The seeds of what was to become the US Investor Stewardship Group (ISG) were sowed in the fall of 2014 on the sidelines of the Council of Institutional Investors’ conference in Los Angeles.
There, a small cadre of asset owners and asset managers met against an unsettling backdrop of criticisms that, generally speaking, institutional investors didn’t operate according to a set of common beliefs, nor were they doing their own analysis and arriving at studied conclusions to vote their proxies. Blindly following the recommendations of proxy firms, critics maintained, was the order of the day.
In the initial meetings, the group deliberated on how to help mitigate many of the criticisms being levelled at the investment industry, particularly at those who voted their own proxies: what were their overall governance policies and were there any commonalities in the public-facing polices of the group’s members? Over the course of the next three months, Allison Bennington of ValueAct Capital analysed public documents to isolate common principles, if any. As a next step, an online survey was fielded to test how much agreement there was among the group’s members on key issues. The survey included statements, such as ‘the majority of board members should be independent’, ‘issuers should adopt a vote share one vote standard’ and ‘boards should have a policy on periodic refreshment of directors’, among many others. Respondents were asked to rank their answers on a one to five scale, with five equalling ‘I completely agree’, one equalling I don’t agree at all’ and 3 equalling ‘this subject doesn’t matter to me’.
Building consensus
The survey was completed several weeks later and, as a member of the group, we studied the results to see if any commonalities existed among us. What we found was high agreement on 15 of the policy and rights statements, high overall agreement with some indifference to 17 of the statements and some disagreement with 13 of them. Our objective was to focus only on where there was complete agreement and, by fall of 2015, we had drafted our first set of common corporate governance principles that were based on only those principles that were supported by all members of the group.
In September 2015, the group met again, this time at State Street Global Advisors’ offices during the Council of Institutional Investors’ Boston conference. We reviewed the draft principles, which were company-related only at that time, and noted the members’ feedback for later incorporation into the second draft.
At that point, we took the liberty of developing a set of accompanying stewardship principles that would apply to any institutional investor who would be signing on to the principles. These stewardship principles were designed to hold institutional investors accountable to their clients for their stewardship activities related to the oversight of
their clients’/beneficiaries’ investments in portfolio companies. Our rationale was that, as the initiative was primarily investor-driven, we needed to hold ourselves to a set of principles, too. That’s how they came into being. As for the company version, we were very happy with the second draft. Reaction to the stewardship principles was also very positive and the group voted unanimously to incorporate them as part of the framework we were developing.
“THESE STEWARDSHIP PRINCIPLES WERE DESIGNED TO HOLD INSTITUTIONAL INVESTORS ACCOUNTABLE TO THEIR CLIENTS FOR THEIR STEWARDSHIP ACTIVITIES RELATED TO THE OVERSIGHT OF THEIR CLIENTS’/BENEFICIARIES’ INVESTMENTS IN PORTFOLIO COMPANIES”
If you had to ask me to isolate one common thread, one DNA strand, that unites both the stewardship and governance principles, I’d say it was the concept of accountability. Directors are accountable to shareholders and shareholders are accountable to beneficiaries.
Common ground
As early 2016 rolled around, we were satisfied that we had a good draft of both the company and stewardship principles when news broke that another set of principles – the Commonsense Corporate Governance Principles – were being developed by a cadre of eminent CEOs.
Fortunately, after speaking with the ‘Commonsense group’, it turned out that its principles were complementary and primarily boardroom-led, which continued to make our investor-led work unique. We opted to let the Commonsense group come to market first with its manifesto, with ours set to follow several months later.
At the end of the day, our principles turned into exactly what we’d hoped they’d be: a historic initiative by some of the largest US-based institutional investors and global asset managers, along with several international counterparts, that had created a framework for US Stewardship and Governance – in other words, the basic standards of investment stewardship and corporate governance for US institutional investor and boardroom conduct.
$17trillion and counting
With the conclusion to our work in sight, what remained was to encourage asset managers and asset owners to put their names to the principles. We were thrilled that the following prestigious brands, representing some $17trillion in assets, enthusiastically agreed to be our founding signatories and endorsers (endorser designation is for non-US investors only): BlackRock; CalSTRS; Florida State Board of Administration (SBA); GIC Private Limited (Singapore’s Sovereign Wealth Fund); Legal and General Investment Management; MFS Investment Management; MN Netherlands; PGGM; Royal Bank of Canada Global Asset Management; State Street Global Advisors; TIAA Investments; Rowe Price Associates, Inc.; ValueAct Capital; Vanguard; Washington State Investment Board; and Wellington Management.
The principles of the Investor Stewardship Group – as follows – were made public on 31 January 2017 and will come into effect on 1 January 2018.
Stewardship framework for institutional investors
Principle A. Institutional investors are accountable to those whose money they invest.
A.1 Asset managers are responsible to their clients, whose money they manage. Asset owners are responsible to their beneficiaries
A.2 Institutional investors should ensure that they or their managers, as the case may be, oversee client and/or beneficiary assets in a responsible manner
Principle B. Institutional investors should demonstrate how they evaluate corporate governance factors with respect to the companies in which they invest.
B.1 Good corporate governance is essential to long-term value creation and risk mitigation by companies. Therefore, institutional investors should adopt and disclose guidelines and practices that help them oversee the corporate governance practices of their investment portfolio companies. These should include a description of their philosophy on including corporate governance factors in the investment process, as well as their proxy voting and engagement guidelines
B.2 Institutional investors should hold portfolio companies accountable to the corporate governance principles set out in this document, as well as any principles established by their own organisation. They should consider dedicating resources to help evaluate and engage portfolio companies on corporate governance and other matters consistent with the long-term interests of their clients and/or beneficiaries
B.3 On a periodic basis and as appropriate, institutional investors should disclose, publicly or to clients, the proxy voting and general engagement activities undertaken to monitor corporate governance practices of their portfolio companies
B.4 Asset owners who delegate their corporate governance-related tasks to
their asset managers should, on a periodic basis, evaluate how their managers are executing these responsibilities and whether they are doing so in line with
the owners’ investment objectives
Principle C: Institutional investors should disclose, in general terms, how they manage potential conflicts of interest that may arise in their proxy voting and engagement activities.
C.1 The proxy voting and engagement guidelines of investors should generally be designed to protect the interests of their clients and/or beneficiaries in accordance with their objectives
C.2 Institutional investors should have clear procedures that help identify and mitigate potential conflicts of interest that could compromise their ability to put their clients’ and/or beneficiaries’ interests first
C.3 Institutional investors who delegate their proxy voting responsibilities to asset managers should ensure that the asset managers have appropriate mechanisms to identify and mitigate potential conflicts of interest that may be inherent in their business
Principle D. Institutional investors are responsible for proxy voting decisions and should monitor the relevant activities and policies of third parties that advise them on those decisions.
D.1 Institutional investors that delegate their proxy voting responsibilities to a third party have an affirmative obligation to evaluate the third party’s processes, policies and capabilities. The evaluation should help ensure that the third party’s processes, policies and capabilities continue to protect the institutional investors’ (and their beneficiaries’ and/or clients’) long-term interests, in accordance with their objectives
D.2 Institutional investors that rely on third-party recommendations for proxy voting decisions should ensure that the agent has processes in place to avoid/mitigate conflicts of interest
Principle E: Institutional investors should address and attempt to resolve differences with companies in a constructive and pragmatic manner.
E.1 Institutional investors should disclose to companies how to contact them regarding voting and engagement
E.2 Institutional investors should engage with companies in a manner that is intended to build a foundation of trust and common understanding
E.3 As part of their engagement process, institutional investors should clearly communicate their views and any concerns with a company’s practices on governance-related matters. Companies and investors should identify mutually held objectives and areas of disagreement, and ensure their respective views are understood
E.4 Institutional investors should disclose, in general, what further actions they may take in the event they are dissatisfied with the outcome of their engagement efforts
Principle F: Institutional investors should work together, where appropriate, to encourage the adoption and implementation of the Corporate Governance and Stewardship Principles.
F.1 As corporate governance norms evolve over time, institutional investors should collaborate, where appropriate, to ensure that the framework continues to represent their common views on corporate governance best practices
F.2 Institutional investors should consider addressing common concerns related to corporate governance practices, public policy and/or shareholder rights by participating, for example, in discussions as members of industry organisations or associations
Corporate governance framework for US listed companies
Principle 1: Boards are accountable to shareholders.
1.1 It is a fundamental right of shareholders to elect directors whom they believe are best suited to represent their interests and the long-term interests of the company. Directors are accountable to shareholders, and their performance is evaluated through the company’s overall long-term performance, financial and otherwise
1.2 Requiring directors to stand for election annually helps increase their accountability to shareholders. Classified boards can reduce the accountability of companies and directors to their shareholders. With classified boards, a minority of directors stand for elections in a given year, thereby preventing shareholders from voting on all directors in a timely manner
1.3 Individual directors who fail to receive a majority of the votes cast in an uncontested election should tender their resignation. The board should accept the resignation or provide a timely, robust, written rationale for not accepting the resignation. In the absence of an explicit explanation by the board, a director who has failed to receive a majority of shareholder votes should not be allowed to remain on the board
1.4 As a means of enhancing board accountability, shareholders who own a meaningful stake in the company and have owned such stake for a sufficient period of time, should have, in the form of proxy access, the ability to nominate directors to appear on the management ballot at shareholder meetings
1.5 Anti-takeover measures adopted by companies can reduce board accountability and can prevent shareholders from realising maximum value for their shares. If a board adopts such measures, directors should explain to shareholders why adopting these measures are in the best long-term interest of the company
1.6 In order to enhance the board’s accountability to shareholders, directors should encourage companies to disclose sufficient information about their corporate governance and board practices
Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.
2.1 Companies should adopt a one-share, one-vote standard and avoid adopting share structures that create unequal voting rights among their shareholders
2.2 Boards of companies that already have dual or multiple class share structures are expected to review these structures on a regular basis, or as company circumstances change, and establish mechanisms to end or phase out controlling structures at the appropriate time, while minimising costs
to shareholders
Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.
3.1 Boards should respond to a shareholder proposal that receives significant shareholder support by implementing the proposed change(s) or by providing an explanation to shareholders why the actions they have taken or not taken are in the best long-term interests of the company
3.2 Boards should seek to understand the reasons for and respond to significant shareholder opposition to management proposals
3.3 The appropriate independent directors should be available to engage in dialogue with shareholders on matters of significance, in order to understand shareholders’ views
3.4 Shareholders expect responsive boards to work for their benefit and in the best interest of the company. It is reasonable for shareholders to oppose the re-election of directors when they have persistently failed to respond to feedback from their shareholders
Principle 4: Boards should have a strong, independent leadership structure.
4.1 Independent leadership of the board is essential to good governance. One of the primary functions of the board is to oversee and guide management. In turn, management is responsible for managing the business. Independent leadership of the board is necessary to oversee a company’s strategy, assess management’s performance, ensure board and board committee effectiveness and provide a voice independent from management that is accountable directly to shareholders and other stakeholders
4.2 There are two common structures for independent board leadership in the US: 1) an independent chairperson; or 2) a lead independent director. Some investor signatories believe that independent board leadership requires an independent chairperson, while others believe a credible independent lead director also achieves this objective
4.3 The role of the independent board leader should be clearly defined and sufficiently robust to ensure effective and constructive leadership. The responsibilities of the independent board leader and the executive chairperson (if present) should be agreed upon by the board, clearly established in writing and disclosed to shareholders. Further, boards should periodically review the structure and explain how, in their view, the division of responsibilities between the two roles is intended to maintain the integrity of the oversight function of the board
Principle 5: Boards should adopt structures and practices that enhance their effectiveness.
5.1 Boards should be composed of directors having a mix of direct industry expertise and experience and skills relevant to the company’s current and future strategy. In addition, a well-composed board should also embody and encourage diversity, including diversity of thought and background
5.2 A majority of directors on the board should be independent. A board with a majority of independent directors is well positioned to effectively monitor management, provide guidance and perform the oversight functions necessary to protect all shareholder interests
5.3 Boards should establish committees to which they delegate certain tasks to fulfil their oversight responsibilities. At a minimum, these committees should include fully independent audit, executive compensation, and nominating and/or governance committees
5.4 The responsibilities of a public company director are complex and demanding. Directors need to make the substantial time commitment required to fulfil their responsibilities and duties to the company and its shareholders. When considering the nomination of both new and continuing directors, the nominating committee should assess a candidate’s ability to dedicate sufficient time to the company in the context of their relevant outside commitments
5.5 Attending board and committee meetings is a prerequisite for a director to be engaged and able to represent and protect shareholder interests; attendance is integral to a director’s oversight responsibilities. Directors should aim to attend all board meetings, including the annual meeting, and poor attendance should be explained to shareholders
5.6 Boards should ensure that there is a mechanism for individual directors to receive the information they seek regarding any aspect of the business or activities undertaken or proposed by management. Directors should seek access to information from a variety of sources relevant to their role as a director (including for example, outside auditors and mid-level management) and not rely solely on information provided to them by executive management
5.7 Boards should disclose mechanisms to ensure there is appropriate board refreshment. Such mechanisms should include a regular and robust evaluation process, as well as an evaluation of policies relating to term limits and/or retirement ages
Principle 6: Boards should develop management incentive structures that are aligned with the long-term strategy of the company.
6.1 As part of their oversight responsibility, the board or its compensation committee should identify short- and long-term performance goals that underpin the company’s long-term strategy. These goals should be incorporated into the management incentive plans and serve as significant drivers of incentive awards. Boards should clearly communicate these drivers to shareholders and demonstrate how they establish a clear link to the company’s long-term strategy and sustainable economic value creation. All extraordinary pay decisions for the named executive officers should be explained to shareholders
6.2 A change in the company’s long-term strategy should necessitate a re-evaluation of management incentive structures in order to determine whether they continue to incentivise management to achieve the goals of the new strategy
In conclusion
This was and, still is, a grassroots effort. In the fall of 2014, we didn’t know what we had to work with or what we’d end up with, if anything. Thus far, reaction to the Framework has been overwhelmingly positive. Since the January launch, an additional 14 asset owners and asset managers representing assets of some $1.5trillion have signed up to the principles; others are seeking permission from their organisations to do so.[1] But to shape the macro effort in line with our vision, every asset manager and asset owner who invests in the US should be encouraged to join this initiative.
We have governance structures in place to facilitate the inclusion of more members. Our principles are not static. They will be refreshed over time to keep pace with changes in the US governance landscape and we need new members who can help us ensure the viability and dynamism of the Investor Stewardship Group’s Framework for stewardship and governance in the US.
