1) How do you explain the high correlation between proxy advice and voting outcomes?

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1 CNMV ADVISORY COMMITTEE RESPONSE TO THE ESMA CONSULTATION PAPER: "CONSULTATION ON THE DP - AN OVERVIEW OF THE PROXY ADVISORY INDUSTRY. CONSIDERATIONS ON POSSIBLE POLICY OPTIONS- The CNMV's Advisory Committee has been set by the Spanish Securities Market Law as the consultative body of the CNMV. This Committee is composed by market participants (members of secondary markets, issuers, retail investors, intermediaries, the collective investment industry, etc) and its opinions are independent from those of the CNMV. 1) How do you explain the high correlation between proxy advice and voting outcomes? There are currently no effective mechanisms for measuring the real impact of the recommendations of proxy advisors on Spanish listed companies, and it is therefore not possible to state that the correlation is high. One of the difficulties in measuring this impact in the case of Spain lies in the difference in the composition of the capital structure of Spanish listed companies (with the usual presence of shareholders with a very relevant number of shares). According to data published by the CNMV on the corporate governance reports of entities with securities admitted to trading on official secondary markets and in the Ibex 35, a natural or legal person holds a majority of the voting rights, or has a relevant percentage of the shares, in 28.1% of listed companies in 2010 (31.4% in the Ibex 35). In 2010, the sum of significant shareholdings and the share packages in the hands of the board exceeded 50% of the capital in 76.5% of companies (75% in 2009). This was the case in 11 of the 35 companies in the Ibex 35. The general perception is that the higher the level of participation of foreign institutional investors among the shareholders of listed companies, the greater the level of influence of proxy advisors. Similarly, the influence of proxy advisors is especially significant in Spanish companies which, as a consequence of the special legislation regulating their activities, have special limitations with regard to participation in their share capital or the exercising of voting rights by shareholders, as is the case for electricity and gas distribution networks. In these companies, the recommendations of proxy advisors may become decisive factors in the approval or rejection of resolution proposals. The second problem for calibrating the level of real correlation between the voting recommendations issued by proxy advisors and the voting outcomes in general meetings in Spanish listed companies is that the outcome of the shareholders' vote (including institutional investors), although it may coincide with the voting recommendations of one or several proxy advisors, may be the result of different criteria than those expressed in said recommendations, or the result of specific interests of the shareholder in question (which in many cases may hold a relevant percentage). 2) To what extent: a) Do you consider that proxy advisors have a significant influence on voting outcomes? In general, it is difficult to establish with certainty the level of influence of the recommendations of proxy advisors on the vote finally issued by shareholders in Spanish listed companies. Página 1

2 Given that the main users of the services provided by proxy advisers are institutional investors, the influence of the voting recommendations made by proxy advisors largely depends on the participation of those investors among the shareholders of Spanish issuers. In this regard, and as indicated above, it is important to bear in mind that the Spanish stock market is highly concentrated. According to the research service of Bolsas y Mercados Españoles 1, which quotes data provided by FactSet corresponding to the second quarter of 2011, the value of the shareholdings of institutional investors (mutual funds, pension funds and investment trust companies) in Ibex 35 companies amounted to 120,382 million dollars. Considering a total capitalisation of IBEX 35 companies of around 320 billion euros (at the start of 2012), the percentage of capital in the hands of institutional investors accounts for around one third of the total 2. From this same analysis performed on the total capitalisation volume of the Spanish electronic market, we can deduce that in 2011 only 2.6% of the total capitalisation volume was in the hands of Spanish Collective Investment Schemes (CIS) and Pension Funds. According to another recent study 3 which analysed the behaviour of sixty foreign institutional investors present in a large part of the listed companies making up the Ibex 35, during the 2009, 2010 and 2011 General Shareholders' Meetings seasons, the most highly followed proxy advisory firm (ISS) was followed by 55 of the 60 institutional investors surveyed, among which: The voting decision of 30.9% of the institutional investors depended to a large extent on the recommendations of said proxy advisor. For the remaining 69%, the recommendations of said proxy adviser were taken as a reference for internal analysis, without being a decisive factor. Of the 17 investors which reported having a high dependence on said proxy adviser, only three of them deviated from their recommendations in Spain in the General Shareholders' Meetings seasons over the last three years. Of the 38 investors which used said proxy adviser as a reference, 28 of them deviated at some time from their recommendations over the same period. Finally, Spanish institutional investors do not usually use the service of proxy advisors to define their voting choice. In this regard, according to data from a survey carried out in 1 The data has been taken from the article Las compañías del IBEX-35 presentes en fondos mundiales [IBEX-35 companies in 10,000 global funds], prepared by the research service of Bolsas y Mercados Españoles for the third quarter 2011 issue of the Revista de Bolsas y Mercados Españoles. 2 Notwithstanding the above, according to some sources (Revista Capital, March 2011, Grandes Inversores Institucionales [Major Institutional Investors], which in turn cites Bolsas y Mercados Españoles), the purchases and sales of shares involving institutional investors accounted for over 75% of the total in El Gobierno Corporativo y los Inversores Institucionales [Corporate Governance and Institutional Investors], Georgeson Cuatrecasas, Gonçalves Pereira. Ed The main sources of information were: Voting Records of institutional investors available for the 2009, 2010 and 2011 Meetings seasons, sources of internal information of Georgeson; ISS Institutional Voting Tracking platform. Page 2

3 2011 of 13 Spanish institutional investors and entities which managed around 4 billion euros in equity instruments in Spain, 62% reported that they did not take into consideration the voting recommendations of proxy advisors in any case, while 15% use their recommendations exclusively for the General Shareholders' Meetings of listed companies not domiciled in Spain. At any event, in view of the existing data on the recommendations issued (which are mainly focused on matters of remuneration and appointment or re-election of directors), it does not seem that for the time being, and in general, proxy advisors exercise a sufficiently significant influence over the shareholders of Spanish listed companies so as to alter the favourable results, or not, of the votes of resolutions adopted in the respective General Meetings. b) Would you consider this influence as appropriate? As indicated above, up to now, the influence of the voting recommendations made by proxy advisors in quantitative terms does not seem highly significant. Nevertheless, it is increasing. Existing evidence does not allow identifying circumstances in which this influence has been demonstrated as being inappropriate. Certain proxy advisors occasionally issue recommendations which exceed the scope of corporate governance (for example, in relation to the issue of debentures or relating to resolutions on the generic authorisation to acquire treasury shares). This is considered positive providing the corresponding proxy advisor has suitable knowledge on the specific situation of the issuer subject to said recommendations and providing the supporting criteria are clearly expressed. 3) To what extent can the use of proxy advisors voting policies induce a risk of shifting the voting responsibility and weakening the owner s prerogatives? Both in the area of CIS and Pension Funds, Spanish legislation establishes that, in the case of exercising voting rights - only mandatory in certain situations, depending on the quantitative and stable importance of the shareholding - said voting must always be exercised to the exclusive benefit of the unit-holders. Similarly, in both cases, and irrespective of the importance of the shareholding, there is an obligation to report to the unit-holders on the strategies and on the voting decision, and the use of proxy advisors, as is the case with the use of advisors in any other field, does not modify the responsibilities of the management companies. In the case of CIS, these obligations derive from European legislation as established in Article 21 of Commission Directive 2010/43/EU, of 1 July. In Spain, this legislation has been fully transposed. From the above it follows that in Spain an institutional investor cannot be exempt from its fiduciary duties to its unit-holders with regard to the exercising of voting rights resulting from the use of voting recommendations issued by a proxy advisor and that, therefore, there is no risk of "transfer" of the influence in favour of the proxy advisor and to the detriment of the beneficial owners. In those jurisdictions with no specific obligations with regard to the exercising of voting rights in the interests of the beneficial owners and with regard to transparency, the use by institutional investors of the services of a proxy advisor as a sort of liability (reputational) insurance could make it more difficult for the institutional investor to deviate from the voting recommendations received from said proxy advisor. Furthermore, on these occasions it could be even more questionable for the institutional Page 3

4 investor (especially in the case of entities which have limited means to monitor and analyse the companies in which they buy shares) to deviate from the criteria and recommendations of a proxy advisor which, at least from a theoretical point of view, has greater resources and training to form appropriate voting criteria on the issue in question. Consequently, we believe that they may be a risk of a "transfer" of influence in favour of the proxy advisor and to the detriment of the beneficial owners only in those jurisdictions in which the legislation does not establish specific obligations on institutional investors or their management companies (which is not the case in Spain or in the rest of Europe). 4) To what extent do you consider proxy advisors: a) To be subject to conflicts of interest in practice? Bearing in mind the scope of the services offered by the main proxy advisors, we consider that, in practice, there are certain situations which may lead to conflicts of interest, such as: The provision of other services which involve a self-review risk (for example, advising issuers on corporate governance). Belonging or being related to a business group in which the objectives, incentives or priorities of the parent company or of the group may be incompatible or enter into conflict with the independence and objectivity of the proxy advisor (for example, when the parent company of the group which the proxy advisor belongs to is an institutional investor, rating agency, etc.). Having a shareholding (direct or indirect) or interest in the issuer subject to analysis and voting recommendation. Advising on the vote in companies which in turn have a direct or indirect holding in other listed companies. b) Have in place appropriate conflict mitigation measures? Although there is insufficient information on the level of effectiveness of the mechanisms implemented by the main proxy advisors to prevent and mitigate possible conflicts, we consider that the following measures may be suitable for said purpose: Establishing firewalls and similar procedures of legal, physical and technological separation of information and documentation when services are provided which involve self-review risk. Ensuring the independence of the proxy advisor's decision-making when the proxy advisor forms part of a group with possibly conflicting interests. In general, increasing transparency should make it easier to assess and mitigate the impact of situations which may lead to potential conflicts of interest. c) To be sufficiently transparent regarding conflict of interests the face? It is important to highlight the lack of transparency with regard to the business relations between proxy advisors and the issuer or the shareholders of the issuer and, in general, the circumstances which may affect the independence of their opinions. Page 4

5 It would be preferable to have a greater level of transparency, particularly with regard to the proxy advisors' sources of revenue, which would help in adequately assessing the real foreseeable impact of the potential conflict of interest affecting them. 5) If you consider there are conflicts of interest within proxy advisors which have not been appropriately mitigated, which are the most important and would this lead to impaired advice? As far as we are aware, no significant complaints from Spanish shareholders or issuers have arisen in this regard. However, there is a perception, due to their structure and activities, that proxy advisors could be subject to potential conflicts of interest which might not be suitably resolved or mitigated, as described above, particularly in reference to proxy advisors providing services which involve self-review risk (for example, advising issuers on corporate governance). 6) To what extent and how do you consider that there could be improvement: a) For taking into account local market conditions in voting policies? A greater level of local interaction between proxy advisors and regulators and specialised advisors would undoubtedly provide a significant boost to proxy advisors' knowledge and understanding of local market regulation and practices, which clearly need to be taken into account when preparing voting criteria and recommendations. Furthermore, it would be desirable for proxy advisors, as part of their internal functioning, to improve their knowledge of the corporate governance regulation and recommendations applicable locally. To this end, it would be recommendable to hire and provide ongoing training to specialised personnel, with the professional qualifications and technical knowledge necessary relating to the markets in which they specialise for the preparation of their reports, analysis and voting recommendations. It would also be beneficial in practice for the analysts who cover a specific country and market to cover that market on a stable ongoing basis. b) On dialogue between proxy advisors and third parties (issuers and investors) on the development of voting policies and guidelines? It would be desirable to have a greater level of transparency in the processes and schedule for preparing the voting policies and guidelines of proxy advisors and for that schedule to include an additional space for interaction with regulators, issuers and investors so that their vision and experience might be suitably processed. In general, greater interaction between proxy advisors and the institutional investors to which they render services, with the aim of providing them with specific detailed information on the methodology and criteria behind their voting recommendations, would boost the quality of the advisory services provided and help match the voting recommendations to the investors' interests. 7) To what extent do you consider that there needs to be improvement, also as regards to transparency, in: a) The methodology applied by proxy advisors to provide reliable and independent voting recommendations? Greater transparency on the methodology applied would help towards improving its quality and preventing situations in which the preparation of voting recommendations Page 5

6 responds to standardised and mechanical procedures which do not take into account the diverse reality and special nature of each country and issue ("box ticking"). With the necessary level of transparency, disclosures of potential conflicts of interest or business relations between the proxy advisor and the issuer, its shareholders and related persons will contribute towards the quality and reliability of the recommendations. Proxy advisors should apply clear and unambiguous rules when preparing their recommendations so as to ensure consistency in advice in relation to similar matters with different issuers, bearing in mind the specific nature and interests of each investor. b) The dialogue with issuers when drafting voting recommendations? In line with the above, we believe there should be interaction between proxy advisors and issuers. To this end, the schedules for preparing the voting recommendations should be adapted so as to create the space necessary for interaction (exchange of draft reports, for example) with issuers so as to compare information, avoid factual errors and allow issuers to provide proxy advisors with the explanations and clarifications which they consider pertinent with regard to the resolution proposals which are submitted to the General Shareholders' Meeting. c) The standards of skill and experience among proxy advisor staff? Better knowledge of the economic and legal reality of issuers and of sector regulations, as well as local market practices in matters of corporate governance, would undoubtedly have a positive effect on the quality of the advice provided by proxy advisors. Bearing in mind the sharply cyclical nature of the sector in which proxy advisors operate, marked by the excessive workload for staff in the ordinary General Meetings season (condensed into a few months), it would be recommendable to limit the number of issuers and/or meetings which each analyst must cover and, furthermore, aim for the analysts covering one specific country and market to remain in their positions and functions on an ongoing basis. 8) Which policy option do you support, if any? Please explain your choice and your preferred way of pursuing a particular approach within that option, if any. After analysing the four alternatives studied, we can conclude that, on the one hand, the problems deriving from the activity of proxy advisors should not be ignored because of their importance and the risks which they pose, given its growing influence, and, on the other hand, adopting legislative measures with regard to regulation and supervision does not currently seem to be the most recommendable option for addressing such a new and embryonic market. From this perspective, the most reasonable current option would be that of developing a European code subject to the principle of "comply or explain", prepared by ESMA and directed towards proxy advisors, similar to the French Recommandation AMF n sur les agences de conseil en vote, in which a harmonised Community framework is established with regard to the activity of these companies with the aim of subjecting them to certain standards and general principles of conduct which ensure that proxy advisors carry out their advisory function in defence of the best interest of their clients, but also within a framework of flexibility. Page 6

7 This alternative would be more appropriate than self-regulation by the proxy advisors themselves, as a code prepared by ESMA, although voluntary, would raise sector conduct standards for proxy advisors. It would also make it possible to cover and address all the issues identified in relation to their activity and to establish minimum standards at a European level. In addition, of the two approaches put forward by ESMA for Option 3 in paragraph 135 of the consultation document (standards directly applicable to proxy advisors or applicable indirectly through investors), we believe that it would be preferable to develop a code which is directly and exclusively applicable to the service providers analysed in the document (proxy advisors), which does not contain recommendations aimed at users of said service, the majority of which are institutional investors, whose regulations already include clear, strict obligations with regard to exercising voting rights. The European code, which proxy advisors could voluntarily sign up to, would consist of a series of precise and weighted guidelines and recommendations so that the entities signing up to it would have to undertake either to comply with it, or explain why and to what extent they deviate from it. Its effectiveness would be linked to the reputational risk which proxy advisors will be subject to if they do not comply with the recommendations established by ESMA and do not provide any explanation as to why they do not comply. This could lead users of these corporate advisory services to move to other entities which do comply with the recommendations. Furthermore, this reputational risk would also be linked to the expansion strategy of the proxy advisors, which would be negatively affected if they do not comply with the recommendations of the European regulator. The main advantage of this alternative is that, while it offers a harmonised Community framework, it leaves the industry with a certain flexibility compared with the alternative of direct regulation. In this regard, the fact that the code is governed by the "comply or explain" principle would give proxy advisors margin to adapt it to their internal rules and local corporate governance standards as these entities would have the possibility of complying with applicable recommendations or deviating from them, if necessary, based on the specific nature of their businesses or the different market practices and standards of different countries. A European code with recommendations on issues such as transparency, conflicts of interest and quality of the advice would also contribute towards strengthening the positive role of proxy advisors as not only would it increase the informed participation of investors in the General Shareholders' Meetings of issuers, but it may also help to improve issuers' corporate governance practices. Furthermore, adopting a European code of this type is the option which would be most in line with current corporate governance regulation in Europe, which in general is included in national codes with voluntary, non-binding recommendations. 9) Which other approaches do you deem useful to consider as an alternative to the above options? Please explain your suggestions. We cannot fully rule out the appropriateness over time of Option 4 (adopting binding EU-level legislative instruments), in line with the perspective which seems to prevail in the United States and which is also consistent with the regulatory treatment received by Page 7

8 other providers of information to investors such as rating agencies or audit firms, above all to the extent that, as the case may be (i) the influence of proxy advisors on voting decisions increases and (ii) the possible negative risks and effects of their activity and the insufficiency of soft-law measures to mitigate the effects becomes evident. 10) If you support EU-level intervention, which key issues, both from sections IV and V, but also other issues not reflected upon in this paper, should be covered? Please explain your answer. We suggest the following measures with regard to the main issues which should be covered by the European code developed by ESMA: With the aim of providing greater transparency to the activities of proxy advisors, we suggest that they should publish either on their website or in the voting recommendation reports which they issue, as appropriate, information on the following aspects: - Indicating their main sources of revenue, segmented by type of activity. In particular, they should publish what percentage of their revenue comes from (i) voting recommendations to investors (proxy advising), (ii) providing services deriving from voting platforms (proxy voting), (iii) provision of consultancy services to issuers, (iv) preparing research material and (v) other activities. - With regard to the firm's ownership structure, they should publish information on their main shareholders and whether they belong to a group of companies, and, as the case may be, indicate the parent company. - They should publish their general voting policies on their website and, as appropriate, segmented by market or sector, so that interested investors and issuers may consult them. - With regard to managing conflicts of interest, they should include clear information in their reports for investors on potential conflicts of interest which they may have with issuers on whose proposals they issue voting recommendations, indicating the measures adopted to avoid or minimise them. In this regard, they should also indicate in each report which they issue the volume of revenue which they receive from the issuer whose voting proposals are subject to analysis for other services rendered. In order to optimise the technical quality of the advice offered and to avoid excessive standardisation of analyses, we suggest establishing recommendations, inter alia, on: - In general, the professional qualifications and technical knowledge necessary for the analysts which prepare the proxy advisor's voting analyses or recommendations. - In particular, the qualification and technical knowledge that the analyst must have with regard to the regulatory framework and local practices relating to the geographical markets in which they specialise for preparing reports. - The maximum limits on average number of issuers on which each analyst should analyse the issues subjected to voting in the General Shareholders' Meeting. Page 8

9 With regard to the procedure for preparing reports, in order to ensure that the votes are issued in the interests of the investors, the code adopted should recommend: - That the reports on voting recommendations clearly state the proxy advisor's opinion on each one of the items on the agenda, as well as the specific reasons behind their voting recommendation. - That they should provide the issuer with a draft report so that it may clarify or specify those aspects about which there may be a dispute, especially taking into account the specific market characteristics, both legal and in practice, that may exist in each country, thus contributing to improving the quality and accuracy of the reports. With the aim of facilitating the market's assessment of the activity of proxy advisors, the code should require that the entity signing up to, or subject to, the code, as the case may be, issue annual reports explaining the level of compliance with its recommendations. The verification mechanism most consistent with the chosen option, bearing in mind the current status of development of the proxy advising market, is, as explained above, to allow flexibility for the companies which provide the services to comply with the guidelines or to deviate from them, but with the obligation to explain to the market their level of compliance and the reasons why, as the case may be, they do not follow a specific recommendation. Accordingly, the European code of good practices would be based on two basic pillars. The commitment of proxy advisors which decide to sign up to the code to comply with the applicable rules and guidelines contained in the code, on the one hand, and the evaluation by the market, under conditions of information transparency, of their activity and level of compliance with the recommendations, on the other. Finally, it would be necessary to provide maximum publicity and dissemination of the code so as to encourage proxy advisors to sign up to the code as these are mostly companies which are not established in the European Union and which are therefore not subject to supervision by ESMA. This would also promote awareness among issuers and investors as a whole and, therefore, the effectiveness of the code in practice. 11) What would be the potential impact of policy intervention on policy advisors, for example as regards: a) Barriers to entry and competition; On the one hand (and especially in the case of implementing direct regulation), the introduction of intervention measures might hinder the growth and competitive capacity of the proxy advisory sector: complying with legislation always requires resources, which not all proxy advisors may have or may want to allocate to this purpose. However, the alternative which we consider most appropriate (a basic voluntary code of recommendations, but one which any of the proxy advisors of a certain entity should be able to comply with) should contribute towards establishing a proxy advisory sector which only includes those who are truly able and qualified to operate to the benefit of investors and issuers: the quality of the advice is essential, even when the need to ensure quality represents a barrier to entry. Page 9

10 At any event, the proxy advisor market is already a highly concentrated sector. A low number of operators, ISS and Glass Lewis, hold a very significant share of the business as a whole. According to available sources, the former has a 61% market share in the United States and the latter has a 37% share. b) Inducing a risk of shifting the investor responsibility and weakening the owner s prerogatives; and/or As indicated above, in Spain an institutional investor cannot become exempt from its fiduciary duties to its beneficial owners with regard to exercising voting rights as a result of using the voting recommendations issued by a proxy advisor. However, to the extent that proxy advisors become more regulated, which in turn contributes to the reliability of their advice, the perception of their services may be strengthened as a liability and/or reputational insurance for institutional investors and may make it more difficult for institutional investors to deviate from the recommendations and criteria of a proxy advisor (expressly those which are regulated or signed up to a code of good practices). c) Any other areas? Please explain your answer on (i) EU-level; (ii) national level. Considered answered in previous sections. 12) Do you have any other comments that we should take into account for the purposes of this Discussion Paper? Bearing in mind the experience in the United States to date and the debate existing in that market with regard to the activity of proxy advisors, and also taking into account the delocalised and international nature of their activity, we believe that it is recommendable to monitor the initiatives in progress in the United States (such as the SEC Concept Release on this matter) and the responses of the different associations in this regard, with the aim of analysing possible convergence between said initiatives and those developed in the European Union. Page 10