The EU could next month use a giant regulatory sledgehammer to crack a corporate governance nut unless institutional shareholders step up to tell it otherwise.
On June 25, the Paris-based European Securities and Market Association (ESMA), one of the EU’s highest financial authorities, will conclude a thorough survey of institutional investors, corporations, regulators and service providers regarding the apparently seditious activities of shareholder voting advisory firms.
Link to survey
Responsible-investor.com revealed back in March Link the potential new EU regulations proxy firms could be faced with. ESMA says it is considering four regulatory options based on the survey. These include binding EU-level legislation, so-called ‘quasi-binding’ rules such as comply-or-explain, the development of industry ‘best standards’, or the option of no action on the current market-based structure. It says it instigated the review to look at issues such as the accuracy and independence of proxy voting advice. Other issues it is inviting comment on include alleged conflicts of interests in the work of proxy advisors, some of whom advise the companies they research, and the dialogue that takes place between advisors and corporate issuers.Quite how ESMA became involved in a major proxy voting regulatory review is something of a mystery though. Has there been a proxy voting scandal for the main European securities market regulator to contend with? Well, maybe if you consider the baffling lack of interest from some investors in voting their shares or acting as owners prior to the banking crisis. Or perhaps the lamentable state of the ‘plumbing’ of the voting system whereby it is often difficult to know if votes have even been lodged at a corporate AGM. But that’s not what we are talking about here. The plot thickens when you consider that the ‘role’ of proxy advisors is already included in a review by the European Commission for its forthcoming corporate governance green paper. It is, of course, also part of a review in the US by the Securities & Exchange Commission (SEC), so maybe there’s a bit of regulatory keeping up with the Jones’ going on here. Its worryingly ironic though that following a financial crisis where many governments are clamouring for shareholders to step up on corporate governance, their governance advisors are under as much regulatory scrutiny as the credit ratings agencies that mis-rated mortgage-backed securities. Talk of a ‘shareholder spring’ of institutional investors has clearly scared some horses. Perhaps it has something to do with the voting down of outsized corporate executive pay packages?
It’s hard not to suspect the influence of powerful corporate lobbyists, writ global. When the US Business Roundtable and the Chamber of Commerce last year successfully sued the SEC over a technicality on proxy access (the simple possibility for shareholders to nominate a director to the companies they OWN), it claimed that the agency had not done a proper ‘cost-benefit’ analysis before it instituted the new rule. Since when did cost-benefit analysis determine rule making? Evidently, companies were not going to cede ground to investors without a dogfight. The proxy agencies have become the whipping boys (and it’s mostly corporates holding the whip) in the stand-off between investors and companies that has drifted across the Atlantic. I don’t think it is coincidental either that proxy agencies are the weakest link in the chain: voting advice is a research intensive but relatively low budget industry, and thus potentially destabilised by any onerous regulatory requirements. The political undercurrents have been significant enough that a report from the UK’s Financial Reporting Council – not usually renowned for dramatic statement – lamented that corporates and investors had concerns about what one participant referred to as the “quiet tyranny” of proxy voting agencies: Link
One might just as easily talk about a quiet tyranny of proposed legislation where a real problem has yet to be identified.
But let’s be charitable and say that the ESMA review represents an indication that shareholder voting is getting serious; indeed the report is a good read on the ins-and-outs of the shareholder voting system today.
There are minor problems in the field that need fixing as shareholder voting becomes (hopefully) a mature,considered way of registering oversight for the millions of people who expect their savings to be stewarded in the most cost effective and conscientious manner. To that end it’s worth looking closely at the concerns being levelled. But first, a couple of major caveats. I’ve spoken with a lot of institutional investors on this topic and the over-riding view of many is that the policies of proxy advisors have generally been put together in conjunction with investors themselves and that it is investors NOT proxy advisors that vote. It’s an opening statement that is worth repeating before blaming the messenger and considering the related allegation, mostly against the big proxy advisors such as Institutional Shareholder Services (ISS) and Glass Lewis, that they influence a rump of shareholders who vote unconsciously their recommendations. Surely that’s a problem for shareholders to weigh up, if it is indeed even a problem (I’ve yet to see any actual evidence to show it). In fact, it is so rare for votes to go to a majority against corporate management that the argument is ludicrous; indeed the reverse is arguably true when many shareholders vote blindly with management (at which time, of course, there are no such corporate complaints). Another major critique aimed at the proxy agencies is the ‘accuracy’ and ‘independence’ of voting advice. Accuracy is, of course, vital, but can hardly be legislated for any more than it is in journalism, i.e. by the laws of libel, or be subject to market forces (bad advice, no clients). I think there is a case for proxy advice information to be communicated to companies in a timely manner so that they can respond to shareholder concerns. But the bigger problem is the somewhat frenetic proxy voting ‘season’ (why shouldn’t it be spread out better across
the year?) and the lack of clear structure around the shareholder voting system, which would have made for a valuable review! On independence, I fail to see how proxy agents can be any more or less independent than the investors that buy their services. Again, I think this hardly a problem that merits the kind of review that, for example, the systemically important pay-to-play system of bond ratings agencies still definitely does require. The issue of alleged conflict of interests by proxy advisors – notably aimed at ISS, although Glass Lewis has recently been under the lens also: Link – and others have similar conflicts, is one where work needs to be done. Indeed it is the main hook that critics focus on. ISS’ Corporate Services division, for example, advises corporate issuers on the governance process. The firm says the business is ‘firewalled’ from its proxy voting business and that any crossovers are disclosed. In the grand scheme of potential business conflicts in the finance world this one ranks far behind the issue of auditor/corporate advisor overlaps, for example.Nevertheless, the implication of any potential conflict is not good and would be best resolved by drawing a clear line between such businesses.
There are other questions to answer about the proxy voting business model. Are there enough sizeable players in the market to ensure healthy competition? Could and should the business model be supported by regulators in the interest of market oversight? Should investors be obliged to vote? These will not likely be raised by this ESMA review; more is the pity.
The question on the table is whether institutional investors believe they are being hoodwinked by a powerful, calculating intermediary force acting against their interests. The tenor of the ESMA review suggests this could be the case. It is a risible premise. The rights of shareholders to vote their shares and to take the advice they deem necessary to do so is paramount here. Investors must make that very clear to the ESMA.