In 2019, we created an engagement and voting screen that leverages R-Factor, our proprietary scoring system. R-Factor measures the performance of a company’s business operations and governance as it relates to financially material and industry-specific ESG risk factors, as defined by the Sustainability Accounting Standards Board (SASB).
Beginning in the 2020 proxy season, we started taking action against board members at companies in the S&P 500, FTSE 350, ASX 100, TOPIX 100, DAX 30 and CAC 40 indices that are laggards based on their R-Factor scores and that cannot articulate how they plan to improve their score.
SASB Materiality Map
Number of Engagements
Integrating R-Factor Scoring System into Our Asset Stewardship Program
Drawing on data from four leading providers and leveraging the Sustainability Accounting Standards Board (SASB) transparent materiality framework, R-Factor generates unique ESG scores for more than 7,300 listed companies globally and allows us to evaluate a company’s performance against both regional and global industry peers.
Consequently, in 2019, we began integrating R-Factor into our Asset Stewardship program. We have begun sharing companies’ R-Factor scores with them and guiding companies towards resources on how to improve their ESG practices and, ultimately their score. Because the score leverages transparent materiality frameworks, companies have the information needed to understand exactly what powers the score — and which financially material ESG issues to focus on in terms of management and disclosure. Over time, this will bring better ESG data into the market — helping to build more sustainable companies and capital markets.
Employees affiliated with a company’s investor relations, chief financial officer, ESG/sustainability leadership or general secretary’s organizations make request their R-Factor score here.
A Positive Framework for Progress We continue to find that companies we engage with find the transparent nature of the SASB framework as positive, and are open to further exploring the integration of SASB into their reporting efforts. Our company engagements continue to be enhanced by the use of our R-Factor score to demonstrate how investors are using the SASB framework to measure the performance of a company’s business operations and governance as it relates to financially material ESG challenges facing the company’s industry. The R-Factor score provided companies with tangible feedback on how well they were meeting our need for material ESG information, and the SASB framework creates clarity on what that information is.
Screening Engagements and Proxy Voting
We have long believed that ESG issues can pose long-term risks and opportunities to portfolio companies and should be managed as such, including through oversight by a company’s board of directors. Reflecting that belief, in our January 2020 CEO letter to portfolio companies, we outlined a new engagement and voting policy which went into effect in 2020.
As part of this process we created an engagement and voting screen that leverages R-Factor, our proprietary R-Factor scoring system. Beginning in the 2020 proxy season, we started taking action against board members at companies in the S&P 500, FTSE 350, ASX 100, TOPIX 100, DAX 30 and CAC 40 indices that are laggards based on their R-Factor scores and that cannot articulate how they plan to improve their score. In the event that we feel a company is not committed to engaging with us or improving their disclosure or performance related to financially material ESG matters, we may not support the re-election of the board’s independent leader.
In addition, starting in 2022, we will expand our screen to include those companies that have been consistently underperforming their peers on their R-Factor scores for multiple years, and may take voting action unless we see meaningful change.
As of 31 December 2020, 698 companies requested their R-Factor score and this represents 44% of our equity AUM. Of these 70% came from companies based in the United States and 7% from UK-based companies.
During 2020 we voted against directors in 14 companies that were identified as R-Factor Laggards. Of these, seven companies (50%) were in the United States, five companies (36%) were in the United Kingdom, and two (14%) were in Australia.
Figure 1: How Are R-Factor Scores Created?
Weighting Rationale: Why 90+10?
R-Factor scores are designed to create change in companies’ ESG and sustainability practices. While the SASB framework considers governance and oversight of sustainability issues such as regulatory compliance, risk management, and anti-competitive behavior, it does not consider traditional corporate governance factors (such as board independence, shareholder rights, executive compensation).
R-Factor incorporates a CorpGov element in addition to the ESG Score to make it a more comprehensive measure.
Figure 2: Multiple Best-in-Class Data Sources
R-Factor CorpGov Score Screens
In 2020, our team implemented a proactive screen to identify portfolio companies in our key markets that do not comply with their country-specific governance codes. The screen’s methodology centers around the R-Factor Corporate Governance score component (CorpGov), leveraging our proprietary framework to develop insights and drive our engagements with companies identified as laggards based on their low-ranking scores relative to their domestic and global peers. Laggard companies score in the bottom 10% relative to their local peers, and belong to one of the major indices where we applied the screen.
Since most governance codes are implemented on a comply-or-explain basis, we engaged with these companies to understand their reasons for the laggard score status. In the event companies were unable to provide effective explanations for their noncompliance or have not made evident progress to improve their practices, we held them accountable by taking voting action against the independent leader of the board standing for election.
Our team also targets engagements with corporate governance Leaders (top 10% of scores) to understand best practices in their respective region, and include these practices in our guidance to the broader market.
Figure 3: SSGA Voting on Laggard Companies
Guidance for Boards In our view, boards that are responsive to our engagements on improving their governance to meet minimum market expectations are likely to face less investor scrutiny of their governance practices and structure.
We believe that Boards should evaluate their compliance with their national governance codes that have been developed by either regulators or investors, so they can better communicate their approach to governance in the context of investor expectations.
In markets where no country-specific code exists, boards should ensure their practices are aligned with the International Corporate Governance Network’s Global Governance Principles.
Figure 4: Regional Differences in Compliance with Corporate Governance Standards
United States, United Kingdom and Japan We found some variance in the quality of disclosure and performance of companies in the different markets (Figure 4). US companies (S&P 500) on an overall basis profiled better on R-Factor CorpGov scores than their counterparts in other markets, with 30% of the index identified as global Leaders and 29% of companies identified as Outperformers.
In the UK (FTSE 100) and Japan (TOPIX 100) a majority of companies were Leaders and Outperformers. Only a small number of companies were classified as Laggards in the UK (2%) and the US (3%), while Japan exhibited higher levels of Laggards at 6%.
Generally, the R-Factor CorpGov scores indicate that these markets have generally been responsive to calls to action from international investors and domestic regulatory bodies to enhance governance practices on core areas relative to their own national standards in topics including board independence, shareholder rights and executive compensation.
Australia Australia (ASX 100) exhibited the highest levels of companies classified as corporate governance Laggards (18%). From our observations, one driver of this trend is a lower level of board independence on key committees relative to other core markets. Additionally, some Australian companies lag behind their global peers on executive compensation, due to poor remuneration structures and inadequate disclosure or misalignment between pay and performance. In our future Australian engagements, we will continue to focus on encouraging greater board independence on key committees, ensuring compensation plans are linked to long-term performance and that these plans are benchmarked appropriately.
Europe Europe (STOXX 600) exhibited lower levels of Leaders and Outperformers combined when compared to the other key markets and the second highest levels of Laggards and Underperformers after Australia. Companies in the region are continuing to work on their compliance with progressive regulation, including the European Union’s Shareholder Rights Directive. We will continue to engage with companies classified as Laggards and Underperformers to understand their performance and discuss our expectations.
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This information is for informational purposes only, not to be construed as investment advice or a recommendation or offer to buy or sell any security. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. There are no guarantees regarding the achievement of investment objectives, target returns, portfolio construction, allocations or measurements such as alpha, tracking error, stock weightings and other information ratios. The views and strategies described may not be suitable for all investors. SSGA does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision. Investing entails risks and there can be no assurance that SSGA will achieve profits or avoid incurring losses.
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