Asset Managers’ Stewardship Role in Sustainable Investing

Dominique Barker: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape with a view on addressing current issues in a concise format to help you navigate and take action. I’m your host, Dominique Barker. Please join me as we explore today’s most pressing matters with special guests that will give you some new perspective and help you make sense of what really matters.

Henry Boucher: We need to both understand the whole picture, and we need to be able to rely on the information that we’re given as part of that picture. Now, of course, we can do research outside what the company tells us, but we really need to trust what companies are telling us. And what we see at the moment is they’re not admitting basically to the whole picture.

Dominique Barker: Today, we welcome Henry Boucher, Partner and Head of Investment Strategy at Sarasin & Partners LLP in the UK. Henry specializes in multi-asset and global equity fund management. He’s managed a wide variety of funds, including unit trusts, pension funds, life funds and charity endowments. On today’s episode, we’re going to be discussing the stewardship role that asset managers can play in sustainable investing from evolving the investment return mindset to the double materiality. Term you hear through this episode double materiality of ESG positive outcomes and forging active engagement with investee companies on the integration of ESG related disclosures into the accounting. One thing that comes to mind with all this money is that with great power comes great responsibility, and that’s a quote by Spider-Man. So good morning, Henry. Thank you for joining us on today’s episode of The Sustainability Agenda.

Henry Boucher: Hi there. Thank you very much for having me.

Dominique Barker: Okay, let’s start by talking about the stewardship role that asset managers can play broadly speaking, set the stage for us. What does it mean to you and why is it important today?

Henry Boucher: Well, I think to understand stewardship, it helps to think about the brief that’s given to asset managers. Few investors will invest short term capital in the stock market. They’ll keep any cash they may need in the short term to hand or in the bank or say, bonds and things. So asset managers are normally given a mandate to manage long term capital, and that’s typically within a time frame of more than five years. And if you think about pension funds that might be 30 years or some endowment funds are permanently endowed, so they’re investing almost indefinitely. So if you’re in the business of taking a multi year perspective, then effectively you’re an investor and not a speculator. And that’s important because I think speculators may be much more interested in short term financial performance in volatility and price action, whereas long term investors consider how returns are actually generated by the business that they own over time. And issues like climate change or biodiversity loss therefore become much more relevant, and a long term investor also plays a role in governance. They vote and they vote at annual general meetings for how the business operates and particularly who manages it, who the directors are, and that’s a pretty critical part of being a good steward of long term capital. So I think that’s what stewardship means.

Dominique Barker: Okay. So you mentioned biodiversity, and I do want to get into that topic because we had the COP 15 in Montreal recently, the Convention on Biodiversity. And with regards to biodiversity loss, you’ve spoken about the disintermediation of investors and misunderstood linkages. Could you explain that in more detail, please?

Henry Boucher: Sure. Let’s start with disintermediation. In the last few years, we’ve seen literally trillions of dollars invested into ESG assets in one form or another and a lot of new issuance of things like green bonds or social bonds as well. And what we have to assume, I think, is that this reflects the concerns of the underlying investors. They’re concerned about the environment and society, and they want to make returns in a way that doesn’t cause so much harm. But between the owners of the capital, those investors who are very concerned and the end investments are agents and intermediaries, including asset managers, who may not share those concerns in quite the same way and indeed may have conflicting business practices or conflicting incentives. What we find is that investors who are concerned about the environment end up owning companies that destroy it to make money. And we’ve seen it with climate friendly funds that contain fossil fuel companies. That’s a fairly obvious example. But let me just think, if I give you a biodiversity example of where that sort of conflict has arisen, if you think about shampoo, most shampoo has palm oil as a key ingredient. And if you think, well, all other factors remain equal to grow a shampoo business at 5% per annum, well after 15 years, you would have doubled the quantity of palm oil you need and caused presumably quite a lot of deforestation to make way for the additional palm oil production. And the thing about palm oil is because of its versatility, it’s not just used in shampoo, it’s used in a vast range of different products, foodstuffs, consumer goods, biodiesel. If you’re investing for long term growth in most FMCG companies, Fast-moving Consumer Goods companies, you are, in effect, investing in more deforestation. I would think that most financial advisors and asset managers would construct a well-diversified portfolio that would include quite a lot of FMCG companies. And that, in a sense also helps explain the second point the misunderstood linkages many investors don’t make explicit, or perhaps even in some cases not aware of the conflict of interest that they face in effectively being supply siders. And what I mean by that is that to make growing returns, investors want their companies to grow the supply of goods or services over time like the shampoo. And if you extrapolate from the past, it’s very easy to assume that this capacity for growth is infinite. However, the planet is finite. It’s a closed system. We have an open economy, but a closed system planet. And that planet has boundaries and those boundaries have already been exceeded. I think it’s inevitable that some investments are going to hit growth constraints over time. And many people are now familiar with the concept of stranded assets in the fossil fuel industry. But there are many more limits to growth that are almost certainly not discounted yet in markets.

Dominique Barker: So then how do we change the conversation from just achieving returns? And, you know, are there any lessons learned from climate change that we can apply to biodiversity, for example?

Henry Boucher: Well, the conversation on achieving returns is naturally about money, but financial capital only really has a value if you understand the underlying natural capital and social capital on which it depends. And I think from climate change, we’re learning to consider carbon intensity, the amount of greenhouse gas emissions caused to generate a dollar of sales. And as I think you’ve discussed on previous podcasts, the TCFD, the Task Force on Carbon related Financial Disclosures, is being adopted widely to measure carbon emissions and the intensity of companies in many countries. The concept behind that is what gets measured, gets managed and for biodiversity. The follow on from TCFD is TNFD, the Task Force on Nature related Financial Disclosures, and this is a global market led initiative developing a sort of risk management and disclosure framework for organizations to report on their nature related risks and to encourage quite a lot of shift in the sort of financial flows away from nature negative outcomes. So I think this concept of thinking about more than money is what lies behind a lot of the regulation we’re now seeing. It’s a notion, as you mentioned in the introduction, called double materiality, and that’s really what underpins the SFDR, the Sustainable Financial Disclosure Requirements, in Europe, the SDR in the UK, the enhanced climate related financial disclosures in Canada and many other jurisdictions. So I think double materiality, what it does in essence is it extends the original concept of materiality, of financial information in accounts, and it essentially brings new focus onto environmental impacts. So for example, the SEC says that information on a company is material and so should be disclosed if a reasonable person would consider it important. And I think what’s changed is that as a result of the global conversation shifting, it’s now widely accepted that climate related impacts on a company can be material and therefore they require disclosure and hence double materiality.

Dominique Barker: And actually, I don’t know if you’ve seen it, but Gensler, who’s the chair of the SEC, did a great video for the average person just to explain why climate is material to investors and why it needs to be considered. So you’ve advocated for active engagement with investee companies and you’ve called for ESG related disclosures to be integrated into the entire accounts or the, you know, the annual reports and the quarterly reports, not just the CSR report or corporate social responsibility or ESG performance reports. Why is that so critical?

Henry Boucher: Well, I think it’s it’s critical because investors rely on the report and accounts for their decision making. And indeed, they employ an auditor to check those report accounts and to confirm the accuracy, look at how dividends get paid. They’re paid as a result of what appears in the audited accounts. The chief executives remuneration is based on the accounts, so accounts are really critical. They’re like the altimeter on an aeroplane, the trusted source of information. If the information is wrong, then the aeroplane may crash. So certainly for us as asset managers, before we commit clients capital to a company, we really undertake our detailed due diligence. We need to both understand the whole picture and we need to be able to rely on the information that we’re given as part of that picture. Now, of course, we can do research outside what the company tells us, but we really need to trust what companies are telling us. And what we see at the moment is they’re not admitting basically to the whole picture. So what we hear and see is, is a huge growth in the pledges for net zero and other climate related commitments. And I think outside the accounts, we’re seeing a lot of extra sort of noise going on. But just to give you an example of what’s happening inside the accounts, in October last year, Carbon Tracker published a second report indeed, about the degree to which companies are disclosing how they take climate risks into account within the financial statements. And, by the way, they also checked up on whether the auditors were considering the issues, too. And very sadly, by the way, the report is called Still Flying Blind, and I highly recommend it. It found that most companies that they looked at, I think, are about 134 very carbon intensive businesses. They still don’t appear to be including the financial impacts of their climate commitments or any of their climate change risks in the actual financial statements. And yet these are the companies which are making noises like, you know, we want to be one and a half degree aligned and, the challenge here is that they’re not properly taking account of that one and a half degree pathway. They’re unlikely to then allocate capital in line with a one and a half degree pathway. And so. I suppose the big question is if these factors aren’t considered, how can shareholders rely on reported net asset values or have any confidence in the future dividend flows of the business?

Dominique Barker: And I suppose that’s where the topic of this podcast comes in and stewardship and engagement. And so I’m going to ask you to highlight some examples of AGM’s or Annual General Meetings where you’ve applied your superpower as an asset manager and investor in terms of making some change.

Henry Boucher: Superpower. Wow, that would imply that Sarasin has some kind of kryptonite or is sort of super sized in some way. But I’m afraid we’re neither. What we have been able to do is to apply pressure in the right places and share good stewardship with other investors, and that’s then helped us create scale and influence. So I’ll give you one example. Ahead of COP26, we decided to write to the heads of the UK Big four audit firms that PwC, Deloitte, KPMG and Ernst and Young calling on them basically to tell us to sound an alarm when company financial statements ignore the transition to 1.5°C pathway, and what we found was a huge number of investors joining in signing those letters. So those letters ended up being an influence of $4.5 trillion worth of assets landing on the desks of the chiefs of those audit firms. And I think you asked specifically about examples of companies which have responded to engagement and voting at AGMs. And I think one of the most encouraging things in a sense over the last 2 or 3 years that some of the most carbon intensive and therefore material exposed companies in the oil and gas sector, for instance, have seen real improvement in accounting practices. So I think I would call out, say, Shell and BP, who now offer detailed disclosure for how we can see climate factors affecting them. These are examined properly in their accounting processes, and the auditors are now providing some meaningful insight into the steps they’re taking to check that work. And another example might be the Air liquide, which is a large gases, industrial gases company. That’s also shown quite good leadership, I’d say, in its commentary in how it’s considering climate risks in its business within the accounts and how it’s planning to do more. So it’s committed in its 2023 accounts to give much more detailed sensitivity analysis. So, I mean, one of the this sort of superpower effects is that accounting and audit metrics are now included in the Climate action 100 plus benchmark against which companies are assessed, and we’re hopeful that we’ll see some quite rapid progress in accounting and audit disclosures, I think, in 2023 as we go forward. And that of course will be helped by the accounting authorities themselves. So I think the further good news is that the International Financial Reporting Standards Foundation, that’s the body that sets accounting standards for about 120 countries around the world, I think. I mean, that’s now begun work on bringing sustainability into financial disclosure. So, yeah, a lot of the things we’ve talked about, I think there is a superpower out there and it’s coming really from this sort of global conversation and things are beginning to change. But it really does take good stewardship. It takes leadership from the the owners of assets or the agents on behalf of those owners.

Dominique Barker: Right, and to use that power in a responsible way. Henry, this was very enlightening. It sounds like a lot of progress has been made due to some of your engagement and stewardship. Thank you for joining our show today and thank you to our listeners for tuning in.

Henry Boucher: Thank you.

Dominique Barker: Please join us next time as we tackle some of sustainability’s biggest questions, providing different perspectives to help you move forward. I’m your host, Dominique Barker, and this is The Sustainability Agenda.

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