Whilst there are a number of areas where we would welcome a European approach, we

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1 22 July 2011 Dear Sirs GREEN PAPER - THE EU CORPORATE GOVERNANCE FRAMEWORK IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the managers of occupational pension schemes. They are responsible for the management of 3.4 trillion of assets, which are invested on behalf of clients globally. These include authorised investment funds, institutional funds (e.g. pensions and life funds), private client accounts and a wide range of pooled investment vehicles. In particular, the Annual IMA Asset Management Survey shows that in 2010 IMA members managed holdings amounting to just over 40% of the domestic equity market. In managing assets for both retail and institutional investors, IMA members are major investors in companies whose securities are traded on regulated markets. As institutional investors in listed companies, our members take a great interest in the Green Paper on the EU corporate governance framework. IMA welcomes the Green Paper. The recent financial crisis exposed certain weaknesses in governance and at times investors scrutiny and challenge. Although these weaknesses did not cause the crisis, we agree that they need to be addressed. However, these shortcomings were largely failures in execution rather than of the current regulations and guidelines. Thus they necessitate a fine tuning of the existing framework to improve its effectiveness rather than additional regulations. IMA supports a pan European approach to corporate governance - our members hold EU 420 billion of equities in European companies outside the UK. We agree with many of the suggestions in the Paper and, as developed in our response, see a need for improvement in areas as such as: board diversity; disclosure of directors remuneration and a company s risk appetite; uniform shareholder rights across Europe; guidance on the application of the Takeover and Acquisitions Directives to shareholder co-operation; transparency of proxy voting advisors; and common principles on related party transactions. Whilst there are a number of areas where we would welcome a European approach, we 65 Kings wa y Lo nd on W C2B 6TD Tel:+44(0) Fax:+44(0) w w w. i n v e s t m e n t u k. o r g Investment Management Association is a company limited by guarantee registered in England and Wales. Registered number Registered office as above.

2 believe that effective governance and engagement are essentially local disciplines where each market requires a distinctive approach such that an EU wide one size fits all that does not allow diversity would not be effective. We also have concerns about certain of the matters in the Green Paper which we highlight below and in the attached Annex 1, our answers to the specific questions. Shareholders and short-termism The Paper argues that financial market outlooks have become more short-term in recent years. We agree that there has been a growth of new players such as hedge funds and high frequency traders. But we do not agree that there has been any fundamental change in the way in which the assets of long term investors are managed. We offer evidence for this in our response to question 13. It follows, therefore, that we do not believe there is a need for measures to address this, either by modifying existing rules or in respect of incentive structures. We set out our reasons more fully in our detailed responses to questions 13 and 14. Comply or explain and shareholder engagement The Paper argues that the monitoring of comply or explain corporate governance statements is not effective and suggests they should become regulated information. We do not agree with this. Corporate governance is about behaviours which, as noted in our response to question 25, cannot be addressed in legislation. Legislative measures can result in standardised disclosures to ensure compliance rather than a sound corporate governance culture and lack flexibility such that a company would not be able to tailor them to its own circumstances. They would also undermine the role played by shareholders who, as the providers of the risk capital and bearers of the residual risk, are best placed to monitor corporate governance arrangements, engage with companies and hold their boards to account. The UK recently gave new impetus to engagement and issued a code of best practice for institutional investors and the UK regulator now requires investment managers to disclose publicly their commitment to this code or their alternative model. We recently published a report which clearly demonstrated investors commitment to the code. EFAMA also recently published its own code for investor engagement which is largely based on the UK s code. This framework of codes for both companies and investors is relatively new and should be given time to take effect. What is important is shareholders have rights not only so that they can engage actively with companies but also have a say on the issue of capital and offers. We set these rights out in detail in question 17. Please contact me if you would like clarification on any of the points in this letter or if you would like to discuss any issues further. Yours faithfully Liz Murrall Director, Corporate Governance and Reporting 2

3 GENERAL QUESTIONS (1) Should EU corporate governance measures take into account the size of listed companies? How? Should a differentiated and proportionate regime for small and medium-sized listed companies be established? If so, are there any appropriate definitions or thresholds? If so, please suggest ways of adapting them for SMEs where appropriate when answering the questions below. IMA does not believe that EU corporate governance measures need to take into account the size of a listed company on a particular market. Such measures should cover all listed companies but smaller companies should be allowed to apply them in a lighter form through the operation of a comply or explain regime against particular principles as opposed to different principles. Where differentiation would be helpful would be in distinguishing between companies listed on different markets, for example, in the UK there is the main listed market and AIM. Thus companies would be able to choose a market that best suits their needs and investors would be clear as to the governance regime that applies. (2) Should any corporate governance measures be taken at EU level for unlisted companies? Should the EU focus on promoting development and application of voluntary codes for non-listed companies? In listed companies the primary concern of corporate governance is the relationship between a board and its external shareholders where the latter s capital is at risk. As unlisted companies tend to be owned or controlled by individuals or families, corporate governance tends to focus on internal processes and strategies that add value. Similarly with a partnership structure, the interest of the owners and the executives are aligned. As such, IMA does not believe that corporate governance measures at EU level for unlisted companies are necessary in that the voluntary codes and initiatives at European or national level suffice and should continue to be promoted. BOARDS OF DIRECTORS (3) Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided? IMA supports the separation of the functions and duties of the chairperson and the chief executive - a practice common in governance models in the United Kingdom, much of the rest of Europe, as well as Canada and Australia. This separation avoids corporate power being concentrated in the hands of one individual and emphasises the need for shared responsibility in the light of an ever more complex business environment. The two roles are also distinct in that the chairman manages the board, and the board entrusts the chief executive with management of the operational side of the business. However, we do not consider the roles should be required to be divided in that we support a comply or explain approach to give companies flexibility to phase in any change over time and ensure they can bridge the gap should either the chairman or chief executive leave. Similarly, whilst it could be useful to define the position and responsilbities of the chairperson more clearly 1, we consider that it should be left for companies to define this according to their own circumstances. 1 Page 5. 3

4 (4) Should recruitment policies be more specific about the profile of directors, including the chairman, to ensure that they have the right skills and that the board is suitably diverse? If so, how could that be best achieved and at what level of governance, i.e. at national, EU or international level? IMA agrees that for a board to be effective, it needs to have a mix of relevant experience and a broad range of skills. Specifying the particular duties and profile required in recruitment policies would help to ensure that the right skills are recruited at the outset and the policies should be used in board evaluations to assess if the directors concerned are fulfilling the responsibilities prescribed. However, it should be for individual companies to prescribe the profile and skill sets they consider they need in that it is not one size fits all and different structures operate nationally. (5) Should listed companies be required to disclose whether they have a diversity policy and, if so, describe its objectives and main content and regularly report on progress? The functioning and efficiency of boards would be improved if they had an appropriate cross section of ideas, skills and experiences, and were diverse. IMA supports listed companies being required to disclose whether they have a diversity policy and, if so, to describe its objectives and content, and regularly report on progress. In this context, presently investors are not routinely involved in the selection of directors and are rarely consulted by the Nominations Committee unlike remuneration issues where, since investors were given an advisory vote on the remuneration report of UK listed companies, they have been regularly consulted. A number of investors would like to be able to be more proactive in the selection of non-executives. We consider succession planning should be emphasised in the diversity policy and the chairman should be encouraged to report annually on the process. (6) Should listed companies be required to ensure a better gender balance on boards? If so, how? While legal reforms such as those in Norway where boards of large companies have to have at least 40% of both genders, and the similar goals in Spain, France and Italy, seek to ensure that there is a better gender balance on boards, such measures can hinder the efficient workings of the market and result in the loss of experienced talent. Also board appointments should not be simply to fulfil quotas but should be on merit. Gender balance should be ensured through a diversity policy, as noted in question 5, and it is important that potential candidates appear 'on the radar' of those recruiting and the decision-makers. A means to help this would be through proper competency standards. At present recruitment can frequently be from the old boy networks which rule out many female and foreign recruits. There is also a need for better diversity on non-gender or country issues - too many directors are accountants and lawyers with few having marketing experience. Thus there may be merit in having a register of suitable, in some way qualified, nonexecutives, with a structure of on-going training and even an Institute of Non-executives and a charter mark. However, this should be left to individual Member States to decide, for example, the UK s Institute of Directors already has a Chartered Director qualification that IMA has supported. 4

5 (7) Do you believe there should be a measure at EU level limiting the number of mandates a non-executive director may hold? If so, how should it be formulated? Undoubtedly the quality of non-executive directors oversight would be enhanced if they devoted more time to their role and some may need to have fewer posts. However, limiting the number of mandates a non-executive director may hold is too inflexible. It also ignores the impact of commitments outside directorships and that certain individuals may be able to take on a number of sizeable obligations. What is important is that boards have the right skills better to have a few days of someone who has a number of mandates and who makes a valuable contribution than a month of someone who adds very little. Also being too restrictive would reduce the pool of available talent. In summary, it should be for boards to decide how best they are structured and whether their members have sufficient time in view of their other commitments. (8) Should listed companies be encouraged to conduct an external evaluation regularly (e.g. every three years)? If so, how could this be done? IMA supports a listed company s board undertaking a formal and rigorous evaluation. External input to this introduces objectivity, helps raise the tone and gives investors some independent assurance as to the operation of a board as a whole. However, the market in external evaluation services is still evolving and the quality is variable. Thus whilst external evaluation every three years could be encouraged, until the market and standards operated are more developed, the Commission should not go further than expecting listed companies to disclose how frequently they undertake external evaluations and the name of the provider. Again this is something that sits effectively with a comply or explain regime. (9) Should disclosure of remuneration policy, the annual remuneration report (a report on how the remuneration policy was implemented in the past year) and individual remuneration of executive and non-executive directors be mandatory? There are conflicts if directors set their own remuneration and it should be left to nonexecutive directors and shareholders. Thus it is important that there is transparency around directors remuneration. Commission Recommendations 2004/913/EC, 2005/162/EC and 2009/385/EC sought to address this but there are deficiencies in how the Recommendations have been implemented in practice and we support disclosure requirements being mandated in an EU Directive. To give shareholders an appreciation of such arrangements, listed companies should have to disclose their remuneration policy and the individual remuneration of directors (executive and non-executive). The disclosures should contain sufficient detail to enable shareholders to understand fully the components of directors remuneration as well as progress towards the achievement of previously granted awards, and details of pension entitlements and other benefits in kind. (10) Should it be mandatory to put the remuneration policy and the remuneration report to a vote by shareholders? To give shareholders an appropriate level of control over remuneration, we support them having a vote on the board s remuneration report and the EU Recommendation on this. We do not consider a binding vote appropriate or practical in the most part the report is on the remuneration paid and it could be difficult to claw it back. But an advisory vote should serve as an opportunity to comment on the overall structure of the remuneration 5

6 package and how it was implemented in the year, helping inform the company s remuneration policy for the coming year. (11) Do you agree that the board should approve and take responsibility for the company s risk appetite and report it meaningfully to shareholders? Should these disclosure arrangements also include relevant key societal risks? IMA agrees that the board as a whole should have responsibility for the company s risk appetite and that any risk policy needs to be set from the top. However, we recognise that it may be necessary to delegate certain functions to sub-committees, particularly where the demands placed on the board can be great and where it could be difficult for it to dedicate sufficient time to matters such as risk management. For example, the audit committee could be responsible for the detailed oversight of the company s risk appetite and future risk strategy and should report on this to the board. Due to the complexities that can be involved, large groups may want to have a separate risk committee for this role. The board should also report on the risk appetite meaningfully to shareholders. Currently there are overlapping disclosures in the chief executive s statement, the financial review, the directors report and the notes to the financial statements making their analysis difficult. We would support some rationalisation and a more cohesive approach. Shareholders find a summary of the principal risks, especially when their potential impact is quantified, particularly useful. Also, they want know that the risk management and internal control systems are adequate and are operating properly. We draw your attention to the enhanced disclosure guidelines for boards and others developed by the Global Auditor Investor Dialogue, of which we are part, at These are in the course of being updated but recommend that a company s audit or other relevant committee s disclosures include what steps it took to satisfy itself that the risk and control processes are effective. As regards societal risks, if the board considers that there are specific societal risks that need to be addressed then it should also report on these. However, not all companies will be exposed to such risks and it should be for the board to decide whether such specific reporting is necessary. (12) Do you agree that the board should ensure that the company s risk management arrangements are effective and commensurate with the company s risk profile? IMA agrees that the board should have overall responsibility for ensuring that the company s risk management arrangements are effective and commensurate with the company s risk profile. However, as noted above, whilst the board should retain overall responsibility, it may necessary to delegate certain aspects of this to sub-committees such as the audit committee which should then report to the board. 6

7 SHAREHOLDERS (13) Please point to any existing EU legal rules which, in your view, may contribute to inappropriate short-termism among investors and suggest how these rules could be changed to prevent such behavior? IMA does not have any such suggestions to make. Implicit in this question is the presumption that there is inappropriate short term behaviour by investors. We do not believe that evidence for this has been forthcoming, and will explain why. Agent and principal intermediaries have different business models and incentives There are many participants in capital markets, including banks, brokers, market makers, other proprietary traders, hedge funds and asset managers. All have different business models and different incentives. A particular distinction should be drawn between those that act as principal (for example, banks and other proprietary traders) and those, like asset managers, that act as agents for clients: Banks and brokers earn revenue by trading with clients. The relationship is transactional and is a zero-sum game, i.e. one participant's gain or loss is exactly balanced by the losses or gains of the other participant. Thus the more the bank makes, the higher the cost to the client. It is, therefore, motivated to trade frequently and to persuade clients to do so as well. An asset manager is an agent for its client and earns revenues by maximising client revenues. The assets remain the client s and the manager is rewarded by a predetermined fee, normally a percentage of assets under management. The motivation for the manager is therefore two-fold: to retain the client, so as to retain the fee income; and to maximise the value of the client s assets and hereby the management fee. Anything which reduces the client s return (for example unnecessary churning of the portfolio) is therefore contrary to the interests of the manager. This is the reverse of the situation for banking intermediaries, where the bank in effect earns revenue by reducing the client s return. We believe that much of the academic work which has been published on the nature of agency relationships in capital markets fails to recognise this vital distinction. It has been argued that such relationships incentivise intermediaries to exploit information asymmetries and profit at the expense of long term investors. This argument has some force when applied to an intermediary which acts on a principal basis and which does indeed have an incentive to extract rent from other market users. But it does not stand up in the case of an asset manager acting as agent for clients. Indeed, part of the role of the asset manager is to help end investors to redress the information disadvantages they suffer by acting on their behalf in the capital markets. For example, the Paper cites (in footnote 48) a paper by Paul Woolley of the London School of Economics. Much of Woolley s analysis is valid for banking intermediaries, but not for agency businesses. As an example, in the section Rent capture by financial intermediaries, the following statement is made: If a fund manager spots an investment opportunity with a known and certain payoff, he can finance it directly from his own or borrowed funds and enjoy the full gain for himself. 7

8 This is completely incorrect. Asset managers do not trade in the market on their own account; they do so only for clients. The conflict of interest posed in this statement does not exist. No evidence of increased turnover or churning of client portfolios by asset managers The Paper also refers to increased turnover in capital markets. It notes, after Woolley and also Haldane at the Bank of England, turnover of some 150% of market capitalisation, and concludes that this implies average holding periods of eight months. The implication appears to be that there is a concern that fund managers are unnecessarily churning client portfolios. We believe this is incorrect. As noted above, there are many participants in capital markets. They include a number with high portfolio turnover, such as high frequency traders and some hedge funds. We agree that such activity has been increasing in recent years and believe that the observed increase in market turnover is the result of this. The capital markets research consultancy Tabb Group produced the following breakdown earlier this year of turnover in the UK equity market: Hedge funds 37% High frequency traders 28% Investment bank proprietary trading 7% Retail investors 4% Long-only funds 24% Source: Tabb Group Breaking Down the UK Equity Market, January This shows that high quoted turnover rates are largely the result of activities by players other than institutional asset managers. This group however manages the overwhelming bulk of institutional assets: in the UK the traditional asset management industry is about twenty times the size of the hedge fund industry. Nor can we find evidence of investment managers holding the shares of individual companies for shorter periods. We have asked our members for data about portfolio turnover within their funds. Most have reported typical holding periods for stocks of at least four years and no secular rise in turnover over time, though turnover does increase temporarily during periods of market turmoil, such as Please see Annex 2 for turnover figures for two managers funds. We have further corroborated this by examining receipts from stamp duty reserve tax in the UK. This is a 0.5% tax payable when shares are bought, although banks enjoy an exemption as market makers. Total receipts from this tax are published by Her Majesty s Revenue & Customs. We have grossed-up these figures to reach implied total turnover and then compared them with average total market capitalisation for the relevant tax year. This gives what we believe to be a reasonable proxy for average turnover across the market. The results are as follows: 2 This research is proprietary, but Tabb have confirmed that they would be pleased to share it with the Commission if that were helpful [TO BECONFIRMED] 8

9 Tax year Turnover as % of market cap Notional average holding period (months) % % % % % % % % % 44 Source: UK National Statistics, London Stock Exchange and IMA calculations It is clear from this table that there has not been any trend over the last ten years towards higher turnover, although it was unsurprisingly raised in the wake of the bursting of the dot.com bubble in the early years of the last decade and during the credit crisis in To the extent that these calculations include trading entities which pay stamp duty, they may overstate turnover by asset managers. Moreover much turnover may be the result of factors such as managers having to change their holdings in response to flows in and out from clients, or decisions to increase or reduce exposure to a stock while remaining a shareholder. It follows that the periods for which even active managers are likely to remain shareholders in individual companies are likely to be significantly longer than the notional holding periods in the table. We conclude that we have yet to see evidence of what the Paper describes as inappropriate short term behaviour by investors generally. Many managers of retail funds and of institutional money continue to pursue classic buy and hold strategies. Indeed this is the essence of active fund management the manager seeks to identify stocks which are under-priced by the market and buys them in the expectation that over time the return will be greater than that of the market as a whole. This is wholly consistent with what one would expect to find given the incentives against portfolio churning by asset managers described above. Other comments The Paper notes comments to the effect that regulatory bias, including solvency and pension fund accounting rules has been a factor behind short term behaviour. Our view is that the principal impact of such rules has been to drive long term investors into government bonds and other fixed income investments at the expense of equities. While it has reduced their equity holdings, and may damage long run investment returns, we are not aware of evidence that it has led to reduced holding periods. Some have suggested that longer holding periods could be encouraged by giving preferential rights to those that hold shares for the longer term. However, there are significant practical issues in differentiating shares. For example, some investors (for example, index tracking funds) are by definition long term but on their initial investment would be treated as short term. Nor is it clear why an active investor when it first makes a 9

10 considered decision which could be the outcome of prolonged analysis and research to take a position in a company should be disadvantaged; this would almost certainly create market distortion. It is also unclear how an increase (or reduction) in an existing holding would be treated; if an existing long term holder was able to get the same treatment for new purchases, it would be very easy for any investor to secure better rights by taking very small holdings in many companies. (14) Are there measures to be taken, and if so, which ones, as regards the incentive structures for and performance evaluation of asset managers managing long-term institutional investors portfolios? IMA does not consider any such measures are necessary. The Paper argues that the incentives for investment managers encourage them to be short term. It states that many asset managers are selected, evaluated and compensated on the basis of short-term, relative performance. We were puzzled by these statements. Investment managers in both the retail and institutional markets are generally remunerated on the basis of an ad valorem fee, representing a fixed percentage of assets managed. The manager s fee increases if the client gives him more money to manage or if the value of the portfolio increases; this aligns the manager s interests with those of clients. We do not understand how this can be construed as an incentive to target short term performance. The incentives are, first, to retain the business of the client long term and, second, to increase the value of the client s assets over time and hence the fee which is earned over time. Particularly in the institutional market, these ad valorem fees may be supplemented by performance fees. These will be negotiated and agreed in advance with clients and their advisers. We have spoken to a number of our member firms about the type of performance fees they agree with clients. Typically these will be based on rolling three-year performance figures; in some cases any period of underperformance must be followed by fully making up the lost return before any performance fee can be payable. Again, we cannot see how this practice can be construed as incentivising managers to act against the long term interests of clients. It is sometimes suggested that quarterly monitoring of performance by pension fund clients in particular puts pressure on investment managers to target short term returns for fear that they will lose the business because of a short period of underperformance. In order to test this suggestion, we sponsored in 2004 a survey jointly with the National Association of Pension Funds on the length of manager mandates 3. It showed that, while investment managers reported feeling under some pressure from pension funds to deliver performance in the short term, they typically retained mandates for five years or more. While performance will naturally be monitored regularly typically quarterly it would be very rare for mandates to be terminated on the basis of short term underperformance. In addition, when mandates were first awarded, it was reported that clients will look at performance over five years. Individual manager remuneration Individual portfolio managers performance is assessed on a medium to long-term basis,

11 with other factors such as client satisfaction, attitude to risk, and the extent to which the employee is a team player taken into account. For example, for an individual fund managers' remuneration, the basic/fixed part is around to 40% of the total and the performance part is around 60 to 70%, of which a significant amount is deferred over two to four years. To quote various asset managers: [Our] remuneration policy is team based and 75-80% of bonuses is paid in shares and has a three year vesting period. There is therefore no incentive to focus on one year s performance. [We] are increasingly charging performance fees, which are based on at least a yearon-year performance. Remuneration of individual fund managers is based on a mix of team, fund and individual performance (roughly a third each) and no changes have recently been made to this policy. There is no linkage with fees and short termism if they are calculated on an ad valorem basis. [It] does have some funds with performance fees which are calculated each year. Where there has been some underperformance however the fund has to get back to its starting position before any subsequent outperformance can be rewarded. [It] believes this aligns them with the client and as they are building a long term relationship does not lead to taking risks in the short term. [We] have no remuneration structures whether for managers or the company, which incentivize an increased turnover of securities. In any event, the remuneration of individual fund managers is being addressed through the implementation of the Capital Requirements Directive, and its application via MiFID. (15) Should EU law promote more effective monitoring of asset managers by institutional investors with regard to strategies, costs, trading and the extent to which asset managers engage with the investee companies? If so, how? IMA does not consider that an EU law to promote more effective monitoring of asset managers by institutional investors with regard to strategies, costs, trading and the extent to which asset managers engage with the investee companies is necessary. Investment managers owe their duty to their clients. Institutional clients will set the terms of the manager s mandate specifying how they want their money managed and how the manager should report. Costs are negotiated between the client and the manager, and the manager will report to the client on the implementation of the strategies, costs, trading and the extent to which it engages with investee companies as agreed between the parties. The manager must adhere to the terms of the mandate and be transparent to its clients. Of course for retail funds, there is not the same dialogue between manager and client. But authorised retail funds are subject to strict regulatory rules requiring them to be transparent about charges, pricing, portfolio composition and other matters. We welcomed the Commission's proposals to introduce consistent disclosure requirements for all retail investment products, based on the new UCITS requirements, and urge that the "PRIPs" initiative be progressed. Specifically as regards engagement, the UK recently gave new impetus to this and issued a code in July last year that sets out best practice for institutional investors. The UK regulator made it a requirement that authorised investment managers publicly disclose their commitment to the code or their alternative business model. This ensures that those that appoint investment managers are aware of how a manager exercises its stewardship 11

12 responsibilities, if any. The code also expects those that commit to it to report to their clients on how they have exercised their responsibilities and also to have a public policy on voting disclosure. IMA recently published a report 4 which looked at the activities that support institutional investors commitment in practice. The report was compiled from the answers to a questionnaire completed by 41 asset managers, seven asset owners and two proxy advisors. The questionnaire covered the period to September As at that date, the managers that responded managed 590 billion of UK equities representing per cent of the UK market and the owners owned 15 billion. The report clearly demonstrated institutional investors commitment to the code. Moreover, IMA worked with EFAMA in ensuring that a similar framework is adopted throughout the EU. EFAMA recently published its own code for institutional investor engagement which is largely based on the UK s code 5. (16) Should EU rules require a certain independence of the asset managers governing body, for example from its parent company, or are other (legislative) measures needed to enhance disclosure and management of conflicts of interest? All financial services entities are required to have clear policies for identifying, recording, managing (i.e. resolving or minimising) and disclosing conflicts that arise in their activities. MiFID already requires that investment firms maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest from adversely affecting the interests of its clients. Investment firms must clearly disclose the general nature and/or sources of conflicts of interest to the client that cannot be prevented before undertaking business on its behalf. Level 2 sets out detailed requirements on how firms should implement their conflicts of interest policy and UCITS IV has similar requirements. Given the extensive requirements already in place that are supervised by national authorities, we see no need for additional measures. In addition, EFAMA s code on investors engagement requires that an Investment Management Company (IMC) discloses publicly how conflicts of interest are managed. To quote an IMC s duty is to act in the best interests of clients when considering matters such as engagement and voting. Conflicts of interest will inevitably arise from time to time, which may include when voting on matters affecting a parent or related company, or a company related to a client. (17) What would be the best way for the EU to facilitate shareholder cooperation? Shareholder cooperation Shareholders typically have relatively small holdings, particularly in larger companies. This can at times make it difficult for them to be effective on their own and yet there are concerns that should they come together and act collectively, issues of insider trading, changes of control, and industry collusion and the concert party rules could be triggered. At present, the rules in some Member States are uncertain or indeed actively hostile to cooperation between shareholders. The uncertainties arise first, from the mandatory bid

13 rules implementing the Takeover Directive and secondly, from the requirements implementing the Acquisitions Directive. It would be helpful if the Commission could provide some clarity on this. In accordance with the Takeover Directive, if a person and someone acting in concert acquire an interest in shares which exceeds %, a mandatory offer has to be made for all the shares of the company. The underlying philosophy is that if control of a company passes into one hand, all shareholders should have the chance to dispose of their shares at the highest price paid by the new controller. First, they may not wish to remain in the company under a new controller. Secondly, as all shareholders (not just the old controller) should share the premium paid for someone acquiring control the buyer has to offer all shareholders the highest price he paid for his shares. Thus investors fear that if they act collectively such that the combined ownership of the parties acting in concert exceeds % and they seek to change board representation, they would have to make a mandatory bid for the company. We also understand that the parties involved would be jointly and severally liable each could be left with the responsibility to make a full bid. Our preference is that contact, short of control-seeking, should be allowed, but at a minimum there should be a safe harbour for discussions about the exercise of voting rights, meeting attendance and so on. We believe this is vital to ensure shareholders can effectively engage with companies. There are also concerns as to whether collective shareholder action in relation to banks and other financial institutions is caught by the Acquisitions Directive which had to be implemented by 21 March In summary, the Directive requires regulatory approval before an investor, or such persons acting in concert, acquires a direct or indirect "qualifying holding" in a bank, investment firm or insurance company (broadly speaking a holding of 10% or more of the shares or voting rights) first to notify the competent authorities. The Directive does not define when a person is acting in concert but the EU Level 3 Committees have given guidance in that Appendix 1 states: persons are 'acting in concert' when each of them decides to exercise his rights linked to the shares he acquires in accordance with an explicit or implicit agreement made between them. Notification of the voting rights held collectively by these persons will have to be made to the competent authorities by each of the parties concerned or by one of these parties on behalf of the group of persons acting in concert". This could affect investors ability to cooperate, as even an ad hoc agreement or understanding to vote together on an issue could result in the parties being treated as acting in concert. There is, therefore, a risk that they would need prior regulatory approval if their holdings together exceed 10%. However, competent authorities procedures do not tend to envisage such notifications and approvals and the process and time involved could be an impediment to collective engagement. To address these concerns, it would be necessary to have some clarification of the EU Level 3 guidance that the Directive s provisions are not triggered by an ad hoc agreement or understanding to vote together on a particular issue. Other shareholder rights There are other matters that the Commission could address that would facilitate engagement. In particular, the paper largely focuses on the 'softer' aspects such as co- 13

14 operation and proxy voting, rather than the harder aspects such as rights in relation to the issue of capital and making of/accepting offers. First, class test provisions could be introduced on a pan-european basis. These safeguard shareholders rights when they could be diluted and in the UK, major transactions are graded into four classes depending on their size. For example, for class 1 transactions, which include major acquisitions or disposals and reverse takeovers, shareholder approval must be obtained and the matter voted on. This gives shareholders the opportunity to influence an issuer on a matter which could significantly affect the value of their investment. Secondly, the right to one share, one vote which does not exist in a number of Member States. In the interests of promoting shareholder democracy, investors should be given rights in proportion to their capital investment, i.e. there should be one share, one vote. This is fundamental to achieving good governance and the effectiveness of the comply or explain regime. A further right that we believe it is important to preserve throughout the EU is the right of pre-emption in that any attempt to water this down should be resisted. There is a perception among UK managers that this may not be such an issue in Europe as continental companies tend to have a more concentrated ownership model. But regardless of whether they are a minority or majority shareholder there is a need to protect shareholder interests, avoid dilution and the pre-emption issue should be more visible. Another obstacle to effective engagement is that shareholders are often not permitted to speak directly with directors of companies in a number of Member States in that concerns are directed via the investor relations department. To ensure effective engagement this should be addressed. It would also be helpful if institutional investors gave the details of the key contact on their websites so companies could liaise directly with them if necessary. As regards voting, whilst the Shareholder Rights Directive sought to prohibit share blocking, it still continues in markets such as Belgium, Greece, Italy, Luxembourg, Netherlands, Norway, Portugal and Switzerland (although Norway and Switzerland are not in the EU). This is an obstacle to voting, as few managers want to be 'locked-out' of the market for any period of time in that if engagement fails then they want to be able to sell their shares. Nor is it always clear whether blocking is at the instigation of the company or the custodian. Lastly, certain Member States still require shares to be re-registered before they can be voted. For example, in Norway voting rights cannot be exercised on nominee accounts until the shares are re-registered in the name of the beneficial owner. Although in Finland and Sweden, the voting instruction itself serves to re-register the shares, complex deadlines and requirements for a power of attorney in Sweden make it difficult for overseas investors to vote. (18) Should EU law require proxy advisors to be more transparent, e.g. about their analytical methods, conflicts of interest and their policy for managing them and/or whether they apply a code of conduct? If so, how can this best be achieved? At the outset we would highlight that the majority of UK asset managers will use voting service agencies, often two or more, to provide research into the voting decision. An agency s recommendation on voting may not necessarily be followed in that the manager will ultimately decide or follow the direction of their client. Nevertheless, there are other 14

15 managers, particularly those from overseas, and certain clients that instruct agencies to vote on their behalf. It is also possible that the agencies role and influence in stewardship may increase over time. Thus they should not be overlooked and in principle we support them being required to be more transparent. (19) Do you believe that other (legislative) measures are necessary, e.g. restrictions on the ability of proxy advisors to provide consulting services to investee companies? IMA is aware of certain conflicts of interest that arise with the activities of proxy advisors. For example, proxy advisors who issue recommendations about investee companies to whom they provide consulting services. Or proxy advisors selling information on the voting intentions of their institutional clients to investee companies. To ensure the independence of the proxy advisor, we consider measures are necessary to address this, in particular we have concerns when they sell voting information it is not their information to sell. Proxy advisors should at least be transparent about such activities so that their clients can make an informed choice. (20) Do you see a need for a technical and/or legal European mechanism to help issuers identify their shareholders in order to facilitate dialogue on corporate governance issues? If so, do you believe this would also benefit cooperation between investors? Please provide details (e.g. objective(s) pursued, preferred instrument, frequency, level of detail and cost allocation). It is a Companies Act requirement that shareholdings in any UK listed company of 3% and over have to be disclosed. For shareholdings of less than 3%, Section 793 of the Companies Act 2006 allows a public company to require a person it knows, or has reasonable cause to believe, has an interest in its shares to disclose the fact. We consider these provisions strike the right balance and have doubts about the practicability of requiring all investors to provide such information. Nevertheless, due to way shares are held under nominee names such that shareholders are not readily identifiable, companies may not know when it may be appropriate to make such an enquiry. Thus it would be helpful if institutional investors ensured that, where they have holdings in nominee names, they alert companies to their identity and reveal in which name they hold their shares. Even when a company has identified the investment manager concerned, it may not be obvious which part of the group which geographic office, or which subsidiary, for example is the investor. To address this, consideration should be given as to whether registrars, custodians, investment managers and issuers could provide a more comprehensive service than is available today. (21) Do you think that minority shareholders need additional rights to represent their interests effectively in companies with controlling or dominant shareholders? IMA does not consider that minority shareholders need additional rights in that we believe all shareholders should be equal and that there should be one share one vote. Nor do we consider that directors should be appointed to represent minority shareholders. The independent directors have an important role in this regard and it is vital that all directors 15

16 are obliged to act in the interest of the company and ensure that relevant committees are independent. (22) Do you think that minority shareholders need more protection against related party transactions? If so, what measures could be taken? Related party transactions are of vital interest to majority and minority shareholders alike and it is important that the interests of shareholders as a whole are fully protected especially when control of the company or the Board resides with a single party. IMA would welcome a common principle across Europe for this area of corporate governance. The European Corporate Governance Forum produced guidelines 6 on such transactions and proposed: transactions representing less than 1% of assets should be exempted from any special reporting requirements although the independent Directors should take particular care to satisfy themselves that the transaction is in the best interest of the outside shareholders; transactions with the same related party in any 12 month period that have not been approved by shareholders should be aggregated and if these aggregated transactions exceed 5% of assets then approval should be sought for subsequent transactions; transactions representing more than 1% but less than 5% of assets should be publicly announced at the time of the transaction, notified to the relevant authority responsible for financial supervision and accompanied by a letter from an independent advisor confirming that the transaction is fair and reasonable from the perspective of the outside shareholders; transactions representing more than 5% of assets or which have a significant impact on profits or turnover should have the additional requirement of being submitted to a vote by the shareholders in General Meeting but with the related party being precluded from voting; and in all instances the related party should abstain from any Board deliberations about the transaction in question. Consideration should be given to adopting these guidelines throughout the EU. (23) Are there measures to be taken, and if so, which ones, to promote at EU level employee share ownership? Employee share ownership is already a common concept in a large number of Member States. However, especially in large listed companies, employee share owners are often minority shareholders and not necessarily active or engaged. Also if employees own shares in their employer s company they are more exposed to their employer in terms of their jobs as well as their investments. As such we do not consider there should be measures to promote employee share ownership. MONITORING AND IMPLEMENTATION OF CORPORATE GOVERNANCE CODES (24) Do you agree that companies departing from the recommendations of corporate governance codes should be required to provide detailed explanations for such departures and describe the alternative solutions adopted?