ESMA has now released its final report on ‘The Proxy Advisor Industry’. It’s key recommendation, after long deliberation, is that there is “no current market failure related to proxy advisors interaction with investors and issuers in the European Union (EU).”
This finding is very welcome, but to those in the industry, it doesn’t really come as a surprise. Which we don’t mean to be an arrogant statement, it’s simply that the anti-proxy industry rhetoric has always been very hyped and biased towards a US model of governance which, it has to be said, does not encourage stewardship or investor engagement.
Firstly, let’s be absolutely clear, we do not contest the value of a better understanding of the full range of stewardship activities – there is a lot of “Mythbusting” that needs to be done to help issuers understand who is really in control of the governance process. In that regard, ESMA’s suggestion for a harmonised Code of Conduct for the industry might be a useful starting point. However, it is inaccurate to infer that codes of conduct do not exist, or that ESMA is the first organisation to consider the question. Most, if not all, of the participants named as supportive of the exercise already have their own codes of conduct in place.
What really matters though, is that we believe that the ESMA exercise is a missed opportunity. The report, and especially its conclusions have not fully explored all aspects of what is a diverse and nuanced industry where some very real problems exist to undermine shareholders’ rights – this should be of as much concern to companies as it is to investors.
There are numerous problems with the term ‘proxy advisor’ and the description of our activities which ESMA insists on using. It is just plain wrong to suggest that all proxy analysts give ‘Advice’ or make ‘Recommenations’ or are somehow supplanting investors in their ownership duties. The term ‘proxy analyst’ might be a more accurate collective noun for the entities which we believe they have in mind when they use the term ‘proxy advisor’. Proxy Advisor is not a term which has been used in Europe until very recently, it is another US import. This is important as ‘Advice’ in the US context has a very specific regulatory meaning with significant implications for fiduciary responsibility.
There are many other actors in the investment and ownership chain who influence how investors’ votes are executed, including (but not limited to):
- Providers of specialist engagement and voting services which includes use of client voting rights as a part of the engagement service so-called ‘Governance Overlay’;
- Sustainability and SRI advisors;
- Proxy solicitation companies who have a commercial interest in a particular outcome of a meeting and who may work for companies or other shareholders;
- Custodians who offer explicit pre-canned voting advice within the voting services they make available for their clients; and
- Company boards who offer recommendations for how shareholders should vote and have an interest in ensuring shareholders support their proposals.
Fundamentally, it is the relationship between investors and companies which is the central tenet of corporate governance, not the efficiency of stock markets. Regulators like ESMA should be encouraging all stakeholders to focus on long-term, investor-led opinion on all investment matters including corporate governance and proxy voting. The narrow focus upon the ‘advice’ of the research services investors use deflects attention away from the importance of the investor and company relationship.
There are also two elephants in the room which ESMA has failed to acknowledge or address.
Firstly, the lack of competition which characterises the market for proxy services contributes in no small part to the perceived problems with ‘proxy advisors’. Undue influence is certainly exercisable when such a large number of investors and issuers alike (not to mention trade associations) subsidise one single provider, thereby making entry to market for much needed competition significantly challenging. It is ironic that the European Commission and Parliament is concerned that the market for Credit Ratings is defective when it has only three major US providers and audit has the “Big 4” in its sights.
Secondly, irrespective of whether voting decisions may be over-influenced by proxy research or advice, the question is academic if investors cannot actually vote their shares with a sufficient degree of certainty. Without addressing the problems which persist with cross-border voting operations within Europe, such as share blocking, custodian resistance to segregated securities accounts and denial of investor choice as to the mechanisms through which their voting instructions are processed, ESMA is simply handing out instructions as to how to re-arrange the deckchairs on the Titanic.
The first rule in software development, engineering or policy making is to have a clear definition of the problem to be solved. ESMA itself admits that it doesn’t have a definition of what a proxy advisor is. In which case, what is the point of a Code of Conduct if nobody knows what the conduct that is to be codified actually is? What value will the Code have amongst those who have pushed hard for its development if there is no established measurable purpose or objective and governance framework?
ESMA’s report poses and leaves unanswered more questions than it answers; in the mean time foreign shareholders are still having their shares blocked in Germany – 5 years or more on from the EC Directive which was supposed to eradicate barriers to shareholder voting.