By Adrienne Monley – Head of Investment Stewardship — Europe, The Vanguard Group
Working at one of the world’s largest asset managers and meeting with the board directors and senior managers of some of the world’s leading companies is a great opportunity to better understand their corporate governance practices and to understand how those may or may not align with long-term shareholders’ interests.
In the last proxy year, we engaged with more than 700 companies and voted on just over 160,000 vote proposals. Our funds invest in more than 2,000 companies across 27 countries in Europe.
Each market approaches corporate governance a little bit differently. In Germany, for example, employee representatives sit on a company’s board; in France, there are quotas regarding female representation on boards. While local norms and regulations may differ from country to country, we still believe that, no matter where we’re invested, good corporate governance is important for driving long-term value.
Shift to the long term
In the last five years, interest in the corporate governance practices of public companies has been fast growing. This is especially true in Europe, where individuals and institutions alike are keen to ensure their investments in public companies are being managed well and in support of their long-term financial objectives. Despite this, globally, we see the challenge for companies to balance the demands of short-term investors with long-term value creation.
Against this backdrop, policymakers in the European Union, the UK and countries across Europe are actively exploring how they can support longer-term behaviour in markets – both by companies and their investors. The European Commission’s approach to sustainable finance is a good example. The Sustainable Finance Proposals seek to enhance the integration of environmental, social and governance (ESG) factors into the financial markets. The revised UK Stewardship Code also takes an interest in long-term sustainability matters through an investment stewardship lens.
Passive investors, not passive owners
Our stewardship team in London has noticed some key differences and similarities between approaches to corporate governance in the US and Europe. We’ve been surprised to meet a number of European companies who have never spoken with their long-term index investors, perhaps assuming that index investors don’t care about a company’s performance reporting, or corporate governance.
In the US, engagement with index-oriented investors is more common – perhaps due to the historic success of index strategies, which are often a component of US retirement plans.
In Europe, index investing is still on the rise and engagement with index-oriented investors is a newer practice for some companies. As a result, we often have more foundational conversations when first meeting with companies and discuss how our approach to investment stewardship may differ from that of active managers.
You could describe index investors as structurally permanent shareholders. After all, they invest in a company as long as it features in the index being tracked. At Vanguard, we start with the premise that our funds will invest in a company forever. This extreme long-term view drives our approach to investment stewardship. We focus on how a company’s corporate governance practices will support sustainable value creation over the course of years and decades – not months and quarters.
A materiality-driven approach to ESG
As we are a long-term orientated investor, working to ensure our investments are sustainable, we look at ESG topics through a materiality lens. When analysing issues, we consider whether and where they may materially affect the company’s financial performance. The Sustainability Accounting Standards Board’s (SASB) materiality map provides good guidance on sustainability issues that could affect either the financial or operating performance of companies on an industry basis.
We see a strong focus in Europe on the potential financial implications of sustainability issues. However, not all companies take the same approach regarding ESG and materiality. There is a risk that investors and companies can spend too much time on non-material issues than on those driving long-term value.
Sustainability in Europe
Factors affecting material sustainability can take different forms across industries and geographies. It depends on relevant competitive forces, regulation, government action, consumer demand and preferences, and social and environmental considerations. For example, in the oil and gas industry, management of the physical, regulatory and reputational risks associated with greenhouse gas emissions is a key sustainability concern, whereas in the consumer goods sector, supply chain management and product quality and safety are likely more important. For a company to grow its value over the long term and for investors to achieve their long-term objectives, deliberate attention to and oversight of material risks is crucial.
In the last year, sustainability has been a key theme in many of our engagements. In our experience, European companies are willing to discuss and disclose their approach to these issues, including topics drawing wide public interest, such as climate risk. In addition, many companies actively communicate with stakeholders – such as employee groups, non-governmental organisations, academics and others – on sustainability matters.
“Across Europe, we see companies taking steps towards greater transparency on sustainability issues, which we support – particularly when focussed on practices relevant to long-term value creation”
Across Europe, we see companies taking steps towards greater transparency on sustainability issues, which we support – particularly when focussed on practices relevant to long-term value creation. This increasing comfort with transparency isn’t surprising, as many countries and companies in Europe have joined in the aspirations of the Paris Agreement, support the UN Sustainable Development Goals or align with similar objectives. Even companies in industries not usually associated with sustainability, or directly linked with climate risks, appear to be taking interest.
Good governance means good communication
Still, at the heart of long-term sustainability are good corporate governance practices and, importantly, the responsibilities of boards of directors. Today, investors expect boards to understand and oversee material risks that may affect the company’s future, including matters such as cyber or data risk, climate risk and human capital management.
In turn, companies are being asked to communicate about and disclose their relevant risks in a way that is clear and useful to investors. This is a critical priority for investors who must understand the issues affecting their portfolio companies and appropriately value them in the market.
We encourage companies to consider applying sensible frameworks, such as SASB for overarching material risks and the Task Force on Climate-related Financial Disclosures (TCFD) for more specific climate risks. Although we already see some companies embracing enhanced reporting on material risk topics, adoption is not yet consistent around the world.
Globally, the TCFD has more than 500 supporters, representing a combined market capitalisation of more than $7.8trillion. These include 457 companies and 56 other organisations, such as industry associations and governments. Although the SASB standards were only recently released – in November 2018 – a rapidly growing number of companies have already adopted the standards. According to the organisation, there are currently 69 companies publishing SASB-aligned reporting while hundreds more reference SASB in relation to how they consider materiality.
Industry initiatives across the globe are seeking to improve corporate governance and investor stewardship with similar sights on the long term. They range from governance and stewardship principles (such as the UK Stewardship Code, US Investor Stewardship Group and the global Principles for Responsible Investment) to enhanced corporate reporting standards (including SASB and the TCFD). This growing focus on the long term across the investment value chain is encouraging.
Ultimately, if investors, companies and policymakers can broadly align around shared long-term objectives, we have a powerful opportunity to adopt common standards.
About the Author:
Adrienne Monley is the Head of Investment Stewardship—Europe for Vanguard and is based in London, UK. She had previously served as a senior strategist and senior manager on Vanguard’s Investment Stewardship team in the US, where she lead board-level engagement with some of the firm’s largest holdings and oversaw a team of sector-focused analysts and data specialists.
Ms. Monley was formerly Chief of Staff to Vanguard’s general counsel and managing director of the Legal & Compliance Division, having joined Philadelphia-headquartered Vanguard in 2012 through a leadership development rotational program. She began her career in the Rewards, Talent, and Communication consulting practice of Towers Watson. Ms. Monley completed undergraduate studies in English and Communications from the University of Rochester in Rochester, NY, and obtained her Master’s in Business Administration with a focus in global finance and investments at the Simmons School of Management in Boston, MA