Investors are crying out for a single objective way to measure and compare corporate governance practices across broad range of companies in the index, explains Stanley Dubiel senior vice president and director at Institutional Shareholder Services (ISS), which together with FTSE launched the new joint corporate governance index (CGI) series at the end of last year.
The creation of the new index was the result of demand from its institutional clients who wanted to see a benchmark that reflects the traditional international benchmarks of the FTSE indices in terms of the behaviour of the index and the returns that does away with the corporate governance risk.
The new series contains a group of six equity indexes with a corporate governance overlay. It includes companies from a universe of 2,300 companies from the 24 developed markets forming the OECD.
ISS corporate governance ratings are used as the basis for the index. Launched in 2002 its Corporate Governance Quotient rates more than 7,500 companies. The ratings are based on a set of principles laid down by the OECD, which were adopted after much consultation with experts in the field.
In order for the new index to be as close as possible to the performance of the standard indices it had to adopt the same split into 18 different sectors. “There should be no bias such as the exclusion of oil and gas,” notes Marianne Huvé-Allard, director of communications at FTSE Group.
All companies are listed in order of their corporate governance ratings, from the highest to the lowest. A line is drawn at 80% of the total capital of the index. The remaining companies are excluded.
The exclusion of the highest risk companies in each sector is the primary objective of the index. Huvé-Allard: “It is an industrial tool that offers a first screen and helps to set the agenda for some of the pension funds who don’t necessarily have the resources to analyse and engage with all the companies that are in their portfolio.”
Another objective of the new index is to raise the profile of corporate governance as an investment concern by encouraging shareholders and companies to come together and talk around the issues. “We designed a solution which allows companies to benchmark themselves, to validate the information and to compare our interpretation of their corporate governance practices with theirs,” says Dubiel.
“The degree of transparency should mitigate any concerns they may have.”
FTSE is offering the rated companies free access to all the data that ISS has collected and what ISS deems to be a good practice so they can update the data and also engage with ISS if they don’t understand the concepts used.
Huvé-Allard notes: “We are going to run this process until next March when we will do an index review. By then some companies might have an improved rating as a result of this
FTSE and ISS have put together a panel of corporate governance experts who will be examine the methodology used in compiling the index and advise on corporate governance matters and how they develop in the different markets. “So the solution will develop in time as corporate governance practices change and improve around the world,” says Dubiel.
Huvé-Allard adds: “What will change are the expectations from investors, regulators and maybe
legislators. And so we will have to
capture more data because more will be disclosed.”
An assessment of the quality of a company’s corporate governance could be very labour intensive for the companies concerned. Not so the new corporate governance index. Huvé-Allard: “One advantage is that it is not questionnaire-based. The panel of experts analyse the information that they have gathered on the companies in the index according to the ISS approach. One aim of the project was to produce a process that is very light on administration for the companies concerned.”
Given the additional screening for quality of governance it will be interesting to see how the index performs. As Huvé-Allard explains, “while we have designed this index so that it delivers at least the same returns and the same performance as traditional FTSE indices, maybe over time will over-perform”.
She adds: “This will depend on the take-up of the index, how the index is used for analysis.”
So far reaction has been positive – with some exceptions. FTSE and ISS recently held a conference seminar for the Institute of Directors. Huvé-Allard says: “Some directors were not too happy that there was a new measurement; of course people don’t like to be under scrutiny if they are not going to come out of it well.”
But as Dubiel notes: “It is doing what we wanted it to do which is to develop a dialogue on the subject.”