Analysis: Institutional Shareholder Services looking for a new berth

A look at the issues on the table as ISS goes up for grabs

Institutional Shareholder Services (ISS), the world’s largest corporate governance advisory and shareholder voting company, is seeking a new home after parent, MSCI, announced in October last year that it was exploring “strategic alternatives” for the business.

The sale begs the question of who might be a potential buyer for such a key player in the ESG world? It also raises serious issues about how the field of investor share-voting could develop.

ISS, which has more than a trillion dollars under advice for about 1,700 clients, was founded by corporate governance pioneer Bob Monks in 1985.

It was sold to risk management and corporate governance firm RiskMetrics in 2007 for $542.8m. It changed hands again when RiskMetrics was itself swallowed by MSCI in 2010.

It’s perhaps a surprise it stayed with MSCI for so long, given that CEO Henry Fernandez said it was a “non-core” part of the business subsequent to the deal.

ISS had revenues in the nine months to the end of the third quarter of $91.5m (about 11% of MSCI’s total turnover), and observers say it is a solid cash generator, albeit restricted in terms of significant potential business growth in its current format.

It is also a market leader facing headwinds.

These were summarised by MSCI in a revealing 10Q filing to the Securities and Exchange Commission late last year, which look like more than the usual boilerplate disclaimers for business sales.

Challenges include potential data protection restrictions as well as the possibility that the governance business could be regulated as a fiduciary advisor under ERISA guidelines, following currently stalled proceedings instigated by the US Department of Labor. This would potentially introduce a much higher level of regulatory oversight of the current business model.In addition, the company faces potential regulation of the proxy voting industry in the US, Europe, and Canada. The SEC is under pressure to look at the issue – witness its December 5 roundtable on the industry. The European Commission is also understood to be continuing its regulatory investigation of the proxy advisory industry, despite the European Securities and Markets Authority finding no “market failure” in the sector. The proxy industry as a whole is under fire from heavy corporate lobbying by organisations such as the US Chamber of Commerce, who claim it wields unaccountable power.

Another key issue is that ISS advises both investors and corporates, although it says the activities are separated by a firewall. How a new owner tries to address or develop this will be a something to watch out for if a sale takes place.

Any new owner would also have to deal with the fact that, contractually, it is ISS that produces MSCI’s environmental, social and governance (ESG) research, according to the small print. This looks, however, more like a legal/administrative hurdle to overcome.

Another side to that question would be whether a buyer of ISS might itself want to expand into the provision of broader E&S research to compliment the successful ‘G’ business, bringing a new big player into the market.

Despite the caveats, ISS is profitable and understood to have spent well recently to upgrade its IT infrastructure.

RI has been told by people close to the company that MSCI had over 70 initial, serious inquiries in the business.

It seems likely at this stage that a future home could be with a private equity buyer, although the regulatory threats and the muted growth prospects for the business don’t resemble the kinds of deals that PE houses tend to

like. Assuming ISS does end up going to a private equity buyer, presumably ISS (and its investor clients) will have to go through another similar upheaval in three/five years time when the new buyers look to exit.

Given that a private equity buyer is likely to be itself backed by institutional investors, it’s arguable that institutions should consider taking it under their wing directly.

It has been suggested to RI that a group of pension funds has expressed a joint interest in buying ISS, although no further information is known.

This would almost certainly intensify corporate opposition if US investors were involved.

ISS’s main rival, Glass Lewis, is, of course, owned by Canada’s Ontario Teachers Pension Plan (OTPP) and the Alberta Investment Management Co., and that arms-length relationship largely seems to work, despite occasional complaints from corporates.

Another factor to consider is that, assuming the sale happens in the early part of this year, it could mean that it is taking place at the height of proxy voting season.Not the best timing! The strategic review is being handled for MSCI by Morgan Stanley, the investment bank, and the “MS” of the name and still a substantial shareholder alongside fund manager, Capital International (the “CI”). Morgan Stanley declined to comment to Responsible Investor. As an aside, Al Gore and David Blood’s Generation Investment Management holds 6.41% of MSCI.

MSCI clearly sees its own path to growth without ISS. In a little-noticed deal last January, it acquired Investor Force, which provides performance reporting for institutional investment consultants, for $23.6m in cash. MSCI appears to want to provide discrete investment decision support tools to institutional investors “across all client segments and asset classes”. The ‘Intel inside’ for investment, if you like.

The politically-charged, low-growth, ‘utility’ business of ISS doesn’t appear to fit that strategy. It will be intriguing then to see who might be tempted to buy ISS and what it will mean for the future of corporate governance.