When the final report of the European Securities and Markets Authority (ESMA) in February 2013 concluded that there was no ‘clear evidence of market failure in relation to how proxy advisors interact with investors and issuers’, I genuinely thought that the debate would end there, at least in Europe. But issuers decided to keep it alive and the European Commission recently included an article on proxy advisors in its proposal to revise the Shareholder Rights Directive (SRD). My point here will be to try to understand why we are still in the same situation as before the ESMA report and the Best Practice Principles for Shareholder Voting Research Providers implemented by the proxy research industry.
By reviewing the comments from issuers to the numerous consultations on proxy advisors, we can find two main recurring elements justifying the claim to regulate proxy advisors: transparency and influence. In that aspect, the response of the US Chamber of Commerce to the ESMA consultation is very representative: “The Center for Capital Markets Competitiveness is concerned about the lack of transparency and potential conflicts of interest in the operation of proxy advisory firms that advise institutional shareholders on matters of corporate governance, and have tremendous influence over public companies’ corporate governance practices”. The transparency issue covers multiple aspects such as conflicts of interest, policies methodology and accuracy of voting recommendations. On conflicts of interest, the debate resulted in some advances that were not previously obtained or maybe not even asked by investors. For example, the Institutional Shareholder Services (ISS) is now disclosing to its customers the list of issuers that are clients to its consulting branch and Glass Lewis is disclosing its conflicts on the cover of its research reports.
Disclosing Voting Policies
Regarding voting policies, it is still a little more complicated as most proxy advisors offer both house and custom policies. According to ISS and Glass Lewis, the majority of their clients follow custom guidelines and so they can not disclose them publicly. Even if I sometimes doubt the real difference of some of those custom policies compared to the house one, it is the responsibility of the investors to disclose their voting policies and implementation processes. For house policies, I fully agree that their disclosure is important as issuers should be aware of the principles applied to them, of how they are developed and updated, and whether local standards are taken into account. But taking into account local standards does not mean accepting every local practice. An ‘amusing’ case can be found in the response of the French Association of Large Companies (AFEP) to the ESMA consultation where they complain that proxy advisors do not understand the French specificities.
“Companies see the correlation between proxy advice and voting by investors as a proof of ‘undue’ influence”
The AFEP is using the example of censors (non-voting directors) just a few months after a French stock market CAC40 index company experienced two rejected resolutions to renew its censors. The true story is that ISS included an opposition to censors in its 2012 policy, but that this evolution was the fruit of a consultation process with the main French asset managers that had been voting against censors for years considering that this practice was, most of the time, a way to circumvent governance principles regarding levels of independence, overboarding, tenure or diversity. What was seen by issuers as a lack of understanding of the local environment was in fact the adoption of the local best practices from an investor point of view. This is often how the transparency issue can drift slowly to the other one: influence. Issuers are also suggesting to be part of the process of voting policies and recommendations in order to avoid misinterpretation of the specificities of the national market, ‘one size fits all’ or material errors. At this level, issuers are clearly interfering with the content of the service purchased by investors.
A Limited Approach
The practical results of the Autorité des Marchés Financiers (AMF) recommendation No. 2011-06 requiring the submission for feedback of draft reports to issuer and the inclusion of companies’ quote in the final reports showed, in my opinion, the limits of that approach. It did not improve the accuracy of the research and the additional information from issuers was most of the time useless because it had already been covered under another form in the analyses or simple ‘copy and paste’ from the AGM documents. Even worse, we encountered some interesting cases of material errors advantaging the issuer and where they genuinely acknowledged that they chose not to report them to the proxy advisor.
Let’s focus then on the influence issue. Companies see the correlation between proxy advice and voting by investors as a proof of ‘undue’ influence. But correlation must not be directly interpreted as causation and influence. For the ESMA consultation, we analysed the correlation of our votes with ISS recommendations. For this article, I did the same experiment on our votes for the first semester 2014 and the results are nearly identical. Globally, our votes differ from recommendations in only 11 per cent of the resolutions. So are we totally influenced by ISS? I am not sure, because if we exclude the numerous routine resolutions and focus only on the controversial resolutions, either for ISS or for us, the correlation is very different. If we consider only the resolutions with a negative recommendation from ISS, our votes are different for about a third of the resolutions. If we consider only the resolutions where we opposed management, our votes differ from ISS recommendation in nearly 50 per cent of the cases.
How Investors Are Using Proxy Advisors
Is the new conclusion that we need to fire ISS because its recommendations are wrong? No, all those results are explained by the fact that, despite sharing global principles of good governance, our ways of applying them or assessing the specific situation of a company can be different. ISS and our other proxy advisors are only used to provide us with easily accessible and formatted information on an issuer and its AGM. The problem of influence seems to reside in how investors are using proxy advisors. I can only speak of how we work at my current employer but I also know that many large European asset managers are functioning in similar ways. We are using three proxy tadvisors to get at least two external analyses for every shareholder meeting. By doing this, we are limiting the risk of using research with material errors or biased due to conflicts of interests but, more importantly, we are purchasing diverse interpretations of common principles that we can confront to our internal expertise (fund managers, financial analysts, SRI specialists) in order to establish our own informed opinion based on our own voting policy.
Another limit of the influence argument is that, for a substantial part of the assets voted as part of our shareholder dialogue activities, we are informing the companies of our voting intentions well in advance of the meeting at a time where the analyses of proxy advisors are not even published. But let’s consider that some investors are less responsible that the ones I usually meet either at the corporate governance committee of the AFG or at the International Corporate Governance Network (ICGN). Better quality and transparency in voting research will not change anything as ‘shooting the messenger’ is not the solution. The problem is investors not fulfilling properly their fiduciary duty.
Increased Transparency To Stakeholder
The ‘undue’ influence of proxy advisors results from excessively delegated or automated voting from investors. For the ESMA, the industry code was just a step to increase the understanding of proxy advisors’ activities through increased transparency to stakeholders (meaning issuers) and maybe the most important part of their final report is that ‘such understanding and assurance will help to keep attention focused where it belongs, namely on how investors and issuers can, from their respective roles foster effective stewardship and robust corporate governance, and ensure efficient markets’. The Best Practice Principles for Shareholder Voting Research Providers also reaffirms that the ultimate responsibility in voting lies with investors and that stakeholders (again meaning issuers) ‘wishing to understand how an institutional investor discharges its stewardship or ownership responsibilities should consult relevant disclosures of the investor to understand its approach’.
So it seems that stewardship is the solution to ‘undue’ influence. The 2010 UK code sets out principles for investors to enhance the quality of engagement with companies ‘to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’. The other codes developed in the following years in Netherlands, South Africa, Switzerland, Italy and even Japan all follow similar principles. Even more impacting, this approach could be transposed into hard law with the proposal for the revision of the Shareholder Rights Directive (SRD) by the European Commission that requires institutional investors to develop engagement policies. It seems that proxy advisors are solving most of the transparency issues with their industry code and that investors are on track to tackle the influence issue through the development of stewardship. Unfortunately, it would appear that this does not mean the end of the debate. The revised SRD discussion gave an opportunity to some issuers’ associations to continue the fight. They seem to want to tighten the existing self-regulating framework through increased transparency requirements that would give them some influence over proxy advisors work.
The 2010 UK code sets out principles for investors to enhance the quality of engagement with companies ‘to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’
Transparency Used For Influence
It is what I began to explain previously in this article, transparency used for influence. More precisely, but not exhaustively, they try to force proxy advisors to take into account local practices by mandating voting policies for each country, to systematically engage in dialogue with issuers prior to the release of the final report and to include companies quotes in those reports. If this strategy succeeds, it would allow issuers to exercise pressure on proxy advisors for recommendations that would not be considered by them as accurate, reliable or properly integrating local practices.
I can only see two explanations for that strategy, and they are not mutually exclusive. First, is that issuers think that development of stewardship will fail, that investors will continue to delegate proxy voting to third parties as a compliance exercise. Consequently, proxy advisors must be regulated because it would be more difficult for issuers to directly confront their own ‘absentee’ shareholders and ask for them to be regulated so they fulfill their fiduciary duty. Second is that issuers do not want the stewardship/engagement development to succeed because numerous active (not activist) shareholders would be much more difficult to manage than a few proxy advisors and as it could result in being effective in initiating changes in the governance of companies. So where is the truth between those two theories? On the one hand, stewardship could fail due to its adoption by a too limited number of responsible investors or, on the contrary, be diluted into an ineffective compliance exercise if every investor join the movement by just pretending to be active.
On the other hand, issuers are not always facilitating the movement toward direct long-term dialogue with shareholders, nearly half of our alert letters to initiate a dialogue with companies stays unanswered. They are also sometimes even reinforcing the weight of proxy advisors by reacting only to the issues generating a negative recommendation from major proxy advisors. Finally, we are still debating about proxy advisors because it is just more comfortable for investors and issuers than facing their own responsibilities and shortcomings. The ESMA was probably right that there was no market failure in relation to how proxy advisors interact with investors and issuers. But it was mainly because the area to explore was the potential market failure in relation to how investors and issuers interact with each other.
The revised SRD proposal is clearly trying to tackle the real issue even if the very existence of the article on proxy advisors is somewhat an admission of a potential failure of stewardship. Also the heavy administrative requirements are instilling in the directive a compliance mentality that could affect the effectiveness of engagement. Nevertheless, it is a step towards a constructive governance framework where the main actors, investors and issuers are more incentivised to interact directly and proactively. But as markets are global, similar initiatives are also needed in the other major parts of the world so investors and companies can engage toward a shared vision of long-term success. Only then can proxy advisors return to a level of anonymity consistent with their role of research providers.
About the Author:
Cédric Lavérie is Head of Corporate Governance at Amundi, a leading European asset manager with AUM close to €800 billion worldwide (as of 31 March 2014). Cédric is responsible for managing a dedicated team in charge of corporate governance issues, including shareholder dialogue and proxy voting. Prior to this role, he worked as a corporate governance analyst at Credit Agricole Asset Management and AXA Investment Managers and in risk management at Paribas (Suisse) SA. He holds graduate degrees in Banking-Finance from Paris II University, International Economic Law from Paris X University and Politics from New York University.
Cédric Lavérie can be contacted by email: firstname.lastname@example.org