Mike Tyrrell: SRI engagement is a mess. Could 2018 bring a solution?
Part 2 of a in-depth look at the impact of EU’s MIFID II on responsible investment research and engagement.
I’ve been working on company-investor ‘engagement’ on sustainability from all sides (asset manager, intermediary, listed company) for nearly twenty years and, having evaluated the practice from all possible angles (supply, demand, objectives, outcomes etc), the best summary I can come up with is that it’s an inefficient shambles.
This is not, of course, to say that individuals and firms (on both sides) aren’t doing great work. They are. It’s just that when looked at from a systems perspective, it could be so much more efficient…and 2018 could be the year that it improves.
The case for simplicity
At its core ‘engagement’ should be an incredibly simple activity summarised as:
- Companies generally want investors to understand the opportunities and exposures that they face, whether these are caused by sustainability or by other factors.
- Asset managers generally want to receive this information from companies and to ask them challenging questions about (amongst other things) the environmental and social issues that they face.
- Provided both sides of this desired discussion have access to each other’s contact details, every other intervention is noise.
(Exclude for now, those that don’t fit the ‘generally’ categorisation. I’ll return to them at the end of the article. We must not let a tail of irresponsible companies or campaigning asset managers wag the more important dog of constructive investor-company communications on sustainability.)*The case for complexity*
Although ‘engagement’ should be simple, there is considerable complexity in the way that it has been intermediated. For decades, ‘sell-side’ brokers have locked up the supply of ‘corporate access services’ (meaning arranging meetings between analysts and portfolio managers and company management) by offering it ‘for free’ to both sides (where ‘free’ really means bundled invisibly into trading fees). Because these brokers, with notable exceptions, were slow to expand their corporate access (not to mention research) services to cover sustainability and corporate governance issues, the SRI industry developed its own approach to contacting companies. While it is impressive how much has been achieved through collaboration and voluntarism between inherently competing entities, it has been and continues to be hard work and the administrative elements of it are a ludicrous waste of expensive analyst time: i.e. assemble coalition, agree objectives, achieve sign-off, identify first point-of-entry company contact, explain nature of collaboration (companies simply don’t understand collaborative engagement.), request meeting, have meeting request rejected, request again, arrange meeting, re-arrange meeting upon cancellation, conduct meeting, etc.
As a result, many asset managers love the concept of engagement but hate the practice, and asset owners understandably turn their attention to whether impact is achieved from so much input.
The case for 2018; the case for efficiency; the case for MIFID II
You see what I did there? I didn’t put MIFID II in the article’s title because I knew that would guarantee that nobody ready it. However, the legislation that is being implemented across Europe in 2018 is significant to this argument and cannot be avoided. From now (January 2018), European asset managers will not be allowed to pay for ‘corporate access’ services from brokers as a
bundled component of their trading commission. At point of use, they will need to pay for it separately and then either meet the costs out of their own pocket or, if they are using client money in any way, report transparently on this to clients.
Initially, this seems likely to cause some turmoil in the provision of ‘corporate access’ provision as:
- Some ‘sell-side’ brokers withdraw from provision
- Others work much harder to place their corporate access provision within an investment context, such that it justifies payment beyond ‘travel agent’ levels
- Independents (such as Ingage, WeConvene etc) grow share in the market
- Some asset managers bring the process in-house
- Some companies bring the process in-house
After a period of transition, however, the market is likely to recognise that corporate access services are little more than an amalgamation of ‘data’, ‘logistics’, ‘charm’ and ‘research’:
- Data: on which significant managers of relevant companies need to be introduced to which analysts and portfolio managers at which firms.
- Logistics: to determine times, locations and biscuit requirements.
- Charm…and patience…to oil the process.
- Research: that can either be considered as integral to the selection and presentation of companies to investors…or can be wholly disaggregated from the actual ‘access’ process (opinions will differ).Data and logistics will be commoditised, and charm is cheap. Research will remain the disputed variable with some (largely ‘sell-side’ brokers) arguing that it is an essential value-adding part of the service with others (largely independent start-ups) arguing that technology-driven efficiency is more significant. As this recognition dawns, the various components are efficiently priced, costs are allocated and challengers enter the market; all leading to more transparent and cheaper corporate access services than has hitherto been the case.
What does this mean for SRI?
If (and the dispute over the significance of research to ‘corporate access’ remains the variable) the investment value chain emerges from the MIFID II process with an efficient, technologically-slick and priced approach to managing communications between investors and companies, it would be insane for the SRI/CG industry not to align itself with mainstream practice. Given the priority our industry places on ‘integrating’ our activities with ‘mainstream’ investors, the manifold inefficiencies and unnecessary costs in our own contact processes and the fact that we are not all insane, I think that we can assume that convergence will happen between current SRI/CG contact processes and any ‘fit-for-purpose’ corporate access process that emerges from MIFID.
The role for asset owners
As with research (see S&CG research: Fuel or fig leaf?) asset owners can be influential by holding asset managers to the requirements of MIFID. In respect of engagement, they simply need to ask them:
- What resources do you deploy to corporate access?
- What level of contact do you achieve from this?
- What outcomes does this process yield?
The rules are now in place to require asset managers to be disciplined about their approach to corporate engagement. As ever, however, rules get buried unless they are actively applied within the marketplace.
The opportunity for companies
As noted above, companies, generally, want investors to understand the opportunities and exposures that they face – whether these are caused by sustainability or by other factors. Typically, they are constrained from doing so by not understanding SRI-specific expectations and processes, and the time/cost associated with finding out. If convergence occurs between ‘mainstream’ investor engagement and SRI investor engagement, this problem will disappear. Such alignment will also make it easier for the CSR/sustainability managers (who typically want to communicate on these subjects to investors) to work with the Investor Relations managers (who typically know how to do this … and tend, therefore, to be gatekeepers to the process). If companies have a clear idea of what they want to achieve with their sustainable investor communications (not always the case), then achieving it should become much easier.
Will MIFID II bring recalcitrant companies to the table?
As promised, I return to the challenge that is often put to me in the question above. Ultimately, the answer is no. If companies simply don’t want to understand orrespond to investor interests in sustainability or corporate governance, then investors will always have to turn to last resort measures such as letters to the chairman, shareholder resolutions or divestment.
- Many fewer companies are genuinely unwilling to engage than is commonly assumed; most failure to engage by companies is down to the fact that they don’t understand the process or the nature of investor interest
- Peer group pressure is the strongest driver towards investor engagement. So, the existence of an efficient communications process that their sector and country peers are involved in is more likely to bring recalcitrant companies forward than any number of letters by investors
- Once recalcitrance is priced, that price can start to fall. Arranging a meeting with the CEO of SaveTheWorld Inc may only cost $10 but arranging one with Heinous Enterprises might cost $5,000 this year; $4,000 next year, etc.
- The more efficient the core process, the more time will be freed up for investors to chase the few remaining outliers
In summary, MIFID II certainly won’t fix all of the problems of engagement overnight – but it could be a significant step forward.
Mike Tyrrell is Editor of SRI-CONNECT