Evidence and Ambition: The New Rules of Engagement on Climate Change

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by Mirza Baig, Global Head of Governance, Aviva Investors

Mirza Baig explains why far-off commit­ments on climate change by energy ­companies and their lenders are no longer enough, and why COVID-19 has catalysed rather than derailed investor ­engagement on the issue.

This was supposed to be the year when climate change dominated the political and business agenda; with all roads leading to the COP26 summit in Glasgow in November. After the previous climate summit in Madrid proved a huge anti-climax, it was hoped COP26 would get the world back on track towards meeting the commitments of the 2015 Paris Agreement.

But while that event has been put on hold until November 2021, suggestions that climate change has been demoted down the list of investor priorities couldn’t be further from the truth.

In the first of a two-part interview, Mirza Baig, global head of governance at Aviva Investors, discusses why engagement has never been more crucial on climate change, with the convergence of global investor interests in stark contrast to the growing disconnect amongst big energy companies. He also highlights why creditors need to seize their opportunity to play a more meaningful role alongside shareholders in affecting change.

How is your engagement with companies evolving on climate change?

We made a conscious decision at the start of the year to accelerate our climate engagement, with more focus on capital allocation and evidencing of companies’ transition. A few years ago, the challenge was to get climate on a board’s agenda and get companies to a point where they would make transformational commitments in line with the Paris Agreement. Those commitments tended to be very long term, focused on the adoption of 2050 net-zero goals, with 2030 and 2040 milestones along the way.

As part of this year’s engagement priorities, we wanted to break this down into tangible near-term targets, metrics, and proof points, so that companies can demonstrate they are acting on their ambition now. Our engagement programme was broadened to include the equity and credit teams, ensuring climate change became a core part of every company dialogue – not just with chairmen and non-executive directors, but also the CEOs and CFOs, who typically focus more on capital allocation and long-term investment.

Are any companies changing their approach as a result?

Traditionally, the focus has been on the biggest direct emitters – oil and gas companies, the extractive sector more broadly, and utilities. Now, we’ve seen an acknowledgement of the important role of financial services in funding the energy transition.
Take Barclays. Late last year, a shareholder resolution was put forward for the Barclays AGM (which happened in May) to encourage the company to embrace the climate agenda, rather than continue to be perceived as a European laggard. The proposal focused on lending to high-impact sectors. Barclays was initially hesitant because, although listed in the UK, it has a big US presence, and views on climate change among its clients are more “diverse”.

Barclays started a dialogue with the investment community, and we were a prominent voice in that process. We met the chairman and senior representatives of Barclays several times over a concentrated period and argued this was an opportunity for the bank to grab hold of the climate agenda and set a standard for others to follow. We were pleased that Barclays ultimately embraced the spirit of the proposal and even went beyond the letter of the resolution, by committing to transitioning its entire lending book to net zero by 2050.
Was this a collaborative engagement with other investors?

It was a multi-stakeholder effort. ShareAction and progressive asset owners can take credit for helping to catalyse the conversation. But we were one of the first stakeholders Barclays engaged with and had a significant influence in pushing it to go beyond the ‘asks’ of the resolution.

There are other examples. In 2019, we were one of three co-filers of an extensive shareholder proposal at BP. After much discussion with the company, BP backed the proposal and investors gave it over 99 per cent support at the AGM, providing a clear mandate from the market to act. Subsequently, we have had extensive conversations with the chairman, as well as the new CEO Bernard Looney, which culminated in the landmark announcement in February when BP became one of the first oil majors to commit to net zero for its own operations by 2050.

One aspect of BP’s pledge of particular importance to investors related to scope 3 emissions. This is a big issue as some 85 per cent of the lifecycle of emissions of the oil and gas sector is attributed to the point of use by customers.

Only 18 months ago, BP said it was unreasonable to expect the sector to take responsibility for its customers emissions. However, fast forward to today, and BP has embraced ownership of its Scope 3 impacts and committed to setting an array of life cycle emissions targets.

These are significant milestones but there is still a lot of work to do. We will continue to exert all of our influence to push for change but are under no illusions that the magnitude of the task ahead will not be achieved without a genuine and concerted multi-stakeholder effort.

Is our voting approach also changing?

People tend to have a binary view towards whether to back a company or climate shareholder proposal – creating a false dichotomy for shareholders to choose between supporting management or the climate. We have created a more nuanced framework to evaluate the extent to which a company is moving forward constructively and at pace, or conversely being obstructive. In the latter case, we will use our vote as a catalyst for change.

We have developed a five-point framework based around key questions:

1. Has the company set a climate ambition and strategy aligned to Paris, in particular a 1.5-degree temperature rise target?
2. Has the company outlined a credible pathway and roadmap to reach net zero by 2050?
   Can the company evidence near-term adjustments in its capex and operations that would demonstrate its conviction and willingness to change now?
3. What is the culture of engagement like with primary stakeholders, specifically shareholders? Is dialogue constructive or obstructive?
4. What signal will a vote on a director or a shareholder proposal send to the company? Will it support or hinder change?

This balanced framework is important in driving the right outcomes. Again, Barclays is a good example. It has gone a long way towards developing a bold ambition. While the pledge is still light on details, a commitment to provide more colour by the end of this year is reasonable. Recognising the pace of change and the constructive and candid nature of the dialogue, we supported the company and abstained on the shareholder proposal.

The situation was different with Shell. It has spent three years outlining a progressive climate ambition but was unable to move beyond anecdotal evidence of how the business was practically changing in the near term. When it came to capex allocation, the €1bn-€2bn of new energy capex was dwarfed by the €20bn going into ‘old energy’ assets. As a result, we supported the shareholder proposal as a signal to leadership that it needs to increase the pace of change.

We also supported the climate shareholder proposal at Total reflecting concerns over the nature and timing of engagement with shareholders. Meanwhile, Exxon took the extreme position of blocking the inclusion of a climate shareholder proposal on the ballot [a decision approved by the Securities and Exchange Commission]. As a result, we voted against every single standing director that was culpable in the decision.

Should investors be more punitive with laggards, perhaps divesting sooner?

It is the age-old argument between staying engaged and divestment: there is no one-size-fits-all answer but in principle we consider it somewhat of a blunt instrument. There are two reasons for this. Firstly, there is not the critical mass in the market for divestment to be a meaningful tool for change – there are always a queue of other investors ready to take your place should you decide to sell.

The other, and potentially more significant, issue is that while divestment sends a signal of dissatisfaction to a company, it does not allow for a clear communication of a desired future state and expected roadmap for change. We prefer to stay invested, stay engaged, and partner with companies as they develop a transition strategy, allowing us to continue to influence the direction and the pace of travel as well as the pace.
Ultimately, though, climate change presents fundamental risks to the long-term viability of a business. Companies that do not adapt will not survive. If we do not believe companies are prepared and committed to change in a reasonable timeframe, the investment case will be broken, and we will begin moving capital away.

There is a perception less scrupulous investors step in when responsible long-term investors divest: is that perception outdated?

There is some truth to it, but there is a narrowing of investor expectations globally. We are a diverse group with varying views on companies. There will never be a homogenous capital market and we wouldn’t want that. But even though there is a growing gap and divergence between practices at the corporate level, especially between European and US oil and gas companies, the gap among investors on climate change is closing. No longer can you say: ‘European investors care about this, while US funds will go and buy anything’.
There was a significant shareholder revolt at Exxon’s AGM; nearly a third of shareholders voted against senior executives as a protest against their climate stance. At Chevron, the majority of investors supported a shareholder proposal to improve transparency over climate lobbying: that was unprecedented. We are seeing similar trends taking place in Australia.

We will soon get to a tipping point where non-responsive companies will find a dwindling set of investors prepared to stick by them, as we have already witnessed in the US coal sector.

Are creditors doing enough?

We have an integrated ESG research and engagement approach across our credit portfolios, which mirrors our equities framework. However, if you look at the market more broadly, there is considerable scope for improvement.

The whole notion of company engagement came from the equity part of the balance sheet because it was rooted in voting activity and the rights and responsibilities of shareholders.
But there is a growing recognition of two things. Firstly, creditors equally have an economic stake in the long-term sustainability of a business; and that ESG factors are a central determinant in the success and failure of companies.

There is also greater acknowledgement of the influence creditors can have. More companies are tapping the bond market rather than the equity market for future funding. The availability of long-term, stable sources of credit is critical to most companies’ business plans. At the point of issuance, companies need to make creditors comfortable with their financial health and prospects, and they also need to keep creditors onside for servicing and refinancing that debt. So, there is ample opportunity and leverage for creditors to participate in ESG engagement with issuers that has not happened enough to date.

Given this is a borrower’s market, can’t companies just ignore investors’ demands on ESG, such as climate covenants?

The conversation goes beyond green covenants. Issuing any kind of debt involves providing assurances on the long-term viability of the business. Companies operating in sectors tied to the old economy, such as energy and utilities, that issue 10-year bonds with no clear pathway to transition, are coming to the market with a cloud over future cash flows. That will ultimately impact their credit rating and borrowing costs.

Will the conventional bond market adopt ESG more seriously?

Major credit ratings agencies have improved their capabilities in recent years, establishing research teams and methodologies to rate issuers’ ESG credentials, especially their climate credentials. But to date, outside the likes of utilities, we have not seen clear interconnectivity between the ESG/climate rating and the core credit rating of an entity. We need those two methodologies to become more integrated, and for ESG factors to be a more prominent part of an issuers primary credit rating. We are starting to see regulators take action to address this, particularly in the European Union under the sustainable finance action plan, which we are proud to have been involved in shaping.

Is climate change being overlooked given the focus on COVID-19?

I have seen little evidence of that. If anything, COVID-19 has emboldened and catalysed discussions rather than derailed them. Conversations have intensified because there is a greater realisation of the impacts of systemic risks, and the importance of acting early and decisively, before it is too late.

What about at the policy level? Was the postponement of COP-26 a setback?

The postponement was understandable, but frustrating. This year marks five years since Paris, and we expected to see revisions made to nationally determined contributions (NDCs) by individual countries. We know the NDCs submitted to date are more aligned to three degrees than two, so it is disappointing revisions will be postponed.

There are big issues that need to be debated properly; for example, the rulebook for holding countries accountable for their targets, the development of carbon markets, and on ensuring a just energy transition, whereby developed markets help fund and support emerging markets through the transition.

The issues must be resolved to accelerate the commitments companies are willing to make. While some of the big oil majors have outlined bold ambitions, they always caveat this by saying the speed of change will be in line with society – in other words, aligned with government policy. We need governments to move to see widespread transformational changes at a company level.

Read more about Aviva Investor’s engagement activity

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