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Stewardship: How the East can meet Western standards
THE concept of active stewardship by asset managers has come a long way since it first emerged in the UK in the 1980s. The launch of the Principles for Responsible Investment by the United Nations in 2006, and the UK Stewardship Code in 2010 in the aftermath of the Global Financial Crisis (GFC), led to the adoption of Stewardship Codes in multiple countries around the world, including several in Asia: Japan (2014), Malaysia (2014), Singapore (2016) and South Korea (2016), Taiwan (2016), Hong Kong (2016).
In 2019 we have seen the UK Stewardship Code go through a further and substantive update. Across Europe, stewardship continues to develop: the amended EU Shareholder Rights Directive (SRDII), a response to the GFC, will introduce an obligation on asset owners and managers to publish an engagement policy and report delivery against it. The GFC firmly established the view that investors can and should play a role in the governance of the companies in which they invest. This will hopefully encourage public companies in Asia to update their stewardship codes accordingly.
As it stands now
To date, stewardship in public markets has been seen mainly through the lens of voting at annual general meetings by larger asset owners and investment management firms with the help of proxy agencies. There may also have been selective monitoring and engagement on issues such as strategy, capital structure, performance, risk, corporate governance and culture, and material environmental and social issues. Private markets have attracted a more hands-on approach to stewardship, often including a seat or more on company boards.
In Asia, multiple countries, diverse cultures and approaches to governance means that how stewardship works in practice differs in each market. The defining factor in this diversified landscape is the ownership structure in companies. Companies in China are largely government or family-owned. Similarly, significant family ownership forms the majority of large enterprises in Korea, whereas Japanese businesses often have complex ownership structures with various subsidiaries sitting under the parent companies. As a result, it is more challenging to get access to board members in different parts of Asia. Once access is achieved, stewardship normally comprises the investment manager looking to convince senior executives in Asian companies of the powerful commercial logic of employing stronger governance and considering relevant environment and social factors in a substantive way.
Engaging with companies
All investible assets need responsible investors and credit providers who act as engaged stewards, who support long-term sustainable wealth creation and who hold boards and management accountable. Increasingly, robust research supports the positive impact of engagement on investment performance. Successful engagement can translate into significant outperformance; studies have shown that engagement can generate higher annualised returns of up to 7.1 per cent per annum while also leading to lower downside risk.
Unfortunately, surveys and anecdotal evidence confirm that, even in the UK, stewardship is generally centred on the largest companies. Activity is typically reactive and AGM-focused, or crisis-driven rather than continuous and pro-active. There is an excessive focus on executive remuneration at the expense of material board composition, climate change, human capital management, broader strategy and capital allocation issues. Even today, engagement often involves just asking add-on questions following financial updates and is information-seeking rather than change-seeking. In addition, engagers' corporate counterparts are too often relatively junior rather than senior executives and board members.
Asset managers in Asia will need to substantially broaden and deepen their skillset to deliver effective engagement. They must build a strong understanding of how businesses are governed and run in multiple markets in the region and develop the ability to hold challenging board conversations. Investor engagers that can understand and read the nuances between different cultures and business practices, as well as speak relevant languages, will also be key.
As it stands, many engagement objectives focus on governance matters, such as the development of policies and processes, and disclosure on issues such as executive remuneration, carbon emissions and human capital management. The focus globally, including Asia, needs to shift from corporate governance and disclosure towards delivering positive outcomes and impact for society and the environment.
In future, stewardship objectives must be much more outcome-oriented, with clear deliverables, such as asking for the appointment of a director with specific skills or setting quantifiable environmental or social performance targets. This will need to be complemented by externally verifiable key performance indicators (KPIs), such as emissions reductions or gender diversity targets. The metrics associated with the sustainable development goals (SDGs) will provide a useful framework for investors when choosing relevant KPIs.
Investment managers will also need to be more open about the specific stewardship actions they are taking. They should evidence the use of different engagement techniques in Asia, such as private dialogue with the company, at all levels, including the board, as well as engaging with key stakeholders in the relevant ecosystem to effect change, such as regulators and NGOs, and the placing or supporting of shareholder resolutions, or interventions at annual general meetings.
We believe that the implementation of European Union's SRDII (update of the Shareholder Rights Directive) along with the updated Stewardship Code in the UK can help drive a step change in the level and effectiveness of stewardship. It will require those purporting to be effective stewards of their clients' assets to move well beyond boiler-plating, veneer and lip service and into a new world of transparency about objectives, progress measurement and reporting that could also serve as a model for guidance in other Asian markets.
These major regulatory changes and expectations also provide a good opportunity to consider how stewardship can truly add value. Greater clarity about the purpose of different entities in the investment chain is vital; not least for investment managers themselves, with better disclosure on their governance, including information on fund manager remuneration schemes and client fee structures. It is time for regulators and policymakers in Asia to be much clearer in encouraging investment managers to put stewardship at the heart of their business purpose and to be given stronger monitoring and enforcement powers.
A final analogy
It has become commonplace for the investment management industry to focus on delivering a higher return relative to a benchmark, rather than creating sustainable wealth in the assets invested in. Making this disconnect worse, this outperformance is often measured over short time periods. This puts pressure on corporate management teams to deliver short-term share price rises at the expense of long-term sustainable growth, with consequences for investors, the economy and the planet. This has become a global issue with Western country ownership structures being adopted by countries in Asia.
When we look back in 2030, we should ask ourselves whether the investment management industry has evolved to serve the holistic needs of the investors it serves. The investor not only requires an income to spend in their retirement but also goods and services they can afford to buy and a society and environment they wish to live in.
Today, in many respects its impact can be likened to one that encourages the farmer to chop down the trees in the orchard because the value of the wood is worth more than the value of this year's apple harvest. In 2030, the investment management industry must have transformed into one that that has successfully encouraged the farmer to plant more trees, to invest in better-tasting apples, to conserve the land and to create better jobs by investing in more efficient growing and harvesting techniques. For Asia, this means that, moving forward, we have to place a greater emphasis on sustainable wealth creation encouraged and facilitated by effective investor stewardship.
- The writer is head of responsibility, Hermes Investment Management