Once upon a time…
…an old goat had eight young kids. One day, the goat wanted to go into the forest to get some food, but realized that it was much too warm for this time of year. All the herbs, plants and fruit that she normally gathered had already withered or even dried up! So she quickly decided to look for the culprit behind these bad developments…
“Dear children, I have to go out into the world of the oil and gas companies. Only through a dialog with them can I bring about long-term, positive change. Watch out for the wolf while I’m away. Because he is in cahoots with the evil corporations! The bad guy often disguises himself, but you’ll recognize him straight away by his hypocritical promises regarding the climate targets of the oil and gas companies and their poor governance.”
Shortly after the goat left the house, there was a knock at the door: “Open up! Your mother is home again, I’ve brought you the ambitious climate targets for 2050 of the five largest oil and gas companies!”. But the young goats recognized from the unrealistic climate targets that it must not be their mother, but the evil wolf. Sadly, the wolf left. Together with his wolf friends, who also work with the various oil and gas companies, they came up with new ambitions for the official net-zero 2050 targets of the big corporations.
Full of confidence that the eight young goats would no longer be able to expose him, he knocked on their door again: “Your mother is home again! Open up quickly and I’ll tell you how I worked out new, more ambitious climate strategies together with the CEOs of the big companies. This was only possible because the roles of CEO and Chairman of the Board of Directors are often held by the same person, so all the power is concentrated in one person.” But this made the young goats suspicious again, because they knew that this practice could indicate lousy corporate governance. So the little goats shouted: “This is a flimsy governance practice! You’re not our mother, you’re the bad wolf!”
Horrified by the expertise of the eight little goats and at a loss as to what to do next, the bad wolf left…
The true core of the fairy tale
If you now replace the wolf with the French oil and gas company TotalEnergies, the goat with the French SIF (Sustainable Investment Forum) and the eight little goats with Erste Asset Management and seven other sustainable asset managers/owners, you make a direct leap from fairytale land to reality. And the reality almost reads like a thriller:
On 18.04.2024, we, Erste Asset Management, together with 19 other international investors (including Achmea Investment Management, AP7, Candriam, …), under the organization and coordination of the French SIF and the Ethos Foundation, submitted a shareholder resolution to the French oil and gas company TotalEnergies. Erste Asset Management was the only Austrian investor, no investor from Germany was represented.
Clear separation between the roles of managing director and CEO
The shareholder proposal called for the functions of CEO and Chairman of the Board of Directors to be separated, as both roles are currently held by the same person. It was hoped that separating the roles would improve general governance and increase the independence of the Board of Directors. The separation of these two roles is widely recognized as good governance practice and is now applied by two thirds of the companies in the CAC 40 (French stock market benchmark index).
In addition, investors were certain that separating the two roles would improve the dialog between the company, shareholders and the Board of Directors regarding TotalEnergies’ climate and transition strategy, as the current transition efforts could be described as rather poor.
No vote on shareholder proposal
After the board meeting on April 25, 2024, the board of TotalEnergies regrettably decided not to put this advisory shareholder proposal on the agenda of the annual general meeting on May 24, 2024. This decision also meant that the shareholder proposal on the separation of the two management roles will de facto not be put to a vote at the Annual General Meeting.
As the rejection of this shareholder proposal was generally seen as an encroachment on shareholder rights, we, together with 7 other brave little goats, filed an urgent action with the Commercial Court to ensure that the proposed motion was put to the vote of shareholders. And then we had to wait for the Commercial Court’s decision. However, there was not much time, as the deadline for setting the agenda was fast approaching.
Negative signal for willingness to engage in dialog
The first court hearing took place on May 16, 2024, but was adjourned shortly after it began. After many last-minute applications and pleadings by TotalEnergies, the court hearing entered the next and final round on May 21. The verdict was then announced on May 23. One day before the planned Annual General Meeting. Unfortunately with an unpleasant result. Although the court clarified that the action was admissible in principle, which may be relevant for future proceedings, it ultimately ruled that the non-admission of the shareholder motion was lawful.
We believe that the Board’s refusal to include a purely consultative shareholder proposal on the agenda of the Annual General Meeting sends a very negative signal about the company’s willingness to listen to its shareholders and enter into dialog with them.
Environmental proposals will only have a chance in the future if companies are characterized by a strong governance structure. For this reason, we pay particular attention to the corporate governance of oil and gas companies.
What defines good governance?
One can rightfully ask: “What is good corporate governance exactly, and who defines it?” Various jurisdictions have put together their own Corporate Governance Codes, with some being more, and some being less stringent. The UK and Germany impose some of the strictest governance standards on the European continent. The UK calls for a clear division between the leadership of the Board and the executive leadership of the Company. It prescribes the Board to have an independent majority with a very high bar for independence.
Germany mandates a clear separation between management and supervisory functions through the two-tier Board set-up. Some of the world’s stock exchanges have pushed the standards of governance even further. The NYSE listing standards provide that the audit, the nominating, the corporate governance and the compensation committees must be composed entirely of ‘outsiders’. Meanwhile, French corporate governance code (AFEP-MEDEF Code) – one of the softer ones – does not contain any independence requirement.
Rulebook guides our actions regarding corporate governance
Regardless of these differences, corporate governance standards aim to promote transparency, clear accountability, effective oversight. Good governance must establish a “checks-and-balances” system for company’s management – just as it does in the case of sovereigns. It does not require a law degree to tell a good practice from a bad one when presented with facts. Is it good for an organization when its executive power (the C-suite) is setting the standards for itself and is simultaneously the one overseeing their implementation? Is it good when members of the board have no limit as to how many times they can be re-elected?
Clearly, not all issues in the realm of governance are “black-and-white”. Nevertheless, when supervision and oversight are compromised, that is when shareholders must act. We at Erste Asset Management have put together a Corporate Governance Rulebook which guides our communication with portfolio companies. Among other sectors, we are engaging oil and gas companies to push industry governance standards forward and to enhance the governance of ESG topics. We are excited to discuss our Rulebook in the hope that it provides insight into what stands behind our “Active Ownership” approach.
The rulebook first sets out ‘hygiene’ factors of good governance and then digs deeper into the topic of remuneration. The hygiene factors – i.e. ‘minimum requirements’ – span
- Board composition:
(independent and diverse membership, transparent nomination & selection criteria). - Board organization:
(clear roles and responsibilities, power checks and balances, succession planning). - Board oversight:
(regular audits and evaluation, stakeholder engagement, material disclosures).
Linking remuneration with the sustainability strategy
You then might ask why the topic of remuneration has been singled out by us. The answer is simple. Whereas Corporate Strategy provides a good indication of company’s future course of action, that is hardly ever the case for Sustainability Strategy. In their integrated reports, oil and gas companies very frequently paint a beautiful image of transitioning towards a better sustainable future. And yet when you read their remuneration policy the picture turns gloomy.
Management’s bright Net Zero targets rarely find their way into incentives schemes. It is not sufficient to commit to Net Zero on paper. It is even not enough to set up a strategy and a roadmap for getting there. Companies must put the money where their mouth is. There are different ways to do it, but the general idea remains similar. Companies’ risk assessment (i.e., materiality assessment) should give rise to a clear strategy. That strategy must address organization’s negative impacts on – and risks from – the environment and society. The strategy should set measurable time-bound targets and KPIs. Remuneration must be linked to these KPIs.
Furthermore, it must be controlled that old financial targets do not conflict with the new ones. For oil and gas companies, financial KPIs should not encourage the growth of non-renewable energy production at least and encourage green energy transition at best. KPIs must fall into one of the two categories: growth-neutral metrics or transition response metrics. Net Income growth is a poor KPI as it indirectly incentivizes increase in fossil fuel production. Return on Average Capital Employed is a better KPI as it targets profitability achievements not needing fossil fuel output growth. Dividend-to-fossil-capex is a superior metric as it both encourages energy transition and disincentivizes increase in fossil fuel production. It basically tells management: either invest more in clean energy or return that money to shareholders. It is a perfect example of a transition response metric. Unfortunately, today most oil and gas companies have target variable pay metrics which directly or indirectly incentivize fossil fuel production, and very few have transition response metrics.
Transition starts with good governance
Whether we like it or not, oil and gas companies play a leading role in energy transition. Hence, effective engagement with energy companies is critical for Erste AM. As have been seen in the case of TotalEnergies even the ‘hygiene factors’ of good corporate governance such as supervision and oversight over management are often missing in the industry. On the bright side, there are companies we are engaging with where boards have moved further and are working on integrating transition response metrics into their remuneration policies.
Clearly, material behavioral change is only possible when incentives change. Hence, we strongly believe energy transition starts with better governance and a Responsible remuneration policy. As a Responsible Investor and an active owner, Erste AM will continue to advocate for improved governance and thorough management of ESG matters – both in our portfolio companies and in companies which are preeminent for the green transition.