Deconstructing constructive corporate engagements – Sudip Hazra

Rachel Alembakis 0:10

Welcome to the greener way podcast, a show about people planted in purpose and how investors and corporate leaders push forward in a complex world. Welcome to the greener way podcast. I'm your host, Rachel Allen Bacchus. In this episode brought to you by first sent to your investors. We'll be talking about engagements, active owners and investors usually cite deep conversations with portfolio companies as a key weapon in the stewardship arsenal. But how do we know if they're successful? Joining us to discuss this point in more is too deep Hazara a director at first sentier MUFG sustainable investment Institute, the Institute literally research this very question. So so deep, let's get into it. First of all, can you give us a little bit of background, what is the first sentier MUFG sustainable investment Institute? So thank you, Rachel, for for having me with you.

Sudip (Guest) 1:03

I've been in the sustainability space now for about 15 years. And I've seen a good chunk of the ecosystem for investors. So I was attracted to this role, because the institute is kind of exciting and unique concept it was set up a couple of years ago. And it came out of a joint venture between MUFG and Placencia. Investors. So the idea is to have a dedicated sustainability research capability. And we provide thematic research and insights across a number of different environmental, social and corporate governance themes. One of the ways in which we're supported very well is that we have a dedicated academic advisory board with academics across the world really. So there we have quite a robust process and input into our different papers. And also, in terms of the reach of the Institute, we want it to be as broad as possible. So certainly, we interact a lot with our clients and asset owners, but we want it to be available to the entire ecosystem of investors. That includes, for example, investment advisors, consultants, but also regulators, nonprofits, and the media. And the idea there is, we really want to have an educational purpose as well more broadly, to promote sustainability and help with some of the understanding on the scenes that are well established, but also some of the themes that are less well known also. Excellent. So now that we know that you've got the chops, both from the experience and from the advisory boards that you have on this institute, so deep. Can you tell us a little bit more about this particular piece of research? And how do you define what a successful engagement is? So the background to this paper was that we felt obviously, engagement is one of the central outcomes and really vehicles that investors use to identify a number of different things, including financial materiality, but also in terms of establishing a relationship with the company, and in ESG terms, actually establishing impact on ongoing basis. But one thing we did find is that often, the views that we're coming out in existing research, particularly academic research, were more centred on investors themselves, rather than the corporates. So the objective of this paper was to really look at that slightly under viewed area of well, what the corporates think will make engagements better, and what will facilitate a better free flowing, longer conversation. So we've partnered with PwC, here, and the starting point was to look at a lot of the existing research and identify some of the trends and potentially some of the gaps. And after that, we came up with a survey of questions to ask investors to really understand better, what would be their preferences in order to come up with successful outcomes for engagement as a whole. And in terms of the cohort, we took about 100 companies globally of different sizes, and that also included 10 G Suite interviews, to get a little bit more detailed understanding on some of the questions. What are some of the key considerations here so deep in terms of what can how do you define a successful engagement? And to wait, what are the key inputs to having a successful series of ongoing conversations between an investor and a portfolio company? So one thing we did acknowledge in this report is that no, there's no universally accepted definition of a successful engagement. But what we did is for us, we define the successful engagement as being one which results in a meaningful change in corporate behaviour, strategy or policy. But that's really the key

The it's still a pretty open definition because engagements, as I said, can be so many things for so many different people. And even within one firm, you might have slightly different focuses. That was really, you know, one of the outcomes. I often

Rachel Alembakis 5:14

joke with here at Fs sustainability or unofficial motto is Fs sustainability, it depends, because it's, as you say, it's so dependent on the investor, and it's so dependent on the company. So to what extent then, does the successful engagement depend on the knowledge and the diligence of the investor versus the approachability and willingness of the investi? Company? How do we how do you sort of define those halves of the equation?

Sudip (Guest) 5:43

Yeah, sure. So I think I mean, there could be some cases where engagement doesn't actually result in the change that was established and expected. But still shareholders and even the company might view it to be a success. And that could be for a number of reasons I better relationship was established. or, indeed, it may have been the case that the actual initial outcome that was proposed, was found to be maybe not the best outcome of certain changes in time. So really, I guess one of the key things there is helpful sharing of information where both parties are very active, and there's a constructive dialogue. And in some cases, we may see that the shareholders achieve the kind of outcome for their engagement that they didn't always expect. But they still do that as being positive, irrespective of whether they've actually put that as a initial outcome that was looking to be attained. So then,

Rachel Alembakis 6:46

as you've done this research, then how do your colleagues at FSI, then optimise both halves of this converse of this equation to maximise outcomes essentially return for investors.

Sudip (Guest) 6:59

One thing to note is within show that companies themselves are very open to engagement. And in the dialogues you've had so far with asset owners, many have been surprised that what we found was actually that 96% of companies that we interviewed, and the shareholder engagements were a productive use of their time, and resources. And the reason that, I think is because companies are open to dialogue, but they want the dialogue to take place, in a constructive way. So typically, some of the factors, which we think are very important for that kind of success would be that. Typically, engagements have a objective, and some kinds of metrics discussed at the outset. And then also them there's a sense of mutual understanding between the investor and the companies. And that there's a sense that trust is being built. That means also that any kind of confrontational measures are used wisely. That isn't to say that an escalation process isn't there. And what I mean by that is, I think companies themselves will often appreciate some kind of escalation process, which will be clarified to say that if an engagement doesn't reach an outcome, these are the potential actions. Another thing we also found was that having capable and experienced individuals on the investor find leading the engagement, also, was highly appreciated by companies themselves, and certainly made a difference to actionable outcomes, and so on that it could also, you know, include the fact that direct engagement, where the shareholder themselves or other kinds of asset class investors were involved. Having that kind of direct contact was very highly appreciated. So that meant also that one of the findings was that the recommendations of proxy advisors, although valuable, companies wanted to see them as really an advice for investors rather than an instruction. I really like the starting point of a dialogue rather than an end outcome in itself. And also, face to face engagement, which were private, were also highly prized, rather than having intermediaries or just written letters. And I think that's

Rachel Alembakis 9:30

that's a really interesting point. They're so deep and something that, you know, we track here at Fs sustainability that the the utility of a letter campaign is fairly limited in terms of that deep ongoing dialogue that you talk about. So it's interesting that the, the report would highlight that as well. Yeah. So another thing that I found in the report Sudeep was that obviously, you did track that ESG related engagements are on the rise, considering that ESG is becoming more regulated, both from the perspective have laws around the world as well as the fear of greenwashing. How does this affect ESG related engagements?

I think investors are clearly having to respond to a lot of new regulation. And one of the outcomes there is that engagement actually becomes quite a useful tool in producing some of the results that are needed for that regulation. So typically, one of the key issues that investors would face is a lack of data. So often an end of engagement will be transparency and producing some of that data itself. But clearly, I mean, there are still some challenges, and both investors and issuers are still grappling with some of those questions around the regulation and the kinds of results that are required.

And so as a result, does this lead to more nuanced conversations? Does it lead to maybe recalibrating either the timeline for the asks or the requests that investors put to into companies themselves?

So I think one of the changes here is that the demonstrated value of engagement can sometimes be a little bit more aligned with regulatory outcomes. And I think sometimes shareholders will be looking to make that clearer at the outset of an engagement. I think often, some of the regulatory outcomes are really part of an existing set of questions that investors have had for a long time. So it's not necessarily something completely new when we do have a regulatory need to engage on some of the Cymatics.

Interesting Okay, so depot so glad that we are going to have this conversation today because I'll be honest with you the issue of how to define a successful engagement, how investors react or escalate with unsuccessful engagements is something that I think a lot about, and I we spend a lot of time writing about it fs sustainability. What happens if engagements are unsuccessful, you referred that the need for those clear escalation steps as part of the process.

In the report, we identified unsuccessful engagements of having at least one of the following four features, the first was a lack of demonstrated value i issues themselves, were often not clear what the engagement and the idea that engagement outcome would be. Second of all, there was a perception that sometimes there was a lack of shareholder knowledge or understanding, I, there wasn't a full appreciation of the relevance of the engagement question to the business model of the company. And that can be quite important because some engagement styles will typically take a blanket set of questions and propose them to a large number of companies. And that's certainly not our approach. And that's not what we want to do. So one of the outcomes of our survey was certainly that shareholder knowledge and understanding of the issuer was needed for a successful engagement. Awesome, the resource question was very important. And what I mean by that is, if a company felt that it didn't have enough resources to dedicate to an engagement, that was an obstacle, so typically, if a company didn't have, you know, the time the expertise internally, or even the financial resources to dedicate, that was a problem. So typically, really meeting, the resource usage from the issuer point of view as efficient as possible, particularly for smaller companies was a limit that issue was wanted, acknowledged. And then lastly, a confrontational engagement process was definitely something that we could imagine if it was, we're not necessarily comfortable with. And that came up in our survey, as well. So typically, although activist investors, they do generate quite a lot of news flow. We were quite happy to find that, in practice, the activist element of engagement was actually fairly small. But still, there was a confirmation that it wasn't very highly appreciated by issues.

That's interesting. And listen, we're all here for the news, float Fs sustainability. Sometimes it says activist engagements that let us know that there are things going on that we should cover

in the show,

but we do admit that we have a different r&d And you know, not always aligned with sort of the goals of investors when it comes to engagements, but we do acknowledge so based on the report's findings, and what you discovered through this process of the research city, how can investors better approach issuers to ensure that their engagements do lead to action

in terms of key factors that really increase the likelihood of a company taking action in response to an engagement? We had five areas were frequently the most identified. The first one was having a compelling case study Case for engagement, which was really tailor made to the company. And that's important because if it's tailor made, it's more likely to have some kind of benefit for the company itself. So the key element there was that shareholders should be able to effectively communicate that benefit in the customised context of the company itself. The second item was having a quality process and by process, what issue is meant was really something that was face to face and had a direct connection between the issuer and the investor themselves. And typically, when it was felt that there was a quality process, the majority of engagement, actionable outcomes. Another thing, which is very interesting now, and maybe it relates to some of the previous questions, and I mean, also relates to the idea of a regulatory push is the idea of a shareholder consensus. So typically, investi companies did welcome shareholder consensus, so they find collaborative proposals more compelling. And I think we can certainly find that there are certain themes which are quite central to the sustainability space, where collaborative engagements have really gained a lot of traction. So typically, issuers do like that kind of setup, because provided it has direct contact with investors, it really shows them clearly that there's a critical mass of interest in clearly defined and harmonised topics. So shareholder consensus, really one of the key outcomes, were typically investi, companies were more inclined to take action as a result. And then the fourth area was strong leadership. So the more knowledgeable the engagement leader, the more likely the company is to act. So that might seem like a fairly straightforward outcome. But in the structure that investors propose resources for an engagement, it was really important to have some leadership and knowledgeable teams to be discussing with companies and stuff. And then lastly, a very interesting one was the idea of the cost of inaction. So as well, as you know, let's say, the carrot. There was also the stick element, where investi companies were actually interested in understanding, well, what happens if we don't act? So where investors were putting their case for saying that there was a high cost of inaction on some of the themes, and I think we've seen that a lot on the environmental side, inaction was really one of the areas where potentially, you could start to see considerations of introducing or improving policies from issuers themselves, and where there was a kind of case where inaction would be detrimental to customers, and even a wider stakeholder perception of the company. That was often a key identified by companies to say that, yes, if we understand better the cost of inaction, we're more likely to act on an engagement.

I find all of these this part of the analysis so fascinating, so deep, you know, I'll often if I'm talking with asset owners, or asset managers to understand the ways in which particularly collaborative action is a useful tool and where occasionally, a singular engagement by a single asset owner where, where that decision comes down strategically, where they feel the greater utility is always such an interesting part of understanding how an engagement flow works. Yeah, sure. So alternatively, we've done the do's Sudeep, how about the don'ts? What should investors avoid doing if they're looking to approach a company with a particular engagement on an environmental, social or corporate governance issue?

So I mean, some of the key factors that would undermine engagement success would include a lack of demonstrated value. So what an issuer means by a lack of demonstrated value is that when a company isn't acting, it's often that I just don't perceive that the costs of the proposed actions actually outweigh the benefits. And, you know, in our survey, 53% of companies actually said that, that was one of the top reasons that they would not act is that they just didn't see the value of some of the areas that shareholders were proposing to them. Secondly, also, I mean, another area which often undermined success was lack of relevant knowledge. So this is really understanding the business model and the business case for engagement. And 68% of engagements that didn't lead to action. Were directly as a result of this perception. There was a lack of relevant knowledge, by investments as well. And then another couple Various, a lack of company resources. Obviously, there's a limitation on how much resource a company can put into some of the changes that investors think are very needed. And that was often identified as an ongoing factor. So particularly having the financial resources and the time, but also sometimes internally, the expertise, because let's not forget that I mean, some of the areas of engagement, particularly around environmental and social factors, do involve quite a lot of new technical expertise and potential operational changes on the company side. Then, lastly, one of the key areas as well, which was perceived as a negative on engagement, success was a confrontational process. So as a, as an activist investor, you'd have a very different position. But typically, you know, that wasn't seen as a constructive addition. However, there was a feeling that certain kinds of escalation can erode trust, and also reduce the effectiveness of future engagements, particularly when they were public. So that's quite an important area to keep in mind as well that there was a preference for private engagement. And also, when there was an escalation process to keep it literally behind closed doors, in order to really ensure that trust was maximised. So Sudeep,

it sounds like you're clearly passionate about the subject of sustainable investment and ESG. How did you get into this particular role? And what drives you to do this kind of research?

Yeah, so I started in the sustainable investment return research space, about 15 years ago. And my start was actually in the data space. And that's quite important, because I think an understanding of the data is as critical now as it's ever been. And it's only going to get more important. So that's really one of the central bits of thinking that I've always had. But then after some time, with a global data provider, specialising on ESG, I worked on the sell side with a larger bank, which really allowed me to see some of the differing approaches of investors globally. And I think that's still the case where we really have quite a wide variety of interests, which are all very valid and important. And then, of course, most recently, in terms of understanding how asset managers work. I think we're seeing a lot of evolving definitions of materiality. And certainly, that's come a long way. So I do remember, you know, starting off in this space 15 years ago, where a lot of the discussions with issues on materiality are still focused on things like charitable donations, land therapy, or even the number of sheets of paper that were recycled. The idea that, you know, environmental, social, and governance factors will have a material impact financially on a company. I think that's something that's still in evolution, but I've certainly come a long way to the time I've been in the space.

I agree with you there study but I don't read very many research reports by companies anymore, talking about the measure of volunteer days that their employees did as being a key ESG target. We've been talking with city Patra. This episode was brought to you by first incentive your investors. I'm Rachel Ellen Bacchus. And thank you for listening. Thanks for listening to the greener way podcast. If you like today's show, remember to rate and review us on your podcast platform and make sure you're subscribed so you don't miss an episode. Any feedback, contact us on podcast at fs sustainability.com.au I'm Rachel Allen Bacchus.

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