The role of proxy advisors
The main role of proxy advisors is to formulate, on a professional basis, voting recommendations for their shareholder clients (primarily institutional investors, pension funds and other types of funds) concerning the exercise of their voting rights. These companies also act as proxy holders for their clients, in other words they vote for them. Moreover, (institutional) investors are paying increasing attention to the manner in which a company is governed before investing in it. In addition, certain proxy advisors have developed rankings for companies, based on their governance practices. Finally, a fair number of proxy advisors also provide consultancy services to their clients, with regard for instance to remuneration (say on pay) or ways to improve their governance.
The history of proxy advisors dates back to 1980, and the foundation of ISS and PIRC. Since then and mainly since the year 2000, the number of such companies has grown considerably, both in Europe (PIRC, IVIS, Manifest and ECGS in the United Kingdom, Ethos in Switzerland, Proxinvest in France, IVOX and DSW in Germany, and Shareholder Support in the Netherlands) and the United States, where the market is flourishing (Institutional Shareholder Services (ISS) and Glass Lewis). ISS holds alone a market share of close to 60% with around 1,700 clients.
The large number of (cross-border) share portfolios and the complexity of factors to take into account in order to vote knowledgably often render the use of proxy advisors inevitable. These advisors exert considerable influence on the voting behaviour of investors.
Inadequacies of the system
Two main inadequacies have been noted in the manner in which proxy advisors carry out their assignments. Firstly, the methodologies used by proxy advisors to formulate their recommendations often do not sufficiently take into account the local market and regulatory conditions and their methods are generally not sufficiently transparent. Finally, proxy advisors provide services which are capable of compromising their independence and ability to formulate objective and reliable advice. As indicated above, proxy advisors may provide advice to issuers with regard to good governance, while simultaneously formulating voting recommendations for the shareholders of these same issuers.
Need for legislation?
These two inadequacies prompted the European Commission to adopt a proposal for a directive in order to ensure the reliability and quality of the advice of proxy advisors. The goal is to require proxy advisors to implement measures which guarantee that their voting recommendations are accurate and reliable, based on a thorough analysis of all information available to them, and that they are not affected by any existing or potential conflict of interest or business relationship.
Proxy advisors have strongly criticised this proposal. Based on the February 2013 recommendations of ESMA (European Securities and Markets Authority), a self-regulatory approach should be preferred and encouraged so that proxy advisors develop their own codes of conduct. Further to this recommendation, many proxy advisors adopted codes of conduct. Perhaps the Commission considers these to be insufficient. The pressure exerted on shareholders (institutional investors and others) to play an increasingly active role within companies (say on pay, etc.) tends to reinforce recourse to proxy advisors. However, the active influence of proxy advisors on shareholders' voting decisions (based on their recommendations) gives them increasing power. We thus believe that Europe, and Belgium in its wake, will adopt binding rules to reign in their power.