Wednesday 28 February 2018

Melrose / GKN battle continues

Quite a lot of news on the Melrose bid for GKN today.

Unite, which is campaigning strongly against the bid, held a rally and series of meetings at parliament. It is pleasing to see that a lot of Labour MPs are speaking out against the bid too, and it is also attracting scrutiny from the BEIS committee.

As usual, my eye is drawn to what is going on regarding the ownership of the companies involved. On that point, today we've seen two proxy adviser recommendations become public. On the one hand, ISS has come out and given Melrose the thumbs up. According to Reuters, ISS is quite chirpy about it:
“Given the sensible strategic rationale, (Melrose‘s) turnaround track record and reasonable valuation, approval of the acquisition is warranted,” ISS said in a note circulated to clients last week.
On the other, PIRC has come out against the deal:
PIRC has highlighted to investors that Melrose’s decision to go hostile means that it “has not benefited from the co-operation of the GKN board”.
The adviser also said that “significant political and other considerations, including security concerns” have been raised and that Melrose has reported annual losses two years running.
Meanwhile.... speculators gonna speculate. Following up on my last blog, I've been keeping an eye on the total disclosed short position in Melrose. And they've gone up to 11.67%. From a quick skim I think that makes Melrose the 3rd most shorted UK stock in the FCA list currently, after Provident Financial and Debenhams. What is really noticeable is the position held by Davidson Kempner, which has shot up over the past month or so and now stands at 2.46%. Elliott Capital has also built up a position quickly, now at 1.7%. 

I have little doubt that a number of those shorting Melrose are also taking corresponding long positions in GKN. I think the disclosures from the like of HSBC, Bank of America and (more recently) Goldman Sachs probably relate to underlying investors building up an economic interest in GKN, in some cases through derivatives.  

I know M&A arbitrage is a fact of life these days, but it makes me wonder what we should be doing with the takeover rules. I don't believe these sorts of investors have any long-term interest in either GKN or Melrose, they are just trying to skim value off the process of the deal and its likely impact on the values of the shares of each. Yet the deal itself will have an impact - in fact already is having an impact - on the lives of thousands of GKN workers. It seems nuts that we prioritise the interests of the speculators.

Finally, I think there is an important link here with "stewardship". After all, surely one of the genuinely important roles an investor has is influencing the change of ownership of a company. So I thought I'd have a look for Stewardship Code statements for some of investors that are in the mix. 

Here are a few bits from the statement from AQR Capital (which is short Melrose, long GKN) says:
From the introduction 
The Firm uses quantitative tools in a systematic process to build diversified and risk-controlled portfolios. The process does not typically involve subjective assessments of underlying companies or direct contact with the companies in which it invests.  
In relation to principle 3 
AQR’s investment approach, as a quantitative investment manager, is systematic and does not typically involve subjective assessments of underlying companies. AQR’s proprietary quantitative systems analyse various factors, combining them with estimates of transaction costs to arrive at daily investment decisions. All investment decisions are generated by AQR’s quantitative systems, other than in rare instances where the Risk Management Committee deems the circumstances to be exceptional. AQR does not invest in companies with a view to actively intervening in their management. 
I think the firm is pretty straight up about what it does and does not do. What is more, I found the statement very easily.

However I can't find a Stewardship Code statement for Empyrean Capital, and the Davidson Kempner statement (which took some finding) contains some of the cut and paste text to explain non-compliance that I blogged about previously:
The Firm pursues a multi-strategy investment approach, investing in strategies including distressed, event driven and equity long/short, merger arbitrage and convertible/volatility some of which will involve investments in global equities, including UK equities. The Code is therefore relevant to only some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions globally and its approach in relation to the engagement with issuers and their management is therefore determined globally, on a group-wide basis, and will often vary on a case by case basis. That being the case, the Firm does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction or asset class.
In fact the text used by Davidson Kempner is very similar indeed to that used by Elliott:

The Firm pursues a multi-strategy investment approach, including strategies that involve investing in global equities, including UK equities. The Code is therefore only relevant to some aspects of the Firm's trading. While the Firm generally supports the objectives that underlie the Code, the Firm has chosen not to commit to the Code. The Firm invests in a variety of asset classes and in a variety of jurisdictions. The approach/policies of the Firm in relation to engagement with issuers and their management are therefore determined globally, on a group wide basis. The Firm takes a consistent global approach to engagement with issuers and their management in all of the jurisdictions in which it invests and, consequently, does not consider it appropriate to commit to any particular voluntary code of practice relating to any individual jurisdiction.
I guess this is what ownership and stewardship looks like in modern capital markets: generic blurb in regulatory disclosures.

Sunday 18 February 2018

Melrose / GKN bid arbitrage: like flies round...

The Melrose bid for GKN is currently subject to a lot of scrutiny, and is actively being campaigned against by Unite.

What hasn't attracted much scrutiny so far (as far as I am aware) is the extent of speculative activity that is occurring, and as such is affecting the share ownership of both companies involved in the bid. As many people are probably aware, M&A has become quite fertile territory for "event driven" hedge funds, who look to skim off value based on their expectations of how deals usually play out.

Very simply, when there is a bid it is typical for shares in the acquirer to under perform (this could reflect the cost of the acquisition, but perhaps also expectations about how it will play out). On the other side, obviously shares in the target are pushed up when the likely offer is known, but may not totally capture the premium to the pre-bid price because of uncertainty as to whether the bid will be successful. So you will often find some investors are on both sides of the bid - short the acquirer, long the target.

This is happening with Melrose / GKN. The disclosed short interest in Melrose is now over 10%.

To be honest, I've never really followed these trades closely, so I don't know if having 10% of your shares shorted is particularly out of the ordinary. But it does represent a substantial chunk of money that has an interest in the bid going ahead, and being value destructive for Melrose.

Of those that are shorting Melrose, I can already see two investors - AQR and Blackrock - that are also long in GKN (for completeness, Blackrock will also be long Melrose via index funds etc).

Meanwhile, we can also see the impact on the GKN share register. Just in the past few days both Merrill Lynch (Bank of America) and HSBC have disclosed holdings in the company of over 5% (HSBC now has over 6%). When you dig into the detail you can see two things. First, the large majority of this does not NOT relate to traditional asset management (in HSBCs case, it is very clear it is primarily the bank). Secondly, much of the holding in both cases is accounted for by equity swaps.

That means that there are other counter parties out there with an economic interest in the performance of GKN shares, but who have chosen not to (or were not able to) acquire shares. Quite possibly there are counter parties to those swaps that are shorting Melrose. And again we are talking quite a big proportion of GKN's ownership - over 11% - being tied up in these two positions alone.

There are a couple of things that interest me here. First, how do Merrill Lynch and HSBC decide how to respond to the bid? Have they ceded that decision to the counter parties? If so the future of GKN would in part be decided by investors that we can't even see. If not what is the basis of their own decision, and in whose interests is it taken?

Second, it does seem to demonstrate just how far modern capital market activities are away from any notion of "ownership" or "stewardship". A large proportion of the share ownership of both companies is accounted for by investors whose primary interest is in the event of the bid, rather than the future of the companies concerned.

Wednesday 14 February 2018

The Rise of the Working-Class Shareholder: Labor’s Last Best Weapon

Quick plug for a book that will be right up your right if you find my blog interesting... I'll get a copy and review it on here once I've read it....

When Steven Burd, CEO of the supermarket chain Safeway, cut wages and benefits, starting a five-month strike by 59,000 unionized workers, he was confident he would win. But where traditional labor action failed, a novel approach was more successful. With the aid of the California Public Employees’ Retirement System, a $300 billion pension fund, workers led a shareholder revolt that unseated three of Burd’s boardroom allies.
In The Rise of the Working-Class Shareholder: Labor's Last Best Weapon, David Webber uses cases such as Safeway’s to shine a light on labor’s most potent remaining weapon: its multitrillion-dollar pension funds. Outmaneuvered at the bargaining table and under constant assault in Washington, state houses, and the courts, worker organizations are beginning to exercise muscle through markets. Shareholder activism has been used to divest from anti-labor companies, gun makers, and tobacco; diversify corporate boards; support Occupy Wall Street; force global warming onto the corporate agenda; create jobs; and challenge outlandish CEO pay. Webber argues that workers have found in labor’s capital a potent strategy against their exploiters. He explains the tactic’s surmountable difficulties even as he cautions that corporate interests are already working to deny labor’s access to this powerful and underused tool.

Monday 12 February 2018

Rhetoric, politics and executive pay

I've been reading Enough Said by Mark Thompson, which is a thoughtful take on political language, and more generally the relationship between the public, politics and the media. I have some minor gripes already, but overall it is well worth a read.

I'm just at the section where he covers the healthcare debate, and it struck me that much of what he says rings true for the executive pay "debate".

As I've said before, I think a major problem with public policy around executive pay is the gap between rhetoric ("Crackdown" etc) and the proposals that emerge (triennial shareholder votes, companies required to disclose a bit more data). But it's clear that this applies more generally, and what Thompson add to the mix is the role of the policy specialist (or "technocrat").

So for example, on the failure of technocrats to explain what they do:
"[M]ost public policy documents remain impenetrable to the public themselves and, despite freedom of information legislation and ever great 'transparency', the gap between the illuminati and Pericles' 'ordinary working people' has grown steadily wider. And yet precious few technocrats seem to regard the explanation of policy as part of their job. Many were never trained how to do it, and even those who were may doubt whether their listeners would be capable of understanding them, given how intricate the issue have become. As their world and that of popular political debate have diverged and they've come to realise that few politicians are prepared to even raise the question of hard choices and painful trade-offs, some have concluded that even to attempt such explanation is a hiding to nothing."
I think we can see all this at play in discussions about executive pay. I would particularly flag up the way that ordinary people who have views on the subject are regarded by many insiders as unable to grasp the 'real' issues. And the avoidance of talking about trade-offs - and the corresponding emphasis (throughout the ESG world) on 'win-wins'.

Then there is the gap between presentation of policy by technocrats, and by politicians:
"The modern technocrat aims to use data and logic to formulate and debate policy in the most empirical and logically coherent way possible. The politician wants to frame those issues in as sharp and political compelling way as he can. While the first sees no rational need for ideological differentiation - just follow the facts - the second is understandably obsessed with it. Both may regard public understanding of the issues as a good thing in principle , but neither is likely to see it as an over-rising priority. When urgency is high and the potential for partisan advantage is low - following acts of God, say, or when dealing with new diseases or other population health emergencies - technocratic and political priorities may align around simple, clear information and advice to the public. But such moments are rare."
I imagine a fair few people reading this will be mentally tut-tutting about the behaviour of the politicians in these scenarios, and your instinctive sympathy may be with the technocrats. In response to which I will adopt an Alan Hansen voice and say: "You don't know the game." We need to consider why politicians act the way that they do.

Thompson says:
"The crowd listening to expectantly to the candidate require one kind of public language; the audience of of experts discussing an arcane matter of policy quite another. Politicians respond differently to each, not because of a given 'mindset', but rather because they are professional communicators and it is clear to them what the context and pathos of each occasion demands."
He has a bit to say about the changing modes of political rhetoric when a party and its representatives shift from opposition to power, As famous the aphorism puts it: "You campaign in poetry. You govern in prose." When a party is seeking to gain power, which in practice means building a coalition of various groups of voters, the presentation is necessarily different. Problems arise when a shift is required, from campaigning mode, to governing mode.
"Barack Obama is perhaps the most obvious example of the two rhetorics, the change we need giving way almost overnight to tight-lipped and sometimes testy managerialism. The word-worlds of Obama the campaigner and Obama the president turned out to be so different that it was almost as if they were twin brothers with contrasting personalities - the electorate voting twice for the passionate rebel, yet each time finding themselves stuck with a professor who, desire his undoubted intelligence and grasp of the issues, seemed somehow to have mislaid the unbounded sense of possibility and hope which made him so attractive in the first place.
But the thing that really hits home is this bit:
"[T]he character of modern politics - the competitive bidding on emotive policy issues, the immense pressure to oversimplify to get the headline, the sheer complexity of government, the furious media scrutiny which meets any shortcoming - seems to have increased the amplitude, by which I mean the distance from the peak of expectation to the trough of disillusion.

"When we think of political failure, we tend to think of failed actions, the policy that didn't work, or the economy that didn't revive. But much of today's sense of betrayal is focused on politicians' words and the gap that often appears between those words and reality."
These two paragraphs really do apply to executive pay. Over the 15 years or so I have been following it, the language around this issue has become more charged (I'm less sure it has been simplified). Where once the focus was on pay for performance, and avoiding "rewards for failure", the rhetoric introducing policy has shifted markedly towards scale, the pay gap and "greed".

But the underlying policy has not significantly shifted. The default assumptions in the technocratic sphere - in which I would include ESG professionals as well as civil servants in relevant departments - remain that pay is matter for the market, and that shareholders are best placed to oversee it. Policy has been far more focused on alignment with shareholder interests (also known as performance linkage... ;-) ) than the scale of pay, or its relationship to that of employees. I don't think anyone in the technocratic sphere would honestly consider that the last round of executive pay reforms would make a serious dent in inequality, either within the firm or across society. Many would consider that these are not appropriate objectives in any case.

To the extent that the public follows executive pay, I think the impression that they gain is that there is a lot of tough talk, but that after it everything carries on much before. Which is not an unreasonable view. There is a gap between rhetoric and reality.

As I've blogged before, I don't believe this divergence is sustainable, or desirable. As long as it continues it will feed disenchantment with politics (which conversely makes it easier for "insider" interests to control policy). In practical terms, technocrats could shift to policy proposals that at least attempt to meet the aspirations that politicians articulate, or politicians could tone down their language. But something should give.

Thursday 8 February 2018

What's reasonable?

I've been thinking a bit lately about trying to be a bit more constructive in my approach to corporate governance and "responsible investment". As anyone who has followed my blog for a while will know, I am thoroughly disenchanted with the 1990s model of corporate governance. I think it is built on shaky foundations, and has failed to deliver in practice.

Here are some of the views I've expressed on here over the years that sum up where I'm at:
  • Shareholders are not "owners" of companies, either de jure or de facto, and have no inherent right to primacy in the governance of companies.
  • Shareholders are also not generally effective "stewards" of companies, despite repeated public policy initiatives to encourage better oversight.
  • Shareholder and other stakeholder interests within the firm can and do conflict - labour costs are an obvious area, but also worker representation on boards.
  • "Responsible investment" (RI) in practice leans heavily towards G and E issues, and is generally very weak on labour/workplace issues.
  • RI is shot through with class biases - i.e. far more interest in gender diversity at board level than equal rights and remuneration for women throughout companies.
  • The views and interests of beneficiaries are not meaningfully represented within the system, and the shift to "professionalise" trustee boards exacerbates this.
  • A focus on disclosure, performance linkage and shareholder powers as a way to constrain executive pay has had very little success.
  • The views of many ESG professionals on executive pay are to the Right of Conservative voters.
These are obviously all negative views. For balance obviously I know many people would be critical of what I and others in the labour movement thane said and done over the years. I also know many people who are trying hard to make a difference. Nonetheless I do feel we are at an impasse, and further rounds of trying to do the same thing are not going to achieve anything.

As someone who believes that conflict between interests both within the firm and within society is inevitable and desirable to some degree. I don't think any settlement lasts forever. But it does feel like the right time to on the one hand stop trying to reassert a model that is failing and on the on the other stop simply criticising that model in general terms. Instead we ought to be talking seriously about the outlines of what comes next.

So I'm going to start sketching out some initial thoughts. Here are my first two:

1. There should be an acceptance of the role of multiple stakeholders within the governance of the firm, not just shareholders.

I know many of us like to indulge the fiction that it's really the public that who are the shareholders, and therefore we're really arguing against ourselves. But in Actually Existing Corporate Governance a tiny minority of the public think of themselves as shareholders, while most people operating within large shareholding institutions do not act as if they represent the public interest. (I am doubtful if many of them even really think/act day-to-day that the money they manage and exert influence with belongs to other people.)

In reality power resides almost exclusively with asset managers, and most of the people with that power continue to advocate that shareholder interests come first.

This needs to end. Plenty of other successful economies have corporate models that do not place the role of shareholders above all others. Those of us in the UK that advocate for a different model are not plotting a deliberately destructive attack on the status quo to advance a political agenda, we just think the existing model has serious flaws and want to try something different.

Therefore lets have a proper discussion, involving all parties and giving equal weight to each (AUM figures won't count for anything here), about how we get from here to there.

2. Executive pay will have to be tackled politically to some degree.

Two things are obvious about executive pay - it's not going away as a political issue any time soon, and technical fixes of the kind offered by insider experts have been hopeless. It also remains the case that the people who have most control over the setting an approval of executive pay (board members, rem consultants, asset managers) have views that are well to the Right of public opinion, and even Conservative voters. I know many people in that milieu consider that public opinion is basically misinformed / "wrong". But, given that pretty much everyone else in society disagrees, surely it is time for a bit of self reflection.

Executive pay is reputationally corrosive for our economic system. Most people think the system is a swindle. But it's not just popular opinion. You can read just as much material as a rem consultant and reach the same judgment in an informed way. Trying to tackle executive pay through disclosure, performance linkage and shareholder power has taken none of the heat of the issue, and executive pay has continued to outstrip average earnings. It is not unreasonable to think this is unfair, and it is not unreasonable to questions executive pay in terms of whether relative rewards are fair (rather than just whether pay has been "earned" by performance).

It is simply not possible for shareholders to bring about the sorts of changes that society thinks are fair. Indeed, whilst most shareholders are inactive on the aspects of pay that the public finds most infuriating, saying "leave it to the shareholders" is only going to make the politics of pay worse. Therefore, institutional investors are going to have to accept that shareholder oversight is not the only game in town, and they are likely to play a smaller role in this issue in future (and some of them won't mind I think).

Disclosure of pay ratios is very obviously not going to be the end of the story.

Thursday 1 February 2018

Can we expect better from investors?

In a move that should surprise no-one, the two parliamentary committees looking into the Carillion collapse have written to some of the companies major shareholders. Among the things that MPs want to know are the extent to which shareholders engaged with Carillion before its implosion, and whether they complied with the Stewardship Code.

I personally think this is a good thing, and would only add that it would make sense to ask the Investor Forum for any information on engagement with Carillion, whether it got off the ground or not. And perhaps they should also ask institutions who it is within their organisation that engages with a company, and with what objectives, when they are simultaneously short and long on the same stock.

But, snarks aside, I am a bit worried that we roughly know the answers that will come back already. There will have been some engagement with the company, some concerns will have been raised, and investors will argue that they are very committed to the Code. I think it is unlikely that any major investor is going to put their hands up and say they could have done better, or that they need to look at how they apply the Code in practice. There are no lessons to learn, no need to improve.

We can see this a bit in the responses to the news that a certain large asset manager was shorting Carillion whilst also managing money for the company's pension schemes. You can draw a line down the middle and broadly those on the side working in the industry said "huh? so what?" The response of people I have spoken to who are on the other side and not in the industry was... unprintable.

This points to a gulf in expectations between the two groups. For many us, if you contract with a firm you think you have, broadly speaking, bought their loyalty. Therefore to subsequently find out that the firm you contract with is also betting on your demise is.... somewhat aggravating, and... does not serve to build trust (I have put this more politely than others have).

But for people within the industry, there is clear sense that those criticising such practices simply "don't get it". Or, as someone snootily tweeted to a colleague of mine, "trade unions don't understand fund management". There is general incomprehension that anyone could have a problem with a manager betting against a client. Some managers are so big they are bound to have conflicts like this, and they have Chinese walls, and, hey, no-one is doing anything illegal.

Yeah, well, maybe.

In my experience, when anyone starts saying "it's not illegal" in defence of an activity, it is usually also a sign that the sands are shifting under their feet. "You can't charge us with an offence" for a certain activity is a pretty low bar to clear. It's not illegal to not engage with companies in difficulty, it's not illegal to not vote your shares, it's not illegal not comply with the Stewardship Code. But we have moved to an expectation of how big investors ought to behave. And expectations continue to shift. That is what this is really about - what can we reasonably expect from asset managers? Can we expect loyalty to clients?

To be honest, I could accept it if it what comes out of Carillion is that actually, no, we can't expect asset managers to act solely in their clients' interest. They want to be able to both take money from an organisation and bet on its demise at the same time and won't give that up. Many people I speak to have very little trust in the finance sector in general or the asset management industry specifically. So if it's made clear that this lack of trust is warranted, at least this is all out in the open.

But then let's also stop pretending that investors can really play an effective oversight role - they are ultimately going to pursue their own interests. And let's end the fiction that there is a reasonable basis for shareholder pre-eminence in corporate governance. Rather it's just history, habit and the shared interest of corporates and finance in shutting other voices out.

So by all means continue to bet against your own clients, or whatever other activity is required to keep the blood funnel satiated, if that is your wish. But do not be surprised if the recipients of letters from investors telling them they need to start behaving more responsibility think "you first".