The proxy advisory industry’s code of conduct has made more clear for different stakeholders how companies in the sector operate, but more work needs to be done to improve the governance of the best practice principles, the European Securities and Markets Authority (ESMA) has said in a progress report on their implementation.

Published on Friday, the report reviewed the implementation of the ‘Best Practice Principles for Shareholder Voting Research and Analysis’ (BPP) that a group of proxy advisers published in March 2014 after the supervisor ruled out regulation of the industry.

ESMA will communicate the report to the European Commission.

Its review of the BPP is based only on the 2015 proxy season, the first following the adoption of the principles, and incorporates feedback received from stakeholders in response to a public “call for evidence”.

The principles have five signatories: Glass, Lewis & Co., ISS, Manifest, PIRC and Proxinvest.

IVOX was part of the founding group, but was acquired by Glass Lewis in June.

Positives identified by ESMA’s review include that the majority of the industry has signed up to the principles, although broader participation would help the principles become accepted as the industry standard, according to ESMA.

As for the principles themselves, they “generally” meet the supervisory body’s expectations, and signatories’ compliance statements fulfil ESMA’s minimum expectations.

“[W]hile it is still early to draw any definitive conclusion,” the supervisor said, “on the basis of the input it has collected from responses to its call for evidence and roundtable, ESMA concludes that the BPP have to date had a certain amount of impact on the market, especially in terms of enhanced clarity for different stakeholders on how proxy advisers operate.”

Change is perceived as lagging, however, in the governance of the principles and the way in which signatories operate their business with respect to managing potential conflicts of interest and taking local conditions into account, ESMA reported.

The independence of advice was one of the main issues raised by Norway’s sovereign wealth fund in its response to ESMA’s consultation, with its asset manager saying the principles fell short of delivering on concerns about conflicts of interest.

The governance of the best practice principles, meanwhile, “constitutes the main area for improvement” found in ESMA’s review, the supervisor said, noting that governance is “fundamental in ensuring the BPP are fully effective and that stakeholders have confidence in the role of the BPP”. 

The best practice principles group (BPPG) should have a clearer and more robust structure, which could be created by appointing a chairperson or having a broader membership, according to ESMA.

A clearer structure for monitoring the BPP would also be welcome, it said.

Sarah Wilson, chief executive at Manifest, made a range of comments to IPE about the ESMA report and its broader context.

These included noting that ESMA’s initial report recommending a code of conduct involved “an element of proxy advisers being political footballs, kicked around by various constituencies”.

Also, the creators of the best practice principles wanted to take into account a wider range of views than just ESMA’s, and to ensure a global rather than European approach.

With respect to ESMA’s recent progress report more specifically, Wilson said it was overall to be welcomed and that the supervisory body’s work had been helpful.

She gave as an example a tabular overview in the annex to the report that shows whether the various BPP have been “broadly”, “fully”, or “partly fulfilled”, and also said ESMA’s report would inform the review the BPPG will be carrying out after the 2016 proxy season.

The BPPG is “grateful” to ESMA and is not complacent or resting on its laurels, said Wilson.

There was some “nit-picking” in the report, however, she said, and she defended the industry group’s approach to managing conflicts of interest and considering local market conditions.

Many clients do not consider that certain local market standards – of corporate governance, for example – represent best practice, and this will be reflected in the advice proxy agencies give.  

Wilson flagged as notable a statement in the report that “ESMA acknowledges there seems to be a mismatch between many issuers’ expectations regarding the changes in terms of engagement and dialogue on voting policies they would like to see as a result of the BPP and actual changes”.

This, she said, was “possibly one of the strongest statements ESMA has made I can remember about who is meant to be responsible to whom for what”.

“All the providers are strongly of the belief that fund managers and asset owners cannot outsource their governance responsibilities to data vendors and that, ultimately, the relationship between companies and shareholders is not affected by our involvement as service providers,” she added.

The point is also made by ESMA in its concluding remarks.

“While enhanced clarity regarding the business operations of proxy advisers can facilitate confidence across the industry’s stakeholders and a smoother interaction between them, it is equally important to reiterate the ultimate responsibility for voting decisions lies with investors,” it said.

A specialist working in the proxy advisory industry said ESMA’s early review of the proxy advisory business was “certainly useful” and acknowledged that a broader sign-up to the principles would be positive.

However, “ESMA should rather do its best to question the broader issue of the market’s conflicts of interests instead of creating entry barriers against new contrarian voices in this herd-like market,” he said.

He suggested a simple way of thinking about the issue of conflicts of interest.

“Generally, in a balanced world refusing conflicts of interests, the logic of normal agency relationship would do the job for proxy advisers,” he said.

“The investor client is pleased with the job, he pays you. If the job is lousy, he will drop you. Period. But we all know the financial market is heavily concentrated and conflicted.”  

The concentration that characterises the proxy advisory industry came up as a concern during ESMA’s review, but its potential impact on competition ultimately falls outside ESMA’s remit, the report states.