ESG: Governance for the people

There has been a sea change in attitudes to corporate governance with shareholders flexing their muscle at AGMs. Catherine Lafferty takes a look at the new investor order.

It has been a landmark year for governance for more reasons than one. Allegations (and revelations) of sexual misconduct in Hollywood have focused an unforgiving spotlight on management practices in the entertainment industry. Meanwhile, earlier this summer, the investment community threw its weight behind a series of resolutions during the AGM season.

Change whistles through the air. The talk is of watersheds being reached and of rubicons being crossed.

Josh Kendall, ESG analyst at Insight Investment, rationalises the events, even as he acknowledges their significance. “The Weinstein scandal is shocking, of course. It comes back to issues of women on boards.

“There have been significant improvements in recent years, re: women on corporate boards. Weinstein was a personality-led company. Small companies are vulnerable to governance problems largely because they are not accountable,” he says.

It is clear that where companies were falling short, an old-fashioned wielding of the sanctions stick has played a part in achieving more gender balance in the corporate world.

Hans-Christoph Hirt, an executive director at Hermes EOS, a voting service arm of Hermes Investment Management, says Hermes is taking action where expectations are not met.

“We decided this year if a company was not meeting gender diversity requirements on boards, we would vote against the nominations committee chair and that meant we voted against the chair at Rio Tinto,” he says.

At the beginning of the year Willis Towers Watson, a firm of investment consultants, announced it would be requiring fund managers to provide data about the gender composition across their own firms.

A tipping point
In the broader world of ESG – or environmental, social and governance investing – 12 investment consultant firms in the UK, including Aon Hewitt and Willis Towers Watson, agreed in September to ensure clients were made aware of the Pensions Regulator’s guidance that pension schemes take into account responsible investment factors in cases where they are financially material.

Investors have almost certainly toughened up their shareholder muscle over environmental issues. For example, resolutions calling on Exxon and Occidental Petroleum to undertake independent reviews into the impact of a low-carbon economy were supported by more than 50% of investors.

Such proposals have been made for years, but this year succeeded with more than 60% of the vote. What is notable is that Exxon and Occidental are so high-profile, Insight’s Kendall notes.

“The AGM shows that investors are no longer happy to be acquiescent but are pushing for change,” he says. “We have reached a tipping point. Investors feel more confident to implement their responsible investment policies and, secondly, to engage with companies on these issues. There has been a huge growth in demand for responsible investment solutions. More, more, more is my message.”

Axa Investment Managers filed shareholder resolutions last year at Glencor, Rio Tinto and Anglo American and this year at Exxon. All were passed with significant majorities.

Shade Duffy, head of corporate governance at Axa IM, says: “We have noticed a step change. We have put forward these resolutions for a few years but this time, several of these types of resolutions were passed by shareholders or received significant minority support.”

Another policy to have come under scrutiny is that of dual share classes – shares typically found in technology firms or in countries with weak governments and in which controlling shareholders have the majority of the votes but not of the shares. A well-known example is the social media behemoth, Facebook.

Shareholder revolts against this policy have forced climbdowns. S&P, the ratings agency, said it would no longer include dual-share stock companies in its indices. Already-listed companies with dual share classes will remain in the index, but it is an indication of how different the investment environment is now that Facebook would not be included on an S&P index in the future.

Eoin Fahy, head of responsible investing at KBI Global Investors, says: “An interesting feature of the last few months is that both shareholders and indexes are taking a more jaundiced view of this arrangement. There is a change in the framework of how people are thinking about it. It has come to the fore in the last six months and is rising to the top of investors’ agenda.”

Executive pay
The long-time bugbear of egalitarians, executive pay, continued to receive attention in 2017. Some feel that while the topic is being handled with more transparency, compensation is increasingly difficult to measure because pay packages are getting more complicated. Rewards is being twisted into ever-more intricate structures.

Hirt says “A really interesting case in the UK came following the controversial voting season in 2016 with votes against executive remuneration. Prime minister May then took up the topic and companies designed new remuneration policies. Overall, the money paid to CEOs fell for the first time in 2016.”

WPP’s Sir Martin Sorrell, whose pay peaked at £70 million (€79 million), found himself with a new remuneration policy, which was voted on in June. Perhaps not picking up on the rebellious mood, there was an attempted remuneration policy at Imperial brands, which would have meant a significant increase in possible payout for the CEO. But this spring, during the preliminary discussions, shareholders threw the proposal out.

Hirt is clear-sighted about the ability of the investment industry to make impressive-sounding noises about governance and he acknowledges that investors need to use their voting rights systematically to effect change. Nonetheless, he feels positive about the corporate governance outlook.

“What this shows is there is a governance system in UK that is working if you have investors which are engaging with those companies,” he says.

The governance system works because investors now see it as not only their right, but also their responsibility to act as engaged and active shareholders and contribute to creating long-term value for all shareholders.

As Louise Hedberg, head of corporate governance and sustainability at East Capital, says: “If we do not demand accountability from management teams and boards, who will? We should also remember the power of investor collaboration and working in numbers.”

She cites the work done by member-based investor associations (such as the Asian Corporate Governance Association, the Association for Institutional Investors in Moscow, and the Baltic Institute of Corporate Governance), which have had a significant impact in advancing corporate governance on market and corporate levels in their regions.

Howard Sherman, executive director for ESG research at MSCI, says the most notable corporate governance development over the past decade has been the emergence of stewardship as a core responsibility for many asset managers. Given the long-term investment horizons of their institutional clients, more and more managers are coming to understand that it is in their best interests to engage with companies on corporate governance and ESG issues that may impact a company’s long-term strategy.  This is especially true for passive managers, given they will be holding company shares as long as they are included in the indices they follow.  

Sherman says: “There will always be disputes about board composition, capital allocation, executive pay, minority rights and more. But the overall trend towards more engaged shareholders has been a healthy development for European fund managers and for global capital markets.”  

Kendall agrees on the significance of stewardship in propelling governance into the forefront of investors’ agendas. One reason in the UK is the Stewardship Code, launched and administered by the Financial Reporting Council, which puts the onus on investors to take stewardship more seriously.

“Arguably you need a push to make positive changes, “ he says. “You have seen that with the stewardship code and greater transparency with management of climate change risks.”

The importance fund managers attach to good governance has risen significantly in recent years. For example, when KBI Global Investors considers whether to buy a stock, there are four legs to its proprietary investment model, one of which is exclusively dedicated to governance.

Fahy says: “We look at a company and give it a score out of 20. We publish this openly on our website. It has a significant bearing on whether we buy a stock or not.

“We believe companies with good governance are more likely to outperform in the future. It’s as simple as that.”

©2017 funds europe



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