Stewardship shifts to impact

With great power comes great responsibility. As institutional investors exercise their power to invest their clients’ money, they have a responsibility to act as stewards of the capital. Stewardship does not end with buying or selling a stock, but includes the engagement by institutional investors with publicly listed companies to generate long term value for shareholders. Such engagement increasingly requires consideration of environmental, social and governance (ESG) issues.

As put forth in the CFA Institute report titled “Stewardship 2.0: Awareness, Effectiveness, and Progression of Stewardship Codes in Asia Pacific” published in 2020, stewardship is vital to the healthy functioning of markets, supports market integrity, improves capital allocation, and helps deliver good outcomes for clients and ultimate beneficiaries.

The 2008 global financial crisis threw the need for engagement into sharp relief. By acting as responsible stewards of capital, and by addressing company underperformance, institutional investors can check and curb short-term behaviours and excessive risk taking. This was especially pertinent in the UK where it gave rise to the first regulatory-backed stewardship code in 2010.

The adoption of the first Stewardship Code in the UK inspired a number of other markets to follow suit. In Asia Pacific, at least nine markets have since established their own codes to encourage institutional investor engagement.

While the codes share many similarities, such as the requirement to establish and disclose a stewardship policy and a conflicts of interest policy, each market has its own unique objectives. The main driver of the UK code was to prevent a recurrence of the banking crisis, but in Japan, for example, the motivation was to reduce the equity market discount by placing an emphasis on shareholder value creation.

Despite their short track records, stewardship codes have already been getting makeovers to reflect new  challenges. While the focus to date has largely been on disclosure of voting and engagement policies, there is a move toward disclosure of voting records, and disclosure of reasons for such votes. Disclosures of conflicts are also high on the priority list.

One notable trend is in the elevation of sustainability and ESG issues on the stewardship and engagement agenda which encompasses not just voting but also active, constructive dialogue between investors and their companies regarding sustainability and ESG themes. By encouraging companies to pay greater attention and provide more information on material ESG issues, these companies would be better positioned to deal with such challenges and improve their performance, which in turn, would help value creation for shareholders. This is also in-line with the Principles of Responsible Investment in which signatories pledge to be active owners and incorporate ESG issues into ownership policies and practices.

This heightened attention of ESG issues is being reflected in several code upgrades.  The updated 2020 UK Stewardship Code, for example, asks institutional investors to take ESG factors, including climate change, into account and to ensure their investment decisions are aligned with the needs of their clients. In Asia Pacific, similar upgrades took place in 2020 in Japan and Taiwan. Codes in Australia, Malaysia and Thailand also emphasise the importance of ESG factors.

While engagement and monitoring are worthwhile activities, they must also be outcome-oriented and serve a clear purpose. In the past, it may have been sufficient for institutional investors to pay lip service and report on a list of stewardship activities, without drawing attention to how effective those activities were, and how fiduciary duties were fulfilled.

However, as expectations evolve, there is a growing desire for clients to understand better how their money is being invested. The institutional investors which are most advanced in this space undertake thorough research to identify those companies that have the most potential, set well-defined objectives and measurable targets for their engagement activities, and would report to clients the outcomes of their efforts as well as revised action plans, where appropriate. This is effectively a multi-stage, iterative process. In the event that constructive engagement does not deliver the desired outcomes, escalation measures may be considered, including, for example, collaboration with other investors, and even divestment for active investors.

As a result of these trends, adjustments are being made to operating models. Some institutional investors have supplemented their bench strength by hiring dedicated ESG analysts or by providing relevant training to raise the level of knowledge in the investment teams. While there is no one-size-fits-all approach, it is important that the investment professionals stay current and remain effective in this important area.

As sustainable investing continues to gain prominence, so is the expectation of institutional investors to exercise their stewardship for purposeful outcomes. The focus is also shifting from the amount of engagement to its quality. This presents a unique opportunity for institutional investors and companies to elevate the way they engage and create long term, sustainable value for shareholders.

Mary Leung is head of standards and advocacy, Asia Pacific for CFA Institute.