Galloway: The impact of climate change on our environment and the wider socioeconomic ecosystem is one of the most complex problems facing the world today. Vanguard research, based on consensus scientific climate change scenarios, projects a negative impact on global GDP by 2050 in all scenarios. The projected net drag is about 2% to 4% in best cases and closer to 10% in worst cases.
Climate change poses a very real financial risk to long-term investors. It’s hard to identify any Vanguard fund portfolio company that doesn’t face some form of climate-change risk, either a physical risk to its operations and its customer base or transition risk in terms of expected regulatory and market changes.
Our Investment Stewardship team represents Vanguard’s internally managed equity funds, the majority of which are index funds. By design, index funds provide broadly diversified access to global markets, at low cost and for the long term. That broad market diversification also brings exposure to climate risk. That’s why our investment stewardship programme works to help safeguard long-term shareholder value.
Galloway: We are engaged owners on behalf of our funds. Through research and advocacy for strong corporate governance practices, direct engagements with company management teams and boards of directors as well as proxy voting, we work to encourage portfolio companies to take appropriate steps to address the risks that climate change poses to long-term investors.
We believe in the power of engagement. We have ongoing conversations with portfolio companies to share our expectations of them when it comes to addressing climate change risks on behalf of investors. We select engagements through a lens of material risk and set out governance expectations on behalf of each fund.
First, we expect company boards to demonstrate effective oversight of climate-related risks. That starts with a board that has the requisite skill, perspective and independence to exercise appropriate climate risk oversight.
Second, we expect to see evidence that boards have robust strategies and mitigation measures in place to address climate risks.
And third, we expect boards and companies to explain their plans to remain resilient and successful in the face of changing regulatory and market conditions. This includes providing clear, comprehensive and comparable climate-risk disclosures, including any specific climate-change transition targets and progress against those targets over time.
As with other material risks to long-term shareholder value, if a company does not demonstrate meaningful progress toward addressing risks associated with climate change, we may use proxy voting to support appropriately targeted shareholder proposals or to vote against director nominees to demonstrate our concern.
Galloway: On behalf of our investors, Vanguard invests for the long term. By design, our index funds buy and hold companies for as long as they are in the benchmark index. So divestment is not an option for index funds that lack a mandate to avoid certain sectors or companies. In addition, from a real-economy perspective, there are significant limitations and downsides to divestment as an instrument of change.
This is where effective stewardship comes into play. By owning companies throughout their energy transition, and by focusing on the long term, we can encourage boards to oversee and manage climate risks, disclose progress and deliver more long-term sustainable value.
Galloway: Quantifying climate risk at the individual company level, and tracking progress in mitigating those risks, is a work in progress. The lack of mature, standardised measures is a real challenge. A number of industry and regulatory efforts aim to make progress on this front. We have hopes for these efforts, as we’ve seen progress across the fund portfolio companies in the five years since the Paris Agreement—which provides a common framework for reporting on climate efforts—took effect1.
For example, we’re seeing greater adoption of clear and consistent climate-risk reporting frameworks. More than 2,600 organisations now support the Task Force on Climate-related Financial Disclosures (TCFD) framework, including 83 of the world’s 100 largest companies2.
And we see signs of other, more qualitative progress through our engagements. More boards are increasing their understanding of climate risk, either through board education or by adding directors with relevant skills and backgrounds. We also see more companies setting targets in the context of the Paris Agreement, as well as performing scenario analysis to assess future risk and opportunities arising from climate change.
Galloway: Vanguard’s efforts extend beyond engagements and proxy voting. We hold conversations with policymakers and are aligned with several climate-focused organisations and initiatives such as the Net Zero Asset Managers (NZAM) initiative and the Ceres Investor Network on Climate Risk and Sustainability3. We have also been a long-time supporter of the TCFD framework created for disclosing climate-related risks and targets.
As an investment provider, Vanguard offers both passively managed ESG funds that screen out companies based on predetermined ESG screening criteria, including involvement in fossil fuels, and actively managed ESG funds. These invest in companies that the manager believes can deliver long-term value based in part on their stewardship and sustainability practices. And many managers of our active funds consider financially material ESG factors when selecting securities, regardless of an explicit sustainability target.
Galloway: We evaluate each shareholder proposal case by case to assess its long-term effect. Vanguard’s focus is on acting in our investors’ best interests by promoting and protecting long-term shareholder value. While advocates or proponents of a given shareholder proposal may believe it will help address climate change risks, our assessment is based on its relevance to material risks, the practices of a particular company, its expected impact on the issue in question and whether it can support the long-term interests of our investors.
We recognise that our nuanced approach sometimes gets misunderstood or is inaccurately portrayed in the market. Some advocates and observers resort to “scoring” our voting record based on the false presumption that all shareholder proposals are equal. That approach fails to recognise our commitment to protecting our investors from risk and the power of our active engagement and thoughtful voting.
We take our responsibility very seriously. Investors in our index funds have not asked us to pick winners and losers in the market, to dictate strategy to portfolio companies or to pursue an agenda beyond our focus on long-term shareholder value.
John Galloway is global head of Vanguard’s Investment Stewardship team, which applies oversight to the portfolio companies held by our internally managed equity funds through engagement, advocacy for good governance practices and proxy voting. Before joining Vanguard in 2017, Galloway served in several senior roles in the White House and federal Office of Management and Budget, including as special assistant to the President and chief of staff for the National Economic Council.
1 The Paris Agreement, an international treaty on climate change, was adopted in December 2015 and entered into force on 4 November 2016, after its ratification terms had been met.
2 Source: Task Force on Climate-related Financial Disclosures (press release: Fourth TCFD Status Report Highlights Greatest Progress to Date on TCFD Adoption; report: 2021 Status Report).
3 The NZAM initiative is an international group of global asset managers committed to supporting the goal of net-zero greenhouse gas emissions by 2050 or sooner, in line with efforts to limit global warming to 1.5 degrees Celsius, and to supporting investing aligned with net-zero emissions, also by 2050 or sooner. The Ceres Investor Network on Climate Risk and Sustainability represents more than 200 institutional investors working to advance sustainable investment practices and accelerate the transition to a net-zero-emissions economy.
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