The 2015 ‘Dieselgate’ emissions scandal had a significant impact on Volkswagen, from reputational damage to fines and continuing legal cases. The impact has been lasting, with the company typically receiving poor scores from ESG ratings providers, and often being subject to media scrutiny. Volkswagen also saw an increase in regulatory intervention, including compliance monitorship in the US, which ended in September 2020, and a requirement to invest significantly in ZEVs (zero-emission vehicles) as part of the settlement.
Volkswagen has since taken steps to become a leader in electric vehicles (EVs), a transition necessary for its survival, but one which also creates investment opportunities. EVs represent 3% of the company’s sales at present, with the plan for them to reach 20% by 2025 and over 50% by 2030. These opportunities for the future must be balanced against the risks that Dieselgate uncovered at the company, which relate to culture, governance and internal controls. Our ESG quality review and continuing engagement with Volkswagen have sought to gain a better insight into both its moves towards decarbonisation and the cultural changes at the company, in order to inform our investment case. Engagement also provides us with an opportunity to provide feedback to the company on how it is going about these initiatives.
Our engagement activity
Our engagement with Volkswagen began with trying to better understand its sustainability strategy. The company recruited a head of sustainability in 2018, and has appeared to take the subject very seriously and to be integrating sustainability into its business strategy. The company is focused on material issues – chiefly climate change – but also human rights, the circular economy and human capital management. It has demonstrated accountability for its Scope 3 emissions, and has set a 2050 target for carbon neutrality.
Another focus for Volkswagen has been its supply chain. It began using supplier ratings in 2019 and placed greater emphasis on supply-chain mapping, transparency and audits. Given our history in engaging with companies on cobalt risks, this has been pleasing to see. Volkswagen was included in our cobalt engagements under the Principles for Responsible Investment (PRI) collaborative programme, and by the end of 2020 had made significant improvements, having lagged peers previously.
We have also followed the company’s events closely, including its annual ESG event, at which it has discussed its ethics and risk-management programmes extensively. Internal controls, processes and ethics all required stepping up, and it was clear that this would be closely scrutinised. Board oversight of these areas is essential, and this has remained a focus of our engagements.
In early 2020, our fixed-income team also engaged directly with the company regarding its green bond framework. It affirmed its commitment to a transformation and its belief that sustainability was an essential part of the company strategy. It also touched upon specific material ESG issues facing the company, demonstrating consistency across its communications with stakeholders.
To take our engagement further, we requested a call with Volkswagen to have a more detailed conversation around ESG issues, having followed what looked to be positive improvements in the company’s approach. It was clear from our discussions in early 2021 that the company was working hard to improve its reputation, and that it understood the significant impact of the emissions scandal. It discussed improvements in ethics via cultural initiatives, but these were not backed by evidence or data. Culture is difficult to evaluate and measure, but we wanted further assurance given the extent of prior issues, and this was a particular area of concern for some of our portfolio managers.
More recent conversations with Volkswagen, which have also involved several of our portfolio managers, have shed further light and demonstrated that there is substance to claims of a cultural turnaround. The company has developed a means of measuring integrity via an academic partnership, and has linked management remuneration to this. It has also analysed whistle-blower data and found that reports have plateaued since 2019. All data is made available to employees, which is consistent with a more open culture.
A further positive development is that the company has openly raised difficult issues, such as the use of Uyghur labour in China, and discussed the challenges with investors. It has also proactively reported to the regulator and clients when new model launches did not perform as expected. In addition, since late 2020, Volkswagen has discussed its decision to participate in a collaborative cobalt engagement programme. Previously the company had stubbornly refused to do this, so this perhaps indicates a willingness to change course, and a change in mindset at the company. It also represents an example of Volkswagen listening to investor feedback.
Our initial view on Volkswagen was that it was not suitable for inclusion in our sustainable strategies. This decision considered the impacts of its products, as internal combustion engine vehicles contribute significantly to global carbon emissions, but also took into account the significant cultural, ethical and governance concerns following the Dieselgate scandal. These issues meant that the company breached the UN Global Compact and therefore our sustainable ‘red lines’, which aim to add robustness to our sustainable investment process.
However, as the focus on the company’s EV transition story increased, we began proactively discussing if it could be deemed suitable, should it no longer breach our red lines. After the actions taken following the emissions scandal meant that the company was no longer viewed as in breach of the UN Global Compact, we decided that it should be suitable for inclusion in our sustainable strategies as a transition company. Volkswagen is now held in a number of those strategies, across equity, multi-asset and fixed-income portfolios.
We understand that this is a contentious case and will receive scrutiny. However, vehicle portfolio change is central to Volkswagen’s transformation. According to the company’s 2019 annual report, it plans to launch 70 new battery electric vehicles (BEVs) and 60 plug-in hybrid electric vehicles (PHEVs) by 2030. The strategy is that BEVs will represent 20% of its portfolio by 2025 and 50% by 2030, and it hopes that this percentage could be even higher. The company now dedicates 40-50% of research and development spending and capital expenditure to electrification and digitalisation.
Moreover, our engagements have highlighted the extent of work undertaken to implement cultural change across a vast company. While there remain concerns around governance, this has offered reassurance of change following the emissions scandal. Our view is that some third-party ESG agencies underestimate the efforts that have been made elsewhere to improve environmental and social performance. The company has an ambitious EV strategy, meaning it deserves a high future environmental score, which some do not seem to give it credit for. Overall, it appears that some external ratings providers are focusing too much on historic indicators.
We continue to have concerns relating to corporate governance. Volkswagen has made no changes to its supervisory board and there are no truly independent directors. There are also concerns over the company’s commitment to both the cultural and decarbonisation transitions that it is reliant upon.
We will continue to engage and highlight the importance of a strong, independent board to effectively challenge and oversee management. We will also encourage the company to consider the role of the board when appointing directors, and to use refreshment as an opportunity to bring about independence and diversity, which will help to foster constructive challenge.
Furthermore, we have plans to continue engagement around cobalt and supply chains, as well as on the company’s approach to the circular economy, including battery recycling. This is an area that we expect to come under increasing scrutiny as EVs reach their end of lives, and with incoming European Union taxonomy regulations.
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This is a financial promotion. These opinions should not be construed as investment or any other advice and are subject to change. This material is for information purposes only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those countries or sectors. Please note that holdings and positioning are subject to change without notice. Newton research performs ESG quality reviews on equity securities prior to their addition to Newton's research recommended list (RRL). ESG quality reviews are not performed for all fixed-income securities. The portfolio managers may purchase equity securities that are not included on the RRL and which do not have ESG quality reviews. Issued in the UK by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Registered in England No. 01371973. Newton Investment Management is authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation.