Nina Rohrbein analyses the consequences for Swiss pension funds, their advisers and asset managers of the referendum on executive pay
On 3 March 2013 the Swiss public voted overwhelmingly to back the Abzocker-Initiative (rip-off initiative), also referred to as Minder-Initiative after its founder, the businessman and politician, Thomas Minder.
At 68% it was one of the highest levels of support of any vote held in the country, and passed in every canton.
The initiative aims to reduce executive compensation and abolish golden hellos and parachutes by increasing shareholder rights. In particular, it states that Swiss pension funds (Pensionskassen) have to vote annually on the compensation of the board of directors (Verwaltungsrat), executive board (Geschäftsleitung) and advisory committee (Beirat) on all their domestic shareholdings in the interest of their members – meaning they cannot systematically vote yes on board proposals – and disclose how they have voted at least once a year. Pension funds can vote electronically from afar but proxy voting by a member of the company or by a depositary is prohibited.
Failure to do so can result in fines or even prison sentences.
The initiative will lead to a change in culture among Swiss pension funds and companies.
The beginnings of a sea change can be seen in the rejection of the remuneration report of Julius Baer and biotech firm Actelion in April.
However, say-on-pay is not an entirely new debate in Switzerland. Voluntary standards such as the Swiss Code of Best Practice for Corporate Governance had already been advocating including shareholders in the debate on executive compensation. And in 2009, together with eight pension funds, the Swiss foundation for sustainable development Ethos filed a shareholder resolution at the five largest Swiss companies to have consultative say-on-pay votes written in their statutes. In the end, Ethos was able to withdraw the resolution because companies said they would organise such votes on a voluntary basis. Only pharmaceutical company Novartis refused.
“Since then half of the 100 largest Swiss companies have put voluntary say-on-pay votes on their agenda,” says Dominique Biedermann, executive director at Ethos. “But until now Switzerland has remained the only European country other than Spain to introduce a say-on-pay law.”
A separate law from 2004 required pension funds to regulate how they exercised their voting rights.
“However, there are no statistics that show whether they systematically observe these voting rights,” says Christoph Ryter, president of the Swiss pension fund association ASIP.
“The common approach was to exercise them, unless the board of directors decided otherwise.”
How did the initiative come about?
The statistics may be slightly misleading, as executive compensation in Switzerland is not generally high, according to several market participants.
“It may be high in some parts, particularly on boards of larger companies based on international comparisons but at the executive level this is not the case,” says Barbara Heller, CEO of Swiss proxy adviser SWIPRA, which was founded in March. “It is also not the case for small- to mid-sized companies – in other words, high executive remuneration is the exception rather than the rule.”
It is mainly the large international firms such as Novartis and the Swiss banks that have become infamous for their above-average pay packages.
But according to Biedermann, overall purchasing power in Switzerland is higher than in neighbouring countries, not only for managers, but also for general staff. “Secretaries or accountants, for example, are better paid in Switzerland than in France or Germany, so while remuneration is very high in Switzerland this is not only the case at manager level,” he says.
A characteristic of Switzerland’s direct democracy is that people can put forward an initiative if they collect 100,000 signatures, and this will then be put to a public vote. If it is supported, it will eventually be incorporated into the Swiss constitution and, if required, law.
The roots of the Abzocker-Initiative go back to the grounding and subsequent financial collapse of Swissair in 2002, which caused several small Swiss companies, including that of Thomas Minder, to lose a lot of money, while the Swissair CEO pocketed his annual CHF2.5m (€2.01m) salary ex-ante. In 2007, it became compulsory for Swiss companies to disclose the salaries – globally and the highest paid – of the executive board and the board of directors individually. The inflated salaries that were subsequently published shocked the Swiss public and prompted Minder to launch his initiative.
As the parliament took time to prepare its counter-proposal, nothing happened until the vote on 3 March.
The initiative clearly benefited from growing discontent over high executive pay during the financial crisis.
“The pay excesses of recent times, particularly in the banking sector and most notoriously the CHF72m proposed to be paid to Novartis’ outgoing chairman Daniel Vasella, played into Minder’s hands,” says Peter Bänziger, manager at Zurich-based Swisscanto Asset Management.
A bridge too far?
The clear outcome was not expected, especially as many in the industry, such as ASIP, Ethos and CGAS, supported the counter-proposal, which would have been implemented if the initiative had been rejected.
“Minder went too far by granting binding votes to shareholders, not only for the board of directors but also for the executive board,” says Biedermann.
“We will now be the only country in the world where the executive board’s pay is decided by shareholders. Usually the responsibility for this lies with the board of directors.”
And there is a good chance that the voting public was slightly misled by the grand wording of the initiative. After all, it does not recommend a correct level of remuneration but merely stipulates more rights that shareholders have to execute in a regulated process.
Marco Salvi, project manager at Swiss think-tank Avenir Suisse, adds: “The basic principle of the initiative is that all shareholders must be equally interested in exercising their voting rights. This principle is misguided as pension funds are focused on generating cash flows and dividend returns for their investors – they do not have the time or knowledge to deal with all management and strategic issues of a company. Hedge funds and other large investors may be able to do that but not pension funds that have to be extremely diversified and cannot afford to participate in this activism for each investment they make.
Therefore, the fact that all shareholders must now vote is an issue.”
While it is not evident that shareholders are better at controlling executive pay than the board of directors or the remuneration committee, the referendum was a clear sign from the Swiss population that it is not willing to accept existing executive compensation practice. Following the initiative, a board of directors must have good arguments to defend executive compensation.
“The initiative may be a challenge when hiring top executives into Switzerland in the future as many candidates might be used to sign-on bonuses or similar payments for taking up a job, something which might not be possible in the future,” says Hans Münch, senior manager at Towers Watson Zurich.
“But while pay-for-no-return will be a thing of the past, pay-for-performance will still be possible when communicated properly to the shareholders. So on the positive side, we will see more diligent work and more transparency and communication.”
Ryter agrees: “Mandatory voting creates more transparency. However, in the past, increased transparency has not led to lower average pay packages. On the contrary, it can be a measure to contain outliers. But I expect disappointment for many that the initiative will not have the desired effect in all areas.”
For big pension funds, Ryter does not believe the changes are severe, as many pension funds have already exercised their voting rights in the past. But, he adds, because they only make up 6-7% of the Swiss listed market, their influence is limited.
However, by voting systematically in the future, they will be able to communicate how they vote and are unlikely to remain alone in their approach to executive remuneration, according to market participants.
“Other investors, such as mutual funds will also look at it more carefully than in the past,” says Biedermann.
Arguments against the initiative before the referendum included the absence of maximum compensation limits, the restriction of the decision-making freedom of shareholders and potential fostering of short-term thinking and risky investments due to the annual election of the board of directors.
Now, the focus is on the large administrative burden inflicted on pension funds, particularly smaller ones, as they are required to vote and its resulting costs.
“Over the last few years, the regulatory environment in Switzerland has become increasingly complex for pension funds, which has led to higher costs,” says Willi Thurnherr, head of retirement at Mercer in Switzerland. “The actions required by the initiative will, even if minor, add to the already growing pool of costs.”
Bänziger adds: “Mandatory voting by pension funds on all quoted Swiss companies is quite demanding because of the large number of Swiss companies they are invested in. This will lead to increased expenditure and higher costs for pension funds, which the political process will have to address.”
Ryter says: “The amount of time needed to fulfil voting requirements should not be underestimated. Pension funds could hire a proxy adviser and follow his recommendations, but the initiative says that pension funds have to vote in the interest of their beneficiaries, and simply passing the responsibility on to another organisation may contradict this idea. In addition, relying on external help will cause additional administrative costs, which will be passed to the beneficiaries via a lower return.”
“The result is that these proxy firms will get power – firms which themselves are not all that transparent and often do not disclose the background to their voting decision to the general public,” says Münch.
Firms such as Ethos and SWIPRA offer proxy solutions, in particular for pension funds, and insist the cost is not that high and that they are transparent about their voting guidelines and behaviour.
“In Switzerland if you vote at the 100 largest listed companies, you vote at 99% of market capitalisation and pension funds usually have 60, 70, a maximum of 100 Swiss shares, which are impossible to analyse at AGMs alone,” says Biedermann. “Usually it is cheaper to hire a proxy adviser. For example, we offer a 100-solution for CHF8,000 (€6,440), which for pension funds with millions of invested assets is not expensive for an informed solution to exercise their voting rights. And they have no excuse to pass this cost onto their beneficiaries.”
Complementa will also help pension funds with their voting duties if those are covered by the contract with them.
Industry insiders believe the rise in administrative costs is unlikely to speed up consolidation of the Swiss pension fund industry.
“There is a huge consolidation potential in Switzerland, as there are too many – around 2,200 – pension funds in the country right now,” says Salvi. “However, I do not expect the costs to increase substantially enough to result in a significant number of consolidations.”
Heinz Rothacher, CEO of Complementa Investment-Controlling, says: “And it is important not to forget that if the share price rises as a result of better governance and better alignment with investor interest, the pension fund is likely to be compensated for its increase in expenditures.”
In whose interests?
Another issue is the definition of ‘in the interest of policy-holders.’
“It is unclear what this means in practice,” says Thurnherr. “Fundamentally, it means long-term performance but certain members may think environmental factors are crucial while others may want to take into account social criteria. It is difficult to find out what really is the best choice for the beneficiaries in the long term.”
Münch says: “The interests of a 25-year -old, a 50-year-old and an 85-year-old are clearly not the same. The main interest of pension fund members are a good pension, which is not least enabled through a good return on investments. But it is important to bear in mind that while executive compensation plays a significant role, it is not the only influencing factor in investments.”
Stephan Skaanes, partner at consultancy PPCmetrics, says: “From a strict governance perspective, the only way pension funds can demonstrate that they vote in the interest of the ultimate beneficiaries is by creating a voting committee (Stimmrechtsausschuss) that is voted in by the policy-holders. The voting committee might then decide to follow the recommendation of a proxy voting provider.
“In addition, disclosing their votes is alien to the Swiss system. The question is whether they will have to disclose their voting record only to their beneficiaries or also to the public, and whether it will have to contain detailed explanations or just present the facts. All this needs to be decided before it becomes clearer what kind of extra burden the Abzocker-Initiative decree will be.”
Then there is the matter of investments in collective shareholder vehicles like equity funds, which is particularly popular with smaller pension funds.
It remains unclear whether the voting of the shares held in such vehicles will remain in the hands of the fund managers or whether pension funds will have to vote depending on the number of shares they hold in the collective vehicle.
“At present it is unclear how the voting rights on indirect investments will be handled,” says Thurnherr. “But some investment funds are working or have already established solutions that would allow pension funds to vote. We will know more once the decree is adopted by the Swiss government.”
Biedermanns says: “It is still in discussion whether pension funds need to vote their indirect investments, especially if the funds are foreign-owned and not Swiss. If they cannot vote it will be difficult for them to hold such funds.”
Skaanes says: “A large bank, for example, already offers voting rights to the 30 largest titles in its fund to institutional investors invested in its funds, depending on how much they own. Other vendors are also looking into this. But this involves an enormous administrative burden for the fund managers, particularly foreign ones and those of a smaller size. If pension funds are not required to vote the shares they hold in the fund, they could also all opt for indirect investments and sell their direct holdings to save themselves time and money.”
But Heller points out that the idea of the initiative committee was that there is no difference between holding investments directly or indirectly, especially in view of the fact that most of the pension fund money in Switzerland is being invested indirectly. “But to be sure, we will see how this will develop in the current political process,” she says.
ASIP has pleaded for pragmatic solutions including the possibility not to vote in certain circumstances and to abstain, especially when that would be in the interest of pension fund members.
The Swiss trade association (Gewerbeverband) is opposing mandatory voting for collective investment vehicles. Other suggestions are only to vote if the equity to be voted on makes up more than one-tenth of a per cent (one per mille) of the equities in the asset owner’s portfolio. This will also determine the costs resulting from the Abzocker-Initiative.
“The initiative is unlikely to lead to much except to rising costs for pension funds,” says Salvi. “Pension funds have had the chance to intervene in high remuneration packages or be active investors before and few of them did. It simply costs too much, particularly for small pension funds, to intervene when the benefit to them as diversified investors is very small, even if it leads to changes in pay packages. The scope of the initiative – although it is important with regard to executive salaries – was simply overrated. It will make our legal system more exotic, particularly in international comparison, but it will not lead to big shifts in the corporate landscape.”
Whether excessive remuneration will be stopped as a result of the initiative being implemented in the constitution remains to be seen.
“However, we saw the compensation plan of Julius Baer rejected by shareholders of the Swiss banking group for the first time, and there is a possibility that mandatory voting will increasingly lead to more rejection of excessive pay proposals,” says Bänziger. “The number of rejections is likely to increase, particularly as proxy advisory firms will gain in business and are more likely to vote against management, which will improve overall governance.”
Rothacher adds: “The pressure on Swiss companies has increased and it is important that the board of directors takes more responsibility for the remuneration strategy and its implementation. This has been an issue with a number of companies, particularly where the CEO and the chairman of the board have had the same corporate function.”
It remains unclear whether the initiative will curb excessive remuneration, as there is no regulation in relation to the level of compensation. For golden parachutes alternative solutions might be found such as contracts as external consultants or non-compete clauses, believes Thurnherr.
“Companies will have to communicate to their top executives that their arrangements and compensation are subject to a binding vote at the AGM, which adds risk to the employer-employee relationship for which a manager might ask to be compensated for via a risk premium,” says Münch. “High compensation is not always excessive, and there are many reasons for remuneration to be high and for shareholders to vote in favour of high compensation. What is important is to explain the process that leads to high compensation. If that is transparent and makes sense, then high compensation will be approved.”
According to Biedermann, discussions with company boards are already becoming easier year-by-year because companies recognise that pension funds are long-term shareholders.
“This commitment between management on one side and shareholders on the other side is good for the Swiss economy,” he says. “As Swiss pension fund representatives we are loyal, long-term shareholders, which is much better than a hedge fund or another fund coming from abroad. Loyal shareholders contribute to the success of a company.”
The road to implementation
The Federal Council, the Swiss government, needs to provisionally implement the initiative decree (ordinance) within a year of the date of the vote. Justice Minister Simonetta Sommaruga is even targeting an implementation date of 1 January 2014, and has indicated the initiative would be implemented word for word. The draft could be published as early as the end of May.
Following a consultation process on the draft decree, Biedermann expects the government to decide over issues such as timing, collective investment vehicle voting and securities lending in the autumn.
“The initiative states that, for example, a golden hello will be forbidden but the legislator has to give an adaptation period of one year to the companies because they must change their work contract with the management,” says Biedermann “So part of the points of the Minder-Initiative will come into force in 2014 and parts in 2015.”
Due to time constraints the decree will probably only contain the minimal requirements needed to fulfil the goals of the initiative.
A more detailed law is expected to follow within a few years, as the Swiss parliament is not under pressure to act swiftly.
The outcome of the vote was positively received in the international press, particularly as executive remuneration has been a big issue for institutional investors outside Switzerland too. In Germany, for example, the government recently signalled it wants to strengthen shareholder oversight of executive compensation at listed companies.
“The EC’s Michel Barnier is also interested in what is happening in Switzerland on both the company side with the company law implementing the binding say-on-pay vote and also on the investor side with the new fiduciary duty for pension funds to vote,” says Biedermann. “The duty to vote for pension funds could set an example for other European countries.”
While the Abzocker-Initiative decree is certainly on its way, other corporate governance reforms may follow suit in Switzerland, with the 1:12 initiative – designed to reduce disparities in salaries in one and the same company by capping the highest company salary at 12 times the lowest salary – leading the way.
A recent survey on the 1:12 initiative revealed that 50% of the Swiss public would back it, with 40% expected to vote ‘no’ and 10% still unsure. This indicates that its chances of acceptance are low, because, according to Biedermann, Swiss voters tend to answer yes in polls until they are better informed about the consequences of their decisions.
“The 1:12 initiative is much more dangerous than the Minder-Initiative,” says Biedermann.
“If it passes, it will become a problem for the unions because all lower wage, general staff jobs would be outsourced to companies with poorer working conditions, although paradoxically it was the young people of the socialist party who launched the initiative.”
The government has yet to officially announce the date of the vote on the initiative, but it will probably be in November.
Other topics that are being discussed in Switzerland are a unified pension fund or the free selection of a pension provider, according to Thurnherr. “However, neither topic is new and in the near term future, I do not expect them to be discussed,” he says.
“Similarly, the unions want the first pillar to expand by 10% at the expense of the second pillar but again this has been debated for a long time. However, one topic I expect to reappear is the possible reduction of the statutory conversion rate (Umwandlungssatz). A proposed reduction of the rate, which currently stands at 6.8%, was rejected in a referendum three years ago but I believe the legislator will try to hold a referendum on this again. The last one was very polemic but if a reduced conversion rate can be supported with the right arguments it can be sold to the public. Often the winners of referendums won it with big words such as Abzocker and pensions robbery.”