Q:Why is proxy voting like a supermarket lasagne?

A: Suspect ingredients, lack of traceability, bad labelling and poor retailer accountability.

What on earth has dubious food processing got to do with proxy votes I hear you ask? The FT neatly sums it up in its article “From workhorse to main course” (15th Feb 2013): “our food chain is fragmented and open to abuse”. The same is true for proxy voting. Think we are exaggerating – regular readers of this blog will recall numerous occasions when shareholders’ rights have been compromised, German AGMs being the latest in a litany of problems. So, forgive the apparent opportunism of drawing parallels with “Horsegate”, but while shareholders’ rights are under attack from the institutions that are supposed to protect them, voting against a few bank CEOs doesn’t really solve the problem of accountability. Warning, this article contains real meat.

Where’s the beef?

The pressure for cheaper and cheaper goods (lasagna) and services (proxy voting) can only mean one thing, short-cuts, not prime-cuts. In the food chain, beef is cut with what every school boy and girl has for years called “mystery meat”. It’s just the same in the securities chain - one shareholder’s holdings are cut (co-mingled) with someone-else. The net result is the same, frozen blocks of Euro-mush masquerading as prime quality product with no traceability or accountability.

Global custody – the investor expectations gap

What is deeply troubling is that our experience of the abuses in the voting chain are just the most obvious manifestation of a deeply flawed securities system which has been built to facilitate high speed trading rather than long-term investing.  We hesitate to call it “safe custody” because pooled accounts just do not meet the definition of “safe”. Don’t just take our word for it, the Australian Securities and Investments Commission came to the same conclusion in its July 2012 custodial and depository services report:

“there are concerns about an expectation gap between what is legally required of custodians and what investors expect the custodian to be doing to safeguard their investment.”

Among the worrying practices/issues ASIC uncovered we find, at the top of the list “unauthorised debiting of omnibus accounts” closely followed by:
  • stability and safety of IT systems
  • operational risks created by manual and disparate systems
  • the risks inherent in corporate actions such as share buy-backs and rights issues

Shareholder protection – regulators and banks in conflict

It is quite ironic that in the middle of February, IOSCO, the international securities super-association published a consultation report regarding the protection of client assets as its reaction to the Lehman, MF Global failures.  It makes 7 key recommendations but three of them are particularly relevant to informed shareholders:

  • Intermediaries should maintain accurate records of client assets that establish the nature, amount, location, and ownership status of each client’s assets;
  • Accounts held with a third party for the benefit of clients should be titled in such a way to clearly distinguish assets held for the client from assets held from the intermediary;
  • When client assets are held in a foreign jurisdiction, the intermediary should inform the client of this fact and disclose the material differences of the foreign jurisdiction’s insolvency regime.

All good stuff. Until you realise that in the heart of Europe there is a group of bankers working under the auspices of the European Central Bank which has, without any meaningful shareholder input, decided that segregated accounts should be avoided at all costs. So while the European Commission is looking for ways to protect shareholder rights thought the long awaited Securities Law Directive, the bankers’ lobby AFME is looking for ways to keep its cost under control.

So what are the key action points that shareholders should consider? Here are a few thoughts:

Institutional shareholders are incurring significant risks to their stewardship programmes and their assets as a whole through their custodian arrangements. Cross-border governance makes things even more complicated and risky. Omnibus accounts appear seductively attractive because they are “cheaper”  but they transfer operational risk as HSBC explained in an article in a Global Custodian supplement back in 2005. Omnibus accounts do nothing to support stewardship.

  • Company law and share owners property rights exist outside the concept of financial markets, these differences must be respected.
  • Any Securities Law Directive must have investor protection as its utmost consideration, not market or market intermediary protection. Markets exist to facilitate asset ownership, they are not an end in their own right.  It was that kind of thinking that got us into this mess in the first place. To paraphrase Professor John Kay’s evidence to the UK’s Dept BIS Select Committee (February 5th 2012), ‘why do we have a Market Abuse Directive but not a Customer Abuse Directive’?
  • Securities are property in the EU legal context and should not be treated as cash – this has a significant impact in insolvency situations as we saw at Lehman’s. The Americanisation of our basic property rights but be resisted. US investors would dearly love to see their system of ownership overhauled to more closely match the rights enjoyed here in the EU, they know at first hand how deficient a securities law oriented system can be in protecting basic governance freedoms.
  • Segregated securities accounts must be the default option with pooled nominees for certain specific situations (institution-wide omnibus accounts for example). We are not convinced by suggestions that the costs are too great to support individual accounts – computing power has increased exponentially in recent years while the cost has plummeted. The elephant at the table is the potential cost associated with messaging up and down the chain across the full range of accounts. Banks can’t duck the costs of being in business and today that means investing in systems that can cope with what clients need.
  • Legal Entity Identifiers – LEIs are essential to the process of transparency and enabling shareholder ID. Issuers and shareholders need to know each other’s identities to have any governance engagement at all.
  • The Shareholder Rights Directive needs an urgent review as impediments remain to cross border voting.
  • Transparency of the entire proxy voting system is essential to bolster participant confidence. Regulators and stakeholders need a better understanding of the entire process rather than focussing on a small sub-set of activities. In concentrating on a group of participants which make recommendations, ESMA is ignoring the full range of actors and their roles which can make or break the governance process. Manifest has nothing to hide and would welcome a full public enquiry into this most important of issues central to corporate democracy.
Where’s the regulatory focus – mountains or molehills?

While ESMA frets over whether proxy analysts should have an industry-wide code of conduct (as opposed to the ones we’ve already got that nobody reads), it completely ignores unequivocal evidence that shareholders’ assets and property rights are at risk from banks who put their P&L ahead of all else. Perhaps it’s because the evidence doesn’t fit their narrative for building a pan-European securities regulator, or perhaps it’s because the bit of the proxy industry representing concerned shareholders’ views (as opposed to the Robobox-tickers) doesn’t have the same lobbying fire-power as the banks (it wouldn’t be the first time that the words “regulatory capture” are muttered under investors’ breath).

As we have seen with Horsegate, merely codifying or testing one output at the end of an overly, and unnecessarily, complex process does nothing to build quality and integrity into a system designed for consumers. With that in mind let’s leave the last word to the FT : “If the industry believes in self-regulation, it should not have supply chains so complex that they cannot be monitored. The consequence may be higher prices. But consumers will have to learn that there are no free lunches. And that, sometimes, it is right to look a gift horse in the mouth.”

Put another way, just because your cheap lasagne came from one of the biggest food retailers in the world that doesn’t mean it’s a quality product that’s fit for purpose.

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Declaration of Conflict of Interest:

Manifest operates a proxy voting service which, like Morrison’s meat processing facilities, shortens the food chain to the fewest possible links. Votes processed by the Manifest system take the shortest route possible from the investors desk-top straight to the vote tabulator without going via custodian or sub-custodian, unless we are forced to do so by the custodian which mandates the exclusive route we must take. We are paid by investors and not by custodians or issuers.

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