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This article appears in the April 2023 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

As a relative newcomer to the responsible investment field, Michela Gregory relies on her colleagues’ war stories to show how far shareholder engagement has come on ESG issues.

Her firm’s early efforts were marked by questioning and even confusion surrounding ESG, she said, and companies were less responsive. “Over the years, that has really shifted,” said Gregory, who is three years into her role as director of ESG services with Toronto-based NEI Investments.

As investor concerns about topics such as climate change, workplace diversity and human rights have entered the mainstream, Gregory said business executives can no longer afford to meet dialogue requests from asset managers such as NEI with blank stares.

“One of the more interesting things we’re seeing — and I hope it continues — is the fluency of senior leadership on ESG issues,” she said. “In the past, ESG was very siloed, but companies are seeing a real need to integrate it as part of their corporate strategies, and for senior management to be able to consider and articulate how ESG issues factor at the core of their business.”

Kevin Thomas, CEO of the Shareholder Association for Research and Education (SHARE), said ESG engagement has become standard for asset managers over the past decade, although the quality of that engagement has sometimes lacked.

“The downside is that shareholder engagement is too often banal, performative, uninspiring and ineffective,” he said. “That’s a shame because, used well, it can be a pretty powerful tool.”

Passive engagement means investors play little more than a monitoring role for companies, ensuring that management is alerted to potential ESG risks, Thomas said. “I don’t think that a couple of polite annual questions are actually getting anyone anywhere.”

Still, Thomas said ambitious investors have dragged the industry into a second phase of ESG engagement focused on outcomes.

“Engagement 2.0 is about making pointed efforts to achieve particular results,” he said, such as compliance with voluntary standards or disclosure of particular ESG information.

More work is required before a third phase of ESG engagement can be completed, Thomas said.

“Engagement 3.0 takes things a step further by considering whether the results you are asking for are actually sufficient to stop the problem you are trying to resolve,” he said. “If your objective is to fight climate change and you convince a company to disclose more information about its greenhouse-gas emissions, you have to consider whether that is enough to achieve meaningful reductions in the time frame that it needs to happen.”

Tying engagement efforts to larger objectives may require more sophisticated partnerships among investors, external standard-setters and regulators, Thomas said. He pointed to the recent development of Climate Engagement Canada. SHARE is a co-ordinator of this financial sector coalition, which is driving dialogue with 40 of Canada’s largest carbon-emitting public companies.

“The objective is not disclosure. The objective is to change the emissions reality of those companies, which is where we need to be heading,” Thomas said.

Christie Stephenson, executive director of the Peter P. Dhillon Centre for Business Ethics at the University of British Columbia’s Sauder School of Business, expects environmental issues to remain prominent in engagement efforts long into the future.

However, she predicts the next 10 years of environmental engagement could see a shift in emphasis away from a narrow focus on emissions reduction and compliance with the 2015 Paris Agreement.

“We’re at the point where investors are ready to look at a broader basket of environmental issues. One obvious example would be around biodiversity,” Stephenson said. “Climate and biodiversity are separate issues, but they are interconnected.”

Whichever ESG branch investors are engaging on, Stephenson said it will be interesting to see whether global activist trends come to Canada. The 2021 ouster of three ExxonMobil Corp. directors in a U.S. proxy fight, and legal action this year taken personally against board members of energy giant Shell PLC by investors questioning the firm’s net-zero plan, have grabbed attention.

“There are numerous legal cases emerging around climate oversight and also around equity, diversity and inclusion,” Stephenson said.

Gregory said NEI shies away from talk of litigation as part of an ESG engagement strategy.

“Our approach has always been to think of engagement with a company in a way that recognizes that we are seeking to be long-term investors, focused on pushing them forward along the path of sustainable, long-term value creation,” she said. “But that does not mean that we don’t sometimes have to ask hard and challenging questions.”

Whether or not Canadian investors end up turning to the courts over ESG matters, Stephenson said foreign shareholder litigation could still be influential.

“Canada has less of a litigious culture, particularly in contrast to the U.S., so the focus here tends to be on more constructive forms of engagement,” she said. “But just seeing that type of litigation in other jurisdictions is going to affect companies in Canada, and it could be impactful in terms of moving in the direction of greater accountability.”