The increasing influence of Proxy Advisors. Is the tail wagging the dog?
April 19, 2022
Investors often choose to invest in companies with which they feel an alignment; at the same time, companies aim to develop cultures, policies and strategies which are aligned to the interests of the type of investors they wish to attract and whose support they need. Best practice for creating the right balance to reach such alignment is efficient shareholder engagement and communication, particularly with the principal investors.
93% of NEDs who took part in our 2021-2022 Life in the Boardroom Survey, reported that engagement between their companies and shareholders is satisfactory.
It is estimated that institutional investors now account for almost half (50%) of global corporate market capitalisation. A significant proportion of the funds individuals have available for investments in corporates is channelled through institutions (e.g. mutual funds, pension funds or asset managers). This places a high degree of responsibility on investing institutions to explain their investment strategies and to carry out due diligence both on their customers (to understand their financial aspirations and attitude to risk) and on investee companies (to understand their strategies, values, policies and culture). In the UK, the Stewardship Code provides a framework to facilitate this process. Transparency and engagement are at its core. Owing to the realisation that climate change is a major risk to sustainability and that DE&I is also crucial to sustainability and corporate success, ESG has become a major factor in investment decisions and dominates much of the debate between corporates and investors.
The AGM is the one opportunity each year, with the whole board present, for shareholders publicly to express their opinion and to vote on important strategic matters affecting the business in which they have invested. But this is where things become more complicated. In order to make informed decisions, asset managers must review lengthy public filings, which they have no time to read. Big funds invest in many companies. Direct engagement with all of them is not practicable. Hence, the emergence of Proxy Advisors.
Proxy Advisors provide, on a professional and commercial basis, research, advice and voting recommendations to shareholders in publicly listed companies. In the UK, the Proxy Advisors (Shareholders’ Rights) Regulations 2019 require proxy advisor firms to disclose certain information about the way they run their business. But Proxy Advisors are not regulated by the FCA under the Financial Services and Markets Act 2000. The FCA operates a notification regime for in-scope Proxy Advisors. As at January 2022, the FCA list includes the following firms:
- Glass Lewis
- GL & M UK
- Hermes Equity Ownership Services
- ISS Europe
Proxy Advisors provide an important service to shareholders by digesting those lengthy corporate public filings and producing voting recommendations on a number of different topics including corporate governance, executive remuneration, ESG, mergers & acquisitions and many more. Proxy Advisors are more remote from corporates than shareholders and they do not vote. Yet, their role has become increasingly influential to the extent that, in some cases, it has raised serious concerns. For example, US research has identified that many US asset managers consistently and seemingly automatically vote in line with their Proxy Advisors’ voting recommendations, giving rise to what has been coined “Robovoting”.
Guidance published by Proxy Advisors, whilst conforming to a general pattern, contains material differences. Inserting Proxy Advisers between a company and its shareholders creates additional work for in-house teams to satisfy the Proxy Advisor’s, sometimes inconsistent, compliance requirements, in order to secure a positive voting recommendation. We have had recent experience of this in the case of a UK-registered company, whose shares are listed in the US. A consequential risk is that already lengthy filings potentially become even longer, with no improvement in transparency.
Proxy Advisors are commercial enterprises. It is not, therefore, surprising that they seek to distinguish themselves in terms of their guidance, reporting and the models they produce (and, by extension, which companies must acquire and use) to gauge whether a company’s proposals meet the relevant compliance criteria. However, 60% of NEDs participating in Life in the Boardroom reported that the personal demands of their role had increased over the past year. Comments received include:
“The bureaucracy is getting bigger meaning less and less time for the actual business.”
“I am a strong governance advocate but sometime even I think that we could spend all our time following and been seen to follow processes. More pragmatism is needed centrally.”
There is a suspicion that the tail is wagging the dog. A direction of travel leading to a point at which Proxy Advisors determine voting outcomes and provide investors with an opportunity to absolve themselves from responsibility, is not sustainable. Investors should set the tone. Proxy Advisors should report on compliance using criteria set by investors. Perhaps it’s time for Proxy Advisors to report the facts, refrain from making voting recommendations and leave it to investors to make up their own minds based on their knowledge and understanding of the business.
For more information, please contact Margarita Skripina.