Our annual letter to company chairpersons

Read this article to understand:

• Our three stewardship priorities for the year: the cost-of living crisis, transitioning to a low-carbon economy and reversing nature loss
• Why tactical decisions by companies to address short-term challenges cannot undermine longer-term sustainability objectives
• Our commitment to hold company boards and directors accountable where progress does not reflect the urgency required

As a global asset manager with £232 billion of assets under management, we are committed to help create a more sustainable, prosperous and inclusive future for our clients and wider society, while supporting our own ambition to become a net-zero company by 2040.¹

Events over the past year have forced us all to re-evaluate and adjust near-term priorities to navigate the lingering reverberations from the pandemic and the political, social and economic turmoil caused by the war in Ukraine.

However, as we develop strategies to counter energy shocks, supply chain disruptions, elevated inflation, and the risk of recession, it is imperative that tactical responses today do not undermine the delivery of critical longer-term sustainability objectives. These potential conflicts could arise in various ways, including securing reliable energy sources by locking in high-carbon capacity or protecting profit margins by inadvertently damaging the long-term viability of supply chains.

Investors, companies, governments and civil society must maintain a transparent and constructive dialogue to chart a path through the current challenges. At the same time, there can be no wavering from our collective commitment to build a sustainable future, recognising the long-term success of companies is inextricably linked to a thriving planet and society. 

It is in this context we want to share the three key priorities that will shape our stewardship activities as shareholders and bondholders in 2023:

1. Tackling the cost-of-living crisis
2. Transitioning to a low-carbon economy
3. Reversing nature loss 

1. Tackling the cost-of-living crisis

Confronted with multi-decade highs in inflation, rising borrowing costs and a deteriorating trading environment, companies may need to make difficult decisions on costs, pricing, budgets, financing and shareholder distributions.

We expect management to explore all opportunities to deliver cost efficiencies, delay non-essential spending, and leverage their pricing power where appropriate. However, this must not come at the expense of the most vulnerable stakeholders within a corporate’s business model and value chain. Multi-stakeholder management is not a zero-sum game; we will look unfavourably on any attempts to protect profitability and shareholder returns through the disproportionate and excessive transfer of costs to employees, suppliers and customers.

Furthermore, businesses have a responsibility to protect their most vulnerable stakeholders during this period of extreme stress. We encourage boards to consider the following actions:

• Pay a living wage: Everyone has the right to live with dignity and receive a fair wage for their labour that covers their basic cost of living. Companies should commit to paying a “living wage” for all workers, provide secure contracts, predictable hours and appropriate holiday and sick pay. Companies should also seek to mandate comparable obligations on suppliers and contractors.
• Offer financial support: Lower-income workers lack the financial resilience to cope with current levels of inflation and interest rates, pushing many into poverty. Companies should consider providing additional financial support to their most vulnerable workers, including one-off cash payments or other temporary benefits.
  
• Engage with trade unions: Companies must engage with trade unions in good faith and seek a balanced outcome recognising the impact of high inflation on real wages, and the physical and mental toll the pandemic has had on frontline workers. Companies should disclose policies for engaging with unions and report on outcomes and resolutions. 
  
• Uphold human rights: The problem of forced labour predates the current crisis. However, high inflation has exacerbated the risk of exploitation of vulnerable workers. Companies must commit to upholding human rights, undertake robust due diligence, establish appropriate whistleblowing and grievance mechanisms, and provide regular reporting on their efforts to eradicate modern slavery. As part of these steps, we expect companies operating in high-impact sectors to implement the Employer Pays Principle to ensure ethical or responsible recruitment in their own businesses and supply chains.^2,3
  
• Show responsibility on executive pay: Executive compensation is an important signal and barometer of corporate culture. As the workforce are increasingly being forced to make trade-offs to afford essential spending, it would be inappropriate for highly paid executives to be fully insulated from the impacts of inflation. We expect any increases to executive base salaries to be below the average for the wider workforce. Companies should also be mindful of trends in pay ratios when determining total remuneration outcomes for executives.
• Support vulnerable customers: Companies should review their approach to identifying vulnerable and financially stressed customers, exploring opportunities to adapt their products, services and pricing models to provide financial support to those in need. Companies should also consider developing strategic relationships with charitable initiatives to help build greater financial resilience in the communities they serve.

2. Transitioning to a low-carbon economy

The past eight years have been the warmest on record with global mean temperatures estimated at 1.15 degrees Celsius above pre-industrial levels.⁴ The physical impacts of global warming are already having dramatic and devastating impacts, with extreme weather events set to become more acute and frequent as the world moves perilously closer to the 1.5-degrees threshold.

Progress at COP 27 proved disappointing as governments failed to ratchet upwards Nationally Determined Contributions and action plans at the pace required. The rapidly shrinking carbon budget demands the private sector accelerate our own plans and take immediate and decisive climate action.

We expect all companies to develop and publish robust and financially viable climate transition plans that will support the decarbonisation of economies in a socially just and inclusive manner.

We are strong supporters of the UK Transition Plan Taskforce Disclosure Framework and expect its recommendations to be integrated into the International Sustainability Standards Board (ISSB) guidance. We encourage companies to pay particular attention to the following components of the framework:⁵

• Business models: Describe key impacts of the transition plan on products and services, asset acquisitions and disposals, organisational design, resource allocation, and operational and capital expenditures.
• Financial planning: Estimate the impact of the plan on the financial position of the company, including future revenues, costs, cashflows and investment returns. The transition plan should be fully costed and accompanied by sources of funding to implement the strategy.
  
• Incentives and remuneration: Integrate climate targets and metrics into variable incentive arrangements for executives and senior management. The percentage of total compensation linked to climate targets should reflect the extent to which transition plans will fundamentally reshape the business model, growth profile and investment thesis of the company.
  
• Engagement with value chain: Develop strategies to engage and incentivise customers, suppliers and partners to collectively drive the decarbonisation of the entire value chain. Companies should set Scope 3 emissions reduction targets and monitor and report on the success of upstream and downstream initiatives.
  
• Engagement with governments: Engage with governments, regulators, public sector organisations and civil society to help create a coherent, holistic and effective transition pathway.  Companies should seek to evidence alignment between government engagement activities and corporate climate commitments, covering direct lobbying as well as indirect influence through trade associations.

3. Reversing nature loss

The Post-2020 Global Biodiversity Framework agreed at COP15 in Montreal established a 2030 mission and set new targets and goals, most notably the 30x30 target of conserving at least 30 per cent of global land and oceans by 2030. The Global Biodiversity Outlook report highlighted our collective failure to deliver any of the 20 targets in the prior decade. This must not be repeated if we are to halt and reverse nature loss, recognising efforts to combat climate change are inextricably linked to the protection of the planet’s ecosystems.⁶

Delivery of these goals will be dependent upon government action through the robust design and implementation of National Biodiversity Strategies and Action Plans. However, companies have a critical role in engaging governments to establish supportive regulatory regimes that align subsidies and fiscal policies with the delivery of the Montreal targets.

Furthermore, companies need to demonstrate how they are aligning their internal policies and practices with a nature-positive ambition and quantify the financial risks and opportunities associated with their dependencies and impact on nature, providing decision-useful disclosures to investors.

Accordingly, we expect all companies to begin reporting within a reasonable timeframe against the Taskforce on Nature-related Financial Disclosures (TNFD) framework, due to be finalised in 2023. In preparation for reporting against the framework, companies should undertake the TNFD recommended business model assessment process, referred to as LEAP.⁷ The framework has four core components:

• Locate interfaces with nature: Companies should begin by mapping the location of individual assets, business processes, value chains and downstream products to each ecosystem, to enable the appropriate prioritisation of issues and areas for assessment. 
• Evaluate dependencies and impacts: Companies must identify and quantify all ecosystem services that support the generation of revenues, cashflows and enterprise value for each business process and location and measure the impact the business is having on nature.
  
• Assess risks and opportunities: Companies should determine the risks and opportunities associated with its dependencies and impact on nature, outline existing risk mitigation and identify additional potential actions.
• Prepare to respond: Companies should build on the outcomes of the previous steps to define a comprehensive biodiversity strategy. This should include the setting of short-, medium- and long-term targets and action plans to reduce and reverse the impacts of the business on nature. Companies should then determine the scope and substance of financially relevant public disclosures to be made against the TNFD framework.

Our 2023 Global Voting Policy provides more details on our approach and perspectives on governance and sustainability best practice and is available on our website, www.avivainvestors.com. 

We acknowledge the magnitude of these challenges and will evaluate companies on the strength of their commitments and ability to demonstrate progress over time. 

In the spirit of open dialogue and mutual learning, we would welcome feedback on the issues highlighted and our overarching stewardship approach. Please contact our responsible investment team at stewardship@avivainvestors.com.  

Yours sincerely,

Mark Versey
Chief Executive Officer
Aviva Investors