Download CIMA submission to the HM Treasury and Department of Work and

CIMA submission to the HM Treasury and Department of Work and
Pensions consultation on enhancing shareholder activism
Background and summary of findings of recent CIMA research
1.
The Myner’s report recommended that the increase in fund manager’s
interventionist activity be done as part of their basic duty to their client
and argued that such action did not rely on a public interest argument
about shareholder responsibility. It also recommended that the US
Employment Retirement Income Security Act, which outlines the duties
to fund managers to intervene in companies be included in fund
manager mandates and incorporated in UK law. The 1994 US
Department of Labor interpretative bulletin makes it clear that fund
managers should vote proxies on issues that affect value, and that they
should monitor or influence companies when the benefits are expected
to exceed costs. This active monitoring and communication can be
carried out by correspondence, by meeting management and by
exercising legal rights as shareholders.
2.
The main brief for the Myner’s committee was to look at the
performance of institutional investors in terms of supply of new capital
to new and dynamic industries and firms. The Myner’s report
recommended that the venture capital problems could be best
addressed by improving the quality of investment decision-making in
the chain from saver or pensioner, through trustees, investment
managers, and by creating more competition in the ‘market for advice’
provided by consultants. It is important not to lose sight of this. Fund
managers generally make decisions to invest in large companies rather
than small companies because of the market-capitalisation
benchmarks that they work to and the liquidity constraints. Facilitating
change in this area would probably require altering the constraints on
fund managers so that they are not expected only to achieve
conventional benchmark returns. It would also mean reducing the
large unit sizes that big funds such as self-managed pension funds use
to construct portfolios. Fund managers are simply reacting to the
pressures that they are under from clients, namely to demonstrate a
consistent investment policy that reduces benchmark risk and cost.
3.
Major research just published by CIMA, involving 40 of the largest UK
institutional fund manager groups, has identified the considerable
potential of extending the corporate governance role of fund managers.
An extension of this institutional influence, such as encouraging
transparency in governance processes and satisfying wider
stakeholder governance aims, including environmental and ethical
issues, could make them the key to asserting good corporate
governance control in the UK and hence better returns on investment.
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4.
The fund managers involved in our research regard regular contact
with senior management in companies in which they are invested as
being extremely important. The research revealed regular, active
interaction between fund managers of large institutional investors and
company directors when companies are performing well and when they
are under performing and in crisis. Rather than adopting a passive
role, as many believe, these large fund managers primarily attain
corporate governance control behind the scenes in regular private
dialogue with company directors. They encourage the development of
internal corporate governance structures and processes, looking
closely at Cadbury, Greenbury and Hampel as well as other implicit
accountability issues that affect wealth creation.
Furthermore, many issues of strategy, management quality and the
need to understand the intangible value drivers behind corporate
performance are too complex to be reduced to an AGM vote and are
more efficiently dealt with through private dialogue. Typically fund
managers want to understand the long-term strategy being pursued
and make a judgement on the management quality. Previous
experience of management’s ability to deliver is also crucial to a fund
manager’s assessment of a company. More explicit activism is usually
reserved to encourage desired corporate change when a company is
under performing and in crisis. If private influence fails, fund managers
can fall back on public mechanisms. Low attendance at AGMs by
institutional investors does not necessarily indicate that they are not
discharging their responsibilities.
5.
The dominant approach of the large institutions was to be proactive on
those corporate governance matters that had low intervention costs. If
the opportunity costs of not influencing management were high, then
intervention was considered more likely. The institutions also tried to
lower their intervention costs by screening out from their portfolios all
companies performing weakly, and those companies likely to incur high
corporate governance monitoring costs. A core portfolio of investee
companies remained and these became the targets of efficient use of
corporate governance.
6.
Much shareholder intervention takes place behind closed doors.
Certain institutions are more active and take forward corporate
governance and other related issues. The ability of the large case fund
managers to exercise such influence was dependent on factors such
as FM size, the size of their stakes, and the capability of their internal
research and governance functions. Myner’s problems of limited
influence and intervention may be more prevalent where smaller fund
managers are involved with FTSE 100 companies. The relative size of
fund managers and investee companies is a major factor in limiting the
scope of shareholder activism. Our research reveals that only the top
largest fund managers had the power to exert significant influence over
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the top FTSE companies. They have the opportunity for higher levels
of voting and more direct participation in AGMs as well as informal
influence. Therefore, the smaller the stake in a company the less likely
that the fund manager will commit internal resource to the making of
any strategic, board or management changes.
CIMA proposals
7.
Given this knowledge, we would urge Government to rethink the
approach of incorporating a duty on those responsible for the
investment (both pension trustees and fund managers) of pension
scheme assets or those managing other types of funds. Contrary to
the Government’s intention, putting such a requirement in law could
broker a change in approach by fund managers to one that is negative
and characterised by actions which try and avoid being sued rather
than actions that truly add value or enhance the value of investment.
8.
We would support an approach that is based on principles that is
consistent with the otherwise self-regulatory approach in the UK to
corporate governance. The principles of investment decision-making in
the Myner’s report could form Best Practice Guidance (or part of) for
trustees and fund managers. Disclosure of failure to meet such
guidance would probably have to be to a wider audience than the
pension fund members because there is a danger that in some
instances they have little incentive to hold trustees and fund managers
to account.
9.
In addition to CIMA research, there is evidence to show that rules have
not worked in the US because the ‘trustees’ fiduciary duty to act in the
beneficiaries’ interest is so diluted as to ensure that inaction is
condoned’1. A principles based approach should allow the institutions
scope to develop activism that can be tailored to their unique
characteristics including size and investing style.
10.
A regulatory framework is unlikely to guard against the passivism of
fund managers of the smaller institutions. Our research suggests that
medium and smaller sized fund managers need to develop their
activism by comparing what they do, and intend to do, using the
aggregate experience of 40 of the largest fund managers. Our
research provides a robust model to help them consider the
circumstances in which they should intervene in a company, the
degree of intervention and the approaches that they should use.
11.
There is a wider training issue for fund managers and pension fund
trustees that is more important than considering whether these groups
have a legal duty to actively monitor and communicate with the
management of investee companies. Rather than there simply being a
lack of awareness that there is a responsibility on fund managers to be
1
Plender J (2001), A Judicious Shake-up’ Financial Times, 7th March 2001
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active on behalf of their clients, in many cases fund managers could do
with adequate training to take a more informed approach. Some fund
managers (and analysts/brokers) also need more training on how
companies function and on financial and other corporate disclosures.
Others may need greater insight into the role of being more active.
Therefore:
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12.
While informed voting at AGMs is an important part of influencing, the
fund managers of the largest companies are generally active behind
close doors. The public process is also generally an outcome or
residual of the private process. This has various consequences,
including:
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13.
Life long learning is important for fund managers and analysts as it
is for other professions and there needs to be an appropriate
structure in place to deliver it.
There needs to be greater disclosure by companies (see para 13)
Fund managers need experience of understanding the nature of
intangible assets and how they are exploited to drive corporate
success.
Voting control effectively lies with those fund managers who already
have closest contact with companies. Some major institutional
investors also fear that their voting behaviour may give a misleading
impression of their underlying confidence in a company. The
exercising of voting rights as shareholders is likely in many
circumstances to conflict with the investment role of fund managers
and their fiduciary duties to investors in their funds.
The reputation of fund managers is important to gaining credibility
with investee companies. Therefore method and style of
communication adopted is significant.
The private nature of activism means that it is difficult to assess if
the governance process is achieving wider public aims or whether
institutions, either as a group or in collaboration with their invested
companies, are exploiting the process solely for their own
management benefits or for the benefit of their restricted investor or
trustee group. This could be at the expense of other stakeholders
such as shareholders, creditors, customers and employees.
Better corporate disclosures should also assist fund managers in their
efforts to understand corporate performance and to ask the right
questions. Even before the collapse of Enron there had been
increasing pressure on companies to improve their public disclosure.
We supported proposals in the Company Law Review to introduce a
mandatory Operating and Financial Review (OFR) for listed companies
as a key part of their annual report. There needs to greater reporting
from companies on the intangible assets that are behind the corporate
value-creation process, are not captured in company financial
statements, and are behind stock price changes. Such information
should facilitate the influence of both fund managers of larger and
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smaller institutions and private investors. Without greater disclosure, it
is likely that the role of institutional investors will be restricted. Volatile
share prices reflect investor uncertainty and information discontinuities.
The impact for companies in the UK is a higher cost of capital.
14.
CIMA recognises the importance of supplementing financial statements
with understandable, qualitative and forward-looking information and is
in the process of developing best practice guidance for corporates on
being more transparent in their reporting. The following issues are
important in this debate:
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
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Better disclosure would reduce the number and impact of corporate
failure. If there is better information on a range of issues such as
company debts, methods of valuing assets, investment risk,
potential conflicts of interest among key executives, directors and
accountants, investors can assess the risks for themselves.
The new OFR will facilitate greater disclosure by providing key
information to shareholders such as corporate strategy, market
share and position, performance against objectives and risk
reporting.
Further development of the role and influence of institutional
shareholders depends also on the quality of corporate disclosures
and information flows from a company.
Conclusion
15.
CIMA recognises the crucial role of fund managers and their influence
in encouraging transparency, asserting good corporate governance
control and enhancing the value of investments.
16.
Our research shows that the top 40 institutional investors do already
play an active role in the companies that they invest but much of this is
done behind closed doors.
17.
A regulatory framework is unlikely to make fund managers at small
institutions more active. Training and providing these groups greater
insight into the experience of larger institutions is crucial.
18.
We would support an approach that is based on principles. Best
practice guidance for trustees and fund managers based on the
principles of investment decision making espoused by Myners could be
developed and enforced on a ‘comply or explain’ basis.
19.
Improved corporate reporting and disclosures is a key element to
helping fund managers and other stakeholders understand an
organisation and its performance.
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