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April 2018 | Multiple authors

Global ESG Research Update — Shining a light on the “S” of ESG

Our ESG Research Team explains how they engage with companies on issues like the opioid crisis, firearms, and workplace harassment, and why broader stakeholder views and actions on such externalities matter. They also provide an update on ESG engagement activity in the first quarter.

DISCOURSE ON OPIOIDS, FIREARMS, AND SEXUAL HARASSMENT HAS PUT THE “S” IN ENVIRONMENTAL, SOCIAL, AND CORPORATE GOVERNANCE (ESG) INTO SHARP FOCUS. Our investors have long considered social externalities — the negative effects that companies can have on society through their products, cultures, or policies — in our fundamental research and engagement. These nuanced, often misunderstood issues can affect the value of corporate securities. Today, these are no longer just shareholder concerns; companies need to consider the opinions and actions of broader stakeholder constituencies, including employees, customers, and the public.

Seeking greater transparency

Members of our ESG Research Team encourage companies to disclose risk-management strategies that acknowledge their societal impacts. When a company faces litigation or negative press, we inquire about lessons learned and request evidence of substantive changes that aim to prevent recurrence and mitigate downside risk.

We are engaging with drug manufacturers and distributors on their role in the opioid crisis. Most have been open and responsive to enhancing their risk-management processes, as they have become aware of the potential negative impacts on their brand and bottom line. Engagement with weapons-related companies, on the other hand, has been mixed, with some dismissing the public backlash as a passing political issue, and others facing political pressure if they sever ties with the National Rifle Association. Our team will continue to engage on this issue.

Given the flurry of workplace misconduct accusations, we recently collaborated with our Human Resources and Legal Teams to develop questions for assessing the potential financial impact of these incidents as they occur. We believe certain sectors and corporate cultures are more susceptible to such behavior, and company-specific factors, including key-employee risk, can exacerbate the consequences. We increasingly look to open-source and public platforms for information about companies’ tolerance for misconduct. A pattern may indicate a structural problem, posing greater risk to shareholders.

We seek to gauge a company’s attitude and approach on social issues. Is management dismissive and defensive, or receptive to feedback and open to change? We want to see evidence of the latter, which may indicate solid overall risk management and sensitivity to the concerns of shareholders and stakeholders.

1Q2018 Firmwide proxy-voting results

Proxy voting can be a powerful tool that we leverage when engaging with company management teams. Our team examines each proxy proposal and votes against issues that we believe would have a negative effect on shareholder rights or on the current or future market value of the company’s securities. Figure 1 shows the breakdown of the past quarter’s global proxy voting.

Figure 1

Wellington Management’s 1Q2018 proxy-voting results

1Q2018 ESG engagement activity

In the first quarter of 2018, our team engaged with 96 portfolio companies in 18 countries (Figure 2) on ESG topics ranging from climate risk disclosure to diversity and corporate culture to board composition. See the list of our engagement discussions for the quarter below.

Figure 2

Company engagements by Wellington Management’s ESG Team in 1Q2018

1Q2018 ESG engagement activity by company

  Company E S G
  Consumer discretionary
  Advance Auto Parts  
  Cheesecake Factory  
  Ford Motor Co
  Honda Motor Co Ltd
  J Alexander’s Hldgs    
  Lowe’s Companies  
  Maisons du Monde SA  
  Neinor Homes SA  
  Newell Brands Inc  
  Norwegian Cruise Lin
  Persimmon PLC  
  Rakuten Inc    
  Wolverine World Wide    
         
  Company E S G
  Energy
  Cimarex Energy Co
  Concho Resources Inc    
  ConocoPhillips    
  Diamondback Energy  
  EnCana Corp    
  Energy Transfer Prtn  
  Extraction Oil & Gas
  Exxon Mobil Corp    
  Marathon Petroleum
  Oasis Petroleum Inc    
  Royal Dutch Shell  
  YPF SA
         
  Company E S G
  Financials
  American Express Co    
  Assicurazioni Gen  
  Banco Santander SA
  Bank of America Corp  
  BlackRock Inc    
  Brighthouse Financial    
  Comerica Inc    
  Dai-ichi Life Hldgs
  Enstar Group Ltd    
  FCB Financial Hldgs  
  Fidelity Southern    
  Hannon Armstrong    
  MGIC Investment Corp
  Prudential Financial    
  Travelers Cos Inc    
  Wells Fargo & Co  
         
  Company E S G
  Health care
  Anthem Inc  
  athenahealth Inc  
  Baxter International  
  Envision Healthcare    
  Genmab A/S    
         
  Company E S G
  Industrials
  ABB Ltd  
  ACS Actividades Cons    
  Advanced Drainage Sy  
  AerCap Holdings NV  
  Airbus SE  
  Cie de Saint-Gobain
  Continental Building  
  CSX Corp  
  Edenred  
  Equifax Inc  
  General Electric Co  
  Illinois Tool Works  
  Insteel Inds Inc    
  JetBlue Airways Corp  
  Johnson Controls Int    
  Knight-Swift Transpo    
  Mitsubishi Corp
  Navigant Consulting    
  Nippon Yusen KK    
  Pentair PLC  
  Prosegur Cia de Segu    
  Rexnord Corp  
  Schneider Electric    
  Terex Corp  
  United Parcel Servic  
         
  Company E S G
  Information technology
  Acxiom Corp    
  Akamai Technologies    
  Belden Inc    
  Broadcom Ltd    
  CommScope Holding Co    
  HP Inc  
  Nintendo Corp  
  PayPal Holdings Inc  
  Samsung Electronics  
  Sopra Steria Group    
         
  Company E S G
  Materials
  BHP Billiton Ltd
  Cleveland-Cliffs    
  Minerals Tech Inc    
  Nampak Ltd    
  Northern Dynasty Min
  Olin Corp    
         
  Company E S G
  Real estate
  Easterly Govt Pptys    
  Equinix Inc  
  Unibail-Rodamco Se    
         
  Company E S G
  Utilities
  E.ON SE    
  Entergy Corp  
  FirstEnergy Corp  
  Iberdrola SA
  PG&E Corp  
  Pinnacle West Cap    
         

E = environmental, S = social, and G = corporate governance discussions. The companies shown comprise a complete list of all engagement meetings in which Wellington Management’s ESG Team participated in 1Q2018. The companies shown are not representative of all of the securities purchased, sold, or recommended for clients. It should not be assumed that an investment in the companies listed has or will be profitable. Actual holdings will vary for each client and there is no guarantee that a particular client’s account will hold any or all of the companies shown. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities.

1Q2018 ESG engagement examples

ENERGY COMPANY

Overview

We met with the chair and CEO, the CFO, and the incoming lead independent director to discuss board updates, the company’s climate report, and cybersecurity.

Key discussion topics
Climate change

We supported a 2017 shareholder proposal for increased climate risk disclosure, which received notable shareholder support but did not pass. Despite initial resistance to the proposal, the company proactively published a report aligned with the recommendations of the Task Force for Climate-related Financial Disclosures (TCFD). The management team believes the company would fare well, even in a 2-degree scenario, due to the cost advantage of US refining versus global peers and the bullish outlook on natural gas as it relates to the midstream business. The team therefore emphasized continued investment in the company’s export capability and midstream infrastructure. The company has been investing significantly in the resilience of its physical assets, particularly electrical infrastructure and building construction.

The company’s energy intensity may increase temporarily as it makes certain investments to meet the International Maritime Organization (IMO) targets for sulfur reduction in fuel oil by 2020. However, the company believes this temporary trade-off should be a meaningful net positive given the toxic emission improvements that will result. Refiners who can meet the expected increased demand for cleaner, compliant fuel may be poised to gain a competitive advantage as the shipping industry looks to adhere to the new rules.

Cybersecurity

The new lead independent director raised cybersecurity as one of the board’s top priorities, on par with climate risk. The CFO described their approach, as cybersecurity personnel report to him, and he noted that resource allocation to cybersecurity efforts will continue in the future.

At gas stations, personal fraud is the biggest risk. This company will be fully EMV-chip compatible by the end of 2018 across all locations, well ahead of the liability shift for US credit card payments that is expected in 2020. This data security improvement is seen as an opportunity to build customer trust and perhaps push cyberattacks to less proactive competitors. Because terrorist threats pose potential risks to refining operations, the company works with the FBI and Department of Homeland Security. The CFO emphasized the hiring of a cyber expert with a military background as key to these efforts.

Board composition

The CEO shared recent changes to the board, including the addition of two directors—one with global and downstream expertise applicable to the company’s goal of growing exports, and the other with midstream experience applicable to the core business. Two directors will be retiring. The board seeks to add commercial, financial, and technology skill sets with future director appointments. The CEO discussed their commitment to increase board diversity, as the board currently includes two people of color, one of whom is a woman.

The board remains classified after numerous years as an independent company. Although the board put declassification on the proxy ballot in 2013, it did not pass due to the company’s supermajority requirement.

Conclusion/follow-up

The discussion highlighted passionate engagement by the board and senior management on major ESG issues, including climate change and cybersecurity. On climate change, we appreciate the company’s responsiveness to shareholders with improved transparency of climate risks. Its application of the TCFD framework is commendable, including the links from scenario analysis to strategic goals and the discussion of physical risks. We suggested enhancements to future disclosure, specifically to better articulate board oversight and identify efficiency targets to more accurately reflect refinery efforts. On cybersecurity, we are pleased that the CFO and the board are well-versed in cyber risks and that there is a direct escalation channel from information security to top management. We will continue to encourage management to declassify its board and improve board diversity, and we will monitor the company’s progress as the 2020 IMO deadline approaches.

FINANCIALS COMPANY

Overview

We met with the global head of ESG to discuss ongoing efforts to improve the company’s customer relations, employee engagement, and public profile.

Key discussion topics
Corporate culture

Over the past five years, the company has learned that customer-centric growth is not at odds with business results. This mind-set shift was set in motion by the current CEO when he took over. For example, the company eliminated overdraft fees, which had been disproportionately affecting low-income families. This helped create a culture of growing responsibly, and generated significant savings by reducing the number of phone calls from frustrated customers, allowing the company to close call centers.

We asked about the company’s exposure to and management of potential misconduct allegations. The ESG head acknowledged that it’s impossible to stop every bad actor but emphasized the company’s zero-tolerance culture and described mechanisms for employees to report and escalate incidents as vital risk-management tools.

The company closely monitors its progress through employee and customer satisfaction scores, which have been improving. While some competitors have had to correct their employee incentive structures, this company determined it didn’t have to change sales practices or compensation. Nonetheless, the company recognizes the need to counter the strongly negative public opinion about large banks. The ESG head believes that the company’s public profile should improve over time as it should get credited for operating responsibly. As evidence that responsible investment is a priority, the ESG head reports to the vice chair, who reports to the CEO.

Conclusion/follow-up

We appreciate that the head of ESG seems to be truly integrated with the company’s operations, rather than being siloed or overly focused on marketing, as is often the case in this type of role. We are constructive on the company’s progress to address the cultural issues that have historically plagued the industry. We encouraged improvement of disclosure on governance of cybersecurity in the annual ESG report, given the significance of technology to their business. Despite a positive trajectory, in our opinion, companies in this industry will always be magnets for occasional bad press; we will be discerning those headlines for signals of any potential deterioration of this progress.

INFORMATION TECHNOLOGY COMPANY

Overview

We spoke with members of the investor relations team about recent developments at the board and management, as well as labor management.

Key discussion topics
Board composition

The board is adding three new directors in 2018. One is the company’s first non-Korean director. He is an American who brings technology, engineering, and operating expertise. Another is a highly qualified woman with legal expertise, and the third is a man who brings expertise in semiconductor technology and electrical engineering. The board also plans to replace two directors in 2019 and is seeking to attract another international director and another woman. Notably, the company also recently separated the roles of chair and CEO.

The company explained that part of the challenge in attracting foreign directors to the board is that the board meets over ten times per year and director compensation is lower than in other countries. In response, the new chair is considering changes to the format of board meetings, specifically holding fewer, more concentrated board meetings with additional time for discussion of strategy rather than simply administrative voting on various issues.

Business ethics

We asked about the employment status of a key executive who is in significant legal jeopardy as his bribery conviction remains under appeal. The company said that if he is convicted again, it will likely fill his role by promoting from within, and not replace him with another family member.

Labor relations

Unlike others in its country of operations, this company does not have unionized employees; rather, it uses its competitive compensation to ensure employees are content without needing union negotiations. The company does not believe that the negative press about bribery allegations has affected its ability to attract talent.

Conclusion/follow-up

We are pleased that, after years of engagement, the company is making significant improvements to the composition of its board. Governance concerns remain regarding the company’s convoluted ownership structure and family control. The legal trouble of a top executive is less than ideal; we plan to monitor these developments closely and will engage again if the appeals process ultimately goes against him. Nevertheless, the notion that he would be replaced with existing talent — and not another family member — signals a marked shift in succession planning and a potential willingness to impart checks on family control.

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