March 2011

SHAREHOLDER MUSCLE: do fund managers care about remuneration?

Shareholder_muscle_1There has been an outcry against bankers’ pay but as bonus season comes around again, Nick Fitzpatrick asks if fund managers care about the issue as much as the public does With no clear link between individuals’ pay and their performance within banks, who’s to say that if the clampdown on bankers’ remuneration was too severe, the bankers who threaten to leave Europe are the ones worth keeping? Using the law of averages is about as scientific as forecasters could get in trying to measure the impact of the threatened brain drain from London and other banking centres if talent emigrates to locations less restrictive on pay. As much talent would stay put as would go, leaving enough behind to justify tax payerfunded plane tickets for the émigrés. The link between pay and performance has been on the schedules of those who take corporate governance and shareholder activism seriously for some time. Against the backdrop of the financial crisis, the topic’s urgency has been magnified by the link made between pay and performance on the one hand, and a country’s economic stability on the other. The link between bankers’ pay and systemic risk in economies may be pretty clear-cut, but the connection between the way people are rewarded and their individual performance is still opaque. As bonus season comes around again, shareholder activists representing institutional investors are likely to step up pressure to reveal this link, and there is now the worry that bankers’ rewards – which still lack clarity in their structures – are rising again. Colin Melvin, chief executive of Hermes Equity Ownership Services, which advises institutional investors – among them its owner the British Telecom Pension Scheme – about how to vote shares in companies they own, says: “Recently we have seen an increase in fixed pay and we think this is making the situation more risky.” He adds: “We need to recognise that financial services firms’ revenues vary with the value of their assets and that they need flexibility in their employment costs. The key is to link variable pay – bonuses – with individual and company long-term performance, rather than just simply to allow staff payments to rise with a rising market.” Similarly, George Dallas, director of corporate governance at F&C Investments, says better financial results have caused bank rewards to increase, in some cases prematurely, in the recent past. “Many banks in 2009 had a difficult start to the year but results in many cases picked up notably. This caused remuneration committees to grant significant bonuses. “We understand that at one level, but we questioned whether the sector really was improving so much and whether any improvement was down to great management or the fact that sovereign intervention propped up the banking sector as a whole, with the after-effect of creating public sector deficits that are still troubling many economies, including the UK’s.” But F&C and Hermes do note some positive trends, such as an increase in deferred bonuses. Shareholderchampions
In the business of investment management, Hermes and F&C, a London-listed fund management company, are champions of shareholder activism. However, the two managers differ through the ballot box in how to deal with the issue of bankers’ rewards. Shareholder activism usually manifests most quantifiably in activists’ voting records and F&C has a much harsher record of rejecting remuneration packages than Hermes. For the major London-listed banks in 2009, for example, F&C voted against accepting the remuneration reports at Barclays, Lloyds, Royal Bank of Scotland (RBS) and Standard Chartered, while abstaining at HSBC. Hermes voted against RBS but did not oppose the rest. In 2010 Hermes voted for accepting Barclays, Standard Chartered, RBS and HSBC remuneration reports, while voting against Lloyds. Figures were not available for F&C, though Dallas said F&C’s stance generally continued and, in fact, stiffened. Other institutional voters have been similarly tough at the ballot. Pirc, a UK corporate governance agency which advises institutions how to vote, opposed all banks in 2009 except Lloyds, in which it abstained. In 2010 it opposed all of them. Aviva Investors either opposed or abstained on the five banks’ remuneration reports in 2010 and in 2009. So why did Hermes adopt this seemingly softer voting stance? Melvin says: “We consider each vote on a case-by-case basis linked to our ongoing discussions with the banks and we did not vote in favour of all of them. The vote is a blunt tool and what makes change happen is our engagement work, which is in-depth with banks.” By way of indication of their clout, between them the corporate governance activities of Hermes and F&C rest respectively on £70bn (€82.1bn) and £82bn globally. Their aim is not to reflect public sensibilities on issues such as pay, tobacco and arms, but enhance shareholder value. To that extent, all partake in a form of behind-thescenes lobbying away from the occasionally raucous meeting grounds of AGMs. “Many institutional investors have voiced discontent over the issue of remuneration at banks, either publicly or with those institutions directly,” says Iain Richards, regional head of corporate governance at Aviva Investors. “However, it’s important to look at the voting records to see whether and how often they actually opposed the remuneration reports.” Despite the similar voting stance of some of these organisations, they have only managed to make a small dent in the overall shareholder voting patterns over remuneration. In fact, since the banking bail-out, shareholders en masse have only once rejected the executive remuneration package of a British bank. This was at RBS in 2009 when only 8.5% of shareholder votes were in favour of accepting the remuneration report. Dallas says: “Whether a vote achieves 50% or not, I think that shareholders are still sending a clear message about remuneration. We are acting on the basis of our clients’ interests and we are sending a strong signal that this is something boards should be focusing on.” Richards adds: “In many ways, the regulators have achieved a greater amount of change on bank pay than investors have been able to, and much more quickly, as seen through their stance on bonus deferrals and clawbacks. There is a sense that some investors would prefer to let banks manage their business in their own ways rather than confront the design and extent of remuneration.” Remuneration code
The latest regulatory weapon in the UK is the Financial Services Authority’s remuneration code. Introduced in January, it is a revised version of a previous document and designed to apply to hundreds more financial services firms than its predecessor. Richards says: “Following the remuneration code, we expect many pay arrangements to be more risk-sensitive. However, the headlinegrabbing packages for executives and other high-fliers are unlikely to go away.” And neither will the shareholder activists. F&C is focusing on remuneration below the board level. “A main concern is where there are executives whose remuneration may be more obscure because it is not published,” says Dallas. He acknowledges the difficulty in publishing this data without producing a virtual benchmark pay index that could cause banks to ratchet-up pay to stay competitive. “It’s an issue we raise with the banks,” he says. Melvin says Hermes will continue to seek an alignment of interests between its pension fund clients and the banks in which they are long-term shareholders. “We have developed some principles for bank remuneration to align it with long-term shareholder interests and economic stability, which we are using in our engagements,” he says. Does he think Hermes, and others who seek to control rewards, might be responsible for driving banking talent overseas? “No. There is a long way to go with remuneration and risk. We have to tailor remuneration for companies and their individual circumstances and not be beguiled by an illusory market in talent. We need to see reward linked to performance.” ©2011 funds europe

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