Friday 30 January 2015

Pension funds in action

Blogging is light to non-existent currently, but here are three nuggets worth flagging up.

1.  Pretty incredible win for investors worried about climate change - Shell has recommended that shareholders vote FOR their resolution at this year's AGM. Great work by CCLA, Share Action, ClientEarth and others pushing this campaign along. Anyone know if this has happened before? (Maybe at BAA years back??)

2. Railpen, PGGM continue their struggle to bring a bit of sanity to executive pay at Oracle. The company has seen a majority of its shareholders oppose it on its 'say on pay' resolution for three consecutive years, and this is with Larry Ellison controlling 25% of the votes. If you believe that executive pay needs reining in, and that shareholders are part of the solution, you should be very worried by Oracle.

3. A useful guide to help asset owners ensure that asset managers are properly taking account of ESG issues has been produced by a group of UK pension funds. It's available on the website of West Midlands Pension Fund (one of those behind the initiative) here.

Friday 23 January 2015

Why exec pay oversight can be weak

Because I'm a geeky person, I often search Investegate for AGM results. I just found this RNS announcement from Diploma PLC from Wednesday -
All of the resolutions put to shareholders at the Annual General Meeting were passed by poll votes and the results of the AGM are announced on the Company's website at
Move along, nothing to see here? Well, I'm also a suspicious type, so whenever I see an RNS that doesn't have the actual results in but says check the website later I wonder if someone is trying to bury bad news (though to be fair it looks like this is how Diploma normally reports). So off I go to Diploma's IR site for the AGM results (PDF). And look at the result on the rem report (res 12). Not only is the vote against very big (43%) on a for/against split, if you include abstentions then only a minority actively supported the rem report.

Those of you paying attention at the back will remember that the UK Corporate Governance Code recommends companies to publicly respond to big votes. It says -

When, in the opinion of the board, a significant proportion of votes have been cast against a resolution at any general meeting, the company should explain when announcing the results of voting what actions it intends to take to understand the reasons behind the vote result.

Again to be fair to Diploma they do this. Note 4 to their AGM results, as far down the page as they can put it, says the following:

In relation to Resolution 12 (the Directors’ Remuneration Report) there was a significant proportion of votes that were cast against the Resolution. The Board will consult with those shareholders who voted against this Resolution in order to understand their views. To date six shareholders, representing ca. 10% of the Company’s shares have engaged with the Company regarding their decision to vote against or abstain on this Resolution.

I think they can say meet the requirements of the Code. But I am pretty sure, having been involved in the consultation at points on the last round of exec pay reforms, that people were thinking that companies would stick out RNS announcements about their response to big votes against.

As ever, whenever this stuff isn't properly defined some will find ways to wriggle through the gaps.

When unions meet capital markets...

Anyone interested in the capacity for trade unions to mobilise the capital sitting in our pension funds should take a look at the Global Proxy Review produced by the Committee on Workers' Capital. The Review is intended as a tool for trade union trustees to bring accountability into the investment chain.

Already unions in a number of countries carry out their own surveys of how asset managers vote on key issues each season. The CWC review is intended to provide a global overview, something that is increasingly necessary given that in a number of countries our pension funds' equity portfolios have a significant overseas element.

There is some useful commentary, too, about the problems that trustees face when they invest via pooled funds. From what I've heard, this is an issue that has cropped up in a number of markets. We all face the same problem, but it can be overcome. It is entirely possible for managers to vote a pro-rata holding, but trustees need to argue for this to happen.

Anyway, below is some more info on the Review from the CWC site. It is well worth taking the time to have a look at the Review and online resources.

The 2014 Review provides an analysis of 44 key proxy votes that raised environmental, social and governance (ESG) issues at corporations likely to be held in the global equity portfolios of pension funds. In this year’s report, highlights include:
• Key vote analysis suggesting a higher likelihood for shareholders to vote against management in the USA, the UK, Canada and Australia than in Continental Europe and South Africa;
• A section highlighting challenges related to proxy voting guidelines in line with best practice over ESG issues in pooled funds;
• The participation of nine countries, including the addition of France as a contributor.
The Global Proxy Review is a pension trustee’s guide to key shareholder votes at multi-national companies across the globe. With this oversight tool, trustees and investors can evaluate the performance of fund managers or proxy voting services on the most important environmental, social and governance issues of the year.
Access to the 2014 Report (EnEsFr) and media release.
To access previous reports and partner resources, click here   

Sunday 18 January 2015

Standards-based voting

Just a quick point I think is worth developing. Many asset owners now use passive management for at least a sizeable chunk of their assets, usually equities in developed markets. This seems likely to grow due to a mixture of disillusionment with active management and growing pressure to reduce the fees paid to intermediaries.

So we should be clear that, in going passive, those asset owners are at least implicitly making the choice to hold certain equities on the basis of their inclusion in an index rather than because an asset manager has analysed the company and selected it for investment.

Now, one of the arguments against asset owners directing their own votes is that asset managers know or understand the companies better, and that their corporate governance activity is bound up with this. But if you go passive you are rejecting the idea that asset managers can make you money by analysing companies and trading on the basis of that analysis. If that is the case, it is not obvious why you would think they are going to be any better at knowing what corporate governance outcomes are most beneficial or the best way to vote your shares.

If that's the case, then I think there is a good argument for voting in a way that supports a consistent set of values. Obviously for asset owners that are linked to charities, NGOs and similar those values are going to suggest themselves. But even for others, why not build a policy around existing global  standards? Clearly my interest would be in getting investors to vote to promote standards like ILO principles (this in itself would be a straightforward way to stop the S in ESG being silent) but there are plenty of others.

If you don't believe that asset managers can make you money through their analysis, why not use the rights that have landed in hands through investing in equities to promote the kind of corporate behaviour you think beneficiaries would like to see? Adherence to existing and widely accepted global standards seems like a pretty low bar. Why compromise?

Thursday 15 January 2015

Pooled funds, voting and fiduciary duty

As some people will be aware, there is a considerable degree of frustration amongst some asset owners in the UK that they are unable to vote how they want when investing through pooled funds. There isn't any technical reason why this can't happen, some asset managers will let you do it, but, at present only a few play ball.

One of the reasons that asset owners want to vote for themselves is because they don't agree with how managers vote and/or have policies of their own. I personally think there is a strong argument for this when you look at how some of the big mainstream managers vote for the large majority of what companies put in front of them. Unfortunately, as I've blogged before, the FRC has basically sided with the asset management industry on this one.

However, it struck me that the debate around fiduciary duty may require this one to be revisited. Imagine you are a trustee of an asset owner that has a very good sense of what beneficiaries views are. For example, you are a trustee of the pension fund for a charity or NGO. You may have chosen to used pooled funds because you believe they are cheaper than a segregated mandate (might not be true actually, but anyway....). Now imagine there are is a shareholder resolution, or a management proposal for that matter, where you are certain that you know what beneficiaries' views would be, but the manager wants to vote the opposite way. If the manager won't let you over-ride their policy you are contradicting beneficiaries' views.

From my limited understanding, the Law Commission doesn't quite say that you should take beneficiaries' views into account if you are clear what they are. But I do wonder what would happen if someone actually tested this out. It does seem odd that you are forced to support something that you know those you owe a duty to are opposed to.

A standard response would be to say that if you're that bothered about voting you should go down the segregated route and avoid the problem. But arguably that means imposing a financial penalty on those that want to vote, or, if you really want to point it up, charging trustees for acting in the interests of their beneficiaries. Might be worth someone testing the ground?

P.S. This could look particularly weird where the mandate is with a passive manager. In such a case you clearly haven't appointed the manager because you believe that their analysis of companies is superior, you just want to track an index, so it isn't like their voting is part of a package. I'll come back to this one.

Monday 12 January 2015

Fraud: investor priorities and attitudes

Luigi Zingales has been involved in some interesting work on fraud. In this paper he and co-authors look at who detects and exposes fraud, and they find some perhaps surprising results. Employees are the whistle-blowers most often (and, as such, the suggestion is made that further incentives are provided to encourage more of it) followed by regulators and the media. But auditors, analysts and short-sellers are further behind, external shareholders barely get a look in. There is nuance to the picture, if you read the paper they do find that short-sellers are quicker at exposing fraud (9 months versus 21 months for employees), but they expose less of them.

Zingales has also done research into the prevalence of fraud. He and his co-authors estimate that, in any one year, there is a 14.5% probability of a company engaging in fraud. In his book on crony capitalism, Zingales says that 5% to 10% of public companies are affected by fraud every year, though some of this may not be significant in scale. He also argues that one of the reasons it may be so prevalent is because it's not really anyone's job to find it. And notably he goes on to draw a link between the failure to root out unethical behaviour like fraud and the nature of board appointments (i.e. directors are selected by existing board members).
Corporate corruption and fraud occur when controls are weak, and controls are weak when the people in charge have no incentive to challenge the CEO. Yes, there are many serious board members who do their jobs well – but they do so despite the incentives… [C]orporate board members care less about their reputation with shareholders than their reputation with CEOs
So what do we make of all that? A few things suggest themselves. First, investors should probably assume that there is fraud happening somewhere in their portfolio. It may not be a significant risk (though Zingales et al say: average corporate fraud costs investors 22 percent of enterprise value in fraud-committing firms and 3 percent of enterprise value across all firms) but it's probably there.

Second, they should support moves that increase the incentives to expose fraud and decrease/remove the incentives to hide/ignore it. Taking the latter first, this surely means trying to make the auditor as independent as possible, for example by banning or strictly limiting non-audit work. It also seems to strengthen the case for making board members more accountable to others than simply those that appointed them. And it suggests that investors might want to find ways of encouraging employees to speak out.

Finally, in my own corner of the world, I would argue that these findings also mean that corp gov people in particular ought to adopt a sceptical/suspicious approach. Financial (and other) wrongdoing may be much more prevalent than we tend to think, and the incentives for companies to tell investors the truth are... ahem... not straightforward. I can think of a couple of companies I've engaged with that were subject to controversy of one form or another where what we were told initially proved to be wildly inaccurate - and that's if I'm being charitable and assuming they believed what they were saying. It was only because we stuck with it, and probed a bit, that the stories unravelled. And as we saw with News Corp / News International, even major corporations will issue public statements that bear little relation to the truth.

It can be difficult, embarrassing, career-limiting and so on to challenge senior people like board directors when you aren't confident in what they are telling you. But, if you accept Zingales' point that no-one really has the job of exposing wrongdoing, then I think we have a duty (and not just a fiduciary one) to ask the awkward questions.

Saturday 10 January 2015


There's an interesting article in the Economist about the 'on-demand' economy.  As you would expect, they are very positive about the rise of things like Uber, but even they recognise that this isn't a pain-free future. Here are the final few paras:
Consumers are clear winners; so are Western workers who value flexibility over security, such as women who want to combine work with child-rearing. Taxpayers stand to gain if on-demand labour is used to improve efficiency in the provision of public services. But workers who value security over flexibility, including a lot of middle-aged lawyers, doctors and taxi drivers, feel justifiably threatened. And the on-demand economy certainly produces unfairnesses: taxpayers will also end up supporting many contract workers who have never built up pensions.
...Many European tax systems treat freelances as second-class citizens, while American states have different rules for “contract workers” that could be tidied up. Too much of the welfare state is delivered through employers, especially pensions and health care: both should be tied to the individual and made portable, one area where Obamacare was a big step forward.
But even if governments adjust their policies to a more individualistic age, the on-demand economy clearly imposes more risk on individuals. People will have to master multiple skills if they are to survive in such a world—and keep those skills up to date. Professional sorts in big service firms will have to take more responsibility for educating themselves. People will also have to learn how to sell themselves, through personal networking and social media or, if they are really ambitious, turning themselves into brands. In a more fluid world, everybody will need to learn how to manage You Inc.
To be honest, the last bit about people having to develop their own personal brand sounds to me like the perfect background to some sci-fi dystopia. But the point about the individualisation of risk is what I find most interesting. This is actually part of a broader process. For example, it is undoubtedly happening in the pensions world in the UK as DB disappears and is replaced by DC. Companies made this switch precisely because they didn't want to shoulder investment risk, and their investors tend to agree. It's notable that there was a very positive response when Tesco announced, along with other moves, that it was considering planning to close its pension scheme. Similarly, labour market practices like zero hours contracts and self-employment promoted in terms of how 'flexible' they are, but again it is the individual who bears the risk. 

Often you get told that employees like this flexibility too, but I do wonder if this is in part because the risk is difficult to grasp. Certainly the DB to DC shift was accomplished in the private with little resistance, which I think was only possible because people didn't really get what was going on (maybe also because initially it only affected new employees). The same may be true of other forms of flexibility. It seems that quite a few of the Citylink drivers were self-employed, and it's when the company runs into trouble that the nature of risk becomes very real, and flexibility more double-edged.

The outcome of these processes is that actual living human beings are expected to shoulder more risk in their working lives (even if they don't quite understand it) in order that risks within companies are controlled. And this is welcomed and encouraged by market participants, who are often investment intermediaries for the same people onto whose shoulders risk is being shifted, on the basis that this is good for the company and its investors. There seems to be a disconnect between between this being a good thing at an aggregate and/or abstract level (i.e. what does it mean to say offloading risk is a good thing for companies, who specifically is benefitting?) whilst being potentially very damaging in real individuals' lives. 

FWIW I don't think the directors of the companies offloading such risk like it in their own lives. As PwC have pointed out, many directors don't like variable pay very much and, they argue, the total scale of executive reward probably partly reflects an attempt to address this. However, they seem quite comfortable making others with significantly lower incomes and less wealth take more risk.        

Friday 2 January 2015

A few New Years thoughts on corporate governance

When I was at the TUC, we once got Brendan Barber on Newsnight as part of a slot on executive pay. I think this was around the time of the GlaxoSmithkline pay defeat in 2003, and I can remember Brendan arguing that shareholder votes on remuneration should be binding and Peter Montagnon, then at the ABI, arguing that we should give the then new system of advisory votes time to bed down to see if it works.

Ten years or so later and we've just been through the first season of binding votes on remuneration policy. Surprisingly, this has not led to a swift reduction in levels of executive pay... Nonetheless, this got me thinking about some of the other policy positions we were advocating on institutional investment issues back then. Along with binding votes, we also said institutional investors should disclose their voting records, that abstentions were pointless on pay (given the vote was only advisory anyway) and we encouraged trustees to get the ISC principles on responsibilities of shareholders into their schemes' SIPs. (This last bit is basically a greatly watered down version of the Myners Review recommendation that there should be a legal duty on shareholders to intervene.)

At the time, these were all seen as pretty hardline positions, and, as such, were opposed by the large majority of people in the asset management industry (with the honourable exception of what was Co-operative Asset Management). I got used to being told that unions didn't really understand how this stuff really worked, and what we were proposing was nonsense. In particular I fondly remember a very angry man from Newton telling me how wrong we were to campaign for public voting disclosure, and a compliance person from Insight telling me it was legally impossible to make voting records public. 

To state the obvious, these positions that we, and others, were advocating back then are now mainstream. Most large asset managers disclose their voting records, some of the big ones (i.e. Legal and General) now don't abstain on anything - a position also promoted by the NAPF, and we have the Stewardship Code, which is written into many pension schemes' SIPs. It was even a Conservative-led government that introduced binding votes on pay, and a Tory Prime Minister who fronted the policy on TV (on Andrew Marr I think). And, if anything, corporate governance 'reform' has actually gone a bit further. The Stewardship Code expects a lot more than the old ISC principles, we also have annual elections of directors and so on. 

There are two things I take from this. First, and most importantly, the asset management industry talks a lot of crap. Lots of things that were claimed to be dangerous, or even impossible, to enact have been put in place. The sky has not fallen in. To the best of my knowledge, asset managers have not been threatened by shadowy single issue groups (unless you include Barclays under this label...) because of how they have voted or intend to vote. Yet this was an argument that was regularly wheeled out against voting disclosure. Companies have not spent millions unpicking directors' contracts because of the introduction of a binding vote on rem policy. Entire boards have not been voted out because shareholders misused the annual vote on director elections to gain control of companies by stealth. Asset managers haven't been sued for failing to intervene in companies. 

In short, an entire wave of industry lobbying effluent crashed on the rocks of reality. Those of us who still see the need for change should remember this, because they will do it again.

Which leads on to point two: in fact, despite all the reform, not a lot has changed. Shareholders (which in practice means mainly asset managers) have been given more power and more information, and been prodded repeatedly to encourage them to act more like owners. But I remain to be convinced that actual behaviour has shifted considerably. I think the FRC has kind of hinted at this in its work on the Stewardship Code. In at least one report it suggested that companies haven't noticed a change in the nature of engagement since the Code came in. 

This leaves us in an interesting position, since I don't see a lot more that can be ticked off on a shareholder-focused corporate governance program. We could make it easier to file shareholder resolutions, we could introduce a vote on business reviews, and maybe we could improve company disclosure. But essentially this would be 'more of the same', and I don't think anyone would expect much change from a list like that. The UK already has a very pro-shareholder governance regime. The problem continues to be that shareholders don't seem to keen on their responsibilities. Sooner or later this seems likely to lead to a shift in direction.

All this hasn't quite worked itself through the system yet. But I am pretty sure it's in the post. For example, as I blogged quite a lot in the past, I don't think shareholder primacy exists any longer in a meaningful sense in systemically important financial institutions. I think regulators have too little faith in shareholder oversight to see investors playing any serious quasi-regulatory role. I actually think, to the extent they are interested in shareholder activity, they probably care more about trading decisions than engagement. Shorting activity in particular gives you a sense of practical market sentiment, and may help identify problems, but the ability of shareholders to actually fix such problems is unproven. I suspect the FCA knows that big asset managers are too uninterested and conflicted to act as real guardians. (The comments from banker-turned-finance-academic Peter Hahn here are interesting in this respect.)

In my opinion, this means that for banks, and maybe other bits of the finance sector, we actually have a regulatory governance model while formally retaining the fig leaf of shareholder primacy. John Thurso may have lost his battle, via the PCBS, to explicitly remove shareholder primacy at the banks. But I think the point he was trying to make has already been accepted by some important people, even if it isn't explicitly acknowledged.

This is certainly a shift in direction, but isn't a big win for opponents of financialisation or whatever you might call it. The net result is a strengthening of regulators, but their own role is drawn pretty narrowly and this represents what I think is a desire amongst many politicians for a technocratic response. e.g. Let's get some 'experts' to make sure the banks are doing what we think they ought to be doing. What those experts in turn propose and enact will be framed in terms of economic efficiency, with other broader questions not getting a look in. Unfortunately this seems to be a good example of what Peter Mair was getting at in his comments about the 'regulatory state'.

That said, there are some interesting emerging contradictions in all this. Remember, the idea of shareholder oversight is that investors/owners have the strongest incentives to intervene, and, under shareholder primacy, have the legitimacy and power to act. So much for the theory, but it is found wanting in practice. First, the increasing interest amongst some investors in 'public policy engagement' is a recognition that they need some things doing for them (like requiring disclosure of certain types of information). Second, the existence of the Stewardship Code similarly acknowledges that market participants need to be pushed to get them to behave in the way that is supposed to be in their own interests. So the state is required both to compel companies to do things (provide certain information) that their owners can't get them to do, and to get the owners to behave like they are expected to. Both sides of the company-shareholder relationship are being structured by state power to deliver outcomes that are supposed to be market driven. So even in financial markets laissez-faire has to be planned...

On similar turf, I think the failure of shareholders to address the growing gap within companies between executives and the rest (because most asset managers don't have any interest - in either sense - doing so) will become significant. If shareholders can't/won't tackle the aspect of pay that causes the political problem - the size of it! - then either we give up, or we look elsewhere. I don't underestimate the unwillingness of a lot of people to really tackle this one, so the executive class can probably keep asking for more for a few years yet. But at some point I think the political pressure to intervene will be too great, and I think whoever is in government will have to do something quite different. And given that executive pay is the area of most shareholder engagement, if this does happen it will be quite a big knock to the whole shareholder primacy idea.

All this opens up the possibility of a more interesting change of direction, though not much more than that. I think redrawing directors' duties and introducing significant employee representation and ownership in the governance of companies are some of the things the Left should be properly exploring now (I also like the IPPR profit sharing idea). This could form the core of an alternative regime. Shareholders will always be an important component of the governance of public companies, and that will continue. But in the UK we have plenty of experience now of trying to rely on them alone to address a whole range of issues. It doesn't seem to work very well. And, as the executive pay example shows, sometimes their interests pull in a different direction to those of other stakeholders so they may be incapable of doing what is expected. So it makes sense to look at the role others can play, and the failures of recent years provide the opportunity. I think you can see the first signs of a shift in things like the interest in B Corporations, and the increasingly wide range of people who criticise shareholder-centred governance.

To reiterate what I've said before, there is nothing inevitable about such change taking hold. While the existing corporate governance regime looks like it has some big holes in it, if we want something different we need a clear idea of what it is, and what the evidence is for it (and we might have some interesting allies). In addition, as we can see from the response to relatively minor reforms - within the shareholder-centred model - vested interests will claim that such change is a threat to capitalism/wealth creation/small children and fluffy animals. There's a lot to play for, but a lot of work to do.