Reading the headlines these days, especially those south of the border, you would think that ESG is dead or at least on life support. Sadly, this is not just confined to the headlines but is making its way into the United States political process through new legislation as well as anti-ESG shareholder proposals finding their way onto AGM ballots.
To be fair, while assets have been flowing out of ESG funds in 2022, this is not unexpected given market conditions. What the media gets wrong, however, is that ESG is much more than screening for good and bad companies – Exxon versus Tesla. While there is a tendency to focus on ESG products such as indices, this is not how most institutional investors approach ESG. The political noise distracts from the notion that ESG is not political – it is simply about investors seeking assurance that companies are managing material ESG risks to their business. As we take a look at the 2022 annual general meeting (AGM) season, it seems obvious that ESG remains firmly embedded within investors’ approaches and strategies. This contrasts starkly with some of the assertions being made in the press.
What the Voting Trends Tell Us
Reflecting on the most recent AGM season, we see that the absolute number of shareholder proposals filed and ultimately voted on, both in the U.S. and Canada, reached record heights on both fronts within the first six months of 2022. In the U.S., over 500 environmental and social shareholder proposals were filed, easily beating the record of 416 last year. Of course, not all of these went to a vote, indicating that companies and investors are reaching agreement between the filing and the publication of the proxy circular. Institutional Shareholder Services (ISS) indicates that more than 270 proposals went to a vote, partly due to changes in how the Securities and Exchange Commission (SEC) is approaching the proposals. Under the current administration, the rules for allowing shareholder proposals to proceed to a vote have become more lenient, meaning fewer are omitted prior to the AGM.
To understand how investors are approaching these proposals, we must look beyond what is being filed and examine actual vote results. Results from the first half of 2022 suggest that the number of shareholder proposals addressing environmental and social issues that passed remained relatively stable at 30. However, an even more telling statistic is the average support for these proposals, which dropped in 2022 to just over 26%, down from 35% in 2021. This suggests that there is a limit to what investors will support, especially when faced with more prescriptive shareholder proposals.
Climate Remains a Top Concern
About 10% of shareholder proposals in 2022 relate to climate change. Among these are proposals concerning oversight of climate risk or setting targets, including for Scope 3 emissions. Scope 3 emissions occur when a product is used, such as gasoline burned in a vehicle, and this has been a topic of debate. Many investors argue that companies need to take responsibility for the full life cycle of their products, while some companies say that these emissions are not in their control and challenge the methodology for calculating Scope 3 emissions.
Looking at shareholder proposals relating to climate change, it would seem that investors expect that addressing Scope 3 emissions must be a part of a company’s climate transition plan. Companies with proposals that passed include big names like Caterpillar, Boeing, Costco and ExxonMobil. Most of these proposals specifically mention Scope 3 in the context of setting short-term and long-term targets. This contrasts, however, with a more prescriptive shareholder proposal submitted at Enbridge that received 23% support. While Enbridge has already made a net zero commitment, the proposal likely went too far for many investors by suggesting the company should ensure that the target is science-based, including absolute emissions reduction targets and speeding up their decarbonization plans.
Racial Equity Audits in the Spotlight
An emerging area of focus in 2021 very quickly catapulted to the top of the list of most successful shareholder proposals in 2022 – the request to carry out a civil rights or racial equity audit. More than 20 such proposals went to a vote in the U.S., with eight passing, an unusual outcome for such a new type of proposal. While the specifics of each proposal vary, they generally ask companies to conduct an independent audit assessing the impacts of a company’s business and/or products and services on internal and external stakeholders, with a racial justice lens. In Canada we are seeing specific proposals focused on Indigenous issues, such as Toromont in 2022; the Board and management put their support behind a request to report on the extent to which policies and practices are being certified by Indigenous-led standards. These examples point to investors being less interested in policies related to Diversity, Equity and Inclusion, and more in how effective these policies are.
Traditional Governance Issues Still Contentious
With so much attention on environmental and social issues during proxy season, it was one of Canada’s largest companies that brought a longstanding debate over multiple voting shares to the forefront. This, of course, was Shopify in its successful management proposal to grant founding shares to the CEO and Founder of the company that consolidates 40% of the voting power with him, even if his ownership level drops below that threshold. This move reinvigorates the debate around unequal voting rights and the investor response was telling. Only 53% of independent shareholders supported the proposal, which narrowly passed, although there are questions over the role of certain influential shareholders in the process. This particular case raises some questions that many may have thought were put to rest, including: the role of the Special Committee; effective use of sunset clauses; and limits on the ratio of multiple voting shares to ordinary shares. None of this should take away from the company’s phenomenal success over the years but it does illustrate that most investors would like to see more checks and balances in situations like this to protect the rights of minority shareholders.
ESG is Not Going Away
Despite the rhetoric we see in the press, the results from the most recent AGM season would suggest that ESG is a permanent feature of the landscape. This is because when faced with reasonable requests from shareholders, investors increasingly recognize how managing ESG risks and capturing ESG opportunities makes sense in the context of good business. Sadly, ESG still suffers from definitional challenges, which are reflected in the narrative playing out in the media. As an ESG professional, this is frustrating, but it does not mean that ESG simply stops being important. Quite the opposite is true, in my opinion.
Jennifer Coulson is Vice President, ESG, Public Markets, at BCI.