Stewardship and sustainability performance

As stewards of our clients’ assets, we’re mindful of our obligations to endeavor to manage these systemic risks and to encourage change for both financial and nonfinancial reasons. The materialization of climate change risks and the prospect of large-scale ecological collapse—both products of decades of poor environmental stewardship—will likely be well understood in years to come as having presented humanity with a stark choice: Either continue along a path of increasing risk of catastrophic loss or forge a new sense of shared responsibility for managing systemic environmental and social risks as well as their related effects and causes. Our goal is to encourage action, in whatever way we can, to mitigate these challenges, including working with companies we invest in and advocating for change across an array of forums.

Scientific, social, and regulatory pressures are countering systemic risks

The good news now is that powerful scientific, social, and regulatory pressures are being brought to bear at an increasingly rapid pace on our systemic risk-laden contemporary reality. Landmark studies such as the "Stern Review: The Economics of Climate Change in 2006" and "The Economics of Biodiversity: The Dasgupta Review in 2021"—and many other compelling scientific and economically focused studies in between¹—spell out quite clearly that we separate climate issues and natural capital from economic value at our peril. At the same time, these rigorously conceived and researched reports show us that making a concerted effort to account for climate and natural capital in projections of economic value implies a vast and mostly untapped source of economic opportunity.

As for the social movements that have sprung up in response to our present-day environmental crises, they come in both popular and corporate forms, and select examples of both varieties are lending momentum to sincere efforts to find solutions. Activism such as that prompted by Swedish student activist Greta Thunberg is exerting a gathering force of judgment on the failure of global political powers to adequately respond to climate change, as well as on companies’ efforts to retain their social license to operate. And in corporate boardrooms, investors are increasingly party to various forms of stakeholder capitalism, committing substantial resources to collective action aimed at moving the dial on environmental risks.

Last, the regulatory shift in favor of environmental sustainability is already having a profound effect on carbon-intensive industries. As the World Bank has documented, regional, national, and subnational carbon pricing initiatives have already been implemented or are scheduled for implementation across much of the globe, including in the Americas, Europe, and systemically important areas in Asia. As of the spring of 2021, these initiatives were estimated to cover 21.5% of global greenhouse gas (GHG) emissions.² Even as we see regulatory momentum building around the globe, we also see encouraging developments in voluntary carbon markets and international emissions trading under Article 6 of the Paris Agreement. We expect these will help set a carbon price and hasten the low-carbon transition.

In addition to regulatory shifts on carbon pricing, we’re seeing regulatory developments encouraging increased transparency and sustainability disclosure, as well as setting higher standards for sustainable investing. We welcome these developments, and we also contribute to them as part of our stewardship activities through industry groups and regulatory consultations.

Across sectors, companies that fail to adapt will find it increasingly difficult to be successful in this new era in which the aforementioned pressures are gradually depriving the most damaging activities of their economic justification.

Stewardship practices are prerequisites to sustainable investment outcomes

In the present story of economic transformation, sustainability-focused stewardship practices are the fulcrum on which asset managers can make, or fail to make, a difference in managing these systemic risks. In the remainder of this piece, we focus on three aspects of sustainable asset stewardship:

1 Asset stewardship and the evolving role of global capital

2 The power of international collective action

3 Why regional differences matter for stewardship results: the case of Asia

Last, we discuss the connection between stewardship practices and the pursuit of sustainable value. Asset managers are stewards of client capital, which implies a relationship based on transparency and fidelity to specific investment mandates. And yet asset managers would be derelict in their fiduciary duty if they failed to communicate the value—for every client—of operating along the twin axes of sustainability and stewardship. As we see it, facilitating the aggregate corporate shift from stating the material facts to performing the material actions of sustainability is one of the more critical tasks of stewardship in our present decade. But making an appreciable impact requires constant communication about the value and urgency of strong stewardship in the pursuit of sustainable investment value.

1 Asset stewardship and the evolving role of global capital

Both the Stern and Dasgupta reviews—separated though they are by content focus, economic vision, and 15 eventful years³—share an interesting feature in their rhetorical structure. The Stern report stages a dialogue countering an economic perspective that insists on the deficiencies of climate science, while the Dasgupta review interrogates economists’ persistent failure to account for nature, or natural capital, as an “essential element in our economic lives.” Through this dialogue, both reviews demonstrate how the financial benefits of acting to mitigate systemic environmental risks are far superior to those of not acting and how every delay makes risk management more costly. Furthermore, they expose how the traditional grounds of economics tend to be limited by an infatuation with short-term business fundamentals and revenue results, and quarterly shareholder-friendly targets, as well as their fixation on the maximization of profit and perpetual growth, or their lack of consideration for externalities that don’t yet carry a financial cost. Whether because of their willful blindness or unconscious bias, traditional—or perhaps pre-environmentally conscious—economic perspectives are at a loss when it comes to accurately measuring the true dimensions of economic and investment risk.

This dialogue sets the scene for the current narrative, which is shifting from disclosure to action. Now, after much corporate education in climate-related risks, engagement is less concerned with the articulation of material environmental, social, and governance (ESG) facts—although this remains essential—and more with material ESG action; that is, asset managers who are serious about sustainability and an increasing number of regulators worldwide are assessing and directly influencing the design and execution of corporate and sovereign plans for mitigating ESG risks and capturing potential opportunities.

"As we see it, facilitating the aggregate corporate shift from stating the material facts to performing the material actions of sustainability is one of the more critical tasks of stewardship in our present decade."

Sustainable capital: clearing paths toward collective action on sustainability

Another way to characterize this change is as a shift toward sustainability performance. In real terms, this could mean focusing on the steps a company must take to achieve net zero emissions or on the necessary actions to foster ecological sustainability in a supply chain, or it might entail making the actual appointments required to establish a diverse corporate board.

Presently, sustainability performance marks a relatively new phase in key aspects of financial stewardship practices and, in some ways, it’s helping transform the financial markets. Today, stewardship focused on sustainable outcomes is transcending regional boundaries, as well as economic and geopolitical regimes; what’s more, it’s helping investors step around certain traditional limits of ownership as the defining pathway of stakeholder influence.

2 The power of international collective action

The current backdrop of collaborative action in asset management is well described in one of the main findings of the Stern review: “Climate change demands an international response, based on a shared understanding of long-term goals and agreement on frameworks for action.” The U.K. government commissioned the report in an effort to assess the economic costs of climate change and a global low-carbon transition. While it was met with great praise as well as skepticism at its initial release in 2006, the report’s claim for an international response and agreement on frameworks for action feels mildly prophetic. After all, international collective action is a critical feature of committed asset managers’ stewardship practice and, indeed, constitutes an important dimension of contemporary frameworks set by international stewardship codes.

One of the most notable examples of collective action launched following the publication of the Stern report is Climate Action 100+, which is currently developing its second five-year plan. As of January 2022, the initiative included more than 615 investors who are collectively responsible for over US$65 trillion in assets under management. The Climate Action 100+ investor group engages with the world’s largest corporate GHG emitters to encourage improvements in climate disclosure, risk management, performance, and governance.

The investor group’s 2021 progress report notes that “111 [of 167] focus companies have set net zero targets for 2050 or before, compared to just five in 2018 after the initiative’s launch. To demonstrate the scale of impact, it is estimated that these net zero targets—which Climate Action 100+ investors have played a significant role in securing—will reduce GHG emissions by 9.8 billion metric tons annually by 2050, roughly equivalent to China’s annual emissions”—or more than 25% of the world’s total GHG emissions today.⁴

Climate Action 100+ operates through investor groups that work with individual focus companies. In 2021, Manulife Investment Management led the working group focused on a global chemical company, and we participated in working groups engaging with utility and energy companies in Asia. As we’ve seen firsthand through these engagements, collective action is helping investors become more effective and sophisticated in what they require of investee companies, such as indicators on carbon accounting, which further enables engagements that occur outside the purview of Climate Action 100+.

Minority shareholders spark major climate-focused change

When engagement proves ineffective, it’s important for investors to have escalation measures embedded in their stewardship approach. But for minority shareholders, whose power to effect change through escalation has all too often felt like a mirage, a single successful example of a minority shareholder asserting its rights in the effort to combat climate change may prove to be the pebble that starts a landslide.

For decades, oil major Exxon had been unresponsive to investor engagement efforts on climate change. This lack of response came to a head in 2021 when a minority shareholder—Engine No. 1, a little-known hedge fund based in California—executed a successful campaign to replace several members of Exxon’s board. With only a fractional ownership stake in the company, Engine No. 1 convinced its much larger peer shareholders to vote in favor of a dissident slate of directors with more climate-competent leadership. Prioritizing the reduction of the company’s GHG emissions, and perhaps then setting the company on a path to insulate future revenues and dividends against climate-related policy risk, was suddenly a potential plan for transformation in Exxon’s near- to medium-term corporate strategy.

Exxon has since developed a 2050 plan for scope 1 and scope 2 emissions reduction.⁵ This covers emissions from its oil, gas, and chemical production and from the power those operations consume. While the company made no commitment for emissions from consumers using those products, we believe this is a good beginning that could pay dividends to shareholders over the long term.

3 Why regional differences matter for stewardship results: the case of Asia

Broadly shared goals on climate, biodiversity, and social equity are the premise for collective action by investors. But truly effective systemic risk mitigation requires a multipronged approach across asset classes, as well as sensitivity to regional political and cultural differences. The success or failure of any given action will always be conditioned by the regional theaters that govern macroeconomic and political reality.

Asia today offers a case in point. At Manulife Investment Management, we recognize the uniqueness of Asian markets. Large state-owned enterprises are influential in national policy setting, but their strategic corporate planning is also heavily influenced by government input. In addition, Asian markets exhibit a higher prevalence of family-owned companies that may require a different engagement approach from what may work in a Western milieu.

"The success or failure of any given action will always be conditioned by the regional theaters that govern macroeconomic and political reality."

To that end, while strong active stewardship in Asia-based equity strategies is essential, it’s just one element of a holistic approach. Voting power, for example, isn’t necessary for productive engagement with corporate debt issuers, which is especially true in companies whose equity may be privately or majority owned and therefore less likely to be influenced by minority shareholders in Asian contexts. In either case, we’re able to engage directly with companies in bilateral discussions, collaboratively with other investors, or in a combination of the two. At the same time, our experience has shown us how to work toward positive outcomes with many companies by engaging directly with policymakers or stock exchanges and by participating in regulatory consultations.

Working with systemically important companies

One way we seek to address systemic risks is by working with systemically important companies. We believe that it’s important to engage with these issuers to address these topics given the potential impact, and one of our related priorities is to encourage other asset managers to do the same. For example, regarding the systemic risks of climate change, we recognize that more than half of the world’s GHG emissions come from Asia, so we endeavor to engage with the region’s systemically important energy and heavy industry companies. We do this even if we don’t have large positions, or even any holdings. If engaging with them can help move the dial on reducing systemic climate risks, then all of our portfolios may stand to benefit—not just in Asia, but globally.

Putting this into practice, we’ve been active in the Climate Action 100+ groups that are working with three of the region’s oil majors, as well as with teams operating under the Asia Investor Group on Climate Change (AIGCC) that are engaging with the largest utility companies across Asia. These are often state-owned entities that affect the entire energy systems in their markets; however, because the entire economy needs to move toward low-carbon activities—and not just energy companies—we’re also working both directly and collaboratively with the region’s largest cement, chemicals, transportation, and technology companies.

At the same time, we’re working with the Institutional Investors Group on Climate Change task forces engaging with the four largest banks in the region—the largest in the world by asset value—whose financing policies are highly influential in addressing climate change. This collective action is part of our intentional approach to working toward a unified message, which we believe is more likely to create a positive feedback loop that addresses systemic climate risk.

Stewardship and sustainable investment value

As a global asset manager, we play the role of an investor of third-party assets and the role of an owner and operator of certain private market assets. In the first role, we invest according to client guidelines, but because we seek to act as good stewards, we endeavor to communicate the benefits for every investor’s portfolio—in terms of potential resiliency to systemic risks and the potential for long-term value creation—of pursuing each investment mandate with the application of sustainable investing principles and robust stewardship practices. This includes deploying the full range of stewardship tools, from engagement and escalation to proxy voting and collective action to encouraging change in the direction of sustainability performance.

“We firmly believe that those who are acting now to play their part in generating sustainable outcomes for stakeholders are far less likely to face a shock to their portfolio or their business model in the future…”

We also remain acutely aware of the trade-offs involved in some investors’ preferred strategies of divestment, a topic that regularly comes up in conversation with clients and fellow participants in collective actions. We believe divestment has its place as a tool to deploy near the end of an engagement and escalation process, but we generally prefer an approach that pursues changes in governance and business practices in line with our sustainability principles. There are systemic risks to divestment, as well, that are worth considering. For example, there’s emerging concern around the risk of stranded assets as coal, oil, and gas assets are pushed toward private markets by public market entities that are eager to reach their net zero goals or, where these assets are already privately held, they’re taking on the appearance of being an incipient economic loss. We think investors need to be aware of these shifts and continue to focus on real-world decarbonization.

There are innumerable challenges that complicate efforts to forge a sustainable path—whether for companies, sovereigns, asset owners, or asset managers. We firmly believe that those who are acting now to play their part in generating sustainable outcomes for stakeholders are far less likely to face a shock to their portfolio or their business model in the future in a way they can’t control, and which could therefore be costly and challenging to resolve. Encouraged by the positive outcomes that are evident from strong stewardship practices, responsible companies today are looking at how to be part of a circular economy in which as much of their product as possible is generated using recycled materials; they’re considering the full lifecycle of their products and the impact their production and ultimate use have on the planet—whether that means GHG emissions or damage to the natural environment. They’re investing in their people and in research and development and ensuring that they have a diverse workforce at all levels, reflecting the society in which they operate.

Underlying all of these practical actions is a culture of responsibility, a shared sense of ownership of the global challenges, and a determination to act sustainably in a world beset by existential environmental crises.

1 Since—and in some cases prior to—the publication of the Stern report in 2006, regular scientific assessments of climate change from the Intergovernmental Panel on Climate Change, scholarly articles from the Proceedings of the National Academy of Sciences of the United States of America, and research conducted by the International Energy Agency, to name just a few examples, have successively deepened global understanding around the physical risks and economic and social impacts of climate change. 2 The World Bank, April 2021. 3 This period included a variety of major economic shocks, from the global financial crisis and the EU sovereign debt crisis to the gradual debasement over the ensuing decade of social democratic norms (Brexit, authoritarian populism in Europe and the United States, and autocratic eruptions in many other locations), not to mention a litany of climate disasters ranging from destructive tsunamis and unprecedented inland flooding to persistent drought and wildfires that have taken on dystopian-like prominence for the affected populations. 4 BloombergNEF, September 2021. 5 Scope 1 emissions are direct emissions from owned or controlled sources. Scope 2 emissions are indirect emissions from the generation of purchased energy.