A new conversation
Few would dispute the need for an ongoing and active dialogue between those investing in a business as owners, and those tasked with running it. However, ‘ongoing’ and ‘active’ do not always apply to the conversation companies have with their shareholders. CSj looks at some new global and local initiatives to boost shareholder engagement.
As the AGM season gets underway in Hong Kong, it is perhaps a good time to step back for a moment and ask what is the point of it all? As the primary forum for shareholder engagement, the AGM might seem to have an unassailable place in the corporate calendar, but technological developments have presented many alternatives to fulfill the primary functions of the AGM and there has been no shortage of suggestions for better ways to engage shareholders.
One positive benefit of the debate about the purpose and future of the AGM has been a renewed attention to the role shareholders should actually play in corporate governance. Clearly, as the OECD Principles of Corporate Governance puts it, companies ‘cannot be managed by shareholder referendum’. In fast moving and ever changing markets, a company’s management must be able to take business decisions rapidly and it would be entirely impractical to expect shareholders to get involved in operational decisions.
But shareholders do have a role to play and globally there has been a renewed focus on the concept of investor ‘stewardship’. In 2010, for example, the UK brought out its Stewardship Code which emphasises that for investors, stewardship is more than just voting at the AGM. Shareholders stand at the top of the accountability chain of command. Directors hold managers accountable and shareholders hold the board accountable for the fulfillment of its responsibilities. Ideally, therefore, shareholders should
be monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, and corporate governance. ‘Engagement is purposeful dialogue with companies on these matters as well as on issues that are the immediate subject of votes at general meetings,’ the Code states.
This, then, is the theory, but how do shareholders actually interact with companies? In the retail section of the market, shareholders tend to be passive passengers in the corporate vehicle. A relatively small proportion of shareholders generally turn up at a company’s AGM and some of these may chiefly be interested in the sandwiches and the handouts. Moreover, there has been a general trend towards short- term investing. The average period of owning shares in a listed company has been steadily declining over recent years, exacerbated by the increasing use of high speed electronic trading.
In this context the prospects for the concept of investor stewardship catching on do not look great. But there is, of course, another segment of the investor market which in some jurisdictions, notably the US, has changed the game entirely – the institutional investors. The UK’s Stewardship Code is targeted at institutional investors since these organisations have the resources and the motivation to engage with their investee companies to ensure the financial security of their investments.
Is this relevant for Hong Kong?
The issue of shareholder engagement, which is an aspect of investor stewardship, is certainly not new to Hong Kong, though it has generally been approached in terms of the responsibilities of listed companies to engage investors rather than the other way around.
The Corporate Governance Code for example states that ‘the board should endeavour to maintain an ongoing dialogue with shareholders and in particular, use annual general meetings or other general meetings to communicate with shareholders and encourage their participation’ (Code E.1). The Code also requires the chairman of the board to ensure that ‘appropriate steps are taken to provide effective communication with shareholders and that views of shareholders are communicated to the board as a whole’ (Code A.2.8), and for non-executive directors to ‘attend general meetings and develop a balanced understanding of the views of shareholders’ (Code A.5.7).
Hong Kong currently has no official guideline on investors’ responsibilities – is this a weakness in our regulatory regime? Would Hong Kong gain any benefit from new guidelines on shareholder engagement and wider investor stewardship? Some commentators have questioned whether these concepts are really relevant in Hong Kong since shareholder passivity is not generally a problem in dominantly-held companies. The majority of Hong Kong companies are family-owned or dominated by a single or small number of majority shareholders. These shareholders are typically highly engaged in the running of the business. In most cases they sit on the board, or, where they are not formally so appointed, the directors are mindful of their interests.
In this scenario, while ‘shareholder engagement’ may be a non-issue, ‘investor stewardship’ is still highly relevant. Moreover, like most jurisdictions, Hong Kong has been evolving towards a more diversely held market, and, just as significantly, institutional investors are the largest contributor to Hong Kong’s market turnover. These developments have raised many issues which led to the creation of the UK’s Stewardship Code.
Institutional investors typically hold shares on behalf of a great number of investors and they owe a fiduciary duty to such beneficiaries to ensure the financial security of their investments. Issues such as their policies on proxy voting, how well they communicate with the shareholders for whom they act and what interaction they have with the companies in their portfolio, are as relevant in Hong Kong
as they are in the UK. A stewardship code could set out best practice standards on these issues. The principles of the UK Stewardship Code, for example, state that institutional investors should:
- publicly disclose their policy on how they will discharge their stewardship responsibilities
- have a robust policy on managing conflicts of interest in relation to stewardship which should be publicly disclosed
- monitor their investee companies
- establish clear guidelines on when and how they will escalate their stewardship activities
- be willing to act collectively with other investors where appropriate
- have a clear policy on voting and disclosure of voting activity, and
- report periodically on their stewardship and voting activities between companies and investors in a steward position.
While Hong Kong may not be ready for the full gamut of the UK’s Stewardship Code, it could pick and choose some of the Code’s provisions relating to shareholder engagement, and apply them to asset managers, owners and related services providers.
What does this mean for company secretaries?
Company secretaries are often the primary point of contact for investors and are tasked with keeping in touch with shareholder views and concerns. Company secretaries could therefore be powerful advocates should it be deemed appropriate to have a proactive engagement plan to ensure an effective dialogue with shareholders. A recent paper by the Australian government’s Corporations and Markets Advisory Committee (see www.camac.gov.au, under ‘Publications, Current Discussion Papers’) suggests that such an engagement plan should identify:
- dialogue areas – including matters concerning corporate strategy and key business opportunities, corporate governance, board composition and director appointments as well as executive remuneration
- dialogue processes – including various forms of face-to-face contact as well as written communications, and
- dialogue responsibilities – being allocated to specified board members, or the board collectively, depending upon the dialogue area.
The meaning of dialogue
The UK’s Stewardship Code emphasises that dialogue between companies and their shareholders must be just that – a two-way conversation. ‘In publicly listed companies responsibility for stewardship is shared,’ the Code states. ‘The primary responsibility rests with the board of the company, which oversees the actions of its management. Investors in the company also play an important role in holding the board to account for the fulfillment of its responsibilities.’
Moreover, the Code explicitly recognises that the comply or explain system (the enforcement mechanism used by both the UK’s and Hong Kong’s corporate governance codes) relies on investors playing their part in corporate governance. The system only works if there is a real possibility that shareholders will take action where companies fall below the expected standard. The Stewardship Code is aimed at assisting institutional investors to ‘better to exercise their stewardship responsibilities, which in turn gives force to the comply or explain system’, the Code states. In the UK, therefore, the corporate governance and stewardship codes are seen as two complementary halves of a whole. The Corporate Governance Code identifies the principles that underlie an effective board and the Stewardship Code sets out the principles of effective stewardship by investors. One without the other is only half the story.
In practice, however, working out the right level of dialogue between companies and their shareholders will not always be easy. It is worth bearing in mind that, in law, the shareholders’ role is fairly restricted. Shareholders have various information rights and the right to participate in the AGM or other shareholder meetings. They can, with the statutory threshold, initiate an extraordinary general meeting. They may also propose or vote on resolutions within their powers. In some jurisdictions they can also initiate derivative proceedings on behalf of a company.
Despite their limited official role many investors in the US, and increasingly in other jurisdictions, have been able to
use their equity stake to put significant pressure on management. These activist investors have various and sometimes conflicting interests. Large union-affiliated pension funds may be interested in upholding labour standards, other groups might be interested in human rights or environmental concerns. Sometimes these groups can become dogged harassers of corporate boards and executives.
Thus, while poor communication between a company and its shareholders can lead to problems escalating, particularly in the era of social media, directors need to assess whether it is in the company’s best interests to act on specific investor concerns. When implemented effectively, however, a direct dialogue between the company and shareholders can play an important role
in communicating the company’s strategy and vision to the company’s owners, and, in turn, can ensure that the company understands investor concerns.
Thanks to Mohan Datwani, Director, Technical and Research, HKICS, for his help in the preparation of this article.
SIDEBAR: Rules of engagement
In 2011, a group of six institutional investors came together in the UK to clarify what ‘investor stewardship’ should mean. The working group of these six investors asked the Institute of Chartered Secretaries and Administrators (ICSA) to form a steering group led by Sir John Egan to consult the market on this issue. The ICSA subsequently brought out a consultation paper in October 2012 (Improving engagement practices between companies and institutional investors) and the consultation ended in November 2012.
The consultation paper stresses that shareholder engagement should not be a once-a-year issue in the build-up to the AGM. ‘Ideally companies should engage on issues that could become controversial at the AGM well before the proxy materials are published’ the paper states.
The paper identifies four challenges relating to both the quality and the quantity of current stewardship practices in the UK.
- Quality of meetings – companies want meetings that are more purposeful and effective and give a deeper account of the company; more access to investors; more in-depth discussion; better joint handling of issues that reach the media; and better feedback on investors’ views when meetings are over. Companies also said they were frustrated by investors who presented a divided face on company performance and governance issues.
- Quality of information – there is a lack of information about the stewardship approaches of different asset managers, and a lack of comparability to help asset owners make informed decisions.
- Resource limitations – the resources for stewardship are limited and the investment community is not making best use of those resources. Index investors are a vital part of the market and often have the desire and the capability to be stewards, but companies sometimes dismiss them as unimportant.
- Critical mass – for the sake of beneficiaries and companies, the investment community needs to build a critical mass of stewardship investors – investors who are capable of engaging companies in constructive dialogue and holding their boards accountable to shareowners.