Investors to be stricter on ESG during AGM season

The AGM season, which takes place between March and June every year, provides an opportunity for investors to hold management to account on a broad set of issues – in some cases voting against the reappointment of board members. And in an era of climate change when the world is still recovering from Covid, the days of ‘rubber-stamping’ are long gone, says corporate governance specialist Michiel van Esch.

“Climate has taken a spotlight in the last couple of AGM seasons, and is here to stay, he says. What has changed are investor expectations. Several years ago, setting public long-term carbon reduction targets was considered a win for sustainable investors, but now it has become a basic expectation.”

“Investors nowadays expect carbon reduction strategies, including sufficiently detailed plans on how to advance them in the short run. In previous years, we have voted against board members or the approval of reports and accounts of companies that were absolute laggards when it comes to climate change, based on the Climate Action 100+ and Transition Pathway Initiative benchmarks.”

“This year we have even higher expectations on climate strategies and it is likely that we will vote more often against board members – including the chairman of the board if necessary – at those companies that are lagging the pack.”

This will be the second year that companies can propose a ‘Say on Climate’, in which companies asks their shareholders to vote on their climate transition plans. In its inaugural year, when the concept was still bedding down, most of these proposals received high levels of shareholder support.

“This year we expect shareholders will have further developed their voting approaches on Say on Climate and will take a stricter stance on these plans,” says Van Esch. “For example, the starting point for our voting approach is whether the company has set targets such as net zero carbon for all their relevant emission scopes.”

“For our own Say on Climate, companies will need to have set intermediary targets on all their relevant emission scopes, using the guidelines and implementation plans laid out by the Task Force for Climate-Related Financial Disclosures (TCFD), and how they’re aligned with the Paris Agreement.”

The perennially thorny issue of directors’ pay is also likely to rear its head as comparisons are made between how well a company performed during the pandemic, and how much it paid its most senior staff as a result. In many cases, the two are still far from aligned.

“In the last two years, some companies have not shown themselves from their most charming side when it comes to remuneration,” says Van Esch. “And we will be looking out for the kind of tricks or loopholes that some adopt when trying to get away with high pay for poor performance.”

“It is not uncommon for remuneration committees to claim that when markets are up, the company has performed well, and when markets are down, the targets need to be revised because it is ‘not management’s fault’. Investors should be much more critical on how companies deal with this.”

“The situation becomes much more painful when companies ask other stakeholders – such as investors or employees – to take the pain during bad times, but CEO pay remains unaffected or sometimes even sees his or her package increased.”

The use of ESG metrics is, though, very welcome, as this was not common a few years ago. “We are happy to see that ESG metrics are more frequently used in remuneration, though at the same time, it often remains too vague on how performance is measured, and sometimes the chosen metrics are not key to the company’s ESG strategy,” says Van Esch.

“The ESG metrics should be treated the same way as financial metrics in remuneration; they should be measurable, require management effort to achieve them, and be underpinned by a strategy. Just like the rest of incentive pay, ESG in remuneration should also be pay for performance.”

Social issues will also move closer to the spotlight as investors assess how well they dealt with Covid, particularly in industries such as hospitality, travel and high street retail that were badly affected by the lockdowns of 2021.

“The recent health crisis has put social at the spotlight on the S in ESG, and rightly so,” says Van Esch. “Investors are increasingly aware of the relevance of human resource management, providing an equitable workplace, and having diversity in their oversight. Therefore, we will continue to focus on diversity as a key topic.”

And human rights will be scrutinized, particularly when voting at companies with operations or supply chains in trouble spots. “Companies with exposure to human rights issues but which lack a human rights due diligence procedure can expect us to vote against those the reappointment of those directors who should be responsible for this kind of oversight,” Van Esch says.

Meanwhile, the governance aspect of ESG which is so critical to how companies behave will not be forgotten. “Independent oversight and mechanisms that hold executive management, such as by having strong non-executive directors to do this, remain fundamental principles to our voting approach,” says Van Esch.

“We were pleased to see that in Japan the expectations for the percentage of independent directors on boards is increasing, yet oversight is not just a matter of the number of non-execs. They should have the right qualifications to oversee key issues such as accounting, management incentives and their related party transactions. At least half of the members of key committees should be qualified independent members.”

“In all, we’ll be using our voting rights to protect our clients’ interests as shareholders and promote sustainability, and in some cases give a shot across the bows to companies that are not onside with good practice. Shareholders should always use their vote to make a difference.”