The corporate governance framework should provide sound incentives throughout the investment chain and provide for stock markets to function in a way that contributes to good corporate governance.
In order to be effective, the legal and regulatory framework for corporate governance must be developed with a view to the economic reality in which it is to be implemented. In many jurisdictions, the real world of corporate governance and ownership is no longer characterised by a straight and uncompromised relationship between the performance of the company and the income of the ultimate beneficiaries of shareholdings. In reality, the investment chain is often long and complex, with numerous intermediaries that stand between the ultimate beneficiary and the company. The presence of intermediaries acting as independent decision makers influences the incentives and the ability to engage in corporate governance.
The share of investments held by institutional investors such as mutual funds, pension funds, insurance companies and hedge funds has increased significantly, and many of their assets are managed by specialised asset managers. The ability and interest of institutional investors and asset managers to engage in corporate governance vary widely. For some, engagement in corporate governance, including the exercise of voting rights, is a natural part of their business model. Others may offer their beneficiaries and clients a business model and investment strategy that does not include or motivate spending resources on active shareholder engagement. If shareholder engagement is not part of the institution’s business model and investment strategy, mandatory requirements to engage, for example through voting, may or may not be effective and could potentially lead to a box-ticking approach.
The Principles recommend that institutional investors disclose their policies for corporate governance with respect to their investments. Voting at shareholder meetings is, however, only one channel for shareholder engagement. Direct contact and dialogue with the board and management represent other forms of shareholder engagement that are frequently used. In many jurisdictions, codes on shareholder engagement (“stewardship codes”) have been introduced as a complementary governance tool with the aim of strengthening both institutional investor accountability and their role in holding company boards and management accountable. Where corporate governance codes apply on a “comply or explain” basis, the role of institutional investors as shareholders is particularly important in holding companies accountable for their explanations of departures from the provisions of those codes.
III.A. The corporate governance framework should facilitate and support institutional investors’ engagement with their investee companies. Institutional investors acting in a fiduciary capacity should disclose their policies for corporate governance and voting with respect to their investments, including the procedures that they have in place for deciding on the use of their voting rights. Stewardship codes may offer a complementary mechanism to encourage such engagement.
The effectiveness and credibility of the entire corporate governance framework and company oversight could depend in part on institutional investors’ willingness and ability to make informed use of their shareholder rights and effectively exercise their ownership functions in companies in which they invest. While this principle does not necessarily require institutional investors to vote their shares, it calls for potential disclosure of their policies on how they exercise their shareholder rights with due consideration to cost effectiveness. For institutions acting in a fiduciary capacity, such as pension funds, collective investment schemes and some activities of insurance companies, as well as asset managers, the right to vote could be considered part of the value of the investment being undertaken on behalf of their clients. Failure to exercise the ownership rights could potentially result in a loss to the investor who should therefore be made aware of the policy to be followed by the institutional investors.
In some jurisdictions, the demand for disclosure of policies for corporate governance and voting to the market is quite detailed and includes requirements for explicit strategies regarding the circumstances in which the institution will intervene in a company, the approach it will use for such intervention, and how it will assess the effectiveness of the strategy. Disclosure of actual voting records is recognised as good practice, especially where an institution has a declared policy to vote. Disclosure is either to their clients (only with respect to the securities of each client) or, in the case of investment advisors to registered investment companies, to the market via public disclosure.
As part of an engagement policy, institutional investors can establish a continued dialogue with portfolio companies either on company-specific matters or non-diversifiable factors affecting their entire portfolio. Such a dialogue between institutional investors and companies should be encouraged, although it is incumbent on the company to treat all investors equally and not to divulge information to the institutional investors which is not at the same time made available to the market. The additional information provided by a company would normally therefore include general background information about the markets in which the company is operating and further elaboration of information already available to the market.
Stewardship codes have become a well-established practice in many jurisdictions as a complement to other disclosure requirements for institutional investors on their engagement and voting policies. Most codes on shareholder engagement leave it to institutional investors’ discretion whether to apply the code or not. This voluntary and flexible approach has been conceived to allow investors to adapt the codes to their respective investment strategies. Some jurisdictions also have established an implementation mechanism for such codes to ensure compliance and to promote best practice reporting. Some jurisdictions also value carrying out periodic updates and monitoring of these codes to ensure their relevance and oversee their effective implementation.
When institutional investors have developed and disclosed corporate governance and stewardship policies, effective implementation requires that they also set aside the appropriate human and financial resources to pursue these policies in a way that their beneficiaries and portfolio companies can expect. The nature and practical implementation of active corporate governance and voting policies by such institutional investors, including staffing, should be transparent to clients who rely on institutional investors with active corporate governance and stewardship policies.
III.B. Votes should be cast by custodians or nominees in line with the directions of the beneficial owner of the shares.
Custodian institutions holding securities as nominees for customers should not be permitted to cast the votes on those securities unless they have received specific instructions to do so. In some jurisdictions, listing requirements contain broad lists of items on which custodians may not vote without instruction, while leaving this possibility open for certain routine items. Rules should require that either investment advisors or custodian institutions provide shareholders with timely information concerning their options in the exercise of their voting rights. Shareholders may elect to vote by themselves or to delegate all voting rights to custodians. Alternatively, shareholders may choose to be informed of all upcoming shareholder votes and may decide to cast some votes while delegating some voting rights to the custodian.
Holders of depository receipts should be provided with the same ultimate rights and practical opportunities to participate in corporate governance as are accorded to holders of the underlying shares. Where the direct holders of shares may use proxies, the depositary, trust office or equivalent body should therefore issue proxies on a timely basis to depository receipt holders. The depository receipt holders should be able to issue binding voting instructions with respect to the shares, which the depositary or trust office holds on their behalf.
It should be noted that this principle does not apply to the exercise of voting rights by trustees or other persons acting under a special legal mandate (such as, for example, bankruptcy receivers and estate executors).
III.C. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflicts of interest that may affect the exercise of key ownership rights regarding their investments.
The incentives for intermediary owners to vote their shares and exercise key ownership functions may, under certain circumstances, differ from those of direct owners. Such differences may sometimes be commercially sound but may also arise from conflicts of interest which are particularly acute when the fiduciary institution is a subsidiary or an affiliate of another financial institution, and especially an integrated financial group. When such conflicts arise from material business relationships, for example through an agreement to manage the portfolio company’s funds, they should be identified and disclosed.
At the same time, institutions should disclose what actions they are taking to minimise the potentially negative impact on their ability to exercise key shareholder rights to the extent applicable under a jurisdiction’s law. Such actions may include the separation of bonuses for fund management from those related to the acquisition of new business elsewhere in the organisation. Fee structures for asset management and other intermediary services should be transparent.
III.D. The corporate governance framework should require that entities and professionals that provide analysis or advice relevant to decisions by investors, such as proxy advisors, analysts, brokers, ESG rating and data providers, credit rating agencies and index providers, where regulated, disclose and minimise conflicts of interest that might compromise the integrity of their analysis or advice. The methodologies used by ESG rating and data providers, credit rating agencies, index providers and proxy advisors should be transparent and publicly available.
The investment chain from ultimate owners to corporations involves not only multiple intermediary owners but also a wide variety of professions that offer advice and services to intermediary owners. Proxy advisors who offer recommendations to institutional investors on how to vote and sell services that help in the process of voting are among the most relevant from a direct corporate governance perspective. In some cases, proxy advisors also offer corporate governance-related consulting services to corporations. Credit rating agencies rate companies according to their ability to meet their debt obligations and ESG rating providers rate companies according to various environmental, social and governance (ESG) criteria. Analysts and brokers perform similar roles and face the same potential conflicts of interest.
Considering the importance of – and sometimes dependence on – various services in corporate governance, the corporate governance framework should promote the integrity of regulated entities and professionals that provide analysis or advice relevant to decisions by investors, such as proxy advisors, analysts, brokers, ESG rating and data providers, credit rating agencies, and index providers. These service providers, particularly ESG rating and index providers, can have significant impact on companies’ governance and sustainability policies and practices given their rating methodologies and index inclusion criterion. Therefore, the methodologies used by regulated service providers that produce ratings, indices and data should be transparent and publicly available to clients and market participants. This is particularly important when they are also referenced as metrics for regulatory purposes. Exclusive reliance on ratings in regulation may raise questions, while the process for deciding which ratings are eligible for use for regulatory purposes should be transparent and could be subject to evaluation at various levels of frequency. IOSCO’s November 2022 Call for Action covers good practices for ESG ratings and data providers and is addressed to voluntary standard- setting bodies and industry associations operating in financial markets to promote good practices among their members.
At the same time, conflicts of interest may arise and affect judgement, such as when the provider of advice, rating or data is also seeking to provide other services to the company in question, when the provider or its owner have a direct material interest in the company or its competitors, or when the rating provider is at the same time an index provider who will decide on companies’ inclusion in an index based on the rating they produce. Many jurisdictions have adopted regulations or voluntary codes of conduct or have encouraged the implementation of self-regulatory codes designed to mitigate such conflicts of interest or other risks related to integrity, and have provided for private and/or public monitoring arrangements.
Many jurisdictions require or recommend that proxy advisors disclose publicly and/or to investor clients the research and methodology that underpin their recommendations, and the criteria for their voting policies relevant for their clients. Some jurisdictions require that proxy advisors apply and disclose a code of conduct, and disclose information on their research, advice and voting recommendations and any conflict of interest or business relationships that may influence their research, advice or voting recommendations, and the actions they have undertaken to eliminate, mitigate or manage the actual or potential conflicts of interest. In some cases, requirements for proxy advisors include developing appropriate human and operational resources to effectively perform their functions.
III.E. Insider trading and market manipulation should be prohibited and the applicable rules enforced.
As insider trading and market manipulation undermine public confidence in and the effective functioning of capital markets, they are prohibited by securities regulations, company law and/or criminal law in most jurisdictions. These practices can be seen as constituting a breach of good corporate governance as they violate the principle of equitable treatment of shareholders. However, the effectiveness of such prohibition depends on vigorous enforcement action.
III.F. For companies who are listed in a jurisdiction other than their jurisdiction of incorporation, the applicable corporate governance laws and regulations should be clearly disclosed. In the case of cross-listings, the criteria and procedure for recognising the listing requirements of the primary listing should be transparent and documented.
It is increasingly common that companies are listed or traded at venues located in a different jurisdiction than the one where the company is incorporated. This may create uncertainty among investors about which corporate governance rules and regulations apply to that company. It may concern everything from procedures and locations for the annual shareholder meeting to minority rights. The company should therefore clearly disclose which jurisdiction’s rules are applicable. When key corporate governance provisions fall under another jurisdiction than the jurisdiction of trading, the main differences should be noted.
Another important consequence of increased internationalisation and integration of stock markets is the prevalence of secondary listings of an already listed company on another stock exchange, so called cross- listings. Companies with cross-listings are often subject to the regulations and authorities of the jurisdiction where they have their primary listing. In case of a secondary listing, exceptions from local listing rules are typically granted based on the recognition of the listing requirements and corporate governance regulations of the exchange where the company has its primary listing. Stock markets should clearly disclose the rules and procedures that apply to cross listings and related exceptions from local corporate governance rules.
III.G. Stock markets should provide fair and efficient price discovery as a means to help promote effective corporate governance.
Effective corporate governance means that shareholders should be able to monitor and assess their corporate investments by comparing market-related information with the company’s information about its prospects and performance. When shareholders believe it is advantageous, they can either use their voice to influence corporate behaviour, sell their shares (or buy additional shares), or re-evaluate a company’s shares in their portfolios. The quality of and access to market information including fair and efficient price discovery regarding their investments is therefore important for shareholders to exercise their rights.
All types of investors, whether they follow active or passive investment strategies, have relevant roles to play in contributing to well-functioning capital markets and efficient price discovery. In this regard, the quality of and access to market and company-specific information is key, notably for those using this information to follow active corporate governance strategies.