Sustainable, Responsible &/or ESG Policy:

The Vanguard ESG Global Corporate Bond UCITS ETF seeks to track the Bloomberg MSCI Global Corporate Float-Adjusted Liquid Bond Screened Index, which is an exclusionary-based index screened for certain environmental, social and corporate governance criteria by Bloomberg MSCI. The index is a multi-currency benchmark that includes investment-grade corporate fixed-rate bonds from both developed and emerging market issuers.

The index follows the same general criteria as the Bloomberg Global Aggregate Float Adjusted Corporate Index, but removes issuers with ties to non-renewable energy, vice products, weapons and genetically modified organisms (GMOs). The index also excludes issuers with very severe ESG controversies. There are four regional aggregate benchmarks that largely comprise the index: the US Corporate, the Pan-European Corporate, the Asian-Pacific Corporate and the Canadian Corporate Indices.

The screening methodology has three levels of restrictiveness for exclusions (Non-renewables, Weapons and Vice Products, and companies will be screened for both primary (e.g. -  producer/manufacturer) and secondary (e.g. retailer/supplier) involvement in the ESG exclusion categories (e.g.- Alcohol, Controversial Weapons) using revenue-based thresholds.

The screening methodology is outlined below:

• Non-renewables:
  • Nuclear Power (0% primary involvement / 0% secondary involvement)
  • Fossil Fuels (0% primary involvement / 0% Secondary involvement)
• Weapons:
  • Controversial weapons (0% primary involvement / 0% secondary involvement)
  • Conventional military weapons (0% primary involvement / 5% secondary involvement)
  • Civilian firearms (0% primary involvement / 0% secondary involvement)
• Vice Products:
  • Adult Entertainment (5% primary involvement / 10% secondary involvement)
  • Alcohol (5% primary involvement / 10% secondary involvement)
  • Gambling (5% primary involvement / 10% secondary involvement)
  • Tobacco (0% primary involvement / 10% secondary involvement)
  • Cannabis (Not screened)

Process:

The fund promotes environmental and social characteristics by excluding fixed income securities from its portfolio based on the impact of the issuer’s conduct or products on society and / or the environment. This is met by tracking the index, the Bloomberg MSCI Global Corporate Float-Adjusted Liquid Bond Screened Index).

The index excludes the bonds of issuers that MSCI, the Index provider’s data source, determines engage in activities in, and/or derive revenue (above a threshold specified by the index provider) from, certain business segments of the following: adult entertainment, alcohol, gambling, tobacco, nuclear weapons, controversial weapons, conventional weapons, civilian firearms, nuclear power, or thermal coal, oil, or gas.

The index methodology also excludes the bonds of issuers that, as determined by MSCI, have no controversy score or a controversy score of less than one as defined by MSCI’s ESG controversies
assessment framework. Where MSCI has insufficient or no data available to adequately assess a particular issuer relative to the ESG criteria of the Index, such bonds of the issuer may not be excluded and shall remain constituents of the Index until such time as they may be determined to be ineligible by MSCI.

In circumstances where the fund holds securities which do not comply with the ESG requirements of the index (including in circumstances where MSCI receives further data allowing it to determine that an issuer of a security does not meet the relevant ESG criteria of the index), the fund may hold such securities until such time as the relevant securities cease to form part of the index and it is possible and practicable (in the Investment Manager’s view) to liquidate the position.

Company product and conduct involvement is monitored on a yearly basis by the index provider and as new data is made available to the index provider. In this regard, the index is consistent with the characteristics promoted by the fund.

Given fixed income market structure dynamics, pure index matching is usually not practical for broad, well-diversified fixed income indices (such as aggregate or credit benchmarks), which may contain thousands of underlying securities. For these indices, we believe it is more effective to match the primary risk factors, such as those presented below, taking a sampling approach.

• Our objective is to match the benchmark return and risk after fees.
• We aim to match the benchmark for all primary and secondary factors.
• All positions and risk factors are reviewed on a daily basis.

Fixed income index portfolios are managed using a daily, disciplined and tightly risk-controlled investment process. This ensures minimal tracking error and consistent performance relative to benchmarks. The Fixed Income Group (FIG) uses third-party order management software, Aladdin, which combines risk analytics with portfolio management, trading, compliance and operations capabilities to allow efficient straight-through transaction processing.

FIG’s daily investment and trading process is described below.

Start-of-day input

The following controls and activities are performed by our portfolio managers:

• Client activity: Portfolio management receives daily cash flow activities.
• Holdings reconciliation: RMG and middle office reconcile holdings and cash balances.
• Index updates: Portfolio management incorporates index changes into the rebalancing process in order to stay closely matched to the benchmarks.

FIG also reviews the portfolio’s characteristics to identify if any thresholds have been exceeded, which would indicate that trading is required. Intraday cash activity and instructions from Vanguard’s other geographical locations (also known as pass the book) may also make trading necessary.

Research

Credit research resources

Vanguard has a dedicated credit research team within FIG. The specialists in this department evaluate the creditworthiness and relative value of corporate, sovereign and municipal issuers. As we typically track broad fixed income indices containing thousands of securities via a sampling approach, the work of our credit analysts plays a vital role.

To make informed decisions about the short and long-term outlook for credit markets, credit analysts refer to a number of external research sources, including:

• Standard & Poor’s
• Moody’s Investor Service, Inc.
• Annual reports
• Daily online credit reviews and outlooks
• Live webcasts

The team evaluates financial and credit trends across sectors, as well as for individual issuers in which Vanguard invests (or expects to invest). Credit analysts perform an objective, thorough and independent analysis of an issuer’s overall creditworthiness for those securities.

This research process may include:

• Analysis of the issuer’s recent and historical financial statements
• Sensitivity testing on projected cash flows
• Discussions with management and/or rating agency analysts
• Site visits
• Road show presentations

FIG incorporates the views of our credit analysts within the issuer selection process.

Portfolio review and construction

FIG uses Aladdin to facilitate portfolio construction and risk management. All of the benchmark indices are available within Aladdin, which ensures quantitative analyses and portfolio analytics are run on a consistent and comparable basis.

FIG continuously reviews risk factors to ensure our portfolios closely track their respective benchmarks.

Risk factors we seek to match include duration, yield curve, convexity, country and currency exposure, sector and industry exposure, credit quality exposure and issuer exposure. In addition, we examine risk in more detail as we disaggregate the above major factors into sub-factors. For example, as we examine our corporate exposure, we monitor option adjusted spread distribution, capital structure and duration times spread.

FIG uses Aladdin to determine which credit risk and government bond exposures need to be adjusted versus the benchmark, to match the index’s key risk factors. Issue selection is as follows:

• Credit bonds: Once credit risk factors are determined, FIG incorporates our analysts’ assessments of credit trends, event risk and performance outlook to select the individual issuers that will address these risk exposures.

Aside from Aladdin, FIG also uses a variety of quantitative tools provided by our counterparties, such as the Bloomberg PORT Global Risk Model and Optimiser. In addition, we use FactSet, a centralised system for performance attribution and risk analysis, as well as additional in-house proprietary models which enable monitoring, analysis and risk management.

Buy and sell discipline

For Vanguard’s passively managed index funds, our buy and sell discipline is applied with the objective of maintaining portfolio holdings that match the risk characteristics of the benchmark as closely as possible, thereby minimising tracking error. Portfolio managers are responsible for security selection and portfolio construction, working as part of a team and basing their decisions on comprehensive buy/sell decision rules.

Fund investment decisions are a function of a daily analysis of cash flow (e.g. subscriptions, redemptions and dividends), corporate actions and index changes. Additionally, portfolio managers review daily reconciliation and deviation reports (which compare each portfolio’s positions to its index), as well as each fund’s risk/return profile. When required, securities are traded using proprietary software to bring portfolios back into line. Vanguard has several layers of monitoring and uses risk controls to ensure portfolios track their indices appropriately.

Our investment framework was created to minimise costs, risks and tracking error and to take into consideration future events. Vanguard’s portfolio managers work within set policies and guidelines; any deviation must be justified and have clear rationale. Risk Management Group (RMG) evaluates performance and risk characteristics of all portfolios and works closely with the portfolio managers to help ensure that risks are understood and are managed in accordance with established guidelines.

PRD works in conjunction with each fund’s board of directors to monitor portfolios, ensuring portfolios adhere to defined objectives. The team reviews performance regularly – generally on a weekly, monthly and quarterly schedule.

Derivatives usage

Vanguard does not use derivatives for leverage or speculation. We use derivatives only in circumstances where they offer the most cost-effective means of improving a portfolio’s risk profile. We always compare the cost of the derivative to the cost of constructing an equivalent position in traditional securities. We take a conservative approach to the use of derivatives and operate with closely monitored internal maximum limits.

We use a number of systems to manage derivatives. Software applications from third parties and those developed on a proprietary basis are used for trade execution and position management. Also, derivative positions are incorporated into portfolio management systems that manage a fund's positions as a whole in both derivatives and conventional securities. Our fund accounting department monitors daily contracts and margins.

A team process guides the trading and monitoring of our derivatives positions. Many eyes are focused on derivatives exposures, to ensure that the portfolios’ positions remain within the agreed-upon tolerance levels, including the following:

• Index portfolio managers
• Index traders
• Dedicated derivatives traders
• Risk management group

For our fixed income portfolios, futures, options, swaptions, caps, forwards, interest rate swaps and credit default swaps may be used for duration, yield curve, credit risk, volatility and FX management. We have expertise in their application and risk management.

We collateralise derivative positions at or exceeding 100%, subject to the minimum transfer amount.

Appropriate collateral instruments include government, corporate and asset-backed securities. The required amount of over-collateralisation increases for non-Treasury securities. Vanguard’s fund
accounting department maintains the collateral, with market prices used to value the securities.

Index selection

 We have a rigorous approach to benchmark selection. For index funds, our experts select a benchmark index based on how accurately it tracks the returns of the designated market segment. Some examples of the criteria we consider include index coverage, construction rules, rebalancing and cost.

We use float-adjusted indices that:

• Represent actual liquidity in the marketplace
• Better capture the investable universe
• Reflect best practice in indexing

Given our history and deep investment experience in managing index funds, we have identified certain criteria – or best practices – in selecting a benchmark, such as construction rules, adjustment for float, approach to market capitalisation, rebalancing, and the market impact cost. As a firm, we have a long history with many providers such as FTSE, CRSP, MSCI, S&P, Russell, Bloomberg and even bespoke benchmarks for certain select objectives (e.g. a high dividend product).

On the fixed income side, we have partnered with Bloomberg primarily, which has provided building blocks to produce a global allocation to the investment grade universe. In addition, we switched to Bloomberg float-adjusted benchmarks in recent times; these benchmarks reflect the true liquidity of a given segment of the market as central banks have engaged in quantitative easing and taken securities private.

Rebalancing considerations

Our funds track indices that rebalance at month-end. Correspondingly, our index funds also rebalance at that time, to account for any changes and ensure our funds closely match the index (e.g. in terms of duration and curve exposure). We also reinvest any principal and interest at the time it is received during the month.

As a result of new issuances occurring throughout the month (not necessarily at month-end), FIG exercises discretion as to whether to participate in the primary market, or to buy the bond in the secondary market at some point in the future. This flexibility is crucial in adding potential incremental returns, as new issues are not included in the benchmark until month-end.

In making the decision, the portfolio managers and dedicated traders have in-depth discussions with our team of credit analysts and conduct relative value analysis (comparing outstanding issues of that issuer with those of similar issuers). Through our analysis, FIG may determine that investors are better served by buying the bond post-issuance if the pricing offers no concession to comparable bonds. Alternatively, FIG may believe that the bond’s spreads will tighten (i.e. bond price will rise) by month-end, in which case investors would benefit by participating in the new issue.

Resources, Affiliations & Corporate Strategies:

There are close to 100 employees who consider ESG as part of their responsibilities. This includes employees in Investment Stewardship who consider ESG issues as part of their daily responsibilities, as well as credit research analysts that consider ESG as a risk factor from an integration perspective.

Our credit analysts develop independent risk assessments and investment opinions for each fixed income issuer. They seek to understand the investment implications of ESG risks and determine whether market pricing adequately reflects these risks.

Similarly, investment stewardship sector analysts use ESG data and research to inform our active ownership practices, including engagement. In our engagements, we advocate for effective oversight of ESG practices that consistently support the creation of long-term value for investors.

Representatives from all these groups also sit on our cross-divisional responsible investment team. In recent years, additional staff members were hired to support our approach to analysing ESG risks in our funds.

The Fixed Income Group (FIG) credit research analysts make use of both internal and external sources for ESG information.

Internal resources

For our fixed income assets, the team evaluates financial and credit trends across sectors, as well as for individual issuers in which Vanguard invests (or expects to invest). Credit analysts perform an objective, thorough and independent analysis of an issuer’s overall creditworthiness for those securities. This research process may include:

• Analysis of the issuer’s recent and historical financial statements
• Sensitivity testing on projected cash flows
• Discussions with management and/or rating agency analysts
• Site visits
• Road show presentations

These resources are inputs to independent analyses conducted by our team of credit research analysts, which are tailored to each investment opportunity. Our approach carefully considers the investment implications of ESG risk factors along with other risk factors to ensure thorough due diligence is done both prior to initial investment and on an ongoing basis. FIG incorporates the views of our credit analysts within the issuer selection process.

In addition, credit analysts in FIG use an ESG risk assessment process to flag issuers with material ESG risks. Analysts are responsible for identifying, recording, and monitoring the issuer’s ESG risk and progress toward addressing related issues. This process is overseen by our ESG committee, composed of six members of the global fixed income credit research team. This committee complements our investment decision-making process, including the assessment of ESG risks among other risk assessments conducted by our team of fixed income analysts. The committee is responsible for evaluating external ESG data and research resources used in our investment processes. Team members are also responsible for the continuous improvement in the integration of ESG concepts and department operating procedures.

External resources

Our dedicated research team will use information provided by various sources, including the rating agencies (i.e. Moody’s & S&P), Bloomberg, Sustainalytics sell-side research, and issuers. These resources are inputs to independent analyses conducted by our team of credit research analysts, which are tailored to each investment opportunity. Our approach carefully considers the investment implications of ESG risk factors along with other risk factors to ensure thorough due diligence is done both prior to initial investment and on an ongoing basis.

Vanguard’s participation in industry initiatives

Vanguard’s Investment Stewardship team has a clear, consistent, and compelling mandate – to serve as the voice for our investors to promote long-term value creation at the companies in which our funds invest. We have a strategic framework in place to evaluate our alignment to external organisations and initiatives that support and promote effective standards of governance and sustainable long-term value creation for investors. If we have chosen not to join an initiative at this time, we will continue to assess whether our membership would serve the best interests of our investors in the future.

Below is a list of the organisations and initiatives that Vanguard is a member of/signatory to (year in brackets denotes when we joined or became a signatory):

• CECP (CEO Force for Good) Strategic Investor Initiative (2013) - Co-chaired by Vanguard's former CEO, Bill McNabb, it encourages companies to share their longterm strategic stories and focus more of their disclosure and reporting on sustainable long-term value creation.
• UN Principles for Responsible Investment (2014)  https://www.unpri.org/ - Vanguard is a signatory and fully committed to the adoption of the principles.
• Commonsense Corporate Governance Principles (2016)  http://www.governanceprinciples.org/  - Vanguard is a founding member of this initiative. Former Vanguard CEO, Bill McNabb, participated in preparing the Commonsense Principles of Corporate Governance position paper.
• Sustainability Accounting Standards Board (2016)  https://www.sasb.org/ - Vanguard serves on The Investor Advisory Group and the Infrastructure working group.
• Investor Stewardship Group (2017)  https://www.isgframework.org/ - Vanguard is a founding member. We actively promote the framework and engage with companies on its substance.
• 30% Club (2017)  https://us.30percentclub.org/ - In May 2017, Vanguard joined the 30% Club, a global organisation that advocates for greater representation of women in boardrooms and leadership roles. A Vanguard representative sits on the US Steering Committee.
• Council of Institutional Investors (2017) - Vanguard is a member. CII is a nonprofit, nonpartisan association of corporate, public and union employee benefit funds and endowments with a focused policy mission: to be the leading voice for effective corporate governance practices for US companies and strong shareowner rights and protections.
• International Corporate Governance Network (ICGN) (2019)  https://www.icgn.org/ - ICGN is an investor-led organisation with a mission to promote effectivestandards of corporate governance and investor stewardship to advance efficient markets and sustainable economies worldwide. Vanguard participates in events.
• Business Roundtable's Statement on the Purpose of a Corporation (2019) https://www.businessroundtable.org/ - Vanguard is a signatory.
• Asian Corporate Governance Association (ACGA) (2021)  https://www.acga-asia.org/ - Vanguard Asset Management is a member. The Asian Corporate Governance Association (ACGA) is an independent, non-profit membership organisation dedicated to working with investors, companies and regulators in the implementation of effective corporate governance practices throughout Asia.
• Ceres (2021)  https://www.ceres.org/networks/ceres-investor-network - Vanguard is a member of the investor network.
• The Investment Association (2021)  https://www.theia.org - Vanguard Asset Management, Ltd. is a member.

Vanguard is also aligned with a number of climate-focused collaborative initiatives.

• Task Force on Climate-related Financial Disclosures (TCFD) (2017) - Vanguard publicly supports the TCFD and encourages portfolio companies to disclose climaterelated
  risks in line with the framework.
• CDP (2018) - Vanguard is a signatory to the Climate, Forests, and Water initiatives.
• The Energy Transition and Care for Our Common Home statement on climate risk (2019)  http://www.humandevelopment.va/en/eventi/2019/la-transizione-energetica-e-la-cura-dellanostra-casa-comune.html -  Vanguard is a signatory. The Vatican’s participant statement on climate risk disclosures that calls on companies to be transparent about climate-related matters and disclose them to investors.
• Net Zero Asset Managers initiative (NZAM) (2021) -  Vanguard is a member. Founded in December 2020, the Net Zero Asset Managers initiative is a group of global asset managers committed to supporting the goal of net zero greenhouse gas emissions, in line with global efforts to limit global warming to 1.5 degrees Celsius, and to support investing aligned with net zero emissions, both by 2050 or sooner.
• Institutional Investors Initiative on Climate Change (IIGC) (2021) - Vanguard is a member.
• Investor Group on Climate Change (IGCC) (2021) - Vanguard Investments Australia, Ltd. is a member.
• Asia Investor Group on Climate Change (AIGCC) (2021) - Vanguard Investments Australia, Ltd. is a member.
• Stewardship Codes:
  • The UK Stewardship Code  https://www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance/UK-Stewardship-Code.aspx
• Hong Kong Principles of Responsible Ownership  http://www.sfc.hk/web/EN/rule-book/principles-of-responsible-ownership.html
• Japan’s Corporate Governance Code  http://www.fsa.go.jp/en/refer/councils/corporategovernance/20150306-1.html

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