Analysis: Swiss corporate governance – will loopholes hinder Minder?

As the saying goes, the devil is in the details. At first glance, Switzerland’s so-called Minder initiative looks to be highly effective in curtailing gross executive pay at listed Swiss firms and improving their governance generally.

For, starting in 2015, Minder requires companies to permit shareholders at their annual general meetings (AGMs) to vote on the salary packages for managers and board directors.

The outcome of these votes is also binding – a rarity in industrialised countries where consultative votes on executive pay are the norm. Another feature of Minder is that it gives shareholders the right to elect the Chair, all members of the board and the members of the compensation committee at each AGM. Until now, standard practice was for Swiss companies to hold board elections every few years and/or present a slate of candidates for the board and the pay committee.

The list of Minder reforms does not stop there. To further crack down on excessive executive pay, golden parachutes have been banned as well as dubious bonuses for corporate bosses who negotiate mergers or acquisitions. To ensure that shareholder say-on-pay is taken seriously, Minder expressly requires Swiss pension funds to vote on the issue at AGMs and then report to beneficiaries on how they voted. The implication, or rather hope, here is that if a large shareholder bloc like the Swiss schemes – they own 8% of the share capital of listed firms – resists attempts by companies to overpay their executives, other shareholders will join the cause and the firms will be thwarted.

Indeed, Thomas Minder, the Swiss MP and architect of the initiative, conceived of the voting requirement on schemes due to their role as guardians of social capital. Minder knew that as the Swiss were scandalised by executive pay at the likes of Novartis, UBS and Credit Suisse, they would want their pension funds to take a public stand. Sure enough, Minder’s project was approved overwhelmingly by the Swiss in a March 2013 referendum and has since become law.

All this sounds promising for Swiss corporate governance. Yet when you take a closer look at the law that ultimately passed the Swiss Parliament, you wonder whether much will change at all at Swiss companies.

That’s because of the law’s details, or rather loopholes. Take, for example, the pension funds’ right to abstain during votes on pay, if this, as the law states, “serves the interest of beneficiaries.”And who decides that interest? Not the beneficiaries, but the schemes’ managers who might worry about making corporate enemies by taking a stand or who may simply want to save themselves the work of deciding what is fair executive compensation. There is also a less obvious, yet potentially more damaging loophole. Swiss pension funds can actually circumvent the voting requirement altogether by selling direct holdings in Swiss companies and switching to equity funds. Such a tactic is made possible by the simple fact that Minder does not require fund managers to vote on executive pay.

Industry sources tell Responsible Investor that some Swiss pension funds are already making use of the loophole in the run-up to the 2015 AGM season, when the first votes on executive pay will be held. Currently, about half of the 8% in share capital is directly held by the schemes and the rest is in funds. But the sources say that smaller schemes in particular have begun getting rid of those direct holdings and shifting the money to funds. It’s because, the sources say, the schemes are unhappy by the perceived additional cost and workload associated with the voting requirement.

Why Minder means more work has already been touched on: managers of Swiss pension funds must decide what they think is fair executive compensation and then inform beneficiaries on how they voted. Of course, they have the option of hiring a proxy firm like zRating or Ethos to get a recommendation and then instruct the firm to vote on their behalf. But this means extra cost, which has been more of a problem for smaller Swiss schemes than bigger ones. The proxy firms, for their part, insist that such costs are minimal. Ethos, for example, puts its outsourcing charge for a small fund at around CHF8,000 (€6,630) a year and for a bigger one at CHF15,000.

Even so, Gregor Greber, Executive Chairman of zRating admits: “I don’t want to be negative about Minder, as it was unquestionably a step forward for Swiss corporate governance. But I fear that it will be undermined somewhat by pension funds getting around the voting requirement.” Meanwhile, Swiss pension fund association ASIP denies that its members are trying to get around the voting requirement. “We don’t see any evidence of a mass movement from shares to funds. And I personally think the new requirements will not affect the investment strategy of the members,” ASIP Managing Director Hanspeter Konrad told RI.

Yet even taking ASIP’s comments at face value and assuming that next year, Swiss schemes may resist attempts by corporate executives to overpay themselves, their actions alone may make no difference. Why? Recall that it’s hoped under Minder that if a big shareholder bloc takes a stand, others like fund managers or Swiss insurers will join.

But it’s merely a hope, not a requirement. Then there’s still the problem of family majorities at some listed companies which are not only a hindrance on the pay issue, but, according to Greber, raise other governance issues like the lack of “one share, one vote” or an independent board.

Said an industry source, who spoke on the condition of anonymity: “The executives at Credit Suisse and UBS are not really concerned about Minder’s impact on their pay. What keeps them up at night is the litigation from investors over the financial crisis or the Libor scandal.”

To remedy the situation, Dominique Biedermann, Chief Executive of Ethos, supports extending the Minder voting requirement to Swiss fund managers and insurers. This, he believes, would ensure that Swiss pension schemes vote on executive pay and have the added benefit of creating a formidable shareholder bloc. Ethos’ efforts to persuade politicians in Berne to extend the requirement have, however, come up short. “We haven’t gotten very far, as there is a centre-right majority in the Parliament that was not happy about the Minder project in the first place,” says Biedermann.

It would, in any case, be wrong to suggest that Minder is not a big step forward for Swiss corporate governance. For the first time ever, Swiss companies must get shareholder approval for what they want to pay their managers and boards. Shareholders no longer have to tolerate excessive executive pay if they think it’s a waste of their money. As mentioned, some of the more egregious bonuses like those for M&A activity or golden parachutes have been banned, though companies can provide generous severance pay if, say, the ex-CEO promises not to work for the competition afterward.Another Minder milestone is the voting requirement on pension funds. Sure, some of the more than 2000 schemes will try to get around the requirement, but if their beneficiaries find out – due for example their lack of reporting – they may be forced to.

Consider that Minder was approved with almost 70% of the vote. Furthermore, numerous Swiss pension funds have routinely voted their shares even before Minder.

Examples include the 146 schemes that Ethos represents or the Ist-Investmentstiftung, a foundation that looks after the CHF5bn in assets from around 500 pension funds. Now that Minder is unfolding, their influence on other, previously non-committal schemes, cannot be underestimated.

Says Markus Anliker, CEO of the Ist-Stiftung: “We’ve been voting our shares for several years now, as we are convinced that the exercise of shareholder rights is key to improving corporate governance. And let’s face it: the AGM is the place where shareholders can put greedy executives in their place.”

Certain that demand for proxy voting will increase after 2015, Swiss bank UBS has been actively promoting its “UBS Voice” platform to pension funds. The platform provides pension schemes invested in more than a dozen of the bank’s equity funds voting services for the AGMs of 30 underlying companies – to include household names like ABB, Nestlé, Novartis, Roche, Swatch, Credit Suisse and even UBS itself.

According to Tobias Meyer, Director of Institutional Products at UBS, about one-fifth of the bank’s pension fund clients are using UBS Voice already. But Meyer says that number could increase to half, once the Minder voting requirement takes effect. Indeed, he dismisses the possibility that many Swiss schemes will seek to avoid voting, noting that if they do, their beneficiaries will be aware that they are not respecting the spirit of the Minder initiative. Meyer makes an excellent point, but for now observers of the Minder debate must wait and see just how many Swiss pension funds vote in the 2015 AGM season and what sort of impact this will have.