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 Shakeup’ Financial Times, 7 th 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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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.
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There needs to be greater disclosure by companies (see para 13)
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Fund managers need experience of understanding the nature of intangible assets and how they are exploited to drive corporate success.
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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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.
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The reputation of fund managers is important to gaining credibility with investee companies. Therefore method and style of communication adopted is significant.
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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.
13. 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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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.
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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.
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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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