Moving into the mainstream

As environmental, social and governance issues are increasingly being factored into their mainstream agenda, European institutional investors are taking their roles as responsible owners much more seriously. Companies will be taken to task if they step out of the ESG line, but it is unlikely that a wave of US style class actions suits will arrive on UK and continental shores. The preferred modus operandi of European shareholders is likely to remain engagement rather than confrontation.

If investors do have a grievance against a multinational company, they will typically seek redress through the US justice system where, not surprisingly, the precedents are much clearer. According to a recent report by Institutional Shareholder Services (ISS), a provider of corporate governance and proxy voting services, anecdotal evidence suggests that international investors have been active in US courts for some time, with investors from 17 different countries, represented by 23 different law firms, taking an active role.

ISS estimates approximately $18.3bn (€13.6bn) was recovered through US securities class actions in 2006 alone, but independent reports have suggested that between 30% and 70% of payouts remain unclaimed by investors, including UK and European institutional shareholders.

The ISS report also noted that while there remains some wariness among investors in the UK and Europe to participate in US securities litigation, there are signs that leading international players are becoming more open to the idea. This can be seen in the recent high profile case of Royal Dutch Shell, whereby investors including VEB, which represents individual shareholders in the Netherlands and ABP, Europe’s largest pension fund, filed a suit against the firm in New Jersey over the company’s restatement of its oil and natural gas reserves in 2004.

This April past, the Anglo-Dutch firm agreed to a $353m settlement to non-US shareholders. This ranks as the second-largest securities class action settlement in Europe, behind Ahold’s $1.1bn agreement and ahead of DaimlerChrysler’s $300m deal.

However, Magnus Furugård, president, GES Investment Services, a Swedish-based research firm, believes that European investors will continue to tread a less aggressive tone on their home and regional turf. “The US is a more litigious society and it is an American tradition to be outspoken and assertive. I think most UK and continental European investors are still reluctant to get involved in lawsuits and they prefer to work behind the scenes using diplomacy and engagement.”

Karina Litvack, head of governance and sustainable investment at F&C, the UK based fund management group, also notes that “investors see the excesses of the litigious culture and how reluctant management might be in the US to discuss certain things and read off script for fear of being sued. The one area where we would expect to see an increase is in third-party class action suits where an investment bank could be sued for conducting inadequate due diligence that led to clients purchasing overpriced securities.”

Moreover, Eugene Rebers, senior counsel of ABP Investments, believes that overall, Europeans prefer to operate on a consensus model. “This does not just apply to SRI issues but across the board. In the longer term we believe it is better for market participants to discuss issues and try to resolve possible problems among each other. In engaging with the company, there is a greater chance of reaching a mutual understanding. A confrontational approach can lead to class action suits.”

 

Despite the cultural differences, corporate governance practices on both sides of the Atlantic are now being closely scrutinised. Scandals such as Enron, Worldcom and Parmalat initially focused shareholders’ collective minds but more recently, there has been a growing recognition that issues such as climate change, workplace conditions and violations of human rights can have a negative impact on a company’s bottom line.

Industry participants also agree that the main catalyst for action has been the UN Principles of Responsible Investment (PRI) which were launched last April and aimed at institutional investors and their asset managers. There are six main tenets including incorporating ESG into conventional investment analysis; being active, responsible owners by promoting good corporate practice and to report transparently on what actions have been taken in these areas. The UN PRI also contains a set of 35 suggested actions including, significantly, the embedding of adherence to the principles into the investment mandates that pension schemes agree with their asset managers.

According to figures from the UN PRI, it celebrated its first anniversary with over 180 leading institutions as signatories, representing over $8trn in assets under management. One of the most popular initiatives has been the PRI Engagement Clearinghouse, which is the first worldwide collaborative forum for investors to work together and share knowledge and resources to take action on ESG issues. It has proven an effective arena to raise awareness and gain support from other participants for investor activities, globally on a wide range of issues such as climate change, executive remuneration, transparency and investment in sensitive regions.

Colin Melvin, director of corporate governance at Hermes Asset Management, comments : “The UN PRI has definitely had a significant impact and we are seeing a lot more collaboration as a result. They have made investors take their responsibility more seriously as owners of the company. There has also been recognition that encouraging good corporate governance, social and environmental responsibility can raise the value of their holdings consistently with their liabilities over the long term.”

Emma Hunt, senior consultant and head of responsible investment in Europe for Mercer, agrees, adding, “We have definitely seen a big change as a result of UN PRI in the way institutions think about themselves and their role as shareholders. We are already seeing a great deal of collaborative activity and we expect this to increase through the use of the UN PRI Clearinghouse with pension funds sharing ideas on the most efficient ways to improve corporate governance.”

There has also been greater collaboration on the country level via formal and informal networks. The theory is that working together will enable institutional investors to pool their resources and exert greater influence. For example, on a more organised level, this past year has seen Sweden’s national pension buffer funds, AP1, AP2, AP3 and AP4, establish a group called the Ethical Council to co-ordinate research efforts when evaluating the environmental and social performance of overseas investments. All four of the funds selected GES Investment Services to systematically screen each fund’s investment portfolio in order to identify infringements of social, environmental or ethical norms.

According to a spokesperson for the Ethical Council: “We are strong believers in engagement. We engage in dialogue with our Swedish companies but for our foreign equity portfolio, which is largely managed by external mangers, we, in most cases, delegate to them the exercise of voting rights”.

Engagement is also the mantra at Eumedion, a corporate governance group representing Dutch institutional investors. “In the past, pension funds in the Netherlands tended to be reactive,” Erik Breen, head of corporate governance and sustainability at Robeco Asset Management. “Together with other parties, we created Eumedion in order to allow us to speak with one voice and to be more proactive. Every year we highlight one or two major issues and prepare a coordinated general stance point. This year we are looking at remuneration, as was highlighted among others in our statement on the packages at Philips.”

Eumedion recently criticised the €1m bonus Philips president and chief executive Gerard Kleisterlee and two other executives received for the sale of the company’s semiconductor arm. Breen argued that the buying and selling of companies was part and parcel of a company’s activities and did not necessitate providing the directors with an extra reward.

Rebers of ABP Investments, also believes that a co-ordinated effort can be more effective. “If each one of the pension funds attends an annual general meeting, then it is an inefficient use of time. Frequently one institutional investor will go and speak on behalf of the other investors.”

 

Although each country has its own practices, approaches and agenda, Hunt at Mercer believes that in some cases, exclusion can be the last resort. In other cases, funds have a special mandate to exclude sectors such as alcohol, tobacco and defence. “Overall, we are seeing the larger European pension funds developing a best of breed list of companies that adhere to international standards found in the International Labour Organisation and UN Declaration of Human Rights.

Also, according to research from the European Corporate Governance Service (ECGS), companies are creating best practice recommendations around several key corporate governance issues. These include board independence, the separation of roles between chairman and chief executive, the establishment of board committees and the disclosure of executive remuneration.

As Litvack observes: “Corporate governance always starts with the effectiveness of the board and the independence of its individual members. It is not just about having the right people on the board, but also the best people for the different committees. For example, on the audit committee, you want to ensure that the right internal controls are in place to avoid another Enron.”

The ECGS 2006 study of the top 300 companies in Europe notes that progress is being made, although more work needs to be done. For example, about 84% of the corporations polled had a separate chairman and chief executive. French and Swiss corporations were the main holdouts, with 53% and 73%, respectively having combined roles. Although a large majority of the board of directors - 69% - were elected on an individual basis, there was still a significant minority which did not follow this practice.

As for board independence, on average 43% were in this category. Top marks went to the Netherlands, Switzerland and Finland followed by Norway and the UK. At the bottom were Italy, Spain, Germany and Austria, although the last two suffer due to regulations requiring employee
representatives.

Remuneration remains one of the most contentious issues in any country. As Breen puts it, “We want clear information on what is being paid. We do not object potentially to special situations but we need to see a clear motivation when the discretionary power of the supervisory board is being used. We do not want to reward a bonus, for example, for underperformance.”

The ECGS report reveals that the worst offenders are companies predominately located in Spain, Belgium, Switzerland and Germany, where 78%, 66%, 59% and 44% respectively do not disclose the exact details of their directors’ fees.

Transparency cuts both ways, though. Pension funds are also being forced to be more accountable. Unlike in the US, where large mutual and pension funds have been required to publicly disclose their investments since the 1970s, European funds have no such obligation, although this is changing. Also, many are publishing their voting records on their websites for the first time.

Recently ABP buckled to pressure after a Dutch current affairs television show revealed that it had holdings in companies that manufactured land mines and cluster bombs. The fund has since divested fund from US based companies Textron, General Dynamics, Alliant Techsystems, and Singapore based Technologies Engineering.

The fund also revealed its entire stock portfolio of around 3,000 public companies in its annual report published in April.