Proxy adviser regulation proposed in Australia?
09/06/2017
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Proxy adviser firms could see new guidelines introduced to govern the recommendations they make for votes in Australia. Regulation has already been proposed for the US and the UK.

Australia’s corporate regulator, the Australian Securities and Investments Commission (ASIC), called a roundtable meeting in early May to discuss the issue of proxy regulation. Ahead of that meeting, proposals for a voluntary code were set forth which included guidelines for proxy recommendations.

The Australasian Investor Relations Association (AIRA) released its own draft “Code for Improving Engagement between Listed Entities and Proxy Advisers” on 8 May (see HERE).

AIRA’s draft code is based on five principles with a view to ensuring the proxy adviser recommendations are clear, correct and free of conflicts. These principles are:

  • proxy research should be factually accurate and issuers should be given the opportunity to correct factual errors
  • proxy adviser firms should be adequately resourced and staffed
  • proxy adviser firms should be given appropriate feedback including industry benchmarking
  • there should be a system for managing conflicts of interest; and
  • proxy adviser firms should report on compliance with the code on a regular basis

Under these proposals, proxy advisers would have to send drafts of their recommendations to issuers before publication with a view to correcting any factual errors. They would then have one working day to make any necessary corrections.

One of the proxy advisers said the code is not necessary, given that Australia’s processes are significantly different from those in the US and UK. Specifically, unlike the countries that have or are about to impose additional regulation, Australia has nurtured a more involved engagement process, whereby proxy advisers and issuers both took great effort to understand each other’s point of view, and get the facts right.

The proposal to send drafts of recommendations to issuers before being sent to the proxy advisers’ clients does have some troubling elements. Should the same principle apply to equity analysts before they release their reports, or brokers before they make sell recommendations? Our free market system operates on the tenet that suppliers who continuously make errors of fact will not remain in the market for too long.

Guerdon Associates have been advising clients for some years to prepare fact sheets replicating each proxy advisers’ methodologies so that they can use these to cross-check their own analysts’ data work. This is particularly useful to ensure recommendations have valid foundations for the two proxy advisers that publish guidelines and base recommendations on this data. This approach minimises the risk of proxy adviser recommendations based on factual errors. It does not do anything, however, where there are simply differences of opinion on what is good, or appropriate, governance.

A compromise that may be adopted in some countries as a result of regulation requires the proxy advisers to provide issuers with the data on which their recommendations will be based a day before reports are finalised and sent to their clients.

This compromise would push up proxy adviser costs, as more resourcing is required to pump more data through their systems in the short window between a company’s disclosures and the lodgement of votes. The capability of the proxy advisers to absorb these additional costs is constrained by thin margins, and may therefore have unintended consequences. For example, it may reduce competition if one proxy adviser goes broke or withdraws its physical presence in Australia as a result. The squeezed margins may put pressure on the supervisory resourcing required for quality recommendations, resulting in worse outcomes.

These would not be issues if institutional investors were prepared to pay more for the additional resourcing required. This is unlikely, although it is difficult to gauge given the absence of institutional investors at the roundtable.

The ability of the proxy advisers to respond also varies.

ISS is cross-subsidised by its corporate consulting business to issuers (see HERE). This has been very successful, justifying the significant price paid by private equity to acquire ISS and spread its US business model globally. It maintains its proxy advice business (albeit with thin margins) to institutional investors so that it continues to reap the rewards from its highly profitable business to issuers. This conflicted business model gave rise to calls for more regulation in the US. It would be an unintended and, frankly, unwelcome consequence if regulation strengthens ISS by weakening  the other providers of proxy advice such that one, or both, withdraw.

CGI Glass Lewis is more of a pure-play adviser to institutional investors. While the firm has an interest in great new disruptive technology (Meetyl) that cuts out the investment banks standing between issuers and providers of capital, and its Australian business is doing well, it has the least financial resources and hard-nosed Canadian pension fund owners that will not invest more unless they achieve a required rate of return.

Ownership Matters maintains its strong relationship with ACSI, provides ancillary governance and advocacy services, and has reports relatively light on data, indicating that it would be least affected by a “get the facts right” regulation.

Unfortunately, ASIC appeared to forget that institutional investors should have a say. Among those attending the meeting were the proxy advisers, ACSI, the AICD, the AIRA, the Australian Shareholders’ Association, two ASIC commissioners and just one institutional investor. As institutional investors could be asked to foot the bill for more proxy adviser resourcing to meet regulatory requirements, it would be useful to hear more from them.

It also seems ASIC did not have much of an idea how institutional investor vote processes work in practice. So the roundtable, despite the absence of institutional investors, was still valuable in assisting ASIC understand the complex process. If anything, it also underscored how legislation would be unlikely, as well as unwise, with the current levels of understanding by the corporate regulator.

This is an interesting space, with several powerful lobby groups and the potential for unintended consequences. Issuers should remain wary, be aware of the consequences, and ensure they speak up directly (or through advocates) so that all the nuances are well understood by all parties before any regulation is fashioned.

© Guerdon Associates 2021
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