Investors cannot have gotten away from hearing about environmental, social, governance (ESG) investing lately, and to many, that means not investing in ‘problem’ sectors, like oil and gas. But to Legal & General Investment Management, this strategy, called divestment, is not always a last stop of engagement strategy with ESG slow movers.
The problem with divestment is also that, once investors pull money out of such ESG laggards, they also give up their say and the voting rights, for example, that could enable them to push changes that take much time to materialize.
It is Not a Prudent Strategy to Close the Door
To Michael Marks, head of investment stewardship at LGIM, divestment is more than just kicking one name out of a portfolio. He looks to bridge the gaps that would cause a stock to be reinstated into the portfolio, as the company meets the proposed changes.
Marks says: “Divestment on its own does not change the underlying business. We’re looking to change the underlying businesses in the real economy, not just our investment portfolio. We could decarbonize our investment portfolios by taking out all those bad companies, but that's not changing the world.”
Even when a name is excluded from the climate-focused portfolios, LGIM can still use its passive investment book to retain its voice as a shareholder in investee companies, and thus continue its engagement efforts.
‘Name and Fame’ Works Better Than ‘Name and Shame’
Marks thinks the publicity about divesting from a ESG laggard can push for changes. He points to Japan Post as an example. In 2021, Japan Post joined LGIM’s divestment list for its climate fund range for not having robust carbon emission disclosures and a transition roadmap.
Marks continues: “We've been talking to Japan Post as an insurance company. We expect [an insurance company] to understand investment portfolio emissions, because they are financing emissions.”
Because of this, LGIM escalated the engagement case through voting against the chairman of the company. Marks says: “That normally gets enough attention. But, there was still not enough movement [at Japan Post].” Therefore, the asset manager decided to divest the holdings from its portfolios that follow LGIM’s climate impact pledge.” Portfolios that follow the climate-aware pledge manage around GBP 158 billion at present.
“The divestment itself isn’t the powerful thing. What’s powerful is when we go public with companies. Suddenly, we saw differences in Japan Post’s behavior.”
Because of this, along with efforts from other investors, Japan Post now has a thermal cold policy in place, has disclosed their scop 3 emissions in their investments, and has published a net-zero target by 2050, with interim targets for 2030. “They've really gone all the way along what we would have expected of them. And, last year we were delighted to be able to reinstate the stock into our portfolios.”
“I suppose, those English phrases ‘name and shame’ are used when the companies are not doing the right things, which we did with Japan Post several years ago. But when they do the right things, we welcome them back, and we call it ‘naming and faming’,” he says.
LGIM Divests from Air China, COSCO Shipping
This month, LGIM’s Future World Range of funds, which follows the firm’s climate pledge, divested from two Chinese companies for failing to meet its standards on climate. Air China (00753) and COSCO Shipping Holdings (01919).
Air China’s lack of operational emissions reduction target was the primary reason for the divestment. For COSCO Shipping, despite an operational target in place, the shipping company shows a low level of ambition for this target compared to leading peers. There is also no commitment or investment in low-carbon fuels, which is key to sector decarbonisation.
Three other Chinese companies – including two banks – are on the list of 14 names.
The asset manager expects banks globally to shift financing away from ‘brown’ to ‘green’. In particular, there is a trend that banks are decarbonizing client portfolios to ensuring global emission goals are met.
For having no thermal coal policy in place and no disclosure of scope 3 emissions associated with investments, China Construction Bank (00939) and Industrial Commercial Bank of China (01398) have been on the divestment list.
China Resources Cement (01313) was also on the 14-name list for lacking operational emissions reduction targets and demonstrating little progress. In cement sector, LGIM expects operational emission reductions from a shift to low-carbon fuels, sourcing renewable electricity and kiln efficiencies. Another player in Chinese cement sector, Anhui Conch Cement are also sanctioned as it fell short on many expectations.
Companies in Emerging Markets Continue to Engage Less on ESG
In 2022, LGIM engaged with 105 companies for targeted engagements. It engaged with 60 companies in 2021.
While some engagement efforts saw achievements, the asset manager also observed that companies in emerging markets, including China, India and Malaysia, were less responsive to their request to engage on climate issues. Among the 105 companies LGIM has engaged with, 21 did not respond, 62% of which were in emerging markets. While the firm will continue to improve the dialogue with these companies, engagement targets will remain the ‘leading laggards’.
Marks says: “We look for those companies that can be influential in their geography as well as in their sector.”
He explains: “In the smallest markets in the world, if we engage with their biggest company, unless it has got a global footprint, it is going to make no difference. So, we need to look at this in terms of how they can drive those market standards and drive for those better outcomes at the global level. A rising tide raises all boats.”
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