The California State Teachers’ Retirement System (CalSTRS), the Florida State Board of Administration and Washington State Investment Board are the lead asset-owner signatories for the Investor Stewardship Group (ISG). This collective of some of the largest US-based asset owners and managers has articulated a set of fundamental stewardship responsibilities for institutional investors.
Among the asset-manager signatories are BlackRock, Vanguard and State Street Global Advisors – three of the largest funds managers in the world.
In addition to the stewardship fundamentals, the group has released a corporate governance framework that articulates six principles it considers fundamental for US-listed companies. They reflect the common beliefs embedded in each member’s proxy voting and engagement guidelines, and are designed to establish a foundational set of investor expectations about governance practices in US publicly traded companies.
The frameworks are long overdue. The US – the largest sharemarket in the world – operates without any stewardship code or agreed-upon corporate governance principles.
Allison Bennington, partner at San Francisco-based investment company ValueAct Capital, another one of the founding ISG signatories, says there is much overlap among the policies of the group’s members, and this helped create the framework.
“This could be useful for the companies themselves. [It] helps companies focus on standard corporate governance terms,” Bennington says. “Directors are accountable to shareholders but we wanted to show we are accountable to our members and stakeholders.”
Aeisha Mastagni, portfolio manager, corporate governance, at CalSTRS, also says it’s important that investors show their accountability to members.
“It’s about their savings and retirement, so we should be accountable,” Mastagni says. “Engagement between investors and issuers has grown exponentially; now is an important time to have this in place. [It’s about] management and board being accountable to shareholders and us as shareholders being accountable to our beneficiaries.”
She pointed to the issue of dual-class shares – highlighted again recently by the Snapchat float, which has three classes of shares, including those available to the public that have no voting rights – as an example of why good principles are essential.
“With dual voting rights, we lose our accountability,” Mastagni says. “We can’t hold the company to account.”
Bennington concurs that the economic interest should reflect the voting interest.
Large role for voluntary codes
Fiona Reynolds, managing director of Principles for Responsible Investment (PRI), says the ISG code is a significant step forward.
“It is a voluntary code, but has some big investors behind it, which I hope means it will gain widespread support,” she says. “Anything that helps investors focus on long-term risks and opportunities is a step in the right direction. We have already seen attempts to wind back parts of [the Dodd-Frank Wall Street Reform and Consumer Protection Act] in the US. If regulation is wound back, then voluntary codes may have to play an increasing oversight role.”
The PRI undertook some research in late 2016 mapping regulation, including codes that underpin responsible long-term investing. The research shows that companies in countries with mandatory, government-led, comprehensive environmental, social and governance (ESG) reporting requirements have, on average, a 33 per cent better MSCI ESG rating than those without. The score indicates better ESG risk-management practices relative to risk exposure.
“We also tested the relationship between voluntary ESG disclosure requirements [and the MSCI ESG rating],” Reynolds says. “We found a small positive relationship (+11 per cent), but it was less significant than with mandatory regulations. So stewardship codes, while not as impactful as regulation, do make a difference. But there [must] be oversight of the stewardship codes, and reporting against them, to make them meaningful.”
Already a global trend
The US has been slow to the party. The first stewardship code was published in 2010 by the UK’s Financial Reporting Council, in response to criticism about the role of institutional investors in the lead up to, and during, the financial crisis.
The code’s 2012 revision clarified the respective stewardship responsibilities of asset managers and owners, including for activities they have chosen to outsource or undertake in collaboration with others. The UK Stewardship Code now has about 300 signatories and is implemented on a ‘comply or explain’ basis.
After the publication of the UK code, other countries established their own. The Netherlands’ Best Practices for Engaged Share-ownership was developed by Dutch corporate governance forum Eumedion; South Africa launched its Code for Responsible Investing in SA; and Switzerland unveiled its Guidelines for Institutional Investors Governing the Exercising of Participation Rights in Public Limited Companies.
One of the most significant launches of a stewardship code took place in Japan in 2014. To date, the country’s Principles for Responsible Institutional Investors is the only country code, apart from the UK’s, to have been drafted by a regulator, Japan’s Financial Services Agency.
Hot on the heels of Japan, Malaysia launched its Malaysian Code for Institutional Investors in 2014 as well. It is the second code in emerging markets, after South Africa’s. Other markets that have followed suit include Taiwan, Hong Kong and Singapore. South Korea and Brazil are looking at launching their own as well.
Six of the 14 countries that have developed stewardship codes since 2014 are in Asia, the PRI states. Codes have typically been modelled after the UK Stewardship Code; they set out principles that aim to improve engagement between investors and companies to help improve long-term, risk-adjusted returns.
Principle A. Institutional investors are accountable to those whose money they invest.
A.1 Asset managers are responsible to their clients, whose money they manage. Asset owners are responsible to their beneficiaries.
- 2 Institutional investors should ensure that they, or their managers, as the case may be, oversee client and/or beneficiary assets in a responsible manner.
Principle B. Institutional investors should demonstrate how they evaluate corporate governance factors with respect to the companies in which they invest.
B.1 Good corporate governance is essential to long-term value creation and risk mitigation by companies. Therefore, institutional investors should adopt and disclose guidelines and practices that help them oversee the corporate governance practices of their investment portfolio companies. These should include a description of their philosophy on including corporate governance factors in the investment process, as well as their proxy voting and engagement guidelines.
B.2 Institutional investors should hold portfolio companies accountable to the Corporate Governance Principles set out in this document, as well as any principles established by their own organization. They should consider dedicating resources to help evaluate and engage portfolio companies on corporate governance and other matters consistent with the long-term interests of their clients and/or beneficiaries.
B.3 On a periodic basis and as appropriate, institutional investors should disclose, publicly or to clients, the proxy voting and general engagement activities undertaken to monitor corporate governance practices of their portfolio companies.
B.4 Asset owners who delegate their corporate governance-related tasks to their asset managers should, on a periodic basis, evaluate how their managers are executing these responsibilities and whether they are doing so in line with the owners’ investment objectives.
Principle C: Institutional investors should disclose, in general terms, how they manage potential conflicts of interest that may arise in their proxy voting and engagement activities.
C.1 The proxy voting and engagement guidelines of investors should generally be designed to protect the interests of their clients and/or beneficiaries in accordance with their objectives.
C.2 Institutional investors should have clear procedures that help identify and mitigate potential conflicts of interest that could compromise their ability to put their clients’ and/or beneficiaries’ interests first.
C.3 Institutional investors who delegate their proxy voting responsibilities to asset managers should ensure that the asset managers have appropriate mechanisms to identify and mitigate potential conflicts of interest that may be inherent in their business.
Principle D. Institutional investors are responsible for proxy voting decisions and should monitor the relevant activities and policies of third parties that advise them on those decisions.
D.1 Institutional investors that delegate their proxy voting responsibilities to a third party have an affirmative obligation to evaluate the third party’s processes, policies and capabilities. The evaluation should help ensure that the third party’s processes, policies and capabilities continue to protect the institutional investors’ (and their beneficiaries’ and/or clients’) long-term interests, in accordance with their objectives.
D.2 Institutional investors that rely on third-party recommendations for proxy voting decisions should ensure that the agent has processes in place to avoid/mitigate conflicts of interest.
Principle E: Institutional investors should address and attempt to resolve differences with companies in a constructive and pragmatic manner.
E.1 Institutional investors should disclose to companies how to contact them regarding voting and engagement.
E.2 Institutional investors should engage with companies in a manner that is intended to build a foundation of trust and common understanding.
E.3 As part of their engagement process, institutional investors should clearly communicate their views and any concerns with a company’s practices on governance-related matters. Companies and investors should identify mutually held objectives and areas of disagreement, and ensure their respective views are understood.
E.4 Institutional investors should disclose, in general, what further actions they may take in the event they are dissatisfied with the outcome of their engagement efforts.
Principle F: Institutional investors should work together, where appropriate, to encourage the adoption and implementation of the Corporate Governance and Stewardship Principles.
F.1 As corporate governance norms evolve over time, institutional investors should collaborate, where appropriate, to ensure that the framework continues to represent their common views on corporate governance best practices.
F.2 Institutional investors should consider addressing common concerns related to corporate governance practices, public policy and/or shareholder rights by participating, for example, in discussions as members of industry organizations or associations.
ISG corporate governance framework for US-listed companies
Principle 1: Boards are accountable to shareholders.
Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.
Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.
Principle 4: Boards should have a strong, independent leadership structure.
Principle 5: Boards should adopt structures and practices that enhance their effectiveness.
Principle 6: Boards should develop management incentive structures that are aligned with the long-term strategy of the company.