The importance of public policy has increased for investors since 2015, when governments committed to shifting trillions of dollars to be consistent with the goals of the Paris Agreement and to increase investments in the Sustainable Development Goals (SDGs). Further, investors have accepted the influence of ESG factors on delivering financial returns, recognizing the need for well-designed and effectively implemented public policies to support national economic and sustainability objectives and increase the attractiveness of countries as investment destinations.
Institutional investor engagement with companies on ESG issues increased substantially throughout the 2010s (2020 Global Sustainable Investment Review). Using their ownership position to influence corporate policy and practice, investors engage with companies through shareholder resolutions, voting, face-to-face meetings, and lawsuits.
Beyond engaging with corporations on ESG issues, an increasing number of asset managers are engaging with policymakers, governments, and government-related institutions. Additionally, investor associations and collaborative initiatives target government officials to change public policy, such as the Emerging Markets Investor Alliance (EMIA), the Interfaith Center on Corporate Responsibility (ICCR), the Investors Policy Dialogue on Deforestation (IPDD), Shareholders for Change (SfC), The Investor Agenda and the Seventh Generation Interfaith Coalition for Responsible Investment.
Theory lags behind practice
The growing importance of public policy for investors is not yet reflected in academic research. While the bulk of the literature on investor engagement focuses on companies as targets of activist investors, little focuses on engagement with policymakers such as parliamentarians, ministers, and sovereign issuers. Further, few academic studies analyze the public policy role of this particular interest group. Based on our literature review, exceptions include van Zanten, Sharma, and Christensen (2021), who guide sovereign debt investors in engaging with sovereign officials on sustainability challenges, and Robins (2006, p. 320), who argue that investors should extend their focus from the company level to that of the system so as “to create market frameworks that reward companies, and their investors, for high levels of social and environmental performance.” In addition, several grey literature publications (e.g., PRI 2014; PRI 2020; UN-convened Net-Zero Asset Owner Alliance 2022), {Formatting Citation} analyze the reasons why investors seek to influence public policy and the strategies investors employ to attain this purpose. For instance, PRI notes that their signatories were not yet engaging with policymakers due to skepticism about whether public policy engagement would make a difference, a lack of understanding of how to influence public processes, and the need for long-term commitment.
Little academic research exists so far analyzing what drives institutional investors to engage with government entities and what challenges they might have. Hence, our study seeks to answer these questions.
Why engage with policymakers?
We understand investor engagement in public policy as developing relations with governments and policymakers to influence public policies and practices directly or through third parties, working groups, or collaborative initiatives. In our paper, we analyzed 11 case studies of investor engagement with policymakers from Australia, Brazil, the EU, Indonesia, Japan, Namibia, amongst others, looking for investor motivations for why they engage with policymakers. We relied on semi-structured interviews with investors (in progress) and secondary data, analyzing reports on the engagement initiatives, reports from investor associations, websites of investors and investor coalitions, investor engagement policies, investor letters to sovereign entities, and others.
According to the case studies analyzed, investors are encouraged to engage with policymakers to comply with their fiduciary duty and act in the best long-term interests of their beneficiaries.
Second, investors engage with sovereigns to manage investment risks from their portfolios. Having regulations that require investee companies to report on ESG issues in a comprehensive, periodic, and comparable manner helps investors monitor and manage their portfolios’ ESG risks. Investors are also concerned about mitigating systemic risks that might influence the economy, such as climate change issues, thereby affecting the beta performance of their portfolios.
From a sovereign investment perspective, sovereign bond investors are encouraged to engage with policymakers to reduce reputational, operational, and regulatory risks that arise from failing to address ESG issues that have the capacity to affect the valuation of the sovereign bonds of these countries.
Third, investors are engaging with policymakers to create enabling conditions for investments in companies with good ESG performance. The enactment of public policies that require companies to internalize externalities contributes to leveling the playing field for all businesses and to creating more rewarding conditions for leading companies and their investors.
Faith-based investors are also concerned with ethical values.
The challenging road ahead for investors
Although still exploratory due to the limited number of interviewees, investors identified challenges in conducting sovereign engagement from the investor perspective.
The first challenge relates to the long-term horizon required for policy engagement. One interviewee explained that in companies, the CEO often has control over the corporate strategy and thus can more quickly implement changes. However, political factors such as changes in administration after elections and the variety of stakeholders at play make it difficult to estimate “a reasonable timeframe to expect [policy] change” and see progress. Similarly, another interviewee noted that it is difficult to measure the impact of policy engagement initiatives due to the longer process compared to corporate engagement.
Another identified challenge is the limited investor influence on governments. One interviewee argued that, whereas they are very influential stakeholders in companies, either as co-owners in the case of stock ownership or lenders in the case of bond ownership, the government’s top priority is their constituents. Likewise, another interviewee argued that corporations are more attentive to investor demands than governments due to the stronger voice that investors have in companies.
A third challenge relates to the need for capacity building on both the investor and the government sides. On the government side, one interviewee argued that governments lack understanding of why investors are concerned about ESG issues and why these risks represent systemic risks. In contrast, another interviewee observed that not even the Ministries of Finance, under which the sovereign bond issuing agencies lie, understand why ESG issues are considered financial risks. Amongst investment professionals, a third interviewee claimed that there is limited understanding of government policy processes, with another interviewee arguing that investors need to be educated about how policymaking works in the target countries.
Interviewees also mentioned the difficulty in accessing the government. As explained by one interviewee, whereas in corporate engagements, the investor relations department, the sustainability area, or the Board of Directors can connect investors to the rest of the organization, it is more difficult to identify the appropriate contact person in sovereign entities. Further, another interviewee recalled that, after elections, investors tend to lose all their contacts to the key decision-makers and must reestablish these connections.
Another challenge is the difficulty in formulating engagement asks to governments, given that it is more difficult to understand how different governments operate compared to companies. In contrast, investors can benchmark companies against their peers in corporate engagement and formulate asks based on the identified gaps.
One interviewee also raised the difficulty in adopting escalation measures in policy engagement, arguing that if a country performs poorly on one ESG issue, such as human rights or deforestation, but has an acceptable overall ESG score, investors will only be able to divest if they have a dedicated divestment policy. Divesting from countries would also be contrary to the investment risk profiles of many of their clients. Moreover, they noted that, whereas in corporate engagement, it is possible to file shareholder resolutions or use voting rights, there is still the need to understand and define the steps for escalation in the case of sovereign engagement.
Another challenge is the effect of cultural differences on the effectiveness of engagement strategies. As an example, one interviewee noted that in certain contexts, culture favors relationship-building before the start of negotiations. This means that “naming and shaming” engagement strategies like the sending of public letters may be counterproductive to the initiative. Instead, they should start a dialogue that requires the building of relationships on the ground for the engagement to work. In other countries, directly contacting key decisionmakers and asking for dialogue might be more acceptable.
Finally, another challenge in policy engagement is the possibility that investors will be blamed for interfering with national sovereignty, especially foreign investors engaging in public policy in another country. One interviewee argued that a way to overcome this potential accusation is to bring domestic investors to the investor coalition, providing more legitimacy to the initiative.
As for recommendations to tackle some of these barriers, the interviewees suggested that investors engage with policymakers collaboratively to add legitimacy and financial clout to the initiative and include sovereign debt investors in the group since they have a more direct link to governments and may already have contacts in governments and knowledge of the local contexts. Further, the approach to engagement should come from a financial standpoint, highlighting why ESG risks are financial risks and starting engagement with topics that are material to the portfolio and measurable. Associated to that, the engagement requests should/must be specific and tangible to track progress. Finally, a secretariat to provide structure and process support to the coalition was found useful so that investors can use their time and knowledge on where they are most valuable rather than spending time on administrative tasks.
Implications for academia and practitioners
Our research contributes to the academic literature on investor engagement, analyzing a new form of investor activism. It also contributes to the public policy literature by identifying a new interest group influencing public policy that has not previously been the focus of academic research.
As for practical contributions, our study offers insights to governments on the demands of the investment community, providing inputs on how sovereign entities can improve their business environment, reduce risk perception, and attract private investments to achieve their national climate and SDG commitments.
Our findings also corroborate some of the literature, indicating that this new type of investor activism brings together two worlds that do not typically meet. Thus, a successful dialogue between these two groups requires capacity building on both sides so that the government side understands what motivates investors to seek changes in the regulatory framework and the investment side understands the complexities and intricacies involved in the policymaking process.
Camila Yamahaki is a senior researcher in Sustainable Finance at the Center for Sustainability Studies at Fundação Getulio Vargas (FGV).
Catherine Marchewitz is a senior researcher in Sustainable Finance in the Climate Policy Department at the German Institute for Economic Research (DIW Berlin).
This post was adapted from their paper, “Collaborative Investor Engagement With Policymakers: Changing the Rules of the Game?,” available on SSRN and as DIW Discussion paper.
