A Thought on Korea Stewardship Code and NPS

Transcription

1 A Thought on Korea Stewardship Code and Nam, Chaewoo There have been calls for the National Pension Service to play a proactive role in expanding the adoption of Korea Stewardship Code (Principles on Stewardship Responsibilities of Institutional Investors) unveiled at the end of As a public fund s fiduciary responsibilities could be viewed as maximizing value via exercising rights, the s enactment of the stewardship code is likened to formulating guidelines to bolster rights. In this regard, the 2015 case of the s action to bolster rights with regard to dividends gives a good reference to the s stewardship code adoption. In formulating the stewardship code of public funds and building an adherence monitoring system, many constraints should be taken into account, e.g., the s excessive market dominance and complex interests, inefficient governance, etc. On top of policy efforts for addressing many legal and institutional constraints, public discussions must take place before the code s adoption in order to maximize its positive impacts. Introduction Two years after the Financial Services Commission (FSC) established a council for adopting the stewardship code at the end of 2014, the council published at the end of 2016 Korea Stewardship Code titled Principles on the Stewardship Responsibilities of Institutional Investors. However, large institutional investors 1) except for few asset managers have not yet adopted the code, carefully watching the s response. Amid the high expectations that the All opinions expressed in this paper represent the author s personal views and thus should not be interpreted as Korea Capital Market Institute s official position. Ph.D., Research Fellow, Fund & Pension Department, Tel: , zeuss@kcmi.re.kr 1) Korea Stewardship Code categorized institutional investors into two categories; asset managers (asset management companies) and asset owners (pension funds, insurers, etc.). 1

2 participation of the managing nearly KRW 50 trillion in the Korean stock market alone could be a turning point helping the Stewardship Code fully take hold in Korea, the FSC leading the Stewardship Code adoption has encouraged the to adopt the code. Inside the, the performance assessment and compensation subcommittee shows a positive stance towards the code and proactively calls for adoption. However, the question here is whether the code the would adopt is part of Korea Stewardship Code initiated by the government. The National Pension Fund (NPF) is a major subject to the 5% rule in almost 300 listed companies in Korea. While the NPF s market dominance as a single fund provides reasoning for adopting the stewardship code, it simultaneously serves as a hindrance to active exercise of rights. This article explores the meaning of the s adoption of the stewardship code in view of bolstering the s rights that have long been a subject of discussion, and reviews the constraints that should be considered for the s code adoption, which involves dealing with entangled interests. Korea Stewardship Code and The stewardship code is defined as the principles on the duty of fiduciaries that manage client assets. 2) Under relevant laws, the fiduciary duty includes the duty of loyalty (working in the interest of beneficiaries), and the duty of care (exercising due care as a good manager). 3) Although the law explicitly states institutional investors fiduciary duty, the principles on the fiduciary duty are mere rhetoric to Korean asset owners and managers in practice, which triggered the government to lead the enactment of the code. The stewardship code is soft law whose enforcement is flexible on a comply or explain basis, 4) and institutional investors can choose whether to endorse and participate in the code or not. However, this is structured to serve as market discipline because the code mandates the disclosure of adherence to the code, and the reasons for noncompliance, if any. In the US where activism is a norm among institutional investors including pension funds, there is little need for the government to take initiative in devising a separate stewardship code. 2) In the UK, stewardship is broadly defined as various relationships sitting outside the fiduciary duty, but the concept of stewardship has not been fully established internationally (Jung, Yoon Mo, 2016, Institutional Investors Fiduciary Duty and Introduction of the Stewardship Code, KCMI). 3) Article 32 and 33 of the Trust Act; and Article 37, etc. of the Financial Investment Services and Capital Markets Act (FSCMA). 4) A regulatory approach where a code should be complied in principle, but exceptions are allowed when explanation for noncompliance is provided. 2

3 Other countries, e.g., the UK and Japan where the government has a strong policy drive for the code, adopted the code in the aftermath of the 2008 financial crisis amid rising calls for stronger fiduciary responsibilities. In this regard, Korea s government taking initiative to penetrate the code into Korean institutional investors appears to be an appropriate policy direction. The problem lies in the lack of motivation to expand the use of such voluntary market discipline. Japan that has similar conditions to Korea tried to address the problem by mobilizing the Government Pension Investment Fund (GPIF). 5) Not only that Japan s GPIF actively participated in the stewardship code from the beginning, but also its inclusion of the code adoption in its standard for evaluating external asset managers functioned as a catalyst for the code s penetration. Benchmarking Japan s case, the Korean government is trying to encourage the NPF to play a similar role, which faces many challenges due to various Koreaspecific constraints. The GPIF is an independent administrative agency, and despite its giant size, its dominance in the domestic stock market is not as large as the NPF s. Another stark difference from the NPF is the GPIF s full delegation of investment management as well as voting rights. Guidelines for stronger rights Certainly, it is a daunting task to fully define the concept and range of stewardship or fiduciary responsibilities for a public fund s overall investment management. Hence, it may be effective to narrow down the range to the fund s stock investments, in which case the fund s fiduciary responsibilities could be interpreted as value maximization by actively exercising rights as a holder of common stocks. The exercise of rights means a wide spectrum of engagement activities, including passively exercising voting rights as well as active engagement such as proposals and lawsuits. Given that rights of the have been thus far limited to the exercise of voting rights, the s stewardship code at issue should mean the guidelines for bolstering the active exercise of rights. There are two approaches to stronger rights of the. First, this should be related to bolstering the public nature of fund management, a subject of heated discussions. The rationale behind the approach is that the investment management of the NPF, a public fund, should head in the direction contributing to the development of the national economy because the s active exercise of rights is expected to bring about many positive external 5) As of March 2017, the GPIF had assets of JPY 145 trillion, of which JPY 35 trillion or 23% was invested in domestic equities via external asset managers. 3

4 effects such as higher dividends and improved corporate governance. However, this requires certain preconditions such as independence from the government, management expertise, etc. As shown in Table 1, the is the major in Korea s 10 largest listed companies by market capitalization. In particular, the is the largest of Korea s major financial holding companies. 6) Given the NPF s organization size, management capabilities, governance not independent from the government, it is unrealistic to expect the NPF to actively exercise its rights of listed companies in which it has a 5% stake. Bolstering the public nature of the requires a kind of social consensus, beyond the NPF s internal decision making. Table 1. Major s in Korea s 10 largest listed companies Company Samsung Electronics SK Hynix Hyundai Motors POSCO Naver KEPCO Samsung C&T Samsung Life Insurance Hyundai Mobis KB Financial Group Largest (9.24%) SK Telecom (20.07%) Hyundai Mobis (20.78%) (11.04%) (10.76%) KDB (32.90%) Lee, Jaeyong (17.23%) Lee, Kunhee (20.76%) Kia Motor (16.88%) (9.85%) Secondlargest Samsung Life Insurance (7.89%) (10.24%) (8.12%) CITIBANK (11.03%) Aberdeen (5.04%) Government (18.20%) KCC (8.97%) Samsung C&T (19.34%) (9.84%) JP Morgan CB (6.95%) Thirdlargest Samsung C&T (4.25%) Fourthlargest Lee, Kunhee (3.54%) Fifthlargest Chung, Mongkoo (5.17%) Employee Stock Ownership Association (1.72%) BlackRock (5.03%) (6.50%) (5.57%) EMART (5.88%) Chung, Mongkoo (6.96%) Employee Stock Ownership Association (0.40%) The Capital Group (5.02%) Citibank (5.65%) Lee, Boojin (5.51%) (5.88%) Hyundai Steel (5.66%) Lee, Seohyun (5.51%) Employee Stock Ownership Association (1.08%) Note: Market cap as of July 17, 2017, and the shareholding ratio according to the quarterly report as of March 31, 2017 Source: Financial Supervisory Service 6) The is the largest of KB Financial Group, Shinhan Financial Group, Hana Financial Group, DGB Financial Group, and BNK Financial Group, and the secondlargest of stateowned Woori Bank and IBK Industrial Bank of Korea. 4

5 The second approach is to improve the s investment management performance. This is about securing longterm, stable returns by actively managing rights for maximum value in Korea s structural lowgrowth trend. Without any social consensus to bolster the s public nature, this is the most critical management principle the NPF must uphold for now. The only right, except for the voting right, exercised by the is higher dividend policy that has been pushed for since As part of such policy, the has called for its investee companies to devise reasonable dividend policy, and has formulated a phased engagement plan ranging from favorable dialogue to focus list designation. The impact of stronger rights with regard to dividends on the s returns is immediate and at the same time sustainable. Figure 1 illustrates a significant increase in dividend yields to 1.74% in 2016 when dividendrelated rights were strengthened in full swing. Dividends accounted for around 20% of the s stock returns, whereas the ratio shot up to 37% in This implies that the lower domestic stocks expected returns, the higher the dividend s returnimproving effect gets. In Korea s stock market where booms fueled by high economic growth are hardly likely any more, dividend income is expected to be even more important in the s domestic stock investment. Figure 1. s dividend yield on Korean stocks Note: The dividend yield means the share of dividends in AUM. Source: In this regard, the current drive for the s enactment of the stewardship code lies in the stretch of the 2015 regulatory revision for stronger dividendrelated rights. This is 5

6 because the concerns raised by businesses, and legal and institutional constraints to the s exercise of rights at that time still exist. For example, the restriction as a large or major 7) is relaxed on the condition that the is a financial investor without any intention to participate in management. However, the Enforcement Decree of the FSCMA uses a positive list approach stipulating what is regarded as management participation, which includes dividend decisions and most of the corporate activities Korea Stewardship Code defines as engagement activities. This shows that a regulatory revision is a must to fundamentally address the constraints to the s rights. 8) It is worth remembering what occurred in the 2015 regulatory revision. Although regulators had tried to benchmark the Japanese case 9) to allow exceptions for a broader range of engagement activities, the FSCMA revision came to limit the exceptions to only dividend decisions. Constraints to the code adoption The constraints to the s adoption of the stewardship code can be broadly divided into two parts; the code s design and implementation. What s the most critical in the code s introduction is to design a reasonable code reflecting the s nature. A stewardship code usually consists of a set of principles and guidance. At the end of 2016, the stewardship council unveiled the seven standard principles, based on which each institution should formulate its own principles and guidance. The gist of the seven standard principles is about setting up the content and tools for the exercise of rights in a preemptive, concrete, and explicit manner, and disclosing the process and results in a transparent manner. At this stage, it is wise to reestablish feasible and realistic principles taking into account the NPF s legal and management constraints. For the tasks requiring any regulatory revision or further improvement in the s capability and expertise, it is desirable to devise a longterm roadmap. Especially, it is tricky for the to predefine the range and depth of any potential conflict of interest that could arise from implementing fiduciary responsibilities. Another source 7) This refers to the 5%rule, the 10%rule, the return of shortterm capital gains, etc. 8) Regarding this issue, the FSC unveiled a regulatory guidebook, while the Korea Corporate Governance Service published a similar guidebook as well. However, exceptions are allowed only under very limited circumstances, which could hardly address legal uncertainties. 9) With regard to all engagement activities for shares held in trust, Japan allows exemptions from filing of the large shareholding report, and from the return of shortterm capital gains without questioning whether the investment is for management participation or not. 6

7 of trouble is how the adjusts its fiduciary responsibility policy with the stewardship codes of its 38 external managers (domestic equity alone, including socially responsible investment funds). Even more difficult in the s code adoption is how to place a reasonable adherence monitoring system. From the cases of the UK and Japan having adopted the governmentinitiated stewardship code similar to Korea, voluntary disclosure alone cannot fully ensure whether a codeendorsing institution actually complies with the code. Although the code is a selfregulation, a stewardship code, if not objectively monitored by an independent agency that has no conflicts of interest, will end up being a mere formality incurring costs with no benefits. This is the very reason why the UK recently transferred the monitoring function from a private association to the Financial Reporting Council, a public institution. The problem is the sheer broadness of the range of interests surrounding the s investment management when considering a system for monitoring the adherence to the code. First of all, the itself works with multiple proxy advisory firms to exercise its voting rights. For equity alone, the is working with a total of 38 external managers, each of which endorses its own stewardship code and simultaneously is subject to adherence monitoring. In addition, the invests in 98% of Korea s SRI funds. The capabilities of proxy advisory services those funds use become an important evaluation standard when the selects an external manager for SRI funds. Taken altogether, it is neither realistic nor easy to find an independent agency that has proven expertise in adherence monitoring without any conflict of interest with the. Conclusion The s adoption of the stewardship code is expected to exert an absolutely significant impact on all stakeholders including asset owners and asset managers in Korea. Each of the asset owners such as pension funds and mutual aid associations will consider the s stewardship code to be an example of the best practice in designing its own code, whereas each of the 38 external managers managing nearly KRW 50 trillion will also devise its own standard. On another front, a total of 277 listed companies in which the has a 5% or higher stake should ponder upon their longterm response to the s stewardship code. This is why the enactment of the s stewardship code requires much more than internal decision making within a single organization. Finalization of the code and the adherence monitoring system must involve sufficient policy efforts in reaching a certain degree of social consensus after due deliberation among a variety of stakeholders. 7