Articles, Thought Pieces
Top 15 things you should know about proxy advisory agencies
Boudicca works with both issuers and activist shareholders with the ultimate aim of maximising positive shareholder voting for the client. Typically, the engagement we undertake on behalf of our clients include proxy advisers, such as ISS and Glass Lewis, who influence institutional shareholders’ voting decisions. Below is a top-15 list of the things you should know about Proxy Advisers:
01: Institutional Investors use Proxy Advisers for research purposes
Institutions tend to subscribe to Proxy Adviser reports for ‘research purposes’ i.e. they are there to assist and provide digestible information on governance. As institutions may hold thousands of votable positions in their portfolio, the process of extracting the necessary information to undertake the vote-decision making would be overly burdensome, and is often outsourced to the Proxy Advisers. Proxy Advisers themselves have stressed that the voting decision is ultimately the responsibility of the shareholder, with a large majority of clients using their own in-house custom policies. One indication of this is the fact that institutional voting records do not necessarily tally with Proxy Adviser recommendations.
02: The two largest Proxy Advisers comprise 97% of the market
When it comes to the Proxy Adviser market, two competitors have sewn up all but a small sliver of the market; these are Institutional Shareholder Services (‘ISS’) and Glass Lewis. Smaller Proxy Advisers also operate with a UK focus such as The Investment Association (‘IA’), a trade body for the asset management industry, Pensions and Investment Research Consultants (‘PIRC’), and Manifest; although the latter does not tend to engage. In the US, however, ISS and Glass Lewis’ dominance in the Proxy Adviser market is near total, with the two advisers estimated to account for 97% of the total US Proxy Adviser market (1).
03: ISS is estimated to cover 25% to 50% of voting shares at mid- and large-cap companies
The grip of ISS on the Proxy Adviser market renders them influential over a large chunk of voting share capital. Bearing in mind that the ISS client base comprises financial institutions who tend to exercise their voting rights (unlike retail shareholders or execution-only PCBs), this further strengthens their influence. ISS is estimated to cover 25% to 50% of the voting shares of mid- and large-cap companies in the US, and has a strong worldwide reach due to its global coverage. Moreover, the propensity of smaller US investment houses often entirely outsourcing their research and voting to ISS, and thus tending to follow ISS vote recommendations, ISS’ influence is all the more predominant at companies with a large US shareholder base.
04: The Investment Association does not deliver vote recommendations
The Investment Association categorically states that it does not issue direct voting recommendation. Instead IVIS (Institutional Voting Information Service), the IA’s governance research team, employs a colour coding system to indicate if there are significant concerns shareholders would wish to consider. The matter for shareholder consideration is then highlighted in the report. Under this system, a ‘Blue Top’ denotes shareholder meetings without significant issues, ‘Amber’ highlights meetings which may contain issues which warrant closer consideration due to non-compliance or complexity, and ‘Red Tops’ are given for significant concerns and breaches of best practice. Nevertheless, while IVIS reports do not provide an outright vote recommendation, many shareholders consider that the colour tops can provide a good indication of votes cast For (Blue), Abstained (Amber) and Against (Red).
05: PIRC is the most likely proxy adviser to make negative vote recommendations
PIRC is guided by its policies to make negative vote recommendations more frequent basis than its mainstream competitors ISS and Glass Lewis. PIRC’s analysis is based on a variety of sustainability issues, such as the business model, accounting irregularities, and environmental, social or governance issues (ESG). This covers issues such as share buybacks and issuances, non-audit fees/auditor independence, and remuneration related proposals, on which PIRC takes a tougher stance than other Proxy Advisers. As these resolutions are standard business at most UK company AGMs, this results in more frequent negative vote recommendations. PIRC is known to service a proportion of the UK’s Local Council investment portfolios, several of whom have stricter investment and voting policies than their institutional investor counterparts. PIRC’s policy therefore varies from much of the governance community. For example, PIRC does not follow standard guidelines on pre-emption rights, resulting in them recommending shareholders vote against resolutions to issue shares without pre-emption rights.
06: An AGAINST recommendation is not the end of the world – most of these resolutions still pass
Whilst negative voting recommendations from the Proxy Advisers can act as a ‘red-flag’ to vote decision-makers, and be reported and circulated amongst voting shareholders generally, these recommendations do not usually condemn a resolution to defeat. Institutions usually utilise their own voting policies, their own in-house vote decision makers and do not automatically follow Proxy Adviser recommendations. However, in particular for special resolutions which require a 75% super majority to pass, a negative vote recommendation can have an important impact. A negative Proxy Adviser recommendation does lead to increased scrutiny by the corporate governance and portfolio managers, who would be compelled to obtain a (comprehensive) explanation from the concerned company as to why they have not fully complied and been ‘caught out’ by the Proxy Adviser. Therefore, strong engagement by issuers and advisers with institutional investors can erode the influence of negative vote recommendations.
07: Glass Lewis always recommends AGAINST the 14-day notice periods in the UK
A standard feature of a typical AGM for a UK-listed company is a special resolution to allow companies to call a General Meeting on 14 days’ notice, rather than the minimum 21 days as stipulated under the Companies Act 2006. This is routinely waived through without protests or negative recommendations. Glass Lewis, however, rarely unanimously recommends support for all resolutions to be proposed at UK companies, due to their long-standing policy of recommending against this routine item. This policy does not reflect market norms, but merely the preferences of their predominantly North American based clients.
08: The IA generally red-tops Rule 9 Waivers, and ISS normally recommends AGAINST
The Rule 9 Waiver, whereby a shareholder who holds more than 30% of a company’s issued share capital may otherwise be subject to making a mandatory offer to the remaining shareholders should their holding increase (such as through a company share buyback if they do not sell any of their shares), is regarded negatively by much of the investor community due to concerns that it can facilitate ‘creeping control’ without the payment of a control premium. This is reflected in the voting recommendations of ISS, recommending AGAINST c.60% of Rule 9 Waivers since January 2013.
09: PIRC is ‘small but noisy’, but has limited influence (usually less <1% of ISC)
Issuers typically have concerns and find faults with the contents and recommendations of PIRC reports, due to their frequent negative voting recommendations, and tendency to make explicitly critical comments on companies’ governance and remuneration. On the other hand, the financial press frequently refers to PIRC, due to the aggressive commentary and findings of their reporting. In terms of their influence on the share register, this tends to be minimal, however. PIRC’s client base is limited to certain local authority pension funds in the UK, and is not used by larger financial institutions. In Boudicca’s experience, it is unusual for PIRC to be used by more than 1% of ISC.
10: Proxy Advisers are open to engagement
Proxy Advisers publish their own policies on engagement, and whilst their reporting is based on publically disclosed information which is available to all shareholders, they can be open to engagement in the run-up to shareholder meetings to discuss issues, concerns and rationale with companies. Glass Lewis does not generally invite engagement with issuers in the preparation of a report, during their ‘busy’ season, unless they have specific questions. However, they are open to discussion afterwards on an on-going basis and provide specific mechanisms for out of proxy-season engagement (‘Proxy Talks’). The Proxy Advisers will also receive comments on their report and republish reports to include any new relevant information, to correct factual errors, and in certain cases, revise their voting recommendations.
11: ISS and Glass Lewis will evaluate the commercial terms of M&A
ISS and Glass Lewis are generally mandated by their institutional clients to provide reports on governance, rather than their judgement on commercial issues. However, ISS and Glass Lewis will employ their own methodology in evaluating the valuations and rationale for M&A transactions involving the use of what they perceive to be appropriate peer groups, financial analysis, and strategic fit; unlike the IA who typically do not comment on such matters and leave this for the commercial judgement of shareholders. Except for smaller companies, M&A transaction may result in the involvement of specialist M&A research teams at ISS and Glass Lewis, which analyse in detail the financial situation and rationale, as well as the strategic fit of the proposed transaction. Normally, this approach from ISS rarely results in negative vote recommendations on M&A related transactions.
12: Proxy Adviser support boosts the success rate of shareholder activism
There is evidence that securing the support of the predominant Proxy Advisers gives a boost to activist shareholders who have requisitioned resolutions, or tabled additional resolutions at the agenda of an AGM. Out of 144 activist proposals at UK companies from 2013-2016 reported upon by ISS, ISS recommended shareholders vote FOR 17 such proposals (11.81%). Of the 17 proposals that met with the approval of ISS, eight out of these were passed (47.06% pass rate), with 34 activist proposals which ISS had recommended a vote against passing (26.77% pass rate). Given that activists tend to put shareholder resolutions on the agenda only when these pose a reasonable chance of success (e.g. a certain level of voting support can be counted upon), this further highlights ISS’ influence on the vote outcome. Hence, ISS recommending a vote AGAINST activist proposals leads to a lower success rate than for management recommendations.
13: Proxy advisers will use their own criteria in judging director independence
Whilst Proxy Advisers typically base their assessment of director independence on the prevailing criteria for the market, such as defined in the UK Corporate Governance Code (the ‘Code’), their definition of independence may sometimes not match that of the issuers or of the market. Sometimes, this may result in a more liberal interpretation (for example, under the UK Code, a tenure length of more than nine years is considered an independence issue, but by itself is not considered a concern by ISS or Glass Lewis unless there is overlap with executive directors on the board). In other instances, however, Proxy Adviser classifications of independence may go beyond the boundaries of market guidance, such as the use of options to remunerate non-executive directors in the US being considered an independence issue by ISS, despite this being common practice in this market. In any case, ISS will not consider a director independent where the issuer considers them non-independent, for whatever reason.
14: Company secretariat, IR and directors should be open to engage with proxy advisers
Since the introduction of the Stewardship Code in 2010, institutional investors have become increasingly aware of their responsibilities to engage with the companies held within their portfolio. At the same time, issuers have proactively sought engagement opportunities with their significant shareholders. While the portfolio managers, and to some extent the governance teams, of institutional investors may prefer to engage directly with the management team of their portfolio companies, the Proxy Advisers tend to prefer communicating with the non-executive directors to prevent any conflict of interests that may arise from discussing remuneration and independence issues with executive directors. The Company Secretary tends to be the facilitator of such engagement meetings with the Proxy Advisers as “the Company Secretary should be responsible for advising the board… on all governance matters” (UK Code, Principle B.5).
15: Plan engagement effectively – proxy advisers are less likely to engage during proxy season
The timing of any general or non-time sensitive engagement is essential. Both Proxy Advisers and institutional investors will be very busy during the run-up of the AGM season, which in the UK starts around the middle of March. Therefore, to ensure that any engagement is conducted in the most conducive and effective way, discussions should preferable be held in the period between September to February. This should also provide a good timeframe to allow for any final proposals being discussed at Board and Remuneration Committee level for sign-off prior to the publication of the next Annual Report.