Recently there has been a lot of focus on the SEC’s proposals on climate disclosure. Less prominent though are some worrying developments in the US on disclosure rules that would negatively impact activist investing, and in so doing, their ability to influence for change.
In summary, the proposed rule changes would essentially make activist investing less likely because 1) it reduces activists' ability to build economically viable positions, and 2) decreases efforts to increase influence through collaboration. So, while the SEC on the one hand is following suit on the backend of developments in the sustainable finance space by asking companies for climate disclosures, they are on the other hand reducing shareholders’ ability to actually pressure companies.
For a detailed article on the disclosure proposals, read this Bloomberg column by Matt Levine.
The case for activism
Shareholder activism is still today a highly debated area, however, net of its advantages and drawbacks, it should help to make both companies and markets more efficient, optimizing capital allocation and corporate decision making.
Certain findings I would like to highlight here include:
Research showing that even good management practices are not adopted by many organizations because of cognitive, knowledge, incentive, and capability barriers.
What research tells us about activism and its effects, where Professor Alex Edmans effectively makes the case for activism, concluding e.g. that “the key characteristic of an investor isn’t so much its holding period as its stake. Only investors with large stakes will have sufficient “skin-in-the-game” to truly engage with a firm, and undertake restructurings that increase productivity and investment efficiency for the benefit of the firm and society as a whole.”
The paper “Investor Relations, Engagement and Shareholder Activism”, which study how the appointment of an investor relations officer (IRO) is associated with the likelihood and extent of activism. In discussing overall findings, the authors suggest that direct and ongoing IR engagement is an important factor in achieving mutual understanding and trust between the firm and its shareholders, which deters activist investors and mitigates the costly escalation of activist campaigns.
The active ownership continuum
Over the years, regulatory and technological changes have disrupted the balance of power between management and shareholders. At the same time, the struggle to influence shareholder opinion by corporate managers and activists respectively has led to calls for more engagement between companies and investors.
As such, engagement dialogues play an important role, both in terms of building trust and aligning on longer-term plans with companies (providing them with preventive rather than reactive defenses against sometimes costly activism), or by functioning as an accountability mechanism (together with activism) influencing companies when their performance is lacking.
To progress on many challenging esg issues, we need to increase collaboration and ensure a fair and level playing field for the different forms of active ownership globally. In this quest, we should work to address both regulatory hurdles and collective action problems.
Starting with the former, - which brings us back to the discussion of how the SEC’s proposal seemingly makes collaboration harder - acting in concert regulation is often perceived as a key regulatory barrier when investors seek to engage collaboratively with companies. The very lengthy, but highly informative report A Legal Framework for Impact, by law firm ‘Freshfields Bruckhaus Deringer’, mentions that in all jurisdictions there is scope for investors to work together to achieve sustainability impact goals, however they will need to comply with various rules on collective action to influence or control the activities of business enterprises.
While most stewardship codes and guidelines approach collaboration in a way that is compliant with such regional regulation, it is still important that institutional investors have a clear understanding of these acting in concert scenarios and disclosure requirements. In an effort to further assist investors here, the PRI is working on providing separate overviews of such regulation across certain key markets, including the UK, where guidance is available. There, the Financial Services Authority (FSA) has stated that it did not believe that its regulatory requirements prevent collective engagement by institutional shareholders designed to raise legitimate concerns on particular corporate issues where these simply involve ad hoc discussions or understandings.
Moving on to the collective action problem, whereby everyone benefits from active ownership efforts regardless of how much work they put in. Herein, importantly, we need to strengthen the mechanisms that pool investor resources to help divide responsibilities and drive needed action. Here are some suggestions of what we need more of:
Improved engagement dialogues, focusing on achieving real-world outcomes, addressing both individual and system-level risks.
Increased demand (and accountability) and supply from asset owners and managers respectively for quality investment stewardship.
Responsible action and lobbying from others in the investment ecosystem, like regulators and industry associations.
Innovation that effectivizes stewardship through a) pooling investor resources, and b) supports transparency, process efficiency, and so forth.
Where do we go from here?
Well, responsible investing has a powerful ally in both activism and active ownership. It can help ensure proper governance of assets, balancing both financial as well as social and environmental objectives. The question today is rather: will we ensure the pace of change is fast enough?
Author: Rickard Nilsson, Spokesperson and Director, Strategy & Growth at Esgaia. With years of experience in responsible investing, Rickard focuses on market intelligence and outreach, and promotion of industry best practices. He is passionate about all things esg, especially investment stewardship and how engagement can help advance sustainability practices. For more information, visit www.esgaia.com