An Overview of the Proxy Advisory Industry. Considerations on Possible Policy Options

Norges Bank Investment Management (NBIM) is the investment management division of the Norwegian central bank (Norges Bank) and is responsible for investing the international assets of the Norwegian Government Pension Fund. NBIM also manages the major share of Norges Bank's foreign exchange reserves.

NBIM holds assets in excess of NOK 3400 billion, (€447 billion) of which approximately €105 billion is invested in European equities. NBIM is committed to make active use of its ownership and voting rights in order to safeguard the financial wealth of future generations by promoting good corporate governance and high ethical, social and environmental standards at investee companies. NBIM supports the initiative of ESMA to review the possible policy options regarding the European proxy advisory industry and we welcome the opportunity to contribute to the consultation process.

NBIM’s opening position on the proxy industry

• NBIM regards proxy advice as a commercial, client-demanded service and integral to our active ownership activities.
• We will support proxy advisory reforms and regulatory initiatives if the outcome is to protect the industry’s independence, enhance its transparency and raise the quality of the services provided. 
• Any policy recommendations made by ESMA should not undermine the commercial foundations of the industry nor disrupt its ability to carry out the services sought by investors.

NBIM as stakeholder in the proxy advisory industry

For context to the views and recommendations set out in this submission, NBIM currently buys a range of services and research products from three proxy advisory firms.  We have in the past bought similar services from other vendors. We have also entered into periodic dialogues with a wider group of proxy advisors with regard to individual shareholder proposals submitted by NBIM. We have a commitment to vote all our holdings wherever practical to do so and we seek to apply our voting rights according to our published guidelines.

Additionally, we execute our votes via an electronic platform owned and operated by a proxy advisory firm. We regard the provision of a proxy vote execution platform as separate to the provision of advisory services.

Given these activities, and our recognition of the important services provided by proxy advisors, we consider NBIM to be a stakeholder in the proxy industry and to have a voice in its future direction.

Consultation on the European proxy advisory industry

NBIM agrees that this is an opportune time for ESMA to consider the activities and influence of the proxy advisory industry in Europe. Parallel initiatives are underway at a national level in a number of jurisdictions across Europe, at an EU level and in other global markets. It is timely to draw the threads of these initiatives together.

There is clear evidence that shareholders are taking their ownership responsibilities increasingly seriously; turnout at AGMs in Europe has been rising in recent years and the willingness of shareholders to hold boards accountable by voting against resolutions at general meetings appears to be growing.

Such invigorated investor activity has not escaped the attention of issuers, most particularly those where there has been shareholder opposition to resolutions in prior years. Advisory votes on ‘say on pay’ have further raised issuer sensitivity to proxy recommendations and voting outcomes. We have also witnessed a marked increase in the use of proxy solicitors working on behalf of companies and more examples of issuers publicly criticizing the conclusions reached by proxy advisors. Given the environment of greater investor intervention and raised issuer opposition, it is inevitable that the role played by proxy advisors should come under scrutiny.

Observed correlation between proxy advice and voting behavior

We question ESMA’s use of the term “high correlation” which seems unsubstantiated. There are only two outcomes of a vote; either the vote resolution is supported or not. The nature of such binominal vote leads to high correlation in itself.

We do observe a correlation between the guidelines of the proxy advisors and our own voting guidelines. This is not surprising, for two reasons: First, there is broad consensus on the key principles of good governance that set the foundation for our respective voting guidelines, and second, we are invited to give input to the guidelines of our contracted proxy advisors through annual investor consultations.

In addition to proxy research, NBIM uses the collective analytical resources of its ownership and investment teams, supporting databases and a variety of external specialists in our voting process. Consequently, the final voting decision on all resolutions at every company meeting is NBIM’s. This is irrespective of what proxy advice we have access to or may choose to consult.

For investors generally, the final voting decision must be acknowledged to be their own. The proxy advisors cannot be held responsible if clients choose to follow their recommendations.

Segmentation of services provided to investor and issuer

ESMA has set out four policy options in its consultation document ranging from no action through to binding EU-level legislative instruments.  NBIM does not consider the proxy advisory industry to be the provider of a single service. Consequently, any consideration on whether regulation/ legislation is appropriate or necessary must be addressed at service level rather than firm or industry level.

We consider there to be at least seven differentiated services provided by the proxy advisory industry: 

1. Operational support a. Provision of voting platform b.Vote execution service
2. Voting policy and guidelines development
3. Fact finding a. Aggregation of issuer  information from publicly available sources
4. Research / analysis a. Interpretation and application  of proxy advisor guidelines b.Interpretation and application of NBIM specific ‘bespoke’ guidelines c. Expert analysis – local, industry and company
5. Recommendations a. Provision of governance-related recommendations b. Provision of recommendations outside normal remit of governance matters e.g. merger, acquisitions etc.
6. Company dialogue a.Negotiating agent on behalf of investor b.Governance advocacy c.Interpretation / negotiating agent on behalf of issuers
7. Consulting services to issuers

Based upon the above segmentation, NBIM finds there to be services that are competitive and well-functioning. However, there are areas of conflict of interests where current practices are opaque and sub-optimal for investor clients. We look to industry participants or regulation to correct these dislocations. More specifically:

• Service 1 – Operational support: The provision of voting platforms should be fully unbundled from advisory research. This will create a clearer pricing structure for these separate services. We see benefit in voting platforms containing competing proxy advisor recommendations on commercially agreeable terms to platform and research providers.
• Service 2 - Voting policy and guidelines development: There is explicit, or implicit, client involvement in the setting of proxy advisors’ voting guidelines.  This is constructive as it contributes to the legitimacy of guidelines as being a fair reflection of market opinion.
• Service 3 – Fact finding:  NBIM recognises the validity of a process where proxy advisors can confirm facts with the relevant issuer upon whom they will base their analysis and, ultimately their recommendations. However, we consider it prudent that this process occurs well before a final voting recommendation has been determined. This will avoid undue focus or directed negotiation on contentious recommendations.
• Service 4 – Research / analysis: We consider the provision of company specific research, the interpretation of proxy advisor guidelines and the analysis of NBIM bespoke guidelines to be a competitive service and operationally effective. In particular, we believe proxy advisors are providing expert, accurate and timely governance knowledge. However, in those instances where published research must stray from clear-cut governance matters into areas of greater subjectivity, we see the need for regulation. In particular, analyst commentary that discusses the relative merits of corporate actions or investment outcomes may be considered as investment advice and, by necessity, worthy of regulation. As an example, the following text is taken from a recent proxy research note:
  ‘from an operating standpoint, [the Company] appears to be making headway under the current board and management team towards achieving greater growth and potential profitability... ....we believe that shareholders would be best served supporting management's slate of director nominees at this time.’ The competencies required to make such statements are not confined to corporate governance knowledge. Regulation should therefore conform to that required of existing forms of investment advice. This may be binding regulation and firm or activity supervision.
• Service 5 – Recommendations:  Our day-to-day analysis of general meetings has led NBIM to categorise resolutions at general meetings into four broad categories (detailed in question 7a response). The categories are based upon the degree to which analysis moves from a proxy firm’s published guideline. For those recommendations built upon proxy analyst judgment, particularly outside the normal confines of corporate governance, we consider this to fall within the regulated regime of investment advice.
• Service 6 – Company Dialogue:  It is not NBIM’s intention to prevent proxy advisors having dialogues with companies. However, we consider that issuer meetings, particularly those held immediately prior to a general meeting, may offer incentive for issuers to retreat from direct contact with their investors. It can also discourage proactive and full disclosure of all necessary information to all shareholders. This is an area where we would welcome reform.
  Furthermore, NBIM does not need or wish proxy advisors to act as negotiating agents with issuers on our behalf. The primacy of the investor as principal must be upheld, and be seen to be upheld. We have two specific areas of concern:
  We require unambiguous clarification when the proxy advisor is acting on behalf of the investor. Currently there is a risk, or opportunity for misunderstanding, that proxy advisors can act as negotiating agent on behalf of both investor and issuer. This is exacerbated by the introduction of ‘stewardship services’ whereby proxy advisors seek to be paid as facilitation-agent between investors and issuers.
  There is a lack of transparency over the purpose of dialogue between issuer and proxy advisor - and a further lack of transparency over the content of such conversations/meetings. This concern can be mitigated by a framework which allows for company comments to be made available to the proxy advisors’ subscribers, by incorporating such comments into the same document containing the proxy advisors analysis and voting recommendations.
• Service 7 – Consulting services to issuers: We see clear risk of conflict of interest when proxy advisors sell services to both investors and issuers. The practice introduces an unavoidable question over the independence and integrity of the resulting analysis and recommendations provided to investors. If it is to occur, there must be detailed and proactive disclosure of all relationships. With regard to conflicts of interest more generally, these should be avoided where possible and mitigated where unavoidable. This is an area where regulation is warranted. The nature of regulation may be binding if it then falls into the realm of EU or national supervised activities.

Policy Recommendation

ESMA has offered four possible policy options in the consultation:

1. No action at EU-level at this stage
2. Encouraging at EU level member states and/or industry to develop standards
3. Quasi-binding EU-level regulatory instruments
4. Binding EU-level legislative instruments

NBIM does not recognize a perfect logic to the four options offered by ESMA as there are a number of additional or alternative steps within those four alternatives set out.  The recommendations NBIM has set out for each of the seven segmented services may necessitate binding regulation at a service level and, furthermore, supervision. We therefore foresee industry reforms that may require elements of policy options 2, 3 and 4.

We are in regular dialogue with our contracted proxy advisors to achieve the service refinements and improvements as set out in our five-point reforms.  Looking to the longer term where the role of proxy research is likely to remain integral to long term investment decision making and to be formally recognized as investment advice, the question of formal regulation must be addressed.

We reiterate our support for the efforts taken by ESMA to review the role and influence of proxy advisors in Europe. As a large, long term shareholder in European companies and as the user of proxy advisory services, we welcome this opportunity to contribute our views on the future shape of the industry in Europe. NBIM will be pleased to discuss our proposals directly with ESMA should that be of value for its considerations.

Yours sincerely,

Jan Thomsen
Chief Risk Officer

Gavin Grant
Head of Corporate Governance, Ownership Policy

Detailed Response to ESMA Questions

Submission in PDF