ESG Investing: Managing Risks and Opportunities with Human Rights, Diversity and Climate Change
We believe positive economic and societal change, and financial performance, is best achieved when ESG analysis is combined with active stewardship — or engaging with company leaders and voting in shareholder meetings to influence corporate strategy and policies. Through active stewardship as part of the ESG investing process, investors can promote human rights, more diversity and a better environment.
Human Rights: Promote Better Supply Chain Management
How a company manages its suppliers can make a significant difference in human rights, fair labor practices, environmental progress and anti-corruption practices. Yet we think supply chain management ranks among global companies’ biggest challenges. To document these challenges, the 2020 Corporate Human Rights Benchmark report by the World Benchmarking Alliance assessed human rights policies based on disclosures by 229 global companies across five sectors with the highest supply chain risks.
The report noted that the auto sector scored very low. A majority of automotive companies failed to demonstrate that they set core expectations with suppliers through contractual arrangements to verify the age of workers, prohibit the charging of recruitment fees to workers, and prevent intimidation or harassment of trade union members and their representatives, according to the report.
Automaker Mercedes-Benz, at the time of the report’s release called Daimler, scored among the highest of 30 automotive companies in the report. Last year, we engaged with Mercedes-Benz to see how they drive the industry best practice in reducing their supply chain risks.
During a call with company representatives, we learned that the company requires sustainability standards when hiring suppliers. With a network of 60,000 direct suppliers, Mercedes-Benz said it demands that they further cascade the Mercedes-Benz sustainability standards into their own supply chain. They established a three-step process to address these risks: 1) create transparency along the raw material supply chains, 2) identify and audit the risky hotspots, 3) take remediation measures.
Mercedes-Benz identified supply chains that supply 24 raw materials as among the riskiest for human rights violations. One is cobalt, often used in batteries. Mercedes-Benz hired a consultant to audit its cobalt suppliers and has required that they obtain an industry-recognized certification for more socially and environmentally responsible mining.
Our discussions with Mercedes-Benz provided insight into how the industry may approach human rights risks in their supply chains, which we plan to use when engaging with other companies.
Diversity: Make Corporate Boards Accountable
We believe diversity begins at the top, and that’s why it is imperative that individual companies examine and change existing talent management practices. From access to opportunities to talent development to equitable compensation strategies, a company’s policies can accelerate, or stall, its progress toward a more diverse, equitable and inclusive workforce. This is reflected in hiring practices, promotion decisions, compensation practices and a host of other related areas. We recognize that unique perspectives and attributes, if allowed to flourish, make our collective society and corporations stronger.
A McKinsey & Company study in 2020 found that:
• Companies in the top quartile for gender diversity on executive teams were 25% more likely to have above average profitability than companies in the fourth quartile.
• Top-quartile companies in terms of ethnic and cultural diversity outperformed those in the fourth quartile by 36% in profitability.
To achieve the goal of more equitable and inclusive companies, we believe that the make-up of corporate boards should reflect a diversity of backgrounds, experience, expertise, age, race, gender, ethnicity and culture. Effective in 2021, our Proxy Committee raised our minimum diversity requirements, encouraging companies to further diversify their boards. Under this new approach we set a standard that all boards globally be at least 20% female and boards in the U.S. additionally have at least one ethnically/racially diverse director.
If we found last year that the composition of a corporate board didn’t reflect the diversity of the workforce and society, we withheld support from the chair of the nominating committee or the highest tenured director on the nominating committee. We applied this policy to director nominees at companies in Australia, Canada, New Zealand, the U.K. and the U.S.
Environment: Collaborate to Tackle Climate Change
Scientists have connected increasing human reliance on fossil fuels over the past 100 years with higher average global temperatures and more severe weather events including drought, wildfires and flooding. To mitigate environmental and societal damage, governments will likely mandate regulatory changes to reduce carbon emissions, and this represents a potential threat to profits of companies that sell oil- or coal-related energy and creates investment risk.
The urgency of addressing climate risk has been underscored by global leaders and increasingly by investors, as the pandemic has made them acutely aware of the impact on returns that result from a non-financial-led crisis. For four years, our annual Capital Market Assumptions report has identified trends related to climate change as among our long-term investment themes.
Investors can influence corporate policy on issues such as climate change by banding together to use the weight of trillions of dollars in investment assets to better influence corporate policies and actions on key environmental issues. One of these collaborations is called Climate Action 100+, backed by about 700 investors with $65 trillion in assets.
As an example on how this works, we led a collaborative engagement with electricity and natural gas provider National Grid over its lack of disclosures of emissions linked to higher global temperatures. National Grid has not disclosed its Scope 3 emission reduction targets. Scope 3 includes emissions by assets that companies don’t own, such as from transportation related to their businesses and their products after sale. Scope 1 represents direct emissions by companies and Scope 2 includes emissions from energy purchased by companies.
Since 2019, as a co-lead investor in the Climate Action 100+ engagement with National Grid, we have urged the company to disclose Scope 3 targets. As a result of those negotiations, in 2021 National Grid set a new medium-term Scope 3 target that covered 80% of the company’s Scope 3 emissions, targeting a 38% reduction by 2034 from a 2019 baseline. National Grid also was the first utility company to put its carbon transition plan to an advisory shareholder vote in 2021. The plan received 99% support from investors.
Aligning Investing with Values
We think asset managers such as ourselves not only have an opportunity but a clear responsibility to act in the best interests of our clients by contributing to a healthy long-term environment, equitable social structures and well-governed companies. Serving as an active owner helps to fulfill this responsibility. By integrating sustainable investment and stewardship, investors can align their investments with their values.
Explore our 2021 Stewardship Report for more details on our engagements with company leaders and proxy voting decisions.
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About Sustainable Investing
At Northern Trust Asset Management (“NTAM”), we define Sustainable Investing as encompassing all of NTAM’s investment strategies and accounts that utilize values based and norms based screens, best-in-class and ESG integration, or thematic investing that may focus on a specific ESG issue such as climate risk. NTAM’s Sustainable Investing includes portfolios designed by NTAM as well as those portfolios managed to client-defined methodologies or screens. As the data, analytical models and aforementioned portfolio construction tools available in the marketplace have evolved over time, so too has NTAM. NTAM’s Sustainable Investing encompasses strategies and client assets managed in accordance with client specified responsible investing terms (historically referred to as Socially Responsible), as well as portfolios that leverage contemporary approaches and datasets, including ESG analytics and ESG thematic investing.
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