Institutional investors using influence to strengthen climate-change governance

The world’s largest fund manager’s decision to publish specific voting information puts boards on notice over ESG risks.

Pressure on boards over climate-change disclosure is intensifying as leading global investors use their voting power and influence to drive change.

BlackRock’s move this year to disclose the rationale behind some of its voting practices in AGM motions sends a powerful signal to the global governance community to ensure appropriate reporting of climate-change policies and practices.

This action could be a game-changer in climate-change governance if other institutional investors follow suit. BlackRock is the world’s largest fund manager with US$5.4 trillion in assets and a pioneer of Environmental, Social and Governance (ESG) analysis.

BlackRock’s change has targeted proposals at AGMs of energy companies, including Santos in Australia. The US-based firm appears to belive there is inadequate reporting from some companies of the impact of climate-change risks on long-term business performance, or insuffienct dialogue between boards and investors on this issue.

The firm’s Vote bulletins, published on its website, provide a rare glimpse into its investment stewardship. Although BlackRock explains how it votes in quarterly reports, the data is often aggregated and high level. It now publishes company-specific reports.

BlackRock says: “Given the interest in certain votes, we decided it was more effective to explain our approach and decision publicly on the day of the meeting, or shortly thereafter, so interested clients and others can be aware of BlackRock’s vote when it is most relevant.”

1. Communicating voting rationale

The firm’s approach is not only to name governance laggards on climate change. BlackRock’s two-page note on Santos, for example, outlined why it voted with the board on two resolutions and emphasises there was effective, long-term dialogue between Santos and BlackRock on the company’s approach to climate-change policies and practices.

BlackRock reviewed Santos’ climate-change disclosures and found they were in line with the draft Task Force on Climate-related Financial Disclosures (TCFD). It said: “There was room for improvement in explanations around the governance of the climate-change risk policy and how it is integrated into the investment decision-making process”, but added that Santos’ “commitment to climate-change disclosures goes well beyond the request in the proposal”.

In contrast, BlackRock’s commentary on ExxonMobil Corporation was negative. The report, published in late May, said the energy company had repeatedly declined to make independent directors available to explain the company’s long-term strategy and capital allocation, in the context of major strategic challenges and regulatory inquiries (including climate-change risk oversight).

BlackRock subsequently voted with shareholders (and against the ExxonMobil board recommendation) on a proposal for the reporting of impacts on climate-change policies. BlackRock said: “We believe it is in the shareholders’ long-term best economic interests for Exxon to enhance its disclosures (around climate-change risks).”

Other institutional investors have also targeted ExxonMobil. Vanguard and State Street were reported to have voted against the board on key proxy resolutions around climate-change reporting.

The shareholder rebellion worked: the oil giant will now report on the impact of global measures designed to keep climate change to 2 degrees Celsius (as per the Paris Agreement), as 62.3 per cent of shareholders voted for the change.

2. Implications of voting commentary

BlackRock’s decision to publish company-specific information on climate-change reporting has four main implications for Australian boards.

First, it reinforces the rising interest from institutional investors on climate change as a material investment risk and key governance issue. Financial-market scrutiny on Environment Social and Governance (ESG) issues, including climate-change risks, is rising.

Global asset managers and investment banks are devoting more resources to analyse ESG performance and factor it into portfolio decisions. Several local investment banks now have analysts producing detailed research on ESG issues, such as climate-change policies and practices, and benchmarking ESG performance against peer companies.

Broad responsible-investment approaches, which use ESG integration as the principal responsible-investment strategy, accounted for $633.2 billion in assets under management in Australia at December 31, 2015 – or almost half of all assets professionally managed, according to latest data from the Responsible Investment Association Australasia (RIAA).

Second, BlackRock’s move shows a greater willingness from asset managers to outline their views publicly on key governance issues. Institutional investors have traditionally kept their views on board performance, and their dialogue with boards, largely private, to maintain their relationship with the company and others like it.

It is rare for fund managers of BlackRock’s size to criticise boards of listed multinationals publicly over climate-change issues, or use such strong language in doing so. Typically, these funds push for change “behind closed doors” through a sustained company-engagement program – and only go public at AGMs as a last option to force change.

Third, BlackRock’s change adds weight to the global rise of shareholder activism – a trend some governance observers believe could fundamentally change the role of boards as directors are required to spend extra time on investor relations, engage a wider group of stakeholders and listen to more views on their organisation’s strategy.

The change suggests asset managers could take a more active, aggressive approach to their investment stewardship, possibly in response to demands from their investors for capital to be invested in responsible companies and sectors. The result could be shareholder activists, such as environmental groups, having powerful support from active investors with greater voting power, such as BlackRock, in campaigns like that against ExxonMobil.

The fourth implication from publishing voting commentary is greater media and market pressure on perceived governance laggards in climate-change reporting. BlackRock’s commentary has attracted significant attention overseas and is potentially fuel for activist campaigns in areas where the asset managers believe change is warranted.

3. Climate change a growing issue for Australian governance community

Boards, of course, should have a measured view about the implications of BlackRock’s change. The firm has so far published only six reports on companies (the others are Mylan, Royal Dutch Shell, Chevron and Occidental Petroleum). Not all of them relate to climate-change risks and some outline progress in climate-change reporting and investor dialogue (as with Santos).

It is unclear whether other global asset managers will follow BlackRock’s lead and publicly explain their voting rationale in contentious AGM motions.

But climate-change governance continues to become a bigger issue for Australian boards. The Governance Leadership Centre in December 2016 reported an analysis of the opinion of Noel Hutley, SC, on the extent to which the law permits or requires Australian company directors to respond to climate-change risk.

Hutley’s opinion confirmed that, from an evidentiary perspective, risks associated with climate change have evolved from “ethical environmental” to material financial issues, and that directors who fail to grapple with them are legally exposed.

Hutley’s view suggests directors who perceive that climate change presents risks to their business should assess the adequacy of their disclosure and reporting of them.

Regulators have also stepped up their focus on climate-change disclosure. The Australian Prudential Regulation Authority (ARPA) in February 2017 publicly warned companies about climate change and urged them to view it as a risk-management issue.

In a landmark speech, APRA highlighted that some climate-change risks are distinctly financial in nature and cannot be considered only through an ethical or environmental lens. The implication is that climate-change risk can have material financial implications for listed companies, which in turn suggests market disclosure is required.

That, in turn, has more asset managers agitating for faster board progress in the oversight, reporting and communication of organisation climate-change policies and practices.