& Securities

Institutional Shareholder Services (ISS) has released results of its Annual Global Benchmark Policy Survey, which is expected to inform policy changes for the upcoming 2023 proxy season. A significant portion of this year’s Global Benchmark Policy Survey, available here, focuses on climate change risk management, including related disclosures and risks globally. U.S.-focused issues surveyed include problematic governance features (such as classified boards, multi-class voting structures and supermajority voting), racial equity and civil rights audits, and share issuance mandates for cross-market companies. Investor responses in particular demonstrate support for holding directors accountable on these topics.

Survey respondents fell into two categories: investors, comprising primarily of asset managers, and non-investors, comprising primarily of public corporations. According to ISS, this year’s survey saw responses from investors rise by 29%, which appears to demonstrate their increasing interest in ESG topics broadly. In total, 205 investors and 212 non-investors participated in this survey. ISS expects to release draft policy updates based on these results in November and, after a comment period, to release policy updates in late November and the final policies in December.

A more detailed summary of the survey results for the Global and U.S. region follows.

Climate Change Risk Management (Global)

• Board Accountability for Significant GHG Emitters. Under ISS’s current policy, for companies that are significant greenhouse gas (GHG) emitters, currently defined as those in the Climate+ Focus Group, ISS recommends voting against the incumbent chair of the responsible committee in cases where the company is not taking the minimum steps, including detailed disclosure of climate-related risks and appropriate GHG emissions reductions targets, needed to understand, assess and mitigate risks related to climate change. In this year’s survey, ISS asked which actions, or lack thereof, demonstrate such poor climate change risk management as to rise to the level of a “material governance failure” which could result in a negative recommendation in director elections. Although a significant majority of both investors (79%) and non-investors (57%) consider a lack of adequate disclosure on climate-related oversight, strategy, risks and targets according to a recognized framework such as the one developed by the Task Force for Climate-related Financial Disclosure (TCFD) to be a material governance failure, investors and companies disagreed with respect to other relevant factors. The survey revealed a gap between investors and non-investors on climate expectations, with investors generally responding that a failure to set realistic (meaning that the targets do not rely on technologies that are not yet commercially available and are not overly reliant on one-offs) medium-term targets and net-zero ambitions should constitute a material governance failure. Specifically, the target-related governance failures identified by survey respondents include: (i) not setting realistic medium-term targets (through 2035) for Scope 1 and Scope 2 emissions (50% investors, 27% non-investors); (ii) not declaring a goal to reach net-zero emissions by 2050 (47% investors, 17% non-investors); and (iii) not setting realistic medium-term targets (through 2035) for Scope 1, 2 and 3 emissions if Scope 3 is relevant (45% investors, 20% non-investors). More generally, only a small number (17%) of investors believe that climate change risk management disclosure and performance should not result in a vote against directors, as opposed to 40% of non-investors. A significant majority of investors (66%) also support applying the ISS policy uniformly across markets, as opposed to a majority of non-investors (60%) who believe that ISS should continue to differentiate by market.
• Adequacy of Climate Transition Plans. ISS surveyed respondents about the top three priorities they consider when determining whether a company’s climate transition plan is adequate. The most popular responses were: (i) the extent to which the company’s climate-related disclosures are in line with TCFD recommendations and meet other market standards (37% investors, 54% non-investors); (ii) whether the company has set adequately comprehensive and realistic medium-term targets for reducing GHG emissions (Scopes 1, 2 and 3 if relevant) to net-zero by 2050 (42% investors, 12% non-investors); (iii) whether the company’s short- and medium-term capital expenditures align with long-term company strategy and the company has disclosed the technical and financial assumptions underpinning its strategic plans (41% investors, 11% non-investors); and (iv) whether the company discloses a commitment to report on the implementation of its plan in subsequent years (22% investors, 35% non-investors).
• Climate Risk as a Critical Audit Matter. A significant majority (75%) of investors favored seeing commentary by auditors in the audit report on climate-related risks for significant GHG emitters, compared to a minority (34%) of non-investors. A majority of investors (64%) believe that climate risk considerations should be included as a Critical Audit Matter (CAM), while 56% of non-investors believe that such considerations should not be included as a CAM. Notably, a majority (62%) of non-investors believe that shareholders should not take any voting action against companies if climate risk considerations are not included as a company’s CAM. In contrast, a majority (52%) of investors believe that shareholders should support a related shareholder proposal.
  • Board Accountability. A significant minority (42%) of investors believe that shareholders should take the further step of voting against the re-election of audit committee members if climate risk considerations are not included among a company’s CAMs.
• Financed Emissions. Prompted by a number of shareholder proposals submitted to companies in the finance sector in 2022 requesting the adoption of a policy to restrict their financing or underwriting for new fossil fuel projects, ISS asked about respondents’ expectations regarding climate-related disclosure and performance of financial institutions. A majority (54%) of investors believe that in 2023, large companies in the banking and insurance sectors should fully disclose GHG emissions associated with their lending, investment and underwriting portfolios, half (51%) of investors also expect such companies to have clear financed emissions reduction targets for high-emitting sectors, and nearly half (49%) of investors believe that such companies should have a net-zero by 2050 ambition including financed portfolio emissions. Non-investors do not support any of the proposed disclosure or target setting alternatives.
• Climate Expectations. Investors (84%) and non-investors (71%) predominately agree that investors’ minimum expectations around climate-related disclosures and performance are growing and will increase over time.

Governance Topics (U.S.)

• Multi-Class Structures and Policy Exemptions. As announced in 2021 and effective as of February 1, 2023, ISS will begin to generally recommend against directors individually, committee members, or the entire board at U.S. companies that maintain a multi-class capital structure with unequal voting rights, including companies that were previously exempted from adverse vote recommendations, subject to certain exceptions including where the company provides sufficient protections for minority shareholders or the unequal voting rights are considered “de minimis.” ISS plans to apply the “de minimis” exception in cases where the company’s capital structure is not deemed to meaningfully disenfranchise public shareholders. In this year’s survey, ISS asked respondents what level of ownership would be “de minimis,” and to identify other relevant factors, if any. Although 32% of investors believe there should be no “de minimis” exception, compared to only 15% of non-investors, a quarter of both investors (25%) and non-investors (25%) believe that the threshold should be no more than 10% and slightly more investors (27%) and non-investors (26%) believe the threshold should be no more than 5%. A majority of investors (53%) believe that any capital structure that disenfranchises public shareholders is problematic, and therefore, no additional factors should be considered in determining whether to apply an exception.
  • Board Accountability. When asked about the appropriate target among members of the board of directors for an adverse vote recommendation based on a capital structure with unequal voting rights, investors support a negative voting recommendation for the chair of the governance committee (41%), any director who holds super-voting shares (35%), all non-independent directors (34%), all the members of the governance committee (33%) and all directors (23%).
• Problematic Governance Structures–Classified Boards and Supermajority Voting Requirements. Currently, ISS generally views a “sunset” provision on problematic governance provisions adopted by a newly public company that is seven years or less to be reasonable. The inclusion of a reasonable sunset provision is a mitigating factor for ISS’s policies regarding other problematic government structures, such as a classified board structure and/or supermajority voting requirements to amend governing documents. While recognizing that the sunset of a classified board may take multiple years, ISS asked respondents to identify the most appropriate time period from the date of their IPO for companies to begin sunsetting problematic governance structures. The plurality of both investors (43%) and non-investors (37%) believe that 3 to 7 years is the most appropriate length of time from the date of the IPO for companies to “sunset” problematic governance structures. The majority (72%) of investors believe that smaller companies should not be exempted, and a significant minority of non-investors (44%) believe that smaller companies should be exempt from negative ISS recommendations for such problematic practices. Further, the vast majority (84%) of non-investors believe that a supermajority vote of two-thirds of outstanding shares, which ISS notes may be easier to obtain than some much higher thresholds, to amend governing documents should generally be considered acceptable, while investors are relatively split with a slight majority (54%) indicating that such a threshold should not acceptable.
  • Board Accountability. The current ISS policy is to recommend voting against all appropriate nominees, except new nominees, when a company’s board is classified, and a continuing director responsible for a problematic governance issue that would warrant an adverse voting recommendation is not up for election.

Racial Equity and Civil Rights Audits (U.S.). The 2022 proxy season saw an increased number of and support for shareholder proposals that asked companies to commission an independent audit to assess potential racial bias in their business practices. Since 2022, ISS’s policy has been to assess proposals calling for racial equity and/or civil rights audits on a case-by-case basis, examining factors related to the company’s disclosure and performance in the area of racial equity and/or civil rights. Investors and non-investors are closely aligned on this topic, with 45% of investors and 56% of non-investors agreeing that whether a company would benefit from an independent racial equity or civil rights audit depends on company-specific factors. When asked about company-specific factors that were relevant, respondents identified the following: (i) significant company diversity-related controversies (83% investors, 77% non-investors); (ii) the company does not provide detailed workforce diversity statistics, such as EEO-1 type data (59% investors, 36% non-investors); and (iii) the company has not undertaken efforts or initiatives aimed at enhancing workforce diversity and inclusion, including training, projects and pay disclosure (45% investors, 30% non-investors).

Share Issuance Mandates at Cross-Market Companies under ISS Coverage (U.S.). U.S. companies generally do not need to seek shareholder approval for share issuances up to the level of authorized capital specified in their organizational documents, unless required by stock exchange listing rules. In contrast, companies incorporated in other countries may be required by local law to seek shareholder approval for share issuances, including offerings for cash. Cross-market companies typically seek approval for a mandate to cover issuances during a fixed period. ISS has typically applied the local market policy to such company proposals, despite the fact that this issue is not one generally faced by their U.S. peers. A majority (57%) of investors and a minority (30%) of non-investors believe that ISS should continue to apply the local market policy for cross-market companies classified as U.S. domestic issuers and listed solely in the U.S. In contrast, a minority (36% of investors) and a plurality (44%) of non-investors believe that ISS should develop a U.S.-specific policy for share issuance mandates. Investors (89%) and non-investors (68%) believe that the same policy should apply to both dual-listed companies (those listed on both a U.S. exchange and a foreign exchange) as to companies listed solely in the U.S. Similarly, investors (85%) and non-investors (61%) agree that the same policy should apply to Foreign Private Issuers as to U.S. domestic issuers.