※Japanese Version → 日本語
Following the Stewardship Code in 2014 and Corporate Governance Code in June 2015, GPIF, which is the largest pension fund of the world, signed up to PRI (Principles of Responsible Investment) in September 2015. Thus, the environment surrounding Japanese companies and investors has been changing day by day, and responsible investment has been focused on more. In addition to that, foreign investors leading responsible investment have started approaching Japanese companies and in fact we can see several cases that some Japanese companies received the engagement from foreign investors.
Then, how should Japanese companies respond to the engagement action from foreign investor or collaborative engagement action from a party consisting of PRI signatories? Most of Japanese companies may have some difficulties in responding to engagement due to the lack of experiences.
Therefore, in order to understand engagement better, we interviewed David Orr, Senior portfolio manager of Sparinvest, which took a leading role in the successful engagement with NTT, regarding the process and goal of engagement and the benefit for companies.
◇Mr. David Orr
David is a Senior Portfolio Manager in a team running actively-managed value equity funds in global developed and emerging markets. He is co-lead manager of the Sparinvest Ethical Emerging Markets Value fund.
David also serves on Sparinvest’s Responsible Investment Committee, where he has played a leading role in shaping RI policy and implementing ESG integration and active ownership programmes within the equity asset class.
Prior to joining Sparinvest in October 2007, David worked for Japanese investment bank Daiwa Securities SMBC in London, covering Japanese and Asian equities, and had previously worked at the prefectural government offices in Nara, Japan. He holds a BA in English Law with French Legal Studies from the University of Oxford, and an MA in Advanced Japan Studies from the School of East Asian Studies, University of Sheffield.
Founded in 1968 in Denmark, and with pan-European operations in Luxembourg since 2001, Sparinvest is an international asset management company. The group is known as a specialist in value investment – both for equity and bond funds.
Sparinvest is owned by a broad range of Danish institutional shareholders who support the group’s independence and prudent investment strategy, focused on providing competitive risk-adjusted long-term returns.
As of September 2016, the group manages total assets of EUR 10.3bn.
Photo：Mr. David Orr
1. Sparinvest’s Investment Strategy
(Q) What is Sparinvest’s investment strategy and how are ESG issues integrated?
(A) When we make investments, we have a duty to our clients to do our best to protect and increase their capital, and this means building an understanding of both the potential and the risks of any investment. Basically, within our equity funds, we invest with a value strategy which often involves a long potential investment horizon – of up to 5 years or longer. Of course, sometimes we sell sooner, but often we remain invested over many years. So it is important for us to understand not just the long-term potential, but also the long-term risks for each investment.
Obviously, ESG risks can materialize in both the short- and long-term, but it’s perhaps fair to say that many of them of are longer-term risks – and that’s perhaps why it’s a natural fit for us to consider ESG.
(Q) How is engagement important to Sparinvest’s investment strategy?
(A) Dialogue with our investments is a useful way of building our understanding of them, and monitoring their progress. But of course engagement goes further than that – it is about having a constructive, two-way dialogue, where perhaps we as shareholders can give feedback to the company that can help reduce risks or recognize and exploit opportunities. Ultimately, it’s about responsibility: we have a responsibility to our clients to be active investors, working to fulfill our fiduciary duty. And we also take the view that as shareholders, we don’t just invest in a piece of paper, but are part-owners of a real company that we have selected for investment because we believe it has potential. Engagement can be a way to encourage the company to fulfill that potential.
(Q) What is the goal of engagement?
(A) The first point is that we don’t see engagement as a unilateral exercise – it goes both ways. I think we have to be humble. It’s not just about us as investors trying to give our opinion, but also about us improving our understanding of the various complicated factors affecting the company and the policies and strategies it adopts.
Actually, the specific goal of engagements varies. In some cases, like anti-corruption or human rights, we might seek a change in the company’s policies, but we also recognize that just having the right words in a policy is no guarantee, so we also consider the implementation of those policies. Some engagements are about more specific practical issues. For example, we might encourage a company to be more proactive about energy efficiency, or take steps to remediate the violation of an international norm.
2. Engagement Process
(Q) What is the trigger to start engagement?
(A) Basically, we look for potential for a constructive dialogue about an issue that could have material impact on the company’s long-term value and sustainability. But there are different catalysts for engagement, and this links to the type of engagement we do. Our engagements are usually direct engagement (by members of our own investment teams) or collaborative (with other investors).
For direct engagement, triggers could be:
- Specific ESG risks or opportunities (where our security analysis shows the issue is material, and has potential for meaningful change)
- Voting-related (if an agenda item is contentious or breaches our voting policy, we try to have a dialogue with the company)
- Breach of International Norms relating to the environment, human rights, corruption, and labour standards
Collaborative engagement is usually via industry bodies such as the PRI. Here, we again consider the materiality of the issue, and whether we think a productive dialogue is feasible.
Another trigger might be if there is some sort of tailwind: for example, if a country starts to have a major shift in corporate governance, it might be sensible timing to focus more on engagement in that country.
(Q) How do you decide the main topic of engagement?
(A) The main topic of engagement is, of course, the underlying ESG risk or opportunity that concerns us. But sometimes that can be too broad. It’s important to think practically about how many things we can realistically discuss at one time. For example, if we have a general concern about “corruption” at a company, we need to consider whether to focus on the overarching policy, the governance structure, training of employees, whistleblower mechanisms, or specific examples of corruption.
Our initial dialogue with a company will usually be fact-finding, to try to get an idea of the culture and to gain more insight into which aspects the company is very strong on, and which aspects perhaps would benefit from dialogue. That initial dialogue then helps us decide which areas should be our main focus.
(Q) How do you start engagement with the target company?
(A) This depends on the individual engagement. If we are seeking a very deep, comprehensive engagement, often our first step will be to mention it in a meeting with senior management or directors. Then it can then spread so that we have contact with people from different operational departments in the company. In other cases, it might start with contacting the IR or CSR departments. The reality is that different companies also have different preferences, and we respect that.
(Q) How often do you contact the target company?
(A) This varies considerably, both between different engagements, but even within the same engagement. Sometimes it is only every few months, but we find that when an engagement does build momentum it’s important to capitalize on that, and work quickly. So, then we might be in contact several times within a week.
(Q) Do you customize the way to engage with those selected companies depend on the region, countries or anything else?
(A) We try to be understanding of cultural differences. In some countries it helps to speak the local language. It’s also important to understand local preference. For example, we acknowledge that there is no single model of “best” corporate governance – there can be variations in different countries and regions.
(Q) How do you check that the target company is working to respond the engagement?
(A) Sometimes this can be relatively easy, because we may have the goal of encouraging the company to improve its disclosure of KPIs, to change its public policy, or to sign up to a specific convention or policy standard. In those cases, you can easily verify if it has been done.
The more difficult aspect is monitoring how a company has really responded to change internally. The most interesting thing to me is the question of corporate culture. The day-to-day working culture at a company has a massive impact on ESG and other risk factors, but can be one of the hardest things to change - and one of the most difficult things to judge from the outside. We’re always interested to hear insights into how we can judge that better.
(Q) If the target company does not seem to respond to engagement, do you take a more strict engagement approach?
(A) Our aim is not to create an antagonistic situation. Our experience is that engagement usually only works well when both parties are at the table willingly. But we try to be persistent. Of course, if it is consistently very difficult to have any sort of dialogue, that in itself is a useful lesson for us about the company.
(Q) How do you finish engagement with the target company?
(A) In any engagement we try to have specific aims so that internally, we can monitor our process. In collaborative engagement, it’s quite common to have fairly concrete timeframes and goals, and therefore, a concrete end to the engagement. In our own engagements, although we do have goals, we often have a more open-ended time frame: our relationship with the company continues for as long as we invest, and even if we have achieved the main goal of our engagement, we will like to keep in touch about the issue, monitoring changes.
3. Cost and Benefits of Engagement
(Q) Who pays for the engagement cost?&
(A) Actually we pay the costs, as the asset management company. For collaborative engagement with other investors, our approach to is try to have a reasonable balance between collaborations where we play a leading role, and collaborations where we participate less actively. This is because the amount of resources needed, depends on the role we play. Of course, we hope that investors in our funds understand and appreciate the engagement efforts!
(Q) Who do you think is the beneficiary of engagement?
(A) We see a successful engagement as a “win-win” situation. Firstly, a healthy dialogue simply means greater understanding between a listed company and the investors providing capital to the company. Secondly, the aims of engagement are very closely linked to corporate value and corporate sustainability, so a positive outcome in theory benefits both the target company, and the investors in our funds.
Actually there can be some kind of dilemma for the target companies in engagement. If we are asking a target company to be a first mover on reducing emissions, that may directly increase their costs relative to competitors. It benefits society, but hurts the company in the short term. However, this is where long-term perspective comes in: we would encourage companies to take the steps which put them in the most competitive and sustainable position for the longer term, rather than focusing on the short term cost.
4. Engagement with Japanese companies
(Q) Do you have any idea about the next target of Japanese company to be engaged?
(A) We are involved in a PRI coordinated collaborative engagement relating to human rights, where we are engaging with a Japanese company as joint lead investor, alongside two others.
(Q) What is the benefit for Japanese companies by responding to engagement?
(A) The most immediate benefit of responding to engagement is a closer relationship with investors, and that in itself can be significantly positive: companies demonstrating a willingness to have a frank and constructive dialogue may well find themselves rewarded in the capital markets, with higher valuations and lower costs of capital. Giving an example, after our recent engagement with NTT, we were encouraged to see comments from the company that they felt our engagement had contributed to corporate value.
Naturally, the target company needs to spend time and resources to make the dialogue successful, but at the same time, the investor is making their resources and input available to the company. And finally, over time, the specific results of the engagement may well lead to a reduction of risk, or better exploitation of an opportunity. So, we see huge benefits for companies responding to engagement.
Interview Date: September 26, 2016