment process. However, leading investors have developed practices to ensure that information and insights collected through active ownership can feed into the investment decision-making process.

Best practices include:

• ensuring regular cross-team meetings and presentations;
• sharing active ownership data across platforms that is accessible to ESG and investment teams;
• encouraging ESG and investment teams to join engagement meetings and roadshows;
• delegating some engagement dialogue to portfolio managers;
• involving portfolio managers when defining an engagement programme and developing voting decisions;
• establishing mechanisms to rebalance portfolio holdings based on levels of interaction and outcomes of engagements and voting; and
• considering active ownership as a mechanism to assess potential future investments.

Download the full report

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  A practical guide to active ownership in listed equity

  February 2018