Sunday, July 22, 2012

UK FRC Calls for EU-Wide Code of Conduct for Proxy Advisory Services and Coordination with SEC

The UK Financial Reporting Council eschews EU regulation of proxy advisory services at this time in favor of an EU-wide Code of Conduct. In a comment letter to the European Securities and Markets Authority, the Council said that proxy advisory firms should be urged to develop a Code of Conduct, and that legislation should be considered if they do not address current concerns. Given the international nature of equity markets, continued the Council, it is important that any EU action should mesh with action in the US. Thus, the FRC urged EU authorities to stay in close contact with the SEC, which has also been considering the need for the regulation of proxy voting agencies.  The Financial Reporting Council is the UK’s independent regulator and standard setter responsible for corporate governance, accounting, and auditing.

The Code of Conduct envisioned by the FRC would consist of best practices and operate on a comply-or-explain basis. Proxy advisory firms would be required to state publicly whether or not they apply the Code. More granularly, the Code would encourage proxy advisory firms to disclose on a comply-or-explain basis how they approach their decisions, how they escalate difficult or non-routine decisions within their own hierarchy, and how far they are prepared to talk to issuers.  When basic research is outsourced to analysts in an overseas jurisdiction, the scope of such work should be clearly explained and companies should have access to a named individual in their own time zone, with which they can discuss any queries. 

The proxy advisory agencies should identify an individual of high public standing to provide independent leadership to the development of the Code.  This corresponds to the model adopted by the UK private equity industry for which Sir David Walker fulfilled this role. The Walker Report set forth guidelines for disclosure and transparency in private equity, on a comply-or-explain basis.

Proxy advisory firms should also consult widely and publicly with interested parties, including issuers and investors on the content and wording of the Code of Conduct.  Once the Code was agreed to and in effect, said the FRC, the industry should organize an objective, independent annual report on compliance.  Obviously, if the industry failed to respond, it should be clear that pressures for formal regulation would increase.

Concerns over the use of proxy advisory services are compounded by the increasing internationalization of the equity markets, noted the FRC, which results in more shareholders being remote from the companies they own which, in turn, make them more reliant on proxy advisory firms.  It also makes it hard for companies to engage directly with even some of their larger shareholders.

These concerns are genuine, emphasized the FRC, and are likely to increase as the equity market becomes more international and resource pressures push more investors to rely on the judgments of proxy advisory services.  Agents who have no value at stake and who do not therefore need to live with the consequences of corporate decisions could thus become a dominant force in deciding how resolutions are voted at annual meetings, while responsibility for the voting decision continues to rest with share owners.

Finally, the FRC cautioned that any regulatory intervention must be set against the overall value that proxy voting agencies bring, especially in an age where there is greater public expectation on shareholders with regard to stewardship.  For most institutional investors managing large portfolios, the availability of a set of benchmark judgments is important in helping them exercise their ownership responsibilities.  It also acts as a filter for identifying difficult and controversial cases.  Without the contribution of proxy voting agencies, warned the Council, there is a risk voting could become chaotic and unpredictable.

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