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RESPONSIBLE INVESTMENT QUARTERLYQ2 2017

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Responsible Investment Quarterly – Q2 2017

CONTENTS01 Foreword .............................................0302 Furthering M&A analysis –

insights through an ESG Lens .............0503 Portfolio Manager Viewpoint ................0904 US Climate change policy –

taking stock… ....................................1305 European Social Bond strategy ...........1806 Marginal propensity to share? –

the ‘sharing economy’ and its investment implications ......................23

07 Proxy voting ........................................2808 Engagement highlights ........................32

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Iain RichardsHead of Responsible Investment

The second quarter of any year is a busy period in responsible investment, but this year more than ever. The peak in Annual General Meetings sets the backdrop for the period, with well over 5x as many companies and their annual meetings being reviewed with investment teams and voted on compared to the first quarter. In the period, 72% of meetings had at least one item of business that either raised or was associated with concerns about companies’ practices and activities. In aggregate, we dissented from management on over 1,600 resolutions – slightly over 14% – which we explore further in this report.

However, our work and focus as responsible investors goes beyond the regular cycle of company research and engagement that is ultimately linked to proxy voting. Managing over US$32bn (as at 30 June 2017) in responsible investment strategies for clients, our ongoing work around enhancing our own analytics, and on the themes that are shaping industries, events, risks and opportunities, continues apace.

Over the quarter, we have continued to work with colleagues from across the business to enhance the analytics we use in responsible investment, around stewardship and environmental, social and governance (ESG) analysis. Through this work, we retain a focus on relevance and materiality when combining related financial and non-financial factors, and a focus on the need for input to be both evidence based and forward looking. The lessons and insights that the related quantitative work produces are both fascinating and something we expect to come back to in more detail later in the year.

In terms of themes, we hope that the insights we offer into this area – for this quarter around the ‘sharing economy’, US climate policy and ESG insights into merger and acquisition (M&A) activity – provide a sense of

the work and discussions that have taken and continue to take place as part of our approach to responsible investment. We continue to take the view that ESG offers a value-added window into the quality of management and operational standards of practices; it is distinct, however, from thematic trends that frame the challenges and opportunities that companies face and can capitalize on in delivering sustainable outcomes. The first reflects internal standards of practice and their implications; the latter, the commercialisation of products and services that respond to the changing needs and demands of customers, the economy and society. Recognising this distinction adds value to our investment approaches and debates and frames the scope and approach we take to our work and stewardship role.

This is also the context in which we have increasingly looked to deliver outcome-orientated solutions to our institutional clients and, with the launch of the UK Social Bond strategy in partnership with Big Issue Invest at the start of 2014, also to our wider client base. This quarter saw the launch of our latest offering focused on both social and sustainable outcomes, the European Social Bond strategy, which we introduce later in this report.

01 Foreword

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Even as we work across these areas and in wider collaborative initiatives, we are seeing the focus of the broad debate evolving quickly and significantly. June saw the publication of the final report and recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures. This was followed by July’s publication of the interim report of the EU Commission’s High-Level Expert Group on Sustainable Finance on ‘Financing a Sustainable European Economy’.

Both groups have drawn together leading figures in the socially responsible and climate-aware investing communities and their respective reports provide proposals for a public policy agenda, framed from their perspective as active leaders in those fields. However, the issues involved and the economies in which we invest are complex beasts. As this work and the debates around it play out, key questions for observers will continue to reflect concerns as to how the evolving public policy debate

serves to enhance or impinge upon the ability of asset owners to meet their investment objectives, and whether the detailed actions recommended will indeed promote sustainable growth, productivity and prosperity over the longer term.

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During the quarter, our Global Investment Themes meeting focused on merger and acquisition (M&A) activity, which reached US$5 trillion in May on an annual running basis – a record high. As equity markets reach new peaks and global interest rates remain low, the financial environment remains conducive to new deals.1

McKinsey highlights the following six archetypes of how companies believe M&A activity will generate shareholder value:2

1. Improve the target company’s performance

2. Consolidate to remove excess capacity from industry

3. Accelerate market access for the target’s (or buyer’s) products

4. Get skills or technologies faster or at lower cost than they can be built

5. Exploit a business’s industry-specific scalability

6. Pick winners early and help them develop their business

Yet experience has shown that M&A has the potential also for value destruction, and is on average much more likely to end in failure than success.

In analysing the performance of more than 2,500 M&A events through two boom-and-bust economic cycles, L.E.K. found that although acquirers generally demonstrated healthy performance in the lead-up to deals (with cumulative total shareholder return of about 15% above the relevant S&P sector index), 60% of events ultimately led to destruction of shareholder value. Averaging across the entire sample,

Rose BealeAnalyst, Responsible Investment

Michael HamblettAnalyst, Responsible Investment

02 Furthering M&A analysis – insights through an ESG Lens

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cumulative total shareholder return dropped 10% in the two years following a deal close.3 Similarly, the failure rate of such activity is considerable, with around 70-90% of approaches ending in failure.4

At our Themes meeting, we posed the questions: if faced with sound strategic rationale, why does M&A so often destroy value or end in failure? Does the structure of management pay make them more (or less) likely to pursue deals? What are the under-analysed risk factors and unintended consequences?

Remuneration and M&AExamining the motivations behind M&A activity provides insights into the range of contributing and competing factors in such decisions. These include the strategies of activist shareholders often seeking short-term opportunities from M&A arbitrage,5 as well as ‘empire building’ tendencies and reputational concerns.6 One area that we particularly highlight is financial incentive, outlining two ways in which CEOs can be more inclined to seek M&A deals via their pay.

1. Performance-based variable pay metrics

Executive pay typically comprises fixed and variable components.

The former includes salary, pension and perquisites. The latter normally includes an annual bonus and a longer-term share-based scheme, where the amount of shares that vest depends on the achievement of performance conditions.

The metrics used vary greatly, though earnings per share (EPS) and total shareholder return (TSR) feature frequently. M&A activity can positively affect both measures. If an acquisition is earnings accretive, EPS will increase by definition. It may be easier to meet targets set previously, resulting in higher payouts.

It is important to look at the specific metrics and determine whether adjustments take place, and the methodology applied. In some cases, the process by which firms’ Remuneration Committees use discretion is opaque, complex and may lead to differences between the numbers reported in financial statements and those used for the calculation of variable pay.

In the US, it is more common for CEOs to receive share options, which are typically available to sell after a certain period of time has elapsed, with no attached performance conditions. The value of the options on the date of sale depends on the difference between the

market price and the pre-determined ‘exercise; price. With a positive market reaction to an M&A announcement, and subsequent jump in share price, an executive’s personal wealth can increase hugely in just a few minutes.

2. Golden parachutes

With many overlapping cycles of share-based awards outstanding, it is important to consider how they would be treated if the firm merged or was acquired. Ideally, prorating would take place, to take time outstanding and performance into account, but this is not automatically the case.

In some circumstances, an acquisition may mean that all outstanding share awards automatically vest, providing executives with an economic windfall of ‘golden parachute’. This may or may not be accompanied by a loss of employment. In the US, “change in control” awards can have a ‘single trigger’ or ‘double trigger’. If single, awards accelerate on a change in control of the company; if double, awards only accelerate if the executive also loses their job.

ESG factors in M&A success Increasingly, the importance of wider ESG factors in M&A activity is becoming evident. Two examples are cited below, where social, cultural

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and sustainability factors have been important in determining the success, or otherwise, of M&A activity. Finally, the potential of ESG weakness to have a material impact post-merger is also outlined.

1. AB InBev & SABMiller*

In 2016, ESG issues were critical to the terms and approval of the deal to acquire SABMiller, when the world’s largest beer company was formed. AB InBev agreed with the South African Government that no jobs would be lost in the country, a notable change from the job cuts entailed in its own formation (Interbrew, Ambev, Anheuser-Busch, completed in 2008).

Beyond employment, the wider package of commitments made by AB InBev to the South African Government also addressed localisation of production and inputs, empowerment in the company, and participation of small beer brewers in the local market. This included 1 billion Rand to support smallholder farmers, as well as to

promote enterprise development; local manufacturing, exports and jobs; the reduction of the harmful use of alcohol (including making available locally produced low and no-alcohol choices for consumers) and green and water-saving technologies.9

2. Unilever and Kraft-Heinz*

By contrast, a key factor behind the cessation of discussions about the takeover of Unilever by Kraft-Heinz related to sustainability and cultural issues.

Whereas the former has been a long-term advocate of an integrated sustainability strategy, encompassing environmental as well as health and nutrition elements, the latter has been less focused on this area. At the time of the proposal, the job cuts experienced during Kraft’s earlier takeover of Cadbury in 2010 resurfaced as a point of public discussion – with the UK’s largest union ‘Unite’ highlighting potential negative implications for the deal.10

3. Oxy RB*

Among the number of cases where environmental and social issues have hampered the realisation of expected synergies, or even detracted from brand and revenue, the experience of Reckitt Benckiser in South Korea is among the most vivid.

In this case, health and safety issues in South Korean company Oxy, acquired in 2001 by Reckitt Benckiser to form Oxy RB, materialised to the detriment of the firm. Ten years after the acquisition, the Korean Centre for Disease Control outlined a link between Oxy RB’s humidifier sanitizer product and lung injury; during the subsequent investigation around 100 deaths were linked to the Oxy RB product and questions were raised over the company’s knowledge of the toxicity risks.

* The mention of any specific shares should not be taken as a recommendation to deal.

Case study: Reckitt Benckiser and Mead Johnson*

In February 2017, UK household product manufacturer Reckitt Benckiser announced its plan to acquire US baby food group Mead Johnson for US$18 billion.

Rakesh Kapoor, CEO of Reckitt Benckiser, is one of the highest paid executives in the UK, whose variable pay is determined almost exclusively on EPS growth. Earnings growth – impacted by the Mead acquisition – would have resulted in a £14 million payout. Following shareholder engagement, the company’s remuneration committee decided to adjust the calculation to exclude expected EPS increases.7

Mead Johnson amended its pay scheme in 2014 to include ‘golden parachute’ arrangements for six executives, meaning they will receive a total of US$32 million if they lose their jobs within two years of a takeover.8

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As well as withdrawing the product, Oxy RB launched a KRW5 billion humanitarian fund (US$ 4.3 million) to compensate victims and their families in 2014, with another funded in the same amount in 2016. Nevertheless, there was a backlash in the country which included a boycott Oxy RB products by South Korea’s leading supermarket chain, Lotte Mart, and led to RB taking a £300m charge in FY 2016. In January 2017, a former CEO of Oxy RB was sentenced by a Korean court to seven years imprisonment.

During the course of the investigation, which expanded beyond Korea to the British headquarters, Korean prosecutors challenged the company for not better understanding and testing the safety risks before the acquisition.

Conclusion The potential significance of factors, such as remuneration and ESG issues, to the genesis and success of M&A has direct implications for investors.

Considering both the motives behind M&A activity and the wider ESG risks and opportunities created. can provide better understanding of the merits of any deal. Investors can undertake an holistic ESG assessment before a deal both to aid their own thinking, and to encourage a wider scope of conversation between the underlying parties. In so doing the potential to reduce risk may be two-fold, both financial by protecting clients’ assets, and social, by reducing the potential for short-term decisions to externalise costs on society.


Sources:1 Kepler Cheuvreux, Q&A Report, 3 July 2017.2 McKinsey, The six types of successful acquisitions,

May 2017.3 L.E.K. Executive Insights, Vol. XV, Issue 16 , Mergers

& Acquisitions: What Winners Do to Beat the Odds.4 Harvard Business Review, M&A: The One Thing You

Need to Get Right, Roger L Martin, June 2016.5 M&A Activism, A Special Report, Activist Insight

and Kingsdale Advisors, 2017.6 Berenberg, Geographic expansion: conglomerates

reborn, 22 September 2016, N. Anderson et al.7 Financial Times, Reckitt Benckiser cuts CEO pay

after investor revolt, March 31 2017.8 Evening Standard, Mead Johnson bosses hit

£25 million jackpot after Reckitt takeover, February 3 2017.

9 The South African Government and Anheuser-Busch InBev agree approach on public interest commitments in proposed acquisition of SABMiller by Anheuser-Busch InBev, Press Release, Brussels, 14 April 2016.

10 www.unitetheunion.org/news/unite-urges-unilever-to-resist-kraft-heinz-predatory-takeover-bid/

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The European Equities investment team incorporates the analysis of environmental, social and governance (ESG) factors into the investment process. We believe the market often underestimates the sustainable competitive advantage of companies that enjoy high barriers to entry – and therefore high returns on capital. Consideration of ESG factors is an important element of our assessment of the long-term sustainability of the companies in which we invest, and ultimately allows our clients to benefit from the value generated from those investments.

In collaboration with the Responsible Investment (RI) team, we integrate ESG factors into the investment process at multiple levels, ranging from the avoidance of investments that conflict with client values, assessment of risk and reward from the ESG perspective, and evaluation of how sustainability themes contribute to long-term performance. Incorporating ESG factors into fundamental stock analysis allows us to consider company- and industry-wide ESG risks and opportunities that other market participants may ignore, but which we believe could have a significant impact on long-term share price performance.

Since the early 1970s, over two thousand academic studies have been published on the link between ESG standards and corporate financial performance. A convincing majority have found a positive relationship that remains stable over time (crucial for long-term shareholders), with 90% finding a non-negative relationship.11 For instance, a recent report by Bank of America Merrill Lynch (BAML) indicated that exposure to 15 of 17 bankruptcies seen in the US since 2008 could have been avoided through the integration of ESG factors within conventional analysis.12

03 Portfolio Manager Viewpoint

Ann SteelePortfolio Manager, European Equities

Yifei WangPortfolio Manager, European Equities

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Before making investment decisions, the investment team works with the RI team to analyse specific areas of potential ESG strength, weakness, opportunity and threat, including governance arrangements (eg, the alignment of senior management incentive with shareholder interests, as well as accounting practices and the strength of ESG policies), social impacts (eg, supply chain management), and environmental factors (eg, carbon emissions). We also look at company-specific areas of potential exposure to sustainable opportunities, such as climate change and innovative healthcare solutions.

Our RI team regularly reviews prospective investments and the investment universe to assess companies’ ESG practices, and to identify any breaches of global standards, including UN Global Compact compliance. The ESG quality of a stock and risks therein can support investment theses, trigger reviews/engagement or even rule out investment where the issues significantly undermine our confidence in the business to deliver sustainable returns. Some examples of our recent engagement with European companies are provided later in this document.

We regularly meet the management of companies in which we invest. Engaging with management helps us to understand the business in greater detail and provides insight into companies beyond reported numbers. This is especially important for companies identified as ESG laggards, where there may be openness to, or evidence of, improvement. It also supports identification of longer-term sustainable opportunities where the time horizon may be longer than that reflected in conventional financial analysis modelling.

Figure 1

Traditional Values Stewardship Materiality Positive Thematic Sustainability

No ESG Exclusionary Engagement Integration Best-in-class Outcome and impact focus

Lighter touch **Intensity** Stronger touch

At focus solely on maximising investment

returns without regard to other (ESG) factors

Avoidance ofinvestments that

conflict with client values and

standards (e.g. ethical or norms

based)

Monitoring and engaging with companies,

including voting to enhance and

protect value

Integrating ESG research on risks, opportunities and

materiality (risk/return) in research and

analysis

Targeting investments that

evidence a commitment to

responsible business practices

Focus on investments positively

exposed to areas within a range of

social or sustainability

themes

Focus on the optimisation

social or sustainability outcomes and impact in the use of capital

Investment ‘sweet spot’ESG

integrationStrong ESGcredentials

Source: Columbia Threadneedle Investments, 30 June 2017.

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As an equity investor, proxy voting is another important consideration. Ahead of general meetings, we review voting recommendations made by the RI team relating to the companies in which we invest. This frequently leads to robust discussion and debate internally and presents another opportunity for engagement with companies, whether for clarification purposes or to express concerns. If we remain dissatisfied, casting a dissenting vote can send a powerful signal to management.

Our fully integrated ESG approach, focussing on both financial and non-financial factors that contribute to the quality of businesses, helps to identify companies which are better able to manage the risks and challenges inherent in business and to capture opportunities that help deliver sustainable value over the longer term to our clients. By actively engaging with companies – whether through engagement or proxy voting – we encourage the improvement of practices, which we believe will consequently lead to improved financial returns. This allows our clients to benefit from the value generated by well-managed companies.

Figure 2

Traditional Values Stewardship Materiality Positive Thematic Sustainability

No ESG Exclusionary Engagement Integration Best-in-class Outcome and impact focus

Lighter touch **Intensity** Stronger touch

At focus solely on maximising investment

returns without regard to other (ESG) factors

Avoidance ofinvestments that

conflict with client values and

standards (e.g. ethical or norms

based)

Monitoring and engaging with companies,

including voting to enhance and

protect value

Integrating ESG research on risks, opportunities and

materiality (risk/return) in research and

analysis

Targeting investments that

evidence a commitment to

responsible business practices

Focus on investments positively

exposed to areas within a range of

social or sustainability

themes

Focus on the optimisation

social or sustainability outcomes and impact in the use of capital

Investment ‘sweet spot’ESG

integrationStrong ESGcredentials

Source: Columbia Threadneedle Investments, 30 June 2017.

Sources:11 GunnarFriede,TimoBusch&AlexanderBassen(2015)ESGandfinancial

performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 5:4, 210-233, DOI: 10.1080/20430795.2015.1118917

12 Bank of America Merrill Lynch, ESG: good companies can make good stocks, December 2016.

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Iain RichardsHead of Responsible Investment

The reaction to US President Donald Trump’s decision to withdraw from the Paris Agreement has been vocal and critical, but what is the actual backdrop to this and what are the implications?

This article is drawn from a more in-depth thematic research paper examining the context of the move, the potential implications and two related investment perspectives (this last is not covered here).

At the time of writing, the US continues to seek withdrawal from the Paris Agreement, a move that puts it alongside only Nicaragua and Syria outside the international agreement to co-ordinate and progressively tighten national responses to climate change. In truth though, when the day came, this was no surprise; US withdrawal from the Paris Agreement had been on the cards since the Presidential election results came in. Although withdrawal will take some time in practice, there are some immediate implications, not least the loss of the US contribution to the UN Green Climate Fund but also the sudden boost to China’s profile as a leading player in the global response to climate change.

These issues aside, the reality is that the world has already begun changing; both in terms of economics

and public attitudes. Climate change and sustainability are well-established and important issues for business, investors, communities and people.

Framing the contextIn March 2017, a Yale University study mapping US public attitudes showed that 70% of Americans believe climate change is happening and will harm future generations. Seventy per cent support regulations on carbon emissions. As illustrated below, the majority of Americans across every state appear to favour US participation in the Paris Agreement.

The long-running transition to a more sustainable economy has already benefitted the US domestically in terms of job creation relating to energy efficiency, transportation, renewable energy, waste reduction, natural resources conservation and education. In line with similar trends in other countries, this effect has been significant. Estimates suggest that it has created 4 to 4.5 million US jobs.13 Solar employment growth and, in particular, the project development trend between 2014 and 2016 (which is typically associated with utility-scale projects), illustrate the point. Slowing the speed of the US move towards renewable energy creates a risk to further job growth in the sector.

04 US Climate change policy – taking stock…

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The interest of the investment community is clear, illustrated at the ExxonMobil annual meeting, where 62.3% of the owners of ExxonMobil (owning ~US$211billion in stock) voted for the oil giant to assess how global warming and the changes it drives will impact its business. The same is true in the business community and the numbers that have signed

the Business Backs Low-Carbon USA statement since November 2016, which as one of its pledges specifically supports continued participation in the Paris Agreement. Nearly two-thirds of Fortune 100 companies and half of Fortune 500 companies now have some form of target for renewable energy deployment, emission reductions or energy efficiency.14

In a broader social context, emissions – a key focus in the climate debate – remain an important factor. According to the US Environmental Protection Agency in 2015, about 128 million people (41% of the US population) still live in areas that are currently in a state of non-attainment for at least one or more of the National Ambient Air Quality Standards.15 Energy production

Figure 3 Percent of Americans by State who support participation in the Paris Agreement

100

% o

f Am

eric

ans

75

50

25

0WV ND KY IN WY AL NM MS OK TN LA MO AR NE GA OH UT IA ME KS DE FL SC MN AZ TX RI WI NC MT NH NV MI CO SD VT PA ID CT VA IL MA AK WA OR MD CA NJ DC HI NY

Overall

2010

350%

300%

250%

200%

150%

100%

50%

0%

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Source: Yale Program on Climate Change Communication, using methods developed for the Yale Climate Opinion Maps.

Figure 4 Solar Employment Growth by Industry, 2010-2016

100

% o

f Am

eric

ans

75

50

25

0WV ND KY IN WY AL NM MS OK TN LA MO AR NE GA OH UT IA ME KS DE FL SC MN AZ TX RI WI NC MT NH NV MI CO SD VT PA ID CT VA IL MA AK WA OR MD CA NJ DC HI NY

Overall

2010

350%

300%

250%

200%

150%

100%

50%

0%

-50%

-100%2011 2012 2013 2014 2015 2016

Sales & DistributionInstallationProject Developers

ManufacturingOther

Source: US Energy and Employment Report 2017 (Dept. of Energy)

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and use not only accounts for most of the air pollution arising from human activity, it also accounts for a very high proportion of the human-related emissions of key pollutants. It is also important recall that key energy sources do vary in terms of emissions characteristics.

CostsIn assessing the transition taking place and how it may be impacted, it is important for investors and others to properly understand the costs associated in developing energy capacity and their implications. The following chart draws on the latest

available data from the US Energy Information Administration in offering a full cost comparison for capacity building. While fossil fuels are still sometimes argued as having a clear cost advantage over renewables, that situation has been changing rapidly and is no longer a truism.

Figure 5 Global average emissions factors and share of major pollutant emissions by fuel, 2015

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SO2 NOX PM2.5

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coal natural gas nuclear petroleumrenewable energy

Reference caseNo Clean

Power Plan

history projections

1,500

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1980 1990 2000 2100 2020 2030 2040 2020 2020 2040

2016

Avr LCOE Avr LACE Avr Net Diff

0Coal

(30% with carbonsequestration)

Coal(90% with carbon

sequestration)

ConventionalCombined Cycle

AdvancedCombined

Cycle

AdvancedCC with CCS

AdvancedNuclear

Geothermal Biomass Wind –Onshore

Wind –Offshore

Solar PV4 SolarThermal

Hydroelectric

projections

Notes: The most relevant fuels in terms of emission factors are represented; fuels not shown are considered negligible. Global average emission factors are calculated across all types of sectoral activity and all types of technology. Source: World Energy Outlook Special Report: Energy and Air Pollution (IEA 2016)

Figure 6 Comparison of non-weighted average LCOE with tax credits and non-weighted average LACE Plants entering service in 2022 (2016 $/MWh)

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Power Plan

history projections

1,500

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1980 1990 2000 2100 2020 2030 2040 2020 2020 2040

2016


0Coal



sequestration)


AdvancedCombined

Cycle

AdvancedCC with CCS

AdvancedNuclear


Wind –Offshore


Hydroelectric

projections

Source: Columbia Threadneedle Investments. US Energy Information Administration data (Annual Energy Outlook 2017) The Levelized cost of electricity (LCOE) offers a summary measure of the overall competitiveness of different generating technologies. Covering the cost (in discounted real dollars) of building and operating a generating plant over an assumed financial life and duty cycle. The “levelized” avoided cost of electricity (LACE) provides a proxy measure for the annual economic value of a candidate project, that can then then be compared with the LCOE value to provide an indication of whether or not the project’s value exceeds its cost. A negative difference indicates that the cost of the marginal new unit of capacity exceeds its value to the system.

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If externalities were to be included, to frame the full economic costs, the reality already looks very different and supportive of the transition taking place. Just in terms of coal, Harvard’s Medical School Center for Health and Global Environment has estimated that the true societal costs of coal, from public health and environmental damage, amount to US$170bn to US$520bn per annum. Subsidies are also an important factor and two

issues bear mentioning here. The first is that as part of the cost comparison shown above, the influence of subsidies plays a much smaller role than has historically been the case, particularly in solar. The second is that, in December 2015, Congress passed a bill extending the Production Tax Credit (PTC) and Investment Tax Credit (ITC), which have benefitted wind and solar respectively. Finally, it is notable that the US has seen a ~10% improvement

in energy productivity over the last five years, meaning the economy is using 10% less energy to power each unit of growth.

In terms then of the expected switch (in generation output) from coal in favour of natural gas, current circumstances suggest that could now potentially be delayed by nearly a decade from 2024 towards 2034.

Figure 7 US net electricity generation from selected fuels (Billion kilowatt hours)

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Biomass

Oil CoalBiomass

Oil

CoalGas

50% 100% 0% 50% 100% 0% 50% 100%

SO2 NOX PM2.5

-150

-100

-50

50

100

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2,500

2,000



Power Plan

history projections

1,500

1,000

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1980 1990 2000 2100 2020 2030 2040 2020 2020 2040

2016


0Coal



sequestration)


AdvancedCombined

Cycle

AdvancedCC with CCS

AdvancedNuclear


Wind –Offshore


Hydroelectric

projections

Source: US Energy Information Administration, Jan 2017.

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So, what next?There is still a chance that the US will not, in the end, withdraw, not least due to the Paris Agreement’s built-in time delay which means withdrawal cannot happen until the next presidential election year, 2020. As matters stand though, mitigating action taken at US State and municipal level looks likely to be particularly significant. This ‘local’ leadership could play a pivotal role in what happens next. The move by 11 US states to form the US Climate Alliance, with others expected to join, is notable, as is the fact that 29 States already have mandates for the use of renewables. There are reports of similar moves by 187 individual US Cities.

While not covered here, in terms of investment, the paper from which this article is drawn examined two facets

of this dynamic relevant in an investment context. The first related to the sources of capital investment that could be impacted, while the second related to the broader sectoral return impacts expected.

ConclusionOverall our conclusion was that:

nn Economics, changes in attitudes, established policies, state/municipal-level action, corporate foresight and investor focus prevail.

nn The current direction of travel in the US and progress seen to date largely continues, albeit perhaps to a slightly different timeframe and with more vestigial involvement from coal.

Sources:13 EDF Climate Corps and Meister Consultants

Group (2017).14 “Power Forward 3.0: How the largest US companies

are capturing business value while addressing climate change” (2016) Calvert, CDP and others

15 National Ambient Air Quality Standards.

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Simon BondPortfolio Manager, Responsible Investment

In May, Columbia Threadneedle Investments launched a new European Social Bond strategy, run in partnership with INCO.* The strategy is underpinned by an innovative approach to social investment based on the principle of positive inclusion, as opposed to negative exclusion, and investing in bonds as opposed to equities. This allows a direct line of sight to the investment, as the strategy only invests where the use of proceeds is clearly to be directed towards purposes that meet pre-determined social criteria.

In short, the strategy’s goal is to invest for social impact while delivering a financial return.

The mantra that ‘you can do well by doing good’ has been proven by the successful track record of our UK Social Bond strategy. Launched three years ago – in partnership with leading social investments organisation, Big Issue Invest – and still one of a kind in its home market, the UK Social Bond strategy has delivered both profit and principle. Most importantly, it has brought positive social outcomes through much-needed investment to some of the UK’s most deprived sectors and regions. Yet it has also achieved in excess of 7% annualised gross return since inception (as at 30 June 2017).

The new European Social Bond strategy is designed to achieve the same ends, but in a pan European context. Furthermore, with a commitment to offer daily liquidity achieved through careful management of a mix of maturities, the strategy offers a compelling alternative to conventional impact investments and other social impact vehicles, which frequently require assets to be tied up for long periods in order to access socially-beneficial investment opportunities.

Bridging a funding gapFor organisations operating in areas of social need, stable long-term financing is critical. But following the financial crisis, many socially-focused sectors are finding it hard to identify traditional sources of funding that are attractive. As a result, some are suffering from chronic underinvestment. Economies need well-directed investment so that they and the individuals within them can thrive.

The urgency of this need prompted European Commission President Jean-Claude Juncker to launch the €300bn InvestEU project in 201416 to jump-start funding in infrastructure, but there are limits to what one institution can achieve. Supplying reliable, affordable capital to organisations in target sectors can lead to tangible social benefits and boost long-term economic growth.

The European Social Bond strategy aims to help bridge this gap by matching investor capital to projects with a defined positive social outcome for individuals across affordable housing, health and welfare, education and training, employment, community, access to services and economic regeneration and development. Investment therefore supports delivery

05 European Social Bond strategy

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ABOUT INCOINCO operates in over 20 countries and its work is channelled through three major activities:

1. Investment: INCO runs the leading global impact investing fund, investing in companies with both a strong social and environmental impact. Fuelled by public institutions and private companies (including insurers and banks), this fund was created in 2010 and managed by Comptoir de l’Innovation. With €100+M under management, Comptoir de l’Innovation brings financial capital to French and European companies that have make a strong social and environmental impact alongside growth.

In addition to the financial support, Comptoir de l’Innovation has developed CDI Ratings, a unique financial and impact assessment methodology adapted to social business. CDI Ratings is based on more than 600 financial and ‘extra-financial’ criteria and provides tailor-made social impact assessments across industries.

Drawing on our partnership with Groupe SOS (one of Europe’s most successful social enterprises, with annual turnover of $900 million and 15,000 employees) and its long established and successful tradition of social innovation and direct experience of social investment, Le Comptoir de l’Innovation has developed a new social outcome methodology. For Columbia Threadneedle Investments, this will focus on assessing the outputs, outcomes and impacts of the European Social Bond strategy’s investments, in line with frameworks developed for the European Commission on social impact measurement – and it will use its expertise to continually assess investments in the strategy. This also provides the framework for reporting on the fund’s social performance.

2. Incubation: INCO has developed the first global network of green and social start-ups, Impact Network, to accompany, train and enable the growth of young entrepreneurs looking to combine entrepreneurial ambition and social impact. This network operates 21 incubation and acceleration programs in 20 countries and four continents. It has also created an exchange program – Jump Seat – that enables the incubated entrepreneurs to move from one incubator to another to explore other cultural practices of social entrepreneurship.

3. Raising awareness: each year at Paris City Hall, INCO organises the leading global event dedicated to entrepreneurship and social innovation, Impact². This ‘Davos’ of social entrepreneurship gathers over 1,500 public decision makers, business leaders and investors from 50 countries. The aim is to generate economically innovative solutions to meet the social challenges of our time. Furthermore, Impact² puts the spotlight on women with an international prize, awarded to an outstanding entrepreneurial woman whose work benefits the local community.

For more information on INCO visit their website http://inco.co.com/

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of real world outcomes, supporting people and communities and creating prosperity.

Some European governments, such as Poland and France, issue sovereign debt whose proceeds are specifically directed towards identifiable projects. These issuances are thus also eligible for inclusion within the strategy – for example, the French administration recently issued a €7bn green energy bond. However, without this kind of commitment, it is hard to invest in government issues because there is little certainty as to where the money is used.

MethodologyINCO acts as the social partner to the strategy and is responsible for researching and assessing the social outcomes of investments on a post-trade basis, as well as forming part of the Social Advisory Panel to review, advise and monitor the strategy’s investments from a social performance perspective.

While the strategy is supported by both the Investment Grade Credit and Responsible Investment teams to find suitable investments and projects across the continent, it does not simply rely on self-certification for the positive

social impact of investments chosen. INCO, a leading global consortium for a new economy, inclusive and sustainable, acts as our independent adviser on the strategy.

Given the size of the potential European investment universe, a rigorous assessment process is used to help rate social outcomes attributable to investment in a particular bond. An evidence-based approach is applied which measures the intensity of social outcomes to distinguish where real social benefit will occur.

For example, housing is considered to be an area of urgent social need, but there is a huge difference between the social outcome that is delivered through investment in commercial housing, as compared to an equivalent investment in an organisation providing accommodation for the socially disadvantaged. A discriminating approach is therefore important to ensure that investments are made in line with the strategy’s investment philosophy.

The assessment criteria we apply to help the fund manager make that distinction are guided by a ‘social hierarchy of needs’ described below.

The next generationOur goal is to achieve social alpha without sacrificing the market rate of return. We are proud to have accomplished this with the UK Social Bond strategy, which importantly is accessible to all types of investor, with daily liquidity and a low minimum investment.

Responsible Investment is becoming increasingly mainstream. But investors still need conventional routes to access positive social outcome investing which meets their needs and risk profiles, without requiring the sacrifice of financial return. Our European Social Bond strategy offers a new approach to help the next generation social investor to meet these goals.

Sources:16 http://europa.eu/investeu/home_en

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Alignment of European Social Bond Strategy with the UN SDGs

Social Hierarchy of Needs Columbia Threadneedle Euro Outcome Matrix Primary SDG Alignment Additive/Contextual SDGs

1. Primary Social Needs Affordable Housingnn Social housing nn Key worker housingnn Independent living housingnn Care homes

11 – Sustainable Cities & Communities

2. Basic Social Needs Health & Welfarenn Physical Healthnn Mental Healthnn Healthy Livingnn Rehabilitation & support

3 – Good Health & Well-Being 2 – Zero Hunger

3. Social Enabling Education & Trainingnn Primary & Secondarynn Vocational training & apprenticeshipsnn Further & Adult education

4 – Quality Education 1 – No Poverty5 – Gender Equality10 – Reduced Inequalities

4. Social Empowerment Employmentnn Creation of jobs in deprived areas; andnn Good employment standards

8 – Decent Work & Economic Growth

1 – No Poverty5 – Gender Equality10 – Reduced Inequalities

5. Social Enhancement Community Servicesnn Local amenities, services & environmentnn Care servicesnn Personal (e.g. elderly)nn Other community services

11 – Sustainable Cities & Communities

6 – Clean Water & Sanitation15 – Life on Land16 – Peace, Justice & Strong

Institutions

6. Social Facilitation Access to servicesnn Affordablefinancialproductsnn First time mortgagesnn Professional servicesnn Communication & broadcast services

10 – Reduced Inequalities 12 – Responsible Consumption & Production

7. Societal Development Economic Regeneration & Developmentnn Sustainable developmentnn Public & community transportnn Urban & community regenerationnn Infrastructure & utility developmentnn Environment & agriculture

9 – Industry, Innovation & Infrastructure

2 – Zero Hunger7 – Affordable & Clean Energy13 – Climate Action

Note: Additive/contextual SDGs are often relevant across outcomes, e.g. the link of an outcomes intensity in addressing social exclusion and deprivation and the Poverty SDG). The Strategy itself and work around it links to SDG 17: Partnership for the Goals.

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The sharing economy is an umbrella term encompassing a range of activities. Broadly, these build networks of online (often mobile) users to facilitate economic relationships focused on one of more of the following areas: increased asset utilization, recirculation of goods, dynamic service and labour exchanges.17

Although these activities need not be for profit,18 such businesses have experienced rapid growth in recent years. The pace of growth of some has been impressive, with Uber reaching a market cap of US$1bn in four years. Businesses have emerged across a range of sectors and geographies,

Rose BealeAnalyst, Responsible Investment

06 Marginal propensity to share? The ‘sharing economy’ and its investment implications

although with key concentrations in the US and China. Currently, eight of the world’s ten largest start-ups by valuation19 can be classified as sharing economy companies:

US based* China based*

#1 Uber (~US$68bn): software company facilitating transportation and delivery, founded 2009.

#2 Ant Financial (~US$60bn): operating Alipay, the world’s largest mobile and online payments platform (and other services including crowdfunding and a social credit rating system) founded 2014.

#4 Airbnb (~US$31bn): offering a platform for listing and booking accommodation around the world, often connecting individuals, founded in 2008.

#3 Didi Chuxing (~US$50bn): a mobile transportation platform, offering commuting options to 400 cities in China, founded in 2012>

#7 WeWork (~US$17bn): offering shared workspace, community, and services focused on freelancers, startups and small businesses, founded in 2010.

#5 Lufax.com (~US$18.5bn): marketplace for trading offinancialassetsincludingpeer-to-peerlendingand online wealth managing, a subsidiary of Ping An Group, founded in 2011.

Europe based* #6 Meituan-Dianping (~US$18bn): the largest on-demand delivery platform, founded in 2009.

#8 Spotify (~US$13bn): music, podcast, and video streaming service, founded in 2008, Stockholm.


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Estimations of both the current and future scope of the sharing economy vary considerably, depending on the differing definitions as much as growth projections. Using a broad definition, Bank of America Merrill Lynch (BAML) assesses the current market at US$250bn and expects this to grow to at least US$335bn by 2025.20

Some government bodies have also made significant claims about the current state and potential of this area – for instance the Chinese State Information Center indicates that sharing economy activities accounted for 5% of China’s GDP in 2016 and that this will likely double to 10% by 2020.

The drivers and the potential Various theories have been prosed as to the rise of the sharing economy, including:

nn Openness to alternatives to (Western) forms of traditional ‘ownership’

nn Technological developments and uptake (including the proliferation of smartphones) enhancing the value of such networks

nn Underutilised assets and resources, including in areas where an increasingly significant proportion of income is spent (eg, accommodation and transport)

nn New models of work accelerated by technological advancement and lifestyle changes

nn Changing consumption patterns – particularly driven by young consumers (GenY, GenZ) – including a shift towards ‘experiences’ and greater awareness of sustainability issues

Exploring just the first two as plausible causes is insightful when considering both the current state of the sharing economy and its potential trajectory.

1. Openness to alternatives to Western forms of ownership

One of the more interesting enablers for the sharing economy is the willingness of consumers to share. According to Nielsen’s 2013 survey, this was significantly higher for online consumers in Asia-Pacific and Latin America than in either Europe or the US, with for instance almost double the proportion of those willing to share in Asia-Pacific than in the US.

Figure 8 The Rise of the Sharing Economy

78%

Asia-Pacific

Willing to share own assets

% of online consumers willing to participate in sharing communities*

*based on an online survey among 30.000 consumers in 60 countries conducted in Q3 2013

Willing to share from others

LatinAmerica

Middle East/Africa

NorthAmerica

Europe GlobalAverage

81%

70% 73%68% 71% 68% 66%

52%

43%

54%

44%

The Nielsen Global Survey of Share Communities, 2014.21

This may help to explain why, despite early innovation and adoption in the US, acceleration in Asia has been more impressive, with three of the top five start-ups by value founded in China (the country most likely to share according to the Nielsen study) all postdating Uber and Airbnb.

The non-Western growth trend also extends beyond China. For instance, Indonesia (which the Nielsen survey found the second most likely country to share) has pioneered new start-ups like Go-Jek, ‘the Uber of motorbikes’, now valued at over US$1bn+.22

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2. Technological development, smartphones and the network effect

Whilst the willingness to share is a key socio-cultural factor behind the sharing economy, another key enabler is technological, which together create ripe economic conditions for sharing businesses.

In fifteen years the number of smartphone users has grown from 100 million in 2000 to 2.1 billion in 2016, and there are projections that this could grow to 6 billion by 2020.23 Increasing internet usage –and smartphone penetration in particular – provides the platform for ‘sharing economy’ activities (many of them focused on apps given the ease of use) and enables the functioning of the asset-light models of ‘sharing economy’ companies, whose value is often in coordinating sharing activities rather than providing the underlying good or service (Airbnb for instance, owns no houses).

Smartphone and internet usage has also provided a wealth of data on which these businesses can build, augmenting their service and entrenching the value of their networks under the right conditions. For instance, Uber’s ability to interface with the location devices on smartphones is instrumental to its model, and also provides the traceability which,

amongst other things, enhances user safety and increases the value proposition.

The increased uptake of technology and related proliferation of data, creates favourable conditions for fast-growing businesses. Their growth is powered by sophisticated networks rather than traditional assets and their associated costs. ‘Metcalfe’s Law’ on network effects outlines the potential, stating that the value of a network is proportional to the square of the number (n²) of connected users of the system.24

Without committing to the specific function, the general effect stands: each additional user increases the value for others by increasing the number of potential connections in the network. For companies like Uber and Airbnb, more users joining the networks creates additional value by increasing the number of hosts, drivers, passengers, and guests in the ecosystem. This in turn can enable companies with a robust network to leverage economies of scale, keeping costs low and prices down.

Disruptive potentialThe failure of incumbents to adapt to smartphones has created some interesting case studies, indicating the

destructive potential of underestimating technological developments and consumer trends (eg, Motorola and Nokia). Nokia, for instance, generated a quarter of Finnish GDP between 1998 and 2007, but its stock has declined over 90% since its peak in June 2000. In part a consequence of smartphone proliferation and related technological developments, this may provide a precedent for the disruptive potential posed by sharing economy companies.

Taking a consumer perspective, the disruptive potential is perhaps greatest for those areas where the greatest proportion of income is spent. Currently, accommodation, transport and food account for 65% of the average US household consumer spend. Alternate models which can increase asset use, make even a small difference to cost, or add to convenience at no extra cost, may be particularly appealing in these areas.

A few of these sectors are already seeing signs of disruption. For the hotel industry, companies like Airbnb are not only providing a new source of competition, but can have a disproportionate margin impact. Through facilitating increased availability of accommodation, including at short notice and at a range of price points, this negatively impacts the ability of hotels to practice

26


price gouging when demand is high (known as compression nights, when occupancy rates are 95%+ and when hotels gain an average extra revenue of 40% per room).25 Although some incumbents are beginning to see this as a threat, estimations of the impact are conservative – for instance, Whitbread, the owner of the Premier Inn brand, estimates that such disruptors will account for c.3% of room nights by 2020.26

Furthermore, in the long term, a broader range of sectors may be impacted. BAML suggests that twelve global sectors comprising 8% of global GDP are at risk of disruption, including energy, where concerns around climate change and trends towards decentralisation provide new opportunities. Examples include Tesla/Solarcity pioneering the storage and sharing of energy with the PowerWall system, and Dutch start-up Vandebron enabling peer-to-peer sharing of power credits and arranging for consumers to buy electricity from independent producers. Examples of growing consumer receptiveness to sustainability issues are also emerging in retail, with the popularisation of clothing rental and second-hand fashion resale sites such as ThredUp.

Investment opportunity in the shared economyGiven that many of the key players are (at least currently) non-public, the opportunity set for investors in listed companies may seem somewhat limited; however, there are key avenues. These include where businesses are evolving towards ‘sharing economy’ models, have subsidiaries in this space, or have developed partnerships with ‘shared economy’ companies.

One example is Ant Financial, an Alibaba affiliate. It operates Alipay, the world’s largest online payment system, as well as services including peer-to-peer lending and crowdfunding. It is also developing a social credit rating system ‘Sesame Credit’ with the Chinese government, which combines online data and consumption patterns to form a personalised social score which can impact access to services.

In the auto and rental sector there are also opportunities, with Avis having the bought pioneer of car-sharing, Zipcar, in 2013. In September 2016, Zipcar had one million members across nine cities. Daimler meanwhile owns Car2Go, the largest car-sharing company in the world with two million members as of October 2016.27

Partnerships also provide a key mechanism for incumbent businesses to adapt, presenting indirect opportunities for investors. In the field of insurance, some companies are developing new sharing products to address the rise of disruptive companies in sectors such as accommodation, transport and recruitment. For instance, the insurance firm Zurich now has key partnerships with both Uber and Airbnb platform/users.28

There are risks to the shared economy, the greatest of which is underestimation Despite the opportunities, it would be naïve to paint a picture of inevitable or uncontested growth, or to suggest that there will not be failures in the ‘sharing economy’.

One immediate pressure comes from regulatory hurdles and increased social critique of some companies. Uber is a prime case study, given controversies over the classification and payment of self-employed drivers, and more generally its classification as a technology vs a transportation company. For example, the European Commission ruled in May 2017 that Uber should be regulated as a

27


transportation company as it operates in the taxi business and therefore be subject to the relevant legislation, which is extensive. Similarly, following an investigation into illegal rental practices through Airbnb, New York (where Airbnb was founded) passed a state law in 2016 to fine owners between US$1,000 and US$7,500 for advertising their homes on sites like Airbnb for short-term letting.

But although regulation is an important challenge, it is an area which will ultimately need to be addressed. This is both because of the force of the underlying economic drivers behind the ‘sharing economy’, and the reality of wider, sometimes unpalatable consequences of technological shifts – such as the necessary rethinking of ‘work’ given technological development including artificial intelligence, the proliferation of data and the implications for privacy law and consumer protection.

In the words of one European Commissioner, banning all companies like Uber is like “fighting with the printing press in medieval times”.29 It is not fighting one company but rather a range of developments which have resulted in demand for, and increasingly the proliferation of, sharing economy companies.

Given the socio-cultural, technological and economic drivers outlined, the disruptive potential, and the emerging areas of opportunity, the phrase could be adapted for investors. Underestimating sharing economy companies may prove short-sighted. Valuing such companies, however, may require more than traditional financial and economic modelling. Given changing consumption patterns, and the increasing economic power of non-Western countries, consideration of the marginal propensity to share may prove a necessary addition to our thinking.

Sources:17 Drawing on the EU Commission 2016 paper,

“Scoping the Sharing Economy: Origins, Definitions,ImpactandRegulatoryIssues”C.Codagnone and B. Martens.

18 It has in fact been argued that any true ‘sharing economy’ is a misnomer as sharing cannot accommodateaforprofitmotive.F.BardhiandG.M. Eckhardt. “Access-Based Consumption: The Case of Car Sharing.” Journal of Consumer Research: December 2012.

19 BankofAmericaMerrillLynch,Uberfication–Global Sharing Economy Primer, 15 June 2017, F. Tran et.al, also referencing CB Insights, as at 15 June 2017.

20 BankofAmericaMerrillLynch,Uberfication–Global Sharing Economy Primer, 15 June 2017, F. Tran et al, also referencing PwC and taking their 335bn projection as the conservative starting point.

21 Conducted between August 14 and September 6, 2013, this polled more than 30,000 online consumers in 60 countries.

22 BankofAmericaMerrillLynch,Uberfication–Global Sharing Economy Primer, 15 June 2017, F. Tran et al.

23 IHS Markit Ltd 2017, A bright future: 5G and continued growth promise new opportunities for the mobile industry.

24 For the theory tested using Facebook and Tencent data see Zhang, XZ., Liu, JJ. & Xu, ZW. J. Comput. Sci. Technol. (2015) 30: 246.

25 UBS, What Is the Scope of the Sharing Economy?, Eric J. Sheridan 20 July 2016.

26 UBS, What Is the Scope of the Sharing Economy?, Eric J. Sheridan 20 July 2016.



29 Elzbieta Bienkowska, commissioner for industry and the internal market, quoted in FT, ‘Banning Uber like trying to stop the printing press, says Brussels’, 4 November 2015, J. Brunsden and D. Robinson.

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Columbia Threadneedle Investments votes actively at company meetings, applying our principles on a pragmatic basis. We view this as one of the most effective ways of signalling approval (or otherwise) of a company’s governance, management, board and strategy.

While analysing meeting agendas and making voting decisions, we use a range of research sources and consider various ESG issues. The Responsible Investment (RI) team makes final voting decisions in

collaboration with the firm’s portfolio managers and analysts. Votes are cast identically across all mandates for which we have voting authority.

All of our voting decisions are available on our website seven days after each company meeting.

The second quarter of every year sees the highest volume of company meetings. This is due to a majority of companies using the calendar year for the purposes of generating annual reports and accounts.

Between April and June 2017, we voted at 770 meetings across 43 global markets. This compares to 140 meetings across 27 markets in the first quarter.

Of the 770 meetings, we cast at least one dissenting vote at 553 (72%). A dissenting vote is where a vote is cast against (or where we abstain/withhold on) a management-tabled proposal, or where we support a shareholder-tabled proposal not endorsed by management.

Figure 9 meetings voted by region

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Directors

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Source: Columbia Threadneedle Investments, ISS ProxyExchange, 30 June 2017.

07 Proxy voting

29


We did not support 1,607 individual voting items throughout the quarter, the majority relating to directors’ elections and executive pay.

Across all regions, not supporting directors’ re-elections was the most common reason for casting a dissenting vote. There are multiple reasons why we may not support directors’ re-elections; the most common are concern for their level of outside commitments, poor attendance, lack of independence or concerns around board composition more generally.

This year, we introduced a new global (excluding Japan) policy of targeting individual directors who we deem responsible for market-lagging diversity practice. The targeted director is most commonly the chair of the nomination committee, the body responsible for selecting and appointing new directors. In developed markets, a dissenting vote is applied whenever women represent less than one-quarter of the board; in other markets, a dissenting vote is applied whenever there are no women on the board. We apply this principle pragmatically: for example, where a company has recently listed, is small, in a state of transition, or there is clear positive momentum (e.g. recent director appointments have favoured females), we may not dissent.

Remuneration continues to be a focus of significant press and investor attention. Where we see a misalignment between executive pay and company performance, or have concerns around transparency or stringency of targets, we will not support.

Figure 10 proportion of dissenting votes per category

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Regional trendsIn the North American markets, as regards proposals raised by management, the presence of a combined chairman/chief executive on the board provided the basis for the vast majority of dissenting votes against nomination committee chair re-elections.

US companies also often face proposals tabled by shareholders. In any given year, these relate to a wide range of topics. This quarter we were generally supportive of shareholder proposals relating to enhanced shareholder rights, including allowing shareholders the right to amend bylaws, lower ownership thresholds for shareholders to call special meetings and requiring a majority vote for the election of directors. Other proposals we saw related to requests for greater transparency around environmental risks, lobbying payments and diversity policies.

A majority of UK companies have been seeking approval of remuneration policies for the first time this year since the introduction of a binding policy vote back in 2014. Following the ‘shareholder spring’ seen last year, many expected this proxy season to feature multiple failed votes. This led to increased engagement activity and the

RI team, alongside the UK Equity team, met multiple companies. Although there were multiple instances of large dissenting votes, few items failed to gain majority support. While the low number of failed items is likely due to extensive company outreach and compromise, a number of companies withdrew seemingly contentious remuneration proposals before they were put to a vote. The most high-profile defeat of the season was at education company Pearson, where 68% of shareholders did not support the rearward looking remuneration report; 36% of shareholders also did not support the forward-looking policy.30

Last year, the UK’s Pre-Emption Group updated its guidelines to recommend that equity issuances without pre-emptive rights up to 10% of a company’s issued share capital should be presented under two separate items, individually requesting up to 5%. As a member of the Pre-Emption Group ourselves, where firms did not apply this format, we did not support the requested capital authorities.

Concerns around non-independent directors drove many dissenting votes at Far East companies. Family and cross-shareholdings dominate many firms in this region, and a key focus of voting was non-independent representation on key committees.

Capitalisation issues, and our concern to manage dilution risk, also saw us frequently dissenting from management’s view. We did not support 30% of all capitalisation-related items in the region as too often we considered companies to be requesting authority to issue capital without pre-emptive rights above a level acceptable under the circumstances.

Likewise, in Europe, potentially dilutive capital authority requests (a tradition in many markets) drove a number of dissenting votes. Where boards are structured in a way that differs significantly from market norms, dissenting votes also tended to be applied eg, at one French company due to the combination of the roles of chairman and CEO.

Across European markets, directors tend to stand for re-election less regularly than in the UK and the US. In Germany, directors most often seek re-election for five-year terms. In addition, in France, it is common for combined Chairmen/CEOs to run companies and in Scandinavian markets, directors are often elected under a single bundled voting item, offering investors an all-or-nothing choice.

In Latin America, poor disclosure frequently drove dissenting votes. Whilst Brazil continues to show some

31


improvements in governance terms, operational issues continue to make it difficult for foreign investors to participate effectively in the director election process.

Japan saw the lowest proportion of dissenting votes overall. Traditionally, Japanese boards have consisted solely of senior executives with no external representation. This is of great concern to us: our view is that a majority independent board can best serve shareholders through provision of robust challenge to and oversight of management.

Since 2014, we have been taking part in a collaborative engagement, writing to 33 leading Japanese companies to encourage boards to meet an independent representation threshold of one-third of directors. We also wrote to the office of the prime minister, the Financial Services Agency and the Tokyo Stock Exchange. In recent years, corporate governance in Japan has undergone a transformation, driven by ‘Abenomics’ and the introduction of the Japan Stewardship Code and counterpart Corporate Governance code. We would like to see further improvement however; although the

average independence level is now 29%, this is still below the majority we prefer. Gender diversity also continues to be a problem; the average proportion of female directors is less than 5%.31

As for Emerging Markets, poor disclosure of auditor’s fees, details on the directors themselves and a lack of independence frequently drove dissenting votes.

Sources:30 For further information, please see ‘Engagement

highlights’.31 Source: Bloomberg.

Figure 11 Proportion of dissenting votes per category, by region

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Columbia Threadneedle Investments has continued to engage with numerous companies throughout the quarter. In prioritising our work, we focus our efforts on the more material or contentious issues and the companies in which we have large holdings – based on either monetary value or the percentage of outstanding shares.

There are a number of companies with which we have ongoing engagements, as well as a number that we speak to on a more ad hoc basis, particularly when concerns or issues arise.

We actively participate in a number of investor networks, which complement our approach to company engagement

and wider sentiment. Along with other investors, we raise market and company-specific environmental, social and governance (ESG) issues, share insights and best practice.

Between April and June, we engaged with the 48 companies listed below, some on multiple occasions.

ESG discussions* AXA SA, BAE Systems, BP, Macquarie, POSCO, Royal Dutch Shell, Sherborne, Total SA, Vestas Wind Systems, Vinci, Wood Group.

Specific environmental focus* Ambev, BRF.

Specific social focus* ICO, RATP.

Specific governance focus* AkzoNobel, Amadeus SA, Amundi, Breedon Group, Burberry, Cellnex Telecom SA, Centrica, CRH, Cypress Semiconductor, Dalata Hotel Group, Electrocomponents, Elementis, Essilor, GKN, Ingenico, Intermediate Capital Group, Irish Continental Group, Johnson Matthey, Kier Group, Kingspan, Pearson, Petrobras, Rentokil Initial, Rotork, Schoeller-Bleckmann Oilfield Equipment, Sika, Smiths Group, St James’s Place, Stagecoach, Tele Columbus, Telepizza, Vectura Group, WM Morrison.

08 Engagement highlights

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Case study: public intervention – AkzoNobel*Dutch company AkzoNobel is the world’s biggest paint manufacturer and among the largest chemical companies.

In March, American paint company PPG Industries approached the company regarding a potential takeover. The board of Akzo – citing undervaluation – rejected the initial offer.

We had concerns that Akzo did not appropriately analyse the offer, and did not engage with PPG around possible benefits of a combined entity. The RI team met with the board and management and encouraged them to engage with PPG multiple times, alongside representatives from the European investment desk.

After Akzo rejected a second offer, we publically stated our position via a press interview. Following the rejection of a third bid, PPG entered a six-month ‘cooling-off period’ per Dutch law.

Due to our concerns with the approach taken by the board and management in respect of the PPG approach, we decided to take voting action at the company’s annual general meeting.

We did not support the discharge of both the management and supervisory boards, sending a tacit signal.

As well as Akzo, other Dutch companies have recently been subject to takeover attempts: Unilever (by Kraft Heinz) and PostNL (by Bpost).

The Dutch government has proposed new legislation regarding takeover bids, specifically a one-year ‘legal timeout’ for hostile takeovers, which would reduce shareholder rights by restricting shareholders from calling extraordinary general meetings or proposing changes to management and supervisory boards.

We decided to co-sign a letter outlining significant investor concerns around the proposals and negative impact on corporate governance standards, efficient markets and sustainable value creation written by the International Corporate Governance Network (ICGN).

Case study: strategic concerns – Pearson*

In January, Pearson, a UK-based education company, issued its fifth profit warning in four years, raising concerns around the company’s strategy, prospects and management/board oversight.

Alongside various portfolio managers and analysts, the RI team engaged with management and the board multiple times throughout the second quarter.

When considering how to vote at the company’s annual general meeting, our view is of a misalignment between pay and performance: in the six months to 30 June 2017, the share price has fallen by over 15%.

Due to concerns around the structure of remuneration – the chief executive received a 20% increase in pay – we did not support a number of remuneration-related items, including the re-election of the chair of the Remuneration Committee.

At the general meeting, the advisory remuneration report failed to gain majority support with 68% of shareholders either voting against or abstaining. The binding policy attracted 36% dissent while the chair of the Remuneration Committee saw 27% of shareholders voting against her reappointment.

34


Case study: remuneration improvements at oil majors – Royal Dutch Shell and BP*

At Shell, when meeting with the company, we encouraged them to adopt an absolute free cashflow target in their performance criteria for determining variable pay. An historic concern of ours has been the focus on relative metrics, which offer little shareholder protection; returns may fall in absolute terms but if they fall less than peers, bonuses can still be awarded (subject to Remuneration Committee discretion).

Though we still have some concerns around the quantum of pay that could result from meeting maximum performance targets, we believe the targets themselves are sufficiently robust and we have had no historic concerns with the link between pay and performance at the company.

We supported all remuneration items at the May AGM, alongside over 90% of shareholders.

At BP, following last year’s defeat of the remuneration report, CEO Bob Dudley’s pay fell by 40%, with the Remuneration Committee using its discretion to reduce the payout.

Improvements to the company’s remuneration policy include: simplification, alignment of the bonus performance scale for executive directors and top management, increased deferral of bonus payments into company shares (further linking management and shareholder interests), inclusion of a returns-based performance metric and the inclusion of a ‘strategic performance’ metric looking at, among other things, renewable trading and alternative energy.

Again, we supported all remuneration items alongside over 96% of shareholders.

Case study: mergers and acquisitions – Essilor*

France’s Essilor is a leading maker of ophthalmic products and supplies. At the company’s general meeting in May, shareholders voted on the proposal to merge with eyewear giant, Luxottica.

Ahead of the vote, we spoke to the company about the resolutions tabled, which required a majority of shareholders to support to allow the merger to go ahead.

Our view is that the synergies created from the resultant global vertically integrated company would benefit shareholders. We therefore supported all proposals relating to the merger, which passed with shareholder support.

We will continue to monitor the combined company as the governance arrangements are confirmed, particularly the composition of the board and how executives are incentivised to deliver a successful combination of companies.


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Important Information: Data as at 30 June 2017, unless otherwise stated. For use by professional investors only (not to be passed on to any third party). Past performance is not a guide to future performance. The value of investments and any income is not guaranteed and can go down as well as up and may be affected by exchange rate fluctuations. This means that an investor may not get back the amount invested. Where references are made to portfolio guidelines and features, these are at the discretion of the portfolio manager and may be subject to change over time and prevailing market conditions. Actual investment parameters will be agreed and set out in the prospectus or formal investment management agreement. The mention of specific stocks is not a recommendation to deal. The research and analysis included in this document has been produced by Columbia Threadneedle Investments for its own investment management activities, may have been acted upon prior to publication and is made available here incidentally. Any opinions expressed are made as at the date of publication but are subject to change without notice and should not be seen as investment advice. Information obtained from external sources is believed to be reliable but its accuracy or completeness cannot be guaranteed. This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Marketing Counterparties and no other Person should act upon it. Issued by Threadneedle Asset Management Limited, registered in England and Wales, No. 573204. Registered Office: Cannon Place, 78 Cannon Street, London EC4N 6AG. Authorised and regulated in the UK by the Financial Conduct Authority. Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies. columbiathreadneedle.com Valid from 08.17 | Valid to 12.17 | J26856

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