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Businesses have been paying markedly more attention to environmental, social and governance (ESG) issues over the past years. Understandably, given the climate emergency, much of the world’s focus has been on environmental factors, with the Covid-19 pandemic also putting social issues such as worker rights and health and safety to the fore.
Governance, the area where investors first engaged with non-financial – or extra-financial – issues, has increased in recent years: in 2021 DWS discussed governance topics in 74 per cent of overall engagements. It can be the bedrock of all the other issues, says Nicolas Huber, head of corporate governance at German asset manager DWS. “The tone from the top is important,” he explains. “Companies with weaker corporate governance structures could be more vulnerable to financial and extra-financial risks. Corporate governance practices can also influence a company’s management of environmental and social factors.” Intact governance, Huber points out, give companies a far better chance of effectively managing these areas.
Good ESG isn’t just ethically appropriate: it’s also good for business. “A good understanding of governance is an important source of higher shareholder returns. It helps companies – and investors – to identify risks and opportunities that normal financial analysis may miss,” says Huber. “It’s part of our fiduciary duty, but it’s more than that. I strongly believe effective corporate governance is important to ensure that companies are in good position to face future challenges.”
A concern for corporate governance is also increasingly important for clients. In the past, Huber says, asset owners would just ask if their managers had a policy and a framework in place. “Now there are detailed questions around how we vote, with whom we have engaged and on what. There is a much more sophisticated approach from clients now, driven in part by stewardship codes in countries such as the UK.”
Engagement with management and supervisory boards is one of the most important ways that investors can influence a company’s corporate governance and its performance on sustainability. “When we engage, we have an escalation process,” Huber explains. “When you are invested in a company, you have the opportunity to effect change. When you’re not invested, it is more difficult to make a difference.”
In 2021, DWS increased its engagement efforts to more than 581. “One example of where engagement has made a difference is in the area of remuneration packages”, he adds. Years ago, remuneration plans were in many ways very complicated, not at all transparent and often had no clear KPIs, especially in the long-term incentives. “We discussed this topic in many of our engagements and we have seen some improvements over the past years.” Companies started to integrate non-financial performance indicators into their remuneration systems, as awareness of companies’ double materiality grew.
Greenhouse gas emissions, water and energy use, biodiversity, health and safety and diversity are increasingly finding their way into executive remuneration policies and DWS expects its investee companies to integrate material ESG factors into their thinking and strategy, as well as to establish and demonstrate a clear link between their stated ESG targets/non-financial KPIs and their remuneration systems.
“One example is a company from the materials sector in Germany, with whom we had an intense dialogue with for nearly two years,” says Huber. “The progress presents true development and can be regarded as a successful engagement leading to a more transparent and shareholder-friendly remuneration system, including a 40 per cent weighting of sustainability within the long-term performance plan, for example on CO2-emissions.” Of the 430 governance engagements that DWS conducted in 2021, more than half covered executive remuneration for which processes were in place where improvements could be made. Following an update to the DWS voting policy in 2021, many of the conversations on this topic included sustainability-linked KPIs in order to tie in extra-financial priorities to executive pay packages.
Board independence is another topic where DWS is very active. “If you have sat on a board for more than 10 years, you are more likely to be less critical of a company’s management. We discussed this topic in 147 engagements, for example with a company from Hong Kong operating in the consumer discretionary sector that will now look for replacements of its long-tenure directors to improve the board’s independence,” Huber points out.
DWS aims to link their engagement activity to their voting behaviour. As a global asset manager, DWS is invested in many companies, but because of the number of holdings they focus on those companies for which they have, for example, significant holdings, special regional focus with sustainability and/or governance concerns.
To ensure transparency on its governance standards and to outline its expectations as an active owner, DWS has published its Corporate Governance & Proxy Voting Policy online. “We have our own DWS corporate governance DNA developed over the past 25 years which considers also international best practice, various governance codes and international frameworks such as UN Global Compact and OECD Guidelines for Multinationals,” Huber says. “We try to be as transparent as possible in regards to what we expect from our investees. The policy is constantly being developed further in order to refine our expectations and have more fruitful discussions with our investee companies in relation to all aspects of E, S and G.
“DWS doesn’t differentiate between active and passive investments. Our corporate governance policy applies to all in the same manner”.
“In general, we are looking for a constructive dialogue with our investee companies. As a further escalation step, when companies do not move into the desired direction, voting against management proposals and participation at annual general meetings are an important way to articulate our concerns. In this, we are able to raise questions, concerns or where appropriate we also commend boards on certain successes. Highlighting issues in public is an important way to define our position which hopefully puts pressure on companies to act. Last year, we submitted questions to 40 AGMs, publicly making clear what our expectations were of the companies concerned.”
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Originally published on Business Reporter
