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Lindsey Hall: Hi. I'm Lindsey Hall, Head of Thought Leadership at S&P Global Sustainable 1.

Esther Whieldon: And I'm Mr. Whieldon, a senior writer on the Sustainable 1 Thought Leadership team.

Lindsey Hall: Welcome to ESG Insider, a podcast hosted by S&P Global, where we explore environmental, social and governance issues that are shaping investor activity and company strategy.

Esther Whieldon: In the ESG world, one key trend we've been watching is the debate over divestment versus engagement. It's a topic that was already heating up in 2021, more large asset owners, asset managers and banks adopted negative screening strategies like excluding or selling off their investments to companies that have weak ESG practices, with a have high exposure to ESG risk. And in recent weeks, the Russia-Ukraine conflict has only served to accelerate that debate.

In this debate over engaging versus divesting, there are a lot of things to consider. Advocates of engagement policies note that breaking ties with companies via divestment or exclusion does not encourage change and could result in the sale of the securities to investors who are less attentive to ESG issues. Advocates of engagement policies note that breaking ties with companies via divestment or exclusion does not encourage change and could result in the sale of those securities to investors who are less attentive to ESG issues. Proponents of engagement, therefore, prefer to use their investments to influence change by engaging with companies.

Lindsey Hall: That's right. And in today's episode of the podcast, we're talking to the world's largest asset manager about its approach to engagement. I'm talking, of course, about BlackRock, which has $10 trillion in assets under management. And in February, the firm released an investment stewardship report outlining its engagement priorities for 2022.

To get more insight, I spoke with Victoria Gaytan. Victoria is Vice President at BlackRock Investment Stewardship, the team in charge of engaging with companies and proxy voting on clients' behalf. Here's our conversation.

At S&B Global Sustainable 1, one thing we're seeing is the debate of our divestment versus engagement heating up in 2022. I'd like to know your perspective here. How have you seen this debate over divestment versus engagement evolve?

Victoria Gaytan: Sure. So we are seeing that a few things will impact capital allocation decisions more than how effectively companies navigate the global energy transition in the years ahead. In addition, as our CEO, Larry Fink, pointed out in his 2022 Letter to CEOs, most stakeholders, including shareholders, employees, customers, communities and regulators, now expect companies to play a role in decarbonizing the global economy.

Our colleagues at the BlackRock Investment Institute recently shared in a paper titled Managing the Net Zero transition. That two principal navigation approaches have been used at scale. As you mentioned, screening that is removing companies or sectors viewed as not aligned with the transition and over or underweighting companies based on static backward-looking ESG metrics.

Our colleagues' research, however, suggests that asset owners can do more to effectively navigate the transition. First, investors can measure transition readiness with forward-looking indicators like emissions targets and other data sources that give insight into how issuers are progressing along several ESG dimensions and positioning themselves for the future. Second, Stewardship's corporate engagement and voting is essential to inform how companies are properly managing transition risks. And third, ESG integration, using transition metrics throughout the investment process can help inform that even portfolios without a climate focus are managing their transition risk.

With this in mind, at the firm level, we have taken a number of steps over the past 2 years to help our clients address the global energy transition. And we are continuing to work to provide our clients with the deepest understanding of how the transition will unfold and to help them invest in a way that meets their investment objectives. We believe that companies leading the transition percent of vital investment opportunity for our clients and driving capital towards these companies will be essential to achieving a net zero world.

Now we recognize that companies cannot deliver the energy transition in isolation. A range of stakeholders, including policymakers and consumers have a role to play to ensure a better equilibrium between supply and demand given the global economy's current dependence on traditional energy sources and the parallel need to invest in cleaner energy alternatives and other technologies.

What I can say from our stewardship perspective is that our focus is on engaging with companies on how they are managing the transition and how they are factoring it into their long-term business plans and emissions reduction targets to create long-term value.

Lindsey Hall: Now you heard Victoria mention that letter to CEOs that BlackRock's Larry Fink wrote earlier this year. And in that letter, he also wrote that, "divesting from entire sectors or simply passing carbon-intensive assets from public markets to private markets will not get the world to net zero, and BlackRock does not pursue divestment from oil and gas companies as a policy".

In my interview with Victoria, I asked her how BlackRock approaches engagement with companies in carbon-intensive sectors.

Victoria Gaytan: The vast majority of BlackRock's equity assets under management are held through index portfolios. So in line with our fiduciary duty, we provide our clients with choice across investment strategies and products to help them reflect their preferences and achieve their investment goals. Also, in line with our fiduciary duty, it is our job to engage with companies across sectors and regions. But we do understand that the energy transition presents different challenges and potential rates of change for each company. So our focus is to engage with companies across sectors and regions regarding how they are managing this transition and how they are factoring it into their long-term business plans and emission reduction targets.

I would also add that we expect to remain long-term investors in carbon-intensive sectors because these companies play crucial roles in the economy and in an orderly energy transition. So how do we engage with them? Well, we look to understand how they are balancing short-term investment with a long-term outlook towards the energy transition, particularly where investments and capital allocation primarily increased dependence on hydrocarbons. And we also look to understand the position of the company's operating model under a low-carbon future scenario, including the role a company expects to play in contributing to the reliable, affordable supply of energy.

In 2020, we focused our climate-related engagements on 440 public companies that represent about 60% of the global scope 1 and 2 greenhouse gas emissions of the companies in which BlackRock invests on behalf of clients. In 2021, we expanded this focus universe to over 1,000 carbon-intensive public companies, representing nearly 90% of the global scope 1 and 2 greenhouse gas emissions of the companies in which BlackRock invests on behalf of our clients. This universe is intended to focus our engagement efforts where the energy transition is likely to have the most material impact on a company. Our climate universe includes many companies that are leaders in their sectors but also others that are at a much earlier stage in that journey.

So like many governance issues, the energy transition is long term in nature and will continue over the coming years. But guided by this climate universe, it is our job to help our clients navigate these risks and opportunities presented by the transition and to engage with these carbon-intensive companies as a pragmatic investor.

Lindsey Hall: Victoria said engagement is core to BlackRock's stewardship efforts.

Victoria Gaytan: As a minority investor, we do not provide direction to companies on how to manage their business, but we do engage year round and not just during proxy season to improve our understanding of the business risks and opportunities that are material to the companies in which we invest on behalf of clients. And these include those related to environmental, social and governance matters.

Engagement also is important because it informs our voting decisions on behalf of clients. Now to give you just some context, in the year ending June 30, 2021, the proxy year, our investment stewardship team held more than 3,600 engagements with 2,300 companies across 55 markets. And I would like to add that we are uniquely placed to have these conversations with thousands of companies each year because we have built one of the largest and most diverse teams in the industry. Our stewardship team of 70 professionals operates across 10 global offices. So this global approach with a deep market and sector-specific expertise really allows us to build a better understanding of the risks and opportunities that companies are facing. And this in turn, enhances the stewardship's team's effectiveness as a supportive long-term investor on behalf of clients.

Lindsey Hall: For 2022, BlackRock has 5 engagement priorities that really span the spectrum of ES&G. Board quality and effectiveness is one, followed by strategy, purpose and financial resilience, then you have incentives aligned with value creation, climate and natural capital and finally, company impacts on people.

Victoria Gaytan: Our first priority is Board quality and effectiveness. Governance is at the core of our stewardship approach at BlackRock. And our primary focus is on the performance of the Board of Directors at the companies we invest on behalf of clients. Why? You might ask. Well, in our view, the performance of the Board is critical to the economic success of the company and the protection of shareholders' interests, including our clients.

So we look to a company's Board of Directors to establish and maintain effective governance mechanisms to oversee the company's strategy as well as the effective management of material ESG risks and opportunities. For this reason, our stewardship team sees the election of directors as one of our most important and impactful responsibilities.

Now we do understand that companies, depending on their location and their sector may face very different challenges. So our regional voting guidelines explain how we assess key issues at the Board level and in the context of local market norms and regulations. These issues might include, among others, issues of director independence, tenure limits, election cycles, diversity and time commitment. So our approach really considers a company's individual circumstances such as market sector or size.

We believe that diversity in the boardroom helps avoid group think, and this leads to more innovation and better long-term economic outcomes for both companies and shareholders, our clients. So we find it very, very useful when companies disclose how diversity is considered in Board composition. And when they disclose the demographic characteristics such as gender, race, ethnicity and age as well as the professional characteristics such as directors, industry experience, areas of expertise and geographic location that compose the Board.

Over time, we believe that greater diversity in the boardroom can also promote greater diversity and resilience in the leadership team and in the workforce more broadly. That diversity can enable companies to develop businesses that more closely reflect and resonate with the customers and the communities they serve.

Lindsey Hall: Okay. Great. So Board quality and effectiveness. What are some of the other priorities that you've identified for engagement in 2022?

Victoria Gaytan: Sure. Our second priority is strategy, purpose and financial resilience. And here, we look to understand the company's strategic framework and the Board's process for oversight and review. BlackRock, as I mentioned earlier, is not in the position to dictate a company strategy or its implementation. Our role as a fiduciary to our clients is to better understand a company's purpose and strategy and the milestones against which we, as investors, can measure performance. So to that end, we really depend on companies to provide clear and comprehensive disclosure. Once again, we look to boards to have a clear understanding of how executive leadership instills the company's strategy and purpose in today operations and how it seeks to ensure that corporate culture is experienced as intended across workforce and the company's key stakeholders.

Lindsey Hall: I'm glad you mentioned culture because this is something I'm hearing pop-up in a lot of my discussions with ESG stakeholders, the importance of weaving ESG considerations into culture, which can sometimes be kind of a hard thing to measure. It's a bit intangible. How are you looking at culture? What are some of the things that you are talking about when you engage with companies on this topic?

Victoria Gaytan: So we encourage companies to disclose industry or company-specific metrics to support their narrative of how they have considered key stakeholders' interests into their business decision-making. We believe that a purpose-driven long-term strategy supports financial resilience. So these disclosures are really helpful for us to build understanding on how executive leadership is driving strategy and purpose into their company's day-to-day operations.

Lindsey Hall: Okay. And within that, can you talk about how BlackRock is looking at executive compensation, and how that approach to executive compensation has changed over time?

Victoria Gaytan: Absolutely. So executive compensation and our engagement priorities defines it as incentives aligned with value creation has been a focus of our engagement efforts for many, many years. Why? Because this is an important tool to drive long-term value creation by incentivizing and rewarding executives for the successful delivery of strategic goals and financial outperformance. However, when compensation policies are not appropriately structured and when outcomes are misaligned with performance, companies may face business or reputational risks or even both.

We, at BlackRock believe that companies benefit from disclosing how their compensation policies and outcomes are consistent with the economic interest of long-term shareholders such as our clients. Once again, our stewardship team looks to a company's boards of directors to put in place a compensation policy that incentivizes and rewards executives against appropriate rigorous and stretching goals tied to relevant strategic metrics.

And now speaking of metrics, it's also the Board's responsibility to determine the appropriate performance metrics to use in incentive plans, including whether the company decides to incorporate sustainability or ESG-related criteria. In that case, where companies choose to use sustainability-related metrics such as those -- for example, those tied to specific diversity, equity and inclusion goals or to greenhouse gas reduction targets. These metrics are best aligned with shareholders' interests when they: one, address models that are material to a company's business model; two, are aligned with long-term strategic priorities; and three, incorporate the same rigor as with other financial or operational targets.

One thing that I would add here, Lindsey, is that an additional thing to look at is that executive compensation outcomes are increasingly assessed in the context of the impacts a company has had on key stakeholders over the relevant period. Our stewardship team believes that accounting for the interests of key stakeholders in compensation policies recognizes the collective nature of long-term value creation and the extent to which each company's prospects for growth are tied to their ability to foster strong sustainable relationships with those key stakeholders.

Lindsey Hall: That's really helpful context. I'd like to focus in on the E and SG specifically because another of the priorities that your report identifies for BlackRock in 2022 is climate and natural capital. And natural capital is becoming a much larger part of the ESG discussion in 2022. The term natural capital appeared 16x in BlackRock's 2022 investment stewardship report. And that's compared to just 2x a year earlier. So I wanted to hear from you about how BlackRock is looking at climate and natural capital.

Victoria Gaytan: As companies consider climate-related risks, it is also likely that they will assess their impact and dependence on natural capital. And we recognize that this is a really complex issues and ecosystems are highly interconnected. But for the purpose of our work, we focus on 3 key areas: biodiversity; deforestation; and water. And we look to companies to disclose detailed information on their approach to managing material natural capital-related business risks and opportunities, including, for example, how their business models are consistent with the sustainable use and management of natural resources such as air, water, land, minerals and forests. We are also interested to hear from companies how they contribute to biodiversity and ecosystem health and consider their broader impact on the communities in which they operate.

Lindsey Hall: And in addition to talking about the energy transition, you also talked about sort of just transition issues in the stewardship report or more specifically about company impacts on people. Can you tell me and our listeners a little bit more about BlackRock's priorities related to people?

Victoria Gaytan: Absolutely. I'd be happy to. So at BlackRock, we believe that companies that consider the interest of their key stakeholders. These include employees, suppliers, customers and communities are in a stronger position to deliver value for shareholders. As our CEO, Larry Fink, wrote in his 2022 Letter to CEOs, putting a company's purpose at the foundation of relationships with stakeholders is critical to long-term success. And in the letter, he also highlighted how no relationship has been changed more by the pandemic than the one between employers and employees.

We deeply care about this, and we have been engaging on issues such as human capital management for several years, and we look to companies to demonstrate a robust approach to human capital management and to provide shareholders with the necessary information to understand how their approach aligns with their strategy and their business models.

This year, we are also encouraging companies to discuss in their reporting how they are considering the interest of the workforce in relation to the global energy transition and how they are addressing significant adverse impacts or unintended consequences that may arise from their business operations. And in addition to disclosing the actions companies are taking to support a diverse and engaged workforce, we're also interested in understanding how the Board is overseeing management and management's approach to due diligence and remediation of adverse impacts to people arising from business operations.

Lindsey Hall: And I wonder if you can take us now behind the scenes a bit. What is your engagement with companies look like on the ground in these initial months of the year?

Victoria Gaytan: Absolutely. So our team reviews our engagement priorities and refreshes them on an annual basis as appropriate. To help us guide our work on the governance and sustainability issues that we consider to be top of mind for companies and for our clients as investors. As you have noticed, some issues have long been core components of our work and others have become priorities more recently. And this is driven by our observation of emerging risks and opportunities for companies as well as from client feedback, from BlackRock's and third-party research as well as market developments, including regulatory developments.

A little bit behind the scenes. So as they have in the past, this year, our 5 engagement priorities reflect a continuing emphasis on the governance issues that we believe are critical drivers of company's ability to deliver durable long-term financial returns. As in prior years, we have also included a high-level globally relevant key performance indicator to help guide our analysis. And we continue to map our engagement priorities to specific United Nations Sustainable Development Goals, also known as UNSDGs, because we believe that there is value in identifying the intersection between many of the topics that we discussed with companies we invest on behalf of clients and key aspects of the UNSDGs.

Now let me stop here and say that we recognize the extraordinary and complex operating environment companies are dealing with, stemming from the continuing pandemic as well as the challenges that an uncertain environment is posting for boards and management teams. As companies navigate this dynamic, we continue to look to boards and executive leadership teams to demonstrate that as they address near-term factors and situations that impact strategy, implementation and operations, they take into consideration the interest of long-term investors, such as our clients and other stakeholders such as employees, customers, suppliers and the communities and this is what we aim to reflect through our engagement priorities.

Lindsey Hall: Okay. Great. So some of those uncertainties that you're talking about, would that be something like the Ukraine-Russia conflict that is ongoing?

Victoria Gaytan: Well, we evaluate. We are obviously looking at this closely, but we evaluate all sorts of ESG risks and opportunities that may impact the companies that we invest -- the company's ability to generate long-term shareholder value over the long term.

Lindsey Hall: Thank you, Victoria. And I guess another follow-up question I have is that BlackRock has faced some criticism from third parties that say it's not doing enough. What does BlackRock's response to those kinds of criticism?

Victoria Gaytan: Our goal is to maximize value for our clients, managing the assets that they have entrusted to us. So everything that we do is in support of that goal, not to further any sort of agenda. So in line with our fiduciary duty to clients, our stewardship work is undertaken to advance the long-term economic interest of our clients. People that are saving over the long term to meet their financial goals such as secure retirement, their children's education or buying a first home.

As one of many and typically a minority shareholder, BlackRock is not in the position to dictate a company strategy or its implementation. Our role on behalf of our clients as long-term shareholders is to better understand how company leadership is managing risks and capitalizing on opportunities to protect and advance the economic interests of shareholders, such as our clients. To that end, we aim to be a constructive supportive shareholder, bringing our long-term perspective to our work with companies as a grapple with governance and sustainability challenges in their business models that when addressed support long-term value creation.

Lindsey Hall: You mentioned the importance of voting, and I think that is a good segue into talking about the upcoming 2022 proxy season. I'd like to know how BlackRock is preparing? And what do you expect to be the most prominent issues in this upcoming proxy season?

Victoria Gaytan: Of course. So companies are naturally navigating extreme complex situations right now, perhaps the most challenging operating environment in decades. On the one hand, the pandemic has turbocharged an evolution in the operating environment for virtually every company. And this environment continues to be challenged by global supply chain disruptions and more recently, rapidly evolving geopolitical events.

Because of the evolution in the operating environment, good governance is more important than ever. Strong leadership and responsiveness to uncertainty and changing conditions will be key as companies balance short-term challenges while remaining mindful of longer-term shifts such as the global energy transition and rising societal expectations.

On the other hand, how companies manage environmental and social risks will also remain issues of focus. We have already seen a growing number of companies, financial institutions and governments commit to advancing net zero. And there is a growing consensus that companies can benefit from the more favorable macroeconomic environment under an orderly, timely and just transition to net zero. As such, investors and other stakeholders will be looking this proxy season at how companies prepare for and participate in the energy transition and how well they seek to drive long-term value by mitigating risks and capturing opportunities.

What we are hearing in our continued engagement with companies is that they are constantly asking themselves what their role should be in contributing to a just transition in ensuring a reliable energy supply and protecting the most vulnerable from energy price shocks and economic dislocation. They are also seeking more clarity as to the public policy path that will help align greenhouse gas reductions actions with commitments.

The events of the past 2 years and the current circumstances have also brought to the floor the need for companies to take a more active role in tackling global challenges. And this includes, of course, social issues. For example, companies still have a long way to achieve workplaces that are truly diverse, equitable and inclusive. But through our engagement, we have been able to assess how companies have weighed their decision-making in relation to their shareholders' interests as well as the experience of their stakeholders, such as employees, suppliers, customers and the communities they operate in. Our conviction remains that companies perform better when they are deliberate about their roles in society and when they act in the interest of their employees, customers, communities and investors.

A third point I would add is, as in the past year, another issue of focus will be sustainability reporting and continued access to reliable comparable data. Many of the companies we invest in on behalf of clients have commented on the burden and difficulty created by the lack of a single standard for sustainability-related disclosures and conflicting requests to adopt competing frameworks. Robust disclosures are essential for investors like us to effectively evaluate company strategy and business models as it relates to material ESG risks and opportunities. And to that end, we encourage companies to align with the reporting framework developed by the task force and climate-related financial disclosures, supported by industry-specific metrics such as those identified by the Sustainability Accounting Standards Board, also known as SASB.

And given the crucial importance of consistent standards companies can adopt, we are supportive of a global baseline set of sustainability reporting standards, such as that, that is underway with the International Financial Reporting Standards Foundation, the IFRS Foundation and the creation of the International Sustainability Standards Board. As efforts to align these different standards make progress, we will continue to support TCFD-aligned reporting, including industry-specific metrics. So investors and companies have the information they need to assess risk management plans, actions and intended outcomes.

And let me just wrap up this question by saying that as we head into the 2022 proxy season, we will aim to be a supportive shareholder, bringing a long-term perspective to our work with companies, and we look forward to engaging in a constructive manner, explaining any concerns and providing our feedback to build mutual understanding. That said, we maintain that executive leadership and the Board informed by feedback from investors and other stakeholders are best positioned to determine the course of action that in their view, is in the best economic interest of their company and their investors.

Lindsey Hall: So Esther, as you can hear, BlackRock as a primarily passive asset manager has a big focus on engagement and it's priorities range from natural capital, to diversity, equity and inclusion, to climate goals for all of those topics. You heard Victoria being explicit about the role of Boards. BlackRock has high expectations for Boards to steer companies in the right way, and we'll be seeing that play out over the coming proxy season.

And what we heard Victoria indicate that wholesale divestment for BlackRock isn't really considered an option, the firm has also been in headlines as a conflict between Russia and Ukraine unfolds. On February 28, 2022, BlackRock suspended the purchase of all Russian securities in its active and index fund and asset index providers to remove Russian securities from broad-based indices. And CEO, Larry Fink wrote in a LinkedIn post in early March 2022 that "the invasion of Ukraine has fundamentally changed Russia's role in the world. Nations have united and imposing sanctions which we strongly support". That's the end of the quote.

This post later continued to say that "capital is being pulled by investors and companies that have long done business in Russia, and this demonstrates how the capital markets can work constructively to provide capital to those working within the system and quickly deny it to those who operate outside it".

Esther Whieldon: In the coming months, we'll be bringing you more episodes about the evolving debate over divestment versus engagement. We'll be talking with more of the world's biggest asset managers and owners about how they're navigating this complex environment.

Lindsey Hall: Thanks so much for listening to this episode of ESG Insider and a special thanks to our producer, Kyle Cangelosi. Please be sure to subscribe to our podcast and sign up for our weekly newsletter, ESG Insider. See you next time.