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ANALYSIS

Swiss referendum: funds’ headache or investor utopia?

The idea of referendums setting the agenda for institutional investors may be a frightening pipe dream in much of the world, but Switzerland’s unique brand of direct democracy is set to revolutionise its funds’ priorities.

Swiss funds are due to be anointed as no less than the country’s official guardians against “rip-off” executive salaries. That is according to a referendum that received the overwhelming backing of the Swiss electorate in March.

Funds do not appear to be hugely thrilled at their boosted future responsibility, however – enhanced by binding annual votes on executive pay and appointments at all publicly listed companies in Switzerland. Some grumbles about cost implications have made their way from investors into the local media.

Referendum reaction

The Swiss pension fund association, ASIP, says it does support greater shareholder rights “but not at the expense of members”. Director of ASIP, Hanspeter Konrad, says funds felt a less stringent government counter-proposal would have been more effective in advancing the underlying principals behind the referendum.

Sabine Doebeli, Zurich-based vice chair of the Sustainable Investment Forum of Germany, Austria and Switzerland (FNG), believes the referendum result is likely to prove a shot in the arm as “the culture of being an active investor is not well anchored in Switzerland”. sabine_doebeli

That challenge centres on the introduction of mandatory voting for pension funds at annual general meetings. It is an obligation funds would definitely not be advised to ignore though as the text of the referendum – championed by the head of a family cosmetics company – envisages jail terms and hefty fines for violations.

Doebeli, pictured right, says that “with existing legislative challenges in Switzerland and low funding ratios at many funds, the commitments add an additional complex aspect to the strategy of time-pressured investors”.

Stephan Skaanes of investment consultancy, PPC Metrics, says the reactions of funds to the results have been more mixed. Nonetheless, he explains that the first shock to the country’s unengaged investors may come as temporary regulation is introduced within a year to pave the way for full implementation of the referendum’s terms within around five years.

Doebeli believes that pension funds will likely wait for votes on executive pay to become mandatory before they assume all their new voting rights.

Naturally, the largest investors should find the task of becoming permanently active shareholders easiest. A spokesperson for the CHF21-billion ($23-billion) BVK fund for civil servants in Zurich, says that given “the scale and scope” of the fund’s organisation, it is “very well positioned” for the new legislation.

Within days of the referendum gaining the approval of the electorate, BVK began publishing the results of the shareholder votes it casts, thereby revealing that it had rejected a controversial remuneration scheme at pharmaceutical giant Novartis in February.

Disclosing the votes they make is another responsibility that the referendum is to hand pension funds, although Skaanes explains there is plenty still to debate as to how and to what audience disclosure is made.

Other Swiss funds to demonstrate engagement include the 90 pension funds, such as the $10.25-billion Basel Stadt pension fund, that are party to the Ethos Engagement Pool – an initiative that seeks shareholder dialogue with the largest companies in Switzerland. That grouping, however, is a small minority of all Swiss funds.

Doebeli says that a likely scenario as the initiative is implemented is that stretched funds will increasingly look to turn an ear to proxy shareholder voting advisers like Swiss firm Ethos or ISS. There has been a wave of activity in that space in recent months, with a new voting advisory firm Swipra launched just days after the referendum, Inrate announcing a new product range ‘for active shareholders’ in January and Ethos reportedly due to go on a post-referendum hiring drive.

Another requirement of the measures approved by referendum is, however, that pension funds vote in the interest of their members. Skaanes says that could place a block on fund’s controversial reliance on proxy advisors while the Swiss parliament interprets the referendum result into legislation. Doebeli says this could instigate some interesting broad-based dialogue with members on investment priorities – “a new element in the Swiss pensions landscape”. Konrad says that as funds are already structured to fully heed the interests of their members, this won’t need to go as far as polling members on their opinions prior to shareholder votes.

Will it work?

The radical new rules will surely boost the workload associated with domestic equity holdings, which averaged 11 per cent across the country’s pension funds in 2012, according to Mercer.

Skaanes says he would be “very surprised” if a drive out of Swiss equity holdings results, even though the tough regulations are not set to apply to overseas equities.

“There might be a switch from direct investing into domestic equity funds if the government decides that collective investment schemes are exempt from the mandatory voting requirements”, he adds.

In the ideal world of the sustainable investment business, perhaps Swiss equities will also gain added outside appeal for the stringent shareholder checks imposed on executive pay?

Leaving aside the obvious objections from the business community to that reasoning (they fear such strict rules will drive investment out of the country), the initiative must first prove it can perform in its chief task of checking pay. Critics point out that with domestic pension funds making up a tiny fraction of domestic share ownership (6.5 per cent according to ASIP), their potential to transform the country’s boardroom culture is limited.

Beda Dueggelin, a spokesperson for Thomas Minder, the businessman who proposed the referendum, agrees that Swiss institutional investors can only do so much on their own. “Foreign pension funds and investors are in the position to have a say on pay due to their voting power,” he says. “If they exercise their increased rights, something will change.”

The current regime was, after all, sufficient to persuade Novartis to recently drop a planned $78-million payment to its outgoing chairman. Credit Suisse and UBS have both also faced shareholder rebellions on their executive compensation plans in the past two years.

While determining “correct” rates of pay is something for newly empowered shareholders and boards to wrangle about in the years ahead, the new rules might not have such an obvious limiting impact on pay. Doebeli says that the experience in the UK shows that increased transparency on executive pay does not necessarily curb it as the keenest observers of salary reports could be rival executives hoping for a raise, although the clout of binding shareholder votes mandatory for pension funds “should definitely make it easier to prevent exaggerations”.

Skaanes adds that funds might be able to simply have a default position of voting in favor of the board under the new rules – perhaps in cases where they currently decide not to vote on a company, as they have no desire to closely monitor it. Should this indeed be a common pattern, the referendum’s impact would seemingly be limited.

Coming to a boardroom near you?

Doebeli says that “the strong international reaction” to the referendum has been noted with interest in Switzerland. Being home to several giant multinationals, particularly in finance and pharmaceuticals, makes the radical changes globally important.

Dueggelin says the proponents of the referendum “are sure that you will see more similar actions like the one in Switzerland in the foreseeable future”.

The European Commission is known to favour legislating for EU-wide binding shareholder votes on executive pay later this year. Days after the Swiss referendum result, the German government also announced that it will look to empower shareholders before then – most likely with binding votes. That is despite Germany’s Industrial Federation warning against “rash conclusions from the Swiss debate” and arguing that Germany’s tradition of employee and shareholder representation on supervisory boards makes new legislation unnecessary.

Gary Lutin, head of the Shareholder Forum in the United States – a group that moderates between boards and shareholders – says “that whether it works well or not, the Swiss adoption of binding compensation votes will certainly encourage others to try it”.

The US enforced the holding of advisory votes on executive pay at large public companies as part of the 2010 Dodd Frank Act.

Speaking on whether there would be demand for binding votes in the US, Lutin says: “You can expect the views of US fund managers on binding votes to be as mixed as they are on everything else. Some will see it as an opportunity to increase their influence, and others will see it as an imposition of increased burden that adds nothing to their portfolio’s performance or to their ability to compete for assets.”

In any case, there might not be a straight path to increased shareholder power.

Before the radical new corporate governance framework takes shape in Switzerland, militant funds might have to confront a growing academic backlash against increased shareholder power emanating from the US. Critics such as Lynn Stout, author of The Shareholder Value Myth, contend that shareholder pressure is actually a major driver of the short-termism in corporations that has spawned the kind of result-linked compensation schemes the public dislikes.

Increased rights should also logically bring increased responsibilities. Lutin poses one of the questions that he feels would result from a Swiss-style radical shake-up of corporate-shareholder relations. “If shareholders now have the kind of real authority to approve compensation that had traditionally been assigned to corporate directors, do they also have the same kind of fiduciary duty as directors to make informed decisions?”

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