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January 2018 | Multiple

Global ESG Research Update — Wellington supports emerging disclosure framework on climate-related financial risks

Our team explains why the new framework should help investors better assess climate risks and opportunities. We also provide an update on recent ESG engagement activity.

On the second anniversary of the 2015 Paris Climate Conference, Wellington Management joined over 230 organizations in signing the Statement of Support for the Financial Stability Board’s (FSB’s) Task Force on Climate-related Financial Disclosures (TCFD).

Developed in late 2015 by the G20’s FSB and championed by Michael Bloomberg and Bank of England Governor Mark Carney, the TCFD recognizes the potential impact of climate change on financial markets and outlines recommendations for voluntary corporate disclosures that can help investors better assess climate risks and opportunities in their portfolio companies. We believe the TCFD’s recommendations are the emerging standards for comparable, reliable, efficient climate-risk disclosure that can help lenders, insurers, and investors make better decisions. The recommendations provide a non-prescriptive framework that corporations and asset managers can adopt in a manner that speaks to their overall climate-adaptation strategy by disclosing details about four key elements: governance, business impact assessment, risk management processes, and metrics selection.

Encouraging adoption through stewardship

The goals of the TCFD are aligned with our ongoing environmental, social, and corporate governance (ESG) integration and stewardship activities. We believe that improved disclosure from companies will help us better assess climate-related risks and enhance our capacity to serve as fiduciaries of client assets. Since the release of the final recommendations in June 2017, our ESG Research Team has been encouraging Wellington’s portfolio companies to adopt them as part of our engagement dialogue. As we head into 2018, we will monitor the first wave of published company reports on climate risk, seeking verification that companies are working to create shareholder value by addressing climate risks related to their physical assets and by mitigating transition risks stemming from changing regulation and technology.

During 2017, we saw a marked increase in the number of shareholder-sponsored proposals encouraging better climate-related disclosure, a trend we expect will continue in 2018. We generally support proposals focused on improved assessment and disclosure of climate risks, particularly when we believe they may be material to a company’s long-term performance and that management has not sufficiently addressed them.

4Q2017 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 4Q2017 proxy-voting results

4Q2017 ESG engagement activity

In the fourth quarter of 2017, our team engaged with 147 portfolio companies in 16 countries (Figure 2) on ESG topics ranging from carbon risk assessment and disclosure to cybersecurity to executive compensation. See the list of our engagement discussions for the quarter below.

Figure 2

Company engagements by Wellington Management’s ESG Team in 4Q2017
 

4Q2017 ESG engagement activity by company

Company E S G
Consumer discretionary
Aptiv PLC
AutoZone Inc
Comcast Corp
Domino’s Pizza Entpr
General Motors Co
Goodyear Tire&Rubber
Groupon Inc
Hilton Worldwide Hld
MCBC Holdings Inc
McDonald's Corp
NVR Inc
TJX Companies Inc
Toll Brothers Inc
Wynn Resorts Ltd
Company E S G
Consumer staples
Asahi Grp Hldgs Ltd
Campbell Soup Co
Coca-Cola Co
Colgate-Palmolive Co
Costco Wholesale Crp
CVS Health Corp
Estee Lauder Cos
Nu Skin Enterprises
Sanderson Farms Inc
Wal-Mart Stores
Company E S G
Energy
Anadarko Pete Corp
Antero Resources Cor
Chevron Corp
ConocoPhillips
Devon Energy Corp
Exxon Mobil Corp
Halliburton Co
Hunting PLC
Karoon Gas Australia
Newfield Exploration
Noble Energy Inc
Occidental Petroleum
Phillips 66
QEP Resources Inc
Total SA
Company E S G
Financials
Ambac Financial Grou
BB&T Corporation
Berkshire Hills Bcp
Chubb Ltd
Evercore Inc
FinecoBank Banca Fin
Hartford Finl Svcs
Huntington Bancshs
Intercontinental Exc
Invesco Ltd
JPMorgan Chase & Co
Julius Baer Grp Ltd
KB Financial Group
Manulife Financial
Marsh & McLennan
MSCI Inc
Prudential Financial
Reinsurance Grp Amer
Swiss Re AG
UBS Group AG
Unum Group
US Bancorp
Wells Fargo & Co
WR Berkley Corp
XL Group Ltd
Zurich Insurance Grp
Company E S G
Health care
Abbott Laboratories
Amgen Inc
Bristol-Myers Squibb
Cardinal Health Inc
Celgene Corp
Dentsply Sirona Inc
Edwards Lifesciences
Eli Lilly & Co
Gilead Sciences Inc
Glaukos Corp
Hologic Inc
Ionis Pharmaceutical
Ironwood Pharma Inc
Lab Corp of America
LifePoint Health Inc
McKesson Corporation
Medtronic PLC
Merck & Co
Pfizer Inc
Regeneron Pharm Inc
Valeant Pharmaceutic
Company E S G
Industrials
3M Co
Air Lease Corp
Alaska Air Group Inc
Alstom SA
Armstrong World Indu
Boeing Co
BWX Technologies Inc
Dover Corp
Equifax Inc
General Dynamics
General Electric Co
Honeywell Intl Inc
IHI CORP
ITT Inc
Kirby Corp
Norfolk Southern
Oshkosh Corp
Raytheon Co
Siemens AG
Spirit Airlines Inc
Union Pacific Corp
United Technologies
Company E S G
Information technology
Accenture PLC
Applied Materials
Autodesk Inc
Diebold Nixdorf Inc
eBay Inc
Fabrinet
Itron Inc
MACOM Tech Solutions
NVIDIA Corp
Paycom Software Inc
salesforce.com inc
Splunk Inc
Teradata Corp
Total System Svcs
Verint Systems Inc
Company E S G
Materials
Carpenter Technology
International Paper
Kobe Steel Ltd
Smurfit Kappa Gr PLC
WestRock Co
Company E S G
Real estate
Kennedy-Wilson Hldgs
Link REIT
Mitsubishi Estate Co
Public Storage
Vonovia SE
Company E S G
Telecommunication services
China Telecom Corp
Deutsche Telekom AG
Company E S G
Utilities
Alliant Energy Corp
Duke Energy Corp
Eversource Energy
OGE Energy Corp
Pinnacle West Cap
Sempra Energy
WEC Energy Group Inc
Xcel Energy Inc

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 4Q2017. 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.

4Q2017 ESG engagement examples

ENERGY COMPANY

Overview

We met with the outgoing chair and CEO to gain insight on the company’s approach to managing several key risks — including climate change — particularly because the company had proactively shared its climate-change strategy with shareholders during the proxy season earlier in the year.

Key discussion topics
Climate change

This company succeeded in getting investors to withdraw the climate-risk disclosure shareholder proposal from its 2017 proxy ballot by issuing its first climate report in March. The company has reduced emissions from its operations, specifically by reducing methane emissions from natural-gas flaring, improving energy efficiency, and exploring carbon capture. Surprisingly, the chair resisted the notion that climate change is a risk for the business. This was reflected in his bearish view on electric vehicle (EV) adoption and renewables, especially in the short term, barring any major policy intervention.

We told the company that the climate report was a good start, but that we expected to see more progress, including more rigorous scenario analysis, to help us gauge whether it is considering the range of possible outcomes from a changing climate and is able to adapt accordingly. In our view, managing these risks should help the company generate long-term value for shareholders, while ignoring them could hamper its resiliency. In a subsequent meeting with the company, we were pleased to hear that it is considering moving toward adoption of the TCFD framework for its next report, which is scheduled for release in March 2018.

Risk management

Process safety is at the top of the board’s agenda. The company makes a concerted effort to prevent oils spills and gas leaks. Not only does it promote best practices within its own operations, it encourages compliance across the industry as well, appreciating the potential contagion risk of poor peer behavior.

Water management

This industry is extremely water intensive, and water handling and disposal are factors that can have profound effects on a company’s environmental impact. The company has been phasing out the use of fresh water, relying more on non-potable grey or recycling water to reduce the cost of disposing water off-site. The chair tied diligent water management to the long-term sustainability of operations, as efficient water use benefits the bottom line and reduces the company’s environmental footprint.

Conclusion/follow-up

The chair’s views on climate change stand in stark contrast to those of his global peers, who are increasingly putting climate risk at the center of their longer-term strategies. This company is a responsible operator with solid governance practices, and in our opinion, its leadership on process safety issues makes it a standout among peers. However, resistance to considering how changing policy and technology might accelerate a shift away from fossil fuels toward renewables could be a blind spot for the company’s strategy longer term. We will continue to engage with the company on this topic and closely monitor the evolution of its climate-risk disclosures.

INDUSTRIALS COMPANY

Overview

We hosted a meeting with the interim chair to focus on a recent consumer data breach and actions the board has taken in response.

Key discussion topics
Data privacy/security

As a result of the breach, the company is the subject of two investigations by independent counsel, experts, and a special board committee. The first focuses on stock sales and is expected to conclude that the company’s preclearance process functioned as planned.

The second investigation, which is broader and ongoing, centers on the company’s governance and oversight processes. The chair acknowledged that the company had been overly reliant on perimeter defenses and not focused enough on response planning. We were pleased to see that the interim Chief Information Security Officer (CISO) now reports directly to the interim CEO, creating a clear escalation channel in the event of future incidents.

Succession planning

The board is conducting formal searches for a permanent CEO and CISO. For the CEO, the board is looking for someone who is focused on restoring brand credibility, has experience operating internationally and with technology, and seeks to develop the talent of the new management team. The interim CEO is being considered for the permanent position in light of his strong performance following the data breach. The company acknowledged the difficulty in hiring a permanent CISO, citing the competitive market for this skill set.

Board structure/composition

A new director joined the board in October and will serve on its technology committee. He is described as being “fascinated” by cybersecurity and was slated to join the firm before the data breach. The board has since learned the importance of having additional resources to monitor day-to-day progress and signal an alarm if needed.

Conclusion/follow-up

This was a positive meeting that suggested the company is being thoughtful about the improvements it is undertaking to its cybersecurity practices and its management team. The chair came across as introspective, candid, and constructive on the company’s future. His facility for speaking to the key issues suggests that he is the right person to continue overseeing the company and its cybersecurity program improvements.

Notably, despite the negative media attention surrounding this matter, the company does not believe that new regulations are imminent, given lack of broad public pressure for change. Nonetheless, we plan to continue engaging with the company to ensure it has a proactive plan in place, should new regulations regarding consumer data protection appear on the horizon.

MATERIALS COMPANY

Overview

We requested a call to discuss a recent data-fabrication controversy involving the quality and safety of the company’s products. In the weeks following our call, the company published a report on the causes and measures it plans to take to prevent future incidents.

Key discussion topics
Product safety and quality

In October 2017, the company reported that employees falsified data about the quality of some of its products. Despite the potential longer-term reputational risk, we were encouraged by the company’s proactive customer conversations, which did not uncover any major product-safety issues. The report stated that safety had so far been confirmed for 90% of the customers to which improperly handled products were supplied.

According to the report, three of the five factors attributable for the data falsification were related to quality-control procedures. First, the lack of automation enabled tampering. Second, employees were overconfident about product quality and lacked awareness about contract compliance. Finally, the quality-assurance function was not independent from quality control. The company is now treating improved automation, training and establishment of independent quality control as priorities.

Employee compensation

The company said that management and employee bonus compensation would not have been directly impacted by delivery-schedule delays, although lower business-division earnings could impact bonuses. On the surface this is good news; however, the company wasn’t willing to share details. We stressed the importance of increased transparency on compensation as a means to help us identify potential incentive misalignments.

The report highlighted an overly profit-focused management team and insular corporate culture as contributing to the incident. The company is reexamining the goals and incentives it sets for management and employees in an effort to foster a more open culture.

Board independence

The lack of independence in both the board and the audit committee and the combined role of chair/CEO are concerning governance features, regardless of the recent product controversy. In addition, there are no women on the board and the majority of the board members graduated from a single university. We believe the board’s lack of independence and diversity contributed to governance failures, as did questionable management and promotion decisions.

Conclusion/follow-up

The company’s recognition of flaws in quality control, incentive structures, and corporate culture are encouraging. We are watching for evidence of improving governance, including a more diverse board, greater independence in the audit committee, and increased transparency on incentive structures. We think this company is taking the right steps to address these issues, and we will continue to monitor its progress. Its positive steps may also be a catalyst for companies in other industries to redouble their efforts to ensure they are providing safe, quality materials.

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