Overcoming Regulatory Challenges to Active Ownership in North America

Recent studies report rapid growth in Responsible Investment (RI) strategies in North America, with a 48% and 42% increase in Canada and the U.S, respectively. Likewise, the PRI reported a 14% and 22% increase in the number of signatories in Canada and the U.S., albeit with North America standing at 589 total signatories compared to 1,285 in Europe. Central to many of these RI strategies is active ownership: investors using their influence through voting and engagement to improve the ESG performance of investee companies.

This trend is impressive against the somewhat surprising backdrop of North American regulatory headwinds towards active ownership, with underlying scepticism from regulators in these markets manifesting as public policy in 2020. By comparison, in Europe regulators pushed for bold regulation promoting responsible investment, as it finalised the EU Taxonomy on Sustainable Finance, alongside improving reporting such as the Sustainable Finance Disclosure Regulation (SFDR). In fact, European regulators aimed for these changes to happen so fast that investors – successfully – pushed back on the timeline of their introduction.

Now more than ever, North American investors need to consider what their role is in influencing the ecosystem in which they operate, reflecting on what has happened over 2020 and how best they can work together in the future.

US regulators create headwinds for active ownership

Early 2020, the U.S. Securities and Exchange Commission (SEC) solicited comments on two proposed sets of rule amendments to increase the regulatory burden on proxy advisers and further restrict the ability for investors to file shareholder proposals. The SEC’s motivation for these was to address its concerns over the accuracy and transparency of proxy voting advice, which investors use to inform their proxy voting decisions, and to amend thresholds and mechanisms by which investors can file shareholder proposals to avoid ‘misuse’ of the process.

Both proposals received significant levels of criticism from the investment community, citing views that the SEC’s underlying concerns regarding the accuracy of proxy research or the irrelevance of shareholder proposals were misplaced, thereby making the proposals not only unnecessary, but also in danger of stifling active ownership activities that have become commonplace throughout the industry.

When the SEC confirmed their final rules, it appeared that investor feedback had an impact, with some of the more troublesome elements, such as requiring that proxy advisers provide a pre-publication review for issuers, dropped entirely. Other burdensome requirements remained, such as the introduction of higher thresholds for investors to file shareholder proposals – disappointingly, given the effectiveness of such proposals in driving improvements in ESG practices at companies.

Simultaneously, the U.S. Department of Labour (DOL) also opened a comment period on two rules that impact private pension plans regulated under the Employee Retirement Income Security Act (ERISA). The first of these rules aimed to block the inclusion of any investment fund partaking in “ESG investing” as a default option to beneficiaries in their ERISA plan. The second sought to increase the burden on ERISA plans to actively vote their proxies by requiring a deep cost-benefit analysis for voting activity related to environmental & socially themed proposals.

Similar to the SEC proposals the investment community responded by raising serious concerns over the underlying reasons motivating the rule-making, as well as the impracticality of the proposals for plan fiduciaries and other institutional investors.

In the final rule concerning  ‘ESG investing’ products, the DOL decided to shift its focus away from the term ‘ESG’ to the use of pecuniary and non-pecuniary factors. Interpreted as a victory by many, it seems that the DOL conceded that ESG factors can in fact be pecuniary – impacting the risk/return profile of an investment or portfolio. In practice this means that funds integrating ESG considerations can still be selected by ERISA plan fiduciaries as a default option.

The proxy voting rule was similarly reframed, noting that fiduciaries must not pursue non-pecuniary objectives through their voting if at the expense of the financial interest of their plans. The concession made here is that the ESG objectives often pursued through active ownership can be pecuniary to fund performance. The prescriptive and impractical nature of the original proposal was replaced by a principles-based approach that puts less burden on fiduciaries to demonstrate that every individual vote has been assessed on a cost/benefit basis. However, it is not all good news; fiduciaries will still need to commit more time to overseeing the proxy voting policies of their funds and service providers.

Although different in scope, the SEC and DOL proposals shared underlying characteristics: separating the goals of ESG investors from traditional investment goals, and limit the tools and spaces in which ESG products could be deployed. While they prompted an impressive and passionate response from the investor community, U.S. regulators still introduced regulation that negatively impacts responsible investment, even if in a weaker form than originally proposed.

Canadian regulators consider similar actions

There has also been a rise in regulatory interest in active ownership in Canada. Although much of this regulatory focus is supportive of accelerating sustainable finance, this past July the Ontario Capital Markets Modernization Taskforce proposed a set of draft regulatory reforms that, by comparison, raised alarm bells in the investment community.

When the Taskforce was formed in early 2020, a group of Canadian investors presented suggestions to make TSX-listed companies more attractive ESG investments on the global market, such as enhancing ESG disclosure requirements in line with the Taskforce on Climate-related Financial Disclosures and the Sustainability Accounting Standards Board and introducing measures to increase board and executive diversity. Those suggestions encouragingly made their way into the Taskforce’s draft report.

However, the Taskforce also proposed regulating proxy advisors, echoing their U.S. counterpart in noting their concerns about transparency and accuracy of proxy advisor reporting to investors. The Taskforce suggested an SEC-like no-action process for shareholder proposals, which is widely regarded by the investment community as a process that dials back shareholder rights in favour of corporate interests. This sceptical attitude towards proxy voting advisors and the shareholder proposal process in Canada was surprising: investor engagement with companies tends to be far less contentious than in the U.S., voting on ESG items or shareholder proposals rarely gets majority votes and investors do not tend to file as many shareholder ESG proposals, which are often used as a last resort.

These Taskforce recommendations impacting proxy voting advisors and the shareholder proposal process received much criticism from investors. The Canadian Coalition for Good Governance (CCGG) warned of the erosion of investor protections and increasing regulatory burden for investors as “antithetical” to the OSC’s investor protection mandate. Canadian shareholders also commented collaboratively, taking the opportunity to provide in-depth context around how active ownership activities work in practice and explain why the Taskforce’s recommendations would be unnecessary in the Canadian market and impractical to implement.

At the time of writing, the Taskforce is yet to release its final set of recommendations due by the end of 2020. The hope is that these final recommendations maintain their support for ESG-related disclosures, but that investor feedback has convinced the Taskforce to revisit reforms that would negatively affect the proxy voting and shareholder proposal processes.

Championing active ownership is more important than ever

With the significant growth in RI strategies that employ active ownership and the resulting focus from regulators, we are at a crossroads where banding together to shape the future of our industry has never been more important. Although the policy initiatives discussed above are either still a work in progress or could be repealed with the U.S. regime change, the misconceptions about our industry that result from these initiatives remain in play.

There are many ways of working together to affect change, such as directly contacting regulators or working through industry associations. At BMO Global Asset Management we take the same approach when engaging policy-makers as we do engaging investee companies: respectfully conveying our investor perspectives, taking the time and energy to dive deeply into topics, sharing our expertise on ESG issues and providing education or examples of best practices when necessary.

One take-away from 2020 is that the investor voice can be incredibly powerful in helping to better educate regulators on ESG and active ownership, and that we have to make ourselves heard to ensure our position as responsible stewards of capital – especially now that responsible investing in North America is growing faster than ever.

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Author

Rosa van den Beemt

Director, Stewardship, Responsible Investment

BMO Global Asset Management

Rosa leads BMO Global Asset Management's (BMO GAM) Stewardship approach, such as engagement with investee companies, proxy voting and public policy advocacy on ESG topics to create positive long-term change on behalf of end clients. She actively represents BMO GAM at industry collaborations and memberships, including on the Advisory Council of the Investor Alliance for Human Rights, the Environmental & Social Committee of the Canadian Coalition for Good Governance, the Steering Committee of Climate Engagement Canada and the Leadership Council of the Responsible Investment Association. Prior to BMO GAM, Rosa worked at NEI Investments where she led their proxy voting program and various corporate engagement initiatives. With approximately 10 years in the responsible investment space, Rosa has extensive experience in North American corporate governance, human rights and investments, and engaging public issuers’ management and board members on ESG. She holds a BA in Political Science and an MSc in International Development Studies from the University of Amsterdam.

David Sneyd

Vice President, Analyst, Responsible Investment

BMO Global Asset Management

David joined the team in 2017. Prior to joining the firm David held senior research positions at the governance research agencies PIRC and ISS, after which he joined the ESG team at Fidelity International. David has extensive experience within a European coverage on researching governance topics, engaging with companies at a board/senior management level and dialoguing with policy makers. As an ESG Manager at Fidelity he expanded his expertise from pure governance to broader ESG topics, with a particular responsibility for integrating ESG themes into their investment research and decision-making processes. David graduated in 2006 from Sussex University with a BA in Philosophy, after which he completed an MSc in Philosophy and Public Policy at the London School of Economics with a thesis topic focusing on shareholder activism.

Nalini Feuilloley

Director

BMO Global Asset Management

Nalini is a Director within the Responsible Investment team at BMO Global Asset Management, based in Canada. Nalini joined the team in 2019 after working for 3 years with the UN supported Principles for Responsible Investment (PRI) as the Head of Canada. At the PRI, Nalini managed the Canadian base of institutional clients and educated the broader investment community on ESG issues and integration strategies. Prior to the PRI, Nalini worked at BlackRock Canada covering pension funds, endowments and foundations and also championed BlackRock’s responsible investment initiatives locally. Previously, Nalini worked in the UK with Roubini Global Economics and the Gerson Lehrman Group, both alternative investment research firms supporting the buy-side. Nalini started her career with Accenture consulting with clients in the Technology, Media and Telecom sector.