Institutional Shareholder Services (“ISS”) has released the results of its 2022 Global Benchmark Policy Survey that was conducted in August 2022. For U.S. companies, the survey focused on governance and risk management as they relate to climate change, problematic governance structures and racial equity audits. Respondents included investors (e.g., asset managers, asset owners and advisors to institutional investors) and non-investors (e.g., public corporations, board members of public corporations and advisors to public corporations). A summary of the survey’s significant findings relevant to U.S. companies follows:
Climate Change and Board Accountability
ISS asked survey participants what governance failures with respect to climate change risk management are so material for significant greenhouse gas (“GHG”) emitters (i.e., the Climate 100+ Focus Group) that ISS should recommend against the directors.
Disclosure. The majority of both investors and non-investors (79% and 57%, respectively) agreed that a lack of adequate disclosure regarding climate-related oversight, strategy, risks and targets, according to a framework such as the Task Force for Climate-related Financial Disclosure (“TCFD”) framework, is a material governance failure requiring an adverse recommendation.
Targets. Investors were about twice as likely as non-investors to view setting particular emissions targets as necessary to avoid a material governance failure. ISS asked survey participants whether a significant emitter needed to do each of the following to avoid a material governance failure (i) declare a “net-zero by 2050” ambition, (ii) set realistic medium-term targets (through 2035) for Scope 1 & 2 only and (iii) set realistic medium-term targets (through 2035) for Scope 1, 2 & 3 if Scope 3 is relevant. For each of the three targets, generally half of investors and a quarter or less of non-investors responded that not setting the particular target would be a material governance failure requiring an adverse recommendation. However, a large majority of investors (69%) and almost half of non-investors (43%) agreed that the failure to set at least one of the three types of emissions targets would be a material failure that would necessitate an adverse recommendation.
GHG Emissions Decline. Most investors and non-investors did not view a failure to show or be on track to show an absolute decline in GHG emissions as an appropriate trigger for an adverse recommendation.
Company Climate Transition Plans
ISS currently recommends voting on a case-by-case basis on management proposals that request shareholders approve the company’s climate transition action plan, taking into account the completeness and rigor of the plan. ISS asked survey participants to choose their three top priorities in determining whether a company’s climate transition plan is adequate. A significant portion of investors and non-investors (37% and 54%, respectively) identified as a top three priority the extent to which the company’s climate-related disclosures are in line with TCFD recommendations and meet other market standards.
The top three priorities for investors for determining whether a company’s climate transition plan is adequate were (i) whether the company has set adequately comprehensive and realistic medium-term targets for reducing operational and supply chain emissions (Scope 1, 2 & 3) to net zero by 2050, (ii) whether the company’s short- and medium- term capital expenditures align with long-term company strategy and the company has disclosed the technical and financial assumptions underpinning its strategic plans and (iii) the extent to which the company’s climate-related disclosures are in line with TCFD recommendations and meet other market standards. Another top priority among investors, though falling out of the top three, was whether the company has sought and received third-party approval that its targets are science-based.
By contrast, the top three priorities for non-investors in determining the adequacy of a company’s climate transition plan were (i) the extent to which the company’s climate-related disclosures are in line with TCFD recommendations and meet other market standards, (ii) whether the company discloses a commitment to report on the implementation of its plan in subsequent years and (iii) whether the company has comprehensive and realistic medium-term targets for reducing operational emissions (Scope 1 & 2) to net zero by 2050.
Climate Risk as a Critical Audit Matter
Although most global auditing standards require consideration of climate risk, a 2021 report “Flying Blind” by Carbon Tracker pointed out over 70% of the world’s biggest corporate emitters failed to disclose the effects of climate change risk in 2020 financial statements, and 80% of their auditors showed no evidence of assessing climate risk when reporting. In the ISS survey, investors and non-investors had diverging views on whether climate issues should be part of the auditor’s report.
Most investors (75%) favored seeing commentary in the audit report on climate-related issues for significant emitters, while most non-investors (58%) did not. Further, most investors (64%) believe climate risk considerations should be included in the critical audit matters, while most non-investors (56%) were against inclusion.
ISS asked survey participants what actions are appropriate to take if climate risk considerations are not included in the critical audit matters. A majority of investors (52%) supported voting for a related shareholder proposal and almost half of investors (42%) agreed with voting against re-election of audit committee members. By contrast, most non-investors (62%) thought no voting action should be taken in such circumstances.
Financed Emissions in the Banking and Insurance Sectors
Some shareholders in the finance sector have submitted proposals for companies to adopt a policy to restrict their financing or underwriting for new fossil fuel projects. With this in mind, ISS asked survey participants what they considered to be appropriate shareholder requests for large banks and insurance companies regarding GHG emissions associated with lending, investment and underwriting.
Approximately half of investors supported four types of shareholder requests related to financed emissions: requests for full disclosure of financed emissions (54%); requests for clear long-term and intermediary financed emissions reductions targets for high emitting sectors (51%); requests for a net-zero by 2050 ambition including financed portfolio emissions (49%); and requests for companies to publicly commit to disclose financed emissions at some point in the future by joining a collaborative group (45%). By contrast, close to half of non-investors (40%) responded that companies in banking and finance should not be expected to comply with shareholder requests regarding financed emissions, and generally only a small portion of non-investors agreed that any particular type of shareholder request related to financed emissions is appropriate.
In addition, a significant majority of both investors (84%) and non-investors (71%) agreed that investors’ minimum expectations for climate-related disclosure and performance will change over time. For investors, the three most significant thresholds they expect to change over time relate to increased and more effective disclosure and a heightened focus on companies’ targets aligning with a net-zero standard.
Potential Exceptions to Adverse Recommendations Under ISS Policy on Multi-Class Capital Structures
Beginning in 2023, ISS plans to start recommending votes against certain directors at U.S. companies with a multi-class capital structure with unequal voting rights, and this will include companies that were previously exempt from an adverse recommendation according to the date they became public. ISS expects to apply a “de minimis” exception in cases where public shareholders are not meaningfully disenfranchised. For the survey, ISS asked what percentage of total voting power, held by the owners of super-voting shares, should qualify as “de minimis” for purposes of an exception. 32% of investors responded that there should be no “de minimis” exception compared to 15% of non-investors. In general, the median investor thought a “de minimis” threshold of no more than 5% would be an acceptable exception compared to the median non-investor that responded a threshold of no more than 10% would be acceptable.
When asked what other factors should be considered in connection with adverse vote recommendations for multi-class capital structures, nearly half of non-investors (45%) viewed limitations on super-voting rights (e.g., super-voting rights only for a merger) as a relevant mitigating factor, and a significant portion of non-investors (38%) viewed whether the company is controlled (or de facto controlled) by current officers/directors as a relevant. By contrast, the majority of investors (53%) responded that none of the presented mitigating factors are relevant, and any capital structure that disenfranchises public shareholders is problematic.
ISS asked who are the appropriate targets for adverse vote recommendations due to a capital structure with unequal voting rights. A third or more of investors responded that appropriate targets include the chair of the governance committee, any director who holds super-voting shares, the board chair or lead independent director and members of the governance committee.
Problematic Governance Structures
ISS’s current policy for newly public companies states that it will issue an adverse voting recommendation if, prior to or in connection with the company's public offering, the company or its board adopted certain governance structures that are considered to be materially adverse to shareholder rights, such as a classified board. A reasonable sunset provision is considered a mitigating factor. However, the policy has not defined a reasonable time period. In response to the ISS survey, a large portion of investors and non-investors (43% and 37%, respectively) responded that between 3 and 7 years from the date of a company’s IPO would be an appropriate time period to sunset the problematic governance structure. A significant portion of investors (35%) responded that a sunset period of 3 years is appropriate, although this was notably less than the number that were comfortable with a period of between 3 and 7 years.
Racial Equity Audits
Since 2020, shareholders have increased their engagement with companies on diversity and racial equity issues. In particular, the number of and support for proposals calling for racial equity or civil rights audits has grown. With this in mind, ISS asked survey participants for their views about whether companies would benefit from third-party racial equity or civil rights audits. The most common response among both investors and non-investors (45% and 56%, respectively) was that whether a company would benefit from an independent racial equity or civil rights audit depends on company-specific factors. Respondents were then asked which of a list of company specific factors would be relevant in the determination. Investors and non-investors both identified the same top three criteria for consideration: the company is involved in significant diversity-related controversies; the company does not provide detailed workforce diversity statistics, such as EEO-1 type data; and the company has not undertaken initiatives/efforts aimed at enhancing workforce diversity and inclusion, including training, projects and pay disclosure.
The results of the 2022 Global Benchmark Policy Survey provide insight into the types of issues on which ISS is currently focused, especially as we head into the upcoming proxy season. It is likely that these survey results will manifest themselves in the voting guidelines that ISS issues in the future.
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