"Seeing that the key to restoring stability lies with them, pension funds are a growing force for change"
The proxy-voting season is getting under way, and company boards across Europe, particularly those of banks, are expected to face their toughest annual general meetings on record. Over the past 12 months equity values have fallen through the floor, wiping millions of euros from company valuations. Among the biggest casualties have been the institutional investors such as pension funds who own these companies and which hold the lifetime savings of millions of ordinary people.
All over Europe, many people will now be forced to work beyond their intended retirement age to make up the shortfalls in their pensions. Many will be faced with higher contributions or lower indexation.
And while there has been the occasional dramatic AGM over the years, by and large, pension funds have left relationships with their portfolio companies to their investment managers. As a result they have witnessed risky M&A decisions, excessive and misaligned executive remuneration, powerful executives clinging to the dual roles of chairman and CEO, poor risk-management, short-term business strategies and off-balance sheet accounting, all of which represented a ticking time bomb of toxicity.
However, some glimmers of hope are now discernable. Some of the world's largest pension funds have started to join forces with the aim of using their combined might to bring about lasting change to the way companies operate. Powerfully motivated by the colossal losses suffered by pension funds, this growing group of heavyweight investors is starting to create a very different investment environment, one in which they recognise and implement their roles as company owners through their shareholdings.
The job of a pension fund trustee has become more complex than ever before, as many of them work part time and they are sometimes from non-financial backgrounds. Support through a formal collaboration and shared specialist expertise is enabling trustees to navigate through the complexities of the global business, financial and regulatory environment. They are concerned to ensure that the credit crisis leads regulators to promote open, fair and transparent markets to facilitate enterprise in the long term.
Seeing that the key to restoring stability lies with them, pension funds are a growing force for change.
Confidence and trust in banks is unlikely to be restored simply through their recapitalisation in publicly-funded bailout packages. A clear task for government is to encourage pension funds and other long-term investors to be better and more-involved company owners. That is for these end-owners to work with the companies in which they are investing to enhance their value to their own benefit and to the benefit of us all. By acting as a united voice, pension funds are helping to steer companies away from dangerous waters towards the safer shores offered by more accountable, transparent and responsible business practices.
For investors, the job of tackling company boards on sensitive issues such as social, ethical, environmental and governance is tough. Last year HEOS engaged with hundreds of companies internationally on behalf of some of the world's largest pension funds to ensure the companies that its clients invest in are behaving in the long-term interests of shareholders. Examples of change coming from those engagements include:
• Major international steel companies and the businesses that trade with them, including white goods and automotive manufacturers, were in the spotlight following allegations of slavery and unsound employment practices in Brazil. We were able to stop these companies buying their steel from compromised sources;
• We secured wholesale board changes at major banking institutions after raising concerns about remuneration and risk management;
• A number of large European companies have introduced formal anti-bribery management frameworks as a result of our work. Bribery causes value destruction in governments and infrastructure and makes countries uninvestable;
• In the UK, we recently engaged successfully with the chairman of a leading retailer on strategy, the need for appropriate succession planning and the structure of the company with a view to adding a new perspective and promoting sustainable growth;
• In the US we convinced several companies, including a media giant, to switch away from the plurality voting system, where a single vote in favour could get a director elected, and move to a majority voting system. Our thinking behind this was that compromised directors lead to compromised debates in boardrooms, which in turn lead to compromised companies, which tend to destroy value.
However, it is in the US that institutional investors face their toughest challenge as shareholder rights in the country are among the poorest in the world. Institutional investors are now looking to President Barack Obama to deliver on his promise to usher in "a new era of responsibility".
Taxpayers have had to shoulder the risky decisions made by businesses on three counts - they have had to pick up the bill through their retirement funds, also as taxpayers and as employees through reduced prospects and large-scale job losses.
It cannot be good for sentiment and confidence in the US economy to witness companies consuming successive rescue packages. More than 70% of the largest corporations in the US are owned by institutional investors. A more sustainable route for the government would be to empower and encourage the owners of those companies, such as pension funds, by strengthening shareholder rights to enable them to be better and more-involved owners, and work with the companies they are investing in to enhance their value.
By acting as a united voice, the HEOS group of pension funds is already helping companies to adopt more accountable, transparent and responsible business practices. It is also working alongside its US counterparts CalPERS and TIAA-CREEF. And because HEOS represents the largest and most advanced group of pension funds co-ordinated internationally, representing equity investments worth over €55bn, its voice is especially effective in dialogue with company boards.
Even before the credit crunch, many pension funds had already begun to spot the damage being done to the companies in which they had invested by the short-termism of the financial markets. Refusing to be dazzled by a self-fulfilling boom in prices and transactions, they had started to provide the companies they invested in with the challenge and support of a good owner. In their view, companies with time horizons that did not extend beyond the next quarter would struggle to become sustainable engines of economic growth. The impact of such short-term behaviour has proven to be catastrophic for the businesses involved.
While I applaud the decision by the G20 to adopt an inter-governmental supervisory approach rather than add another layer of regulation, it is too early to know whether the announced initiatives will make a difference and restore confidence. However, I am certain that it is impossible to solve a global problem through government action alone. We must engage business and connect companies with their owners.
As we in the UK look ahead to the Walker Report on corporate governance in the financial services sector, I hope that it tackles the root causes of the problem, which require a change of culture and the promotion of more accountable business practices.
The more progressive pension funds that are starting to engage in this new model of dialogue are reporting a myriad of benefits from the opportunities to influence the structure, direction and management of the businesses they jointly own. Boards of directors are also seeing the many benefits from a supportive dialogue with institutional investors that take a longer-term perspective.
Most companies are relieved to find that someone in their shareholder base is taking an interest beyond the short-term numbers. The financial crisis has shown the damage that bad corporate governance and ownership can do and companies are becoming receptive to an intervention that promotes long-term growth and value.
CEO of Hermes Equity Ownership Services (HEOS)