The future of proxy advisors – is there one?

Sarah Wilson, CEO of Manifest spoke at the ICGN London Meeting on 20th March 2012.  Her presentation at the breakout session “the future of proxy advisory” was based on the following article.

Proxy advisors – sorting fact from fiction

Don’t confuse what you’ve become familiar with over the last few months about the so-called “tyranny of proxy advisors” with the truth.

The over hyped anti-proxy advisor propaganda is not “the truth”, it’s a point of view, largely emanating from issuers and their advisors in the USA. Just as with shareholder rights themselves, the UK and EU are not the USA, as such our governance problems are not the same. Moreover, not all proxy advisors are the same either.

Hyperbole and propaganda are not, in any rational world, the basis for an evidence-based approach to problem solving or regulation. If Manifest wrote its research reports like the critics wrote their anti-advisory propaganda we’d be out of a job very quickly. We use facts and thoughtful analysis as the basis of our reports, not witch hunts and ducking stools.

Groundless cries for regulation based on emotion and unproven accusations do two things:

1. Makes the critics as bad as they think proxy advisors are;
2. Detracts from resolving the very significant barriers to informed voting and engagement which really do exist.

How can we talk about regulating anything without clear definitions and understanding?

Should proxy advisors be regulated?

Before we decide if we need regulation we need to ask a number of questions: What is the problem? Is it a real problem or perceived? If there are problems why aren’t we solving them ourselves? Have we tried and failed?

Or, perhaps  is it just much more fun to throw mud around. Of all the issues to come out of the financial crisis is this really the most pressing issue to resolve or would out time be better spent sorting out the investment banks?

When it comes to definitions it is clear that there is a general confusion about roles and responsibilities of the parties in the governance monitoring space as evidenced by the interchange of the term Proxy Voting Agency versus a Proxy Advisor.

• A Proxy Voting Agency is involved in the logistics of getting votes to the meeting – this may or may not involve research. 
• A Proxy Advisor works to inform voting decisions – but not necessarily delivering the votes to the meeting.

What’s the problem with regulation?

Nothing if it actually solves a real and intractable problem which the market cannot sort for itself and doesn’t create other uninteded probelms in its wake. Let’s not forget that the world’s financial services participants are swathed in layer upon layer of regulation. Credit Rating Agencies are regulated, so are Goldman Sachs, JP Morgan and Broadridge. So was RBS, Lehman and MF Global. Did regulation stopped highly damaging and inappropriate behaviour in those organisations?

Some proxy service providers are already regulated, some are not. Manifest is not. At our formation in 1995 we asked the Securities and Investments Board whether we should be; we also asked why the Conduct of Business Rulebook omitted any oversight of  voting despite votes being a client assets – we just got blank looks. As we weren’t going to be giving trading or investment advice we didn’t fit into their regulatory world view.

So instead we are regulated by our clients. In Manifest’s case that would be the asset owners and managers (one myth demolished, not all proxy advisors take fee income from issuers) a code of ethical conduct and our moral compass. We are accountable and transparent to our clients, under contract, to execute their instructions. We are not the owners, our clients are. Our role is to facilitate a very complex, labour and technology-intensive process, not to speak for shareholders.

Proxy Advisor Transparency

Manifest has always been transparent to issuers; companies have the opportunity to see the reports we write and see every item of data we hold on them and they are given a right to reply. Unfortunately fewer than half the companies respond to the invitation so most don’t read the reports. At best we get comprehensive and useable feedback or clarification, at the worst we get sent lawyers letters threatening court action after the CEO has read newspaper articles without reading the relevant underlying report and asking us questions.

Our guidelines and methodology are transparent because in EU-context governance policy frameworks are separated from their execution. Guidelines are owned collectively by the market and issuers can and do contribute to their formation. There are no exclusive proprietary rights over the UK Stewardship Code or Vienot in France, for example.

Manifest operates an independently audited ISO 9001 quality management system covering issues such as staff training, product design, business resourcing and systems etc.

We engage with regulators. Sadly they don’t always engage in return and we are still awaiting a response to our letter to the AMF from last June which was written in both English and French. Regrettably the AMF’s recent consultation paper also contains serious misunderstandings and comes to false conclusions based on assumptions and lack of due diligence. We hope for a better response this time around.

Just as a free press is a core feature of a democratic society, professional analysts have to call it as they see it. Proxy research is an issue of free speech and freedom of expression. Of course issuers want to suppress bad news about themselves. The CFA Analyst Objectivity Standards were brought in to defend analysts from inappropriate issuer pressure to adjust ratings and opinions. Just ask Henry Blodget why analyst objectivity matters.

So “What is the future?”

Personally I fear for the future if we continue on the current pathway. Unfortunately we appear to be spending our time on diversionary, misdirection issues rather than focussing on the real and significant issues which are holding the market back. As with Audit, the governance market does not function as an efficient market should. We don’t just have a market oligopoly; we have dominant monopoly players in each of the advisory and execution segments.

The market also has tremendous barriers to entry. Unlike investment research there is a reluctance to change vendors or to use multiple vendors. There is tendency to treat ESG research a bit like the office cleaning – an irritating necessity to be paid for at the lowest possible price. It appears to be tolerated, barely. Even the Kay Review has suggested we are a cost burden in the system. In reality our logistical know-how takes costs out of the system – we don’t see many fund managers wanting to employ 30 governance analysts and IT support staff. Quite the reverse in fact when you consider that there are fund management houses making entire ESG teams redundant due to alleged “lack of demand”. In the business context outsourcing data collection and transaction process is a legitimate service proposition. Outsourcing a fiduciary responsibility is something else entirely and isn’t anything we’ve ever suggested.

Capitalism is about healthy competition. It is essential for innovation which is good for clients and good for markets. Don’t believe me? Just look at the fights with the SEC over proxy plumbing to see the effects of monopolies, market dominance and resistance to change.

It’s all very well calling for “more competition” but there are Stewardship Code, ICGN and UNPRI signatories at this conference who have never once market tested their supplier or undertaken an RFP/due-diligence process. To ask whether a procurement policy exists is to elicit quizzical looks. These types of behaviour are not the hallmarks of a healthy market. And some of these same people are the ones who complain about lack of vote confirmation and the difficulties associated with early vote deadlines.

What do we want, when do we want it?

But enough of problems, what about solutions?

Due process, a fair and responsible process

There must be no more snide remarks about proxy advisors in closed meetings without the right of defence or reply. If the proxy advisory model is as broken as is suggested then we should have an open, independent inquiry into the workings of the industry to find out what issues there are, who is responsible for them and how they can be rectified. We’re not talking about a kangaroo court which picks on just the proxy advisors; we need to look at all the actors: custodian banks, fund managers, issuers, regulators, trade associations, governance advisors, overlay managers. Anyone with an economic or contractual involvement in the Stewardship process should be called to account for their role.

Because Manifest is incorporated in the UK and a signatory to the Stewardship Code, we believe it is entirely appropriate for the FRC to sponsor an independent inquiry to investigate the stewardship market and the roles played by the various actors and, if necessary, make onward referrals to the Competition Commission in either the UK, EU or both.

We have some ideas for potential candidates. Our nominations for independent members of such an inquiry committee would include, for example, Lord Lord John McFall who did such a robust job at probing the audit market; Matthew Hancock MP and Nadhim Zahawi MP whose recent book “Masters of Nothing” identified the weaknesses of financial services regulation; Ken Olisa the ousted NEDD of ENRC who spoke up for good governance and who is a member of Worshipful Company of Information Technologists.

We do not recommend these people because they are close personal friends who would give the industry and Manifest a glowing report. On the contrary, they are entirely outside the governance industry but fully aware of the importance of well functioning financial services industry and shareholder accountability. We could not think of more exacting and thoughtful individuals to take on the task of cutting through the hype. What we cannot do is have an Inquiry comprised of insiders marking their own score card.

Secondly but perhaps more urgently, we believe it is time to address The Four Freedoms of the European Union as they apply shareholder rights  i.e. free movement of goods, people, services and capital. They don’t work. The freedom to exercise shareholder rights across borders is an illusion.

Instead of the European Commission tearing down the barriers to informed Stewardship at the earliest opportunity, and despite the proven dysfunction in the voting chain and market abuses by the voting intermediaries, it appears that the Commission also believes that it is the proxy advisors who need to be investigated. This is ironic given the effort Manifest and others have put into raising awareness of the problems with cross border voting and putting forward proposals for reform. As we have said time and again, the chain of intermediaries binds shareholders to antiquated, anti-competitive protocols which have no place in a progressive society.

The excessive intermediation and ownership obfuscation presents immense dangers to informed engagement. The Lehman and MF Global cases show the dangers or pooled accounts and obscure nominee holdings structures. They don’t protect shareholders; their sole purpose is to enhance bank profitability. They prevent companies from engaging in dialogue with their owners.  Rather than wasting precious resources on issues which are better left to the market (supplier monitoring), we suggest that the European Commission should address the real barriers to stewardship as a matter of urgency, possibly through on of its upcoming Directives currently in the pipeline. From our perspective, the most suitable vehicle would be the Securities Law Directive. The SLD should, as per the recent CSD Directive proposals simplify and make more transparent the process of share ownership so that investors can, for example, have dematerialised, designated securities accounts across all markets.

Markets grow and thrive when clients are provided with innovative and high quality services – and when clients are prepared to back those innovators. We therefore also wish to see a commitment to transparency and client-focus in an environment which encourages innovation. We have long contended that Manifest, or anyone, should be able to electronically vote their clients shares securely and directly to Paris, Frankfurt or Beijing as easily as we can to Bristol or Worthing today. We have the technology and we have the capability. We have, however, hit a Pyrex ceiling created by industry participants who refuse the change and refuse to let their clients exercise their rights in the way they see fit – what we call “Best Execution in Voting”. We regularly ask ourselves “surely those who pay have the say in how their assets are managed?”

The adoption of vendor-neutral “Open Standards” for global electronic voting are key to ensuring that asset owners can have the freedom to chose the service which meets THEIR needs rather than what a custodian thinks they ought to put up with. This move towards a common language has the ability to reduce risk and increase certainty in voting and ensure that investors’ voices are heard. This is not just our view, but a view which Andrew Haldane of the Bank of England espoused in a recent speech to Securities Industry and Financial Markets Association in New York just last week which I would thoroughly encourage all of you to read.

In concluding, I would like to leave you with this thought: the future of proxy is as good as you allow it to be. Doing what you’ve been doing is going to get you what you’ve been getting.  If you don’t like what you’ve got you do have a choice – chose to change. 

Last Updated: 23 March 2012