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ISS Disclosure Response to UK Stewardship Code

September 2010

ISS welcomes the swiftness and pragmatism with which the FRC, in conjunction with the ISC, has established a clear set of best practice guidelines for the discharge of governance responsibilities by institutional investors (and, by extension, proxy voting agencies such as ourselves), through the publication of the UK Stewardship Code (the Code).

As the leading provider of corporate governance advisory and proxy voting services to the UK and international investor communities, ISS places primary importance on conducting its business in a transparent, responsible and constructive manner, as we assist our clients in meeting their fiduciary obligations as owners.

We therefore welcome the opportunity to post this disclosure, which has been updated since our initial submission in July, to highlight how our company and the services we provide align directly with the key principles of the Code. ISS continually re-assesses its role within the governance community and how our services can evolve to meet new market requirements. We believe there is much more we can do to help further the goals of the Code from the solid base we have established and we remain committed to the principles of transparency and collaboration that underpin it. We will continue to consult with our clients over the coming months to help them fulfill their responsibilities under the Code and to explore how our own compliance with the Code can be enhanced.

  • PRINCIPLE 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

Our proxy analyses and voting recommendations are based on publicly disclosed benchmark policies and guidelines which reflect prevailing market best practices, codes and standards of corporate governance in the market in which they are applied.  There is no ‘one size fits all’ - we apply market-specific policies in each jurisdiction, either via a standalone national policy, or a regional policy with national exceptions or qualifications on particular issues where practices vary. These policies are developed and refined annually through a formal policy formation process, which includes input from investors and issuers on key governance trends and topics gathered through surveys and other vehicles.    A distinction we want to make very clear is that, for clients representing over 60% of the aggregate assets held by all of our clients, we provide a custom analysis service through which the voting recommendations for those clients are based on bespoke proxy voting policies developed by, or in conjunction with, each client rather than on ISS benchmark policies.  Such policies (and the resulting vote recommendations) reflect the particular views of an institution and its clients on key governance issues, consistent with their investment strategies and mandates.

In the UK, we apply the NAPF Corporate Governance Policy and Voting Guidelines as our benchmark policy and collaborate with the NAPF in its own policy review process.  We apply the ‘comply or explain’ principle in our analysis and recommendation process by taking account of the explanations with respect to non-compliance provided by a company in its public statements, speaking with companies who approach us to provide explanations with respect to their governance practices and proactively contacting companies seeking further input prior to issuing a recommendation in the event that explanations provided in public disclosures are incomplete or unclear.  In addition, prior to publication of our benchmark vote recommendations, we do our best (having regard to client deadlines and voting cut-offs and contentious situations where advance disclosure of our recommendation may be viewed as price sensitive) to provide companies with an advance copy of the proxy report in order for them to check for any factual errors and to understand the rationale for any recommendation against a management proposal.

Please see http://www.issgovernance.com/policy/EngagingWithISS for our engagement policy and more information on our engagement practices.

Regardless of whether our client subscribes to a benchmark or custom policy-based service, ISS provides voting recommendations - the ultimate voting decision for each resolution at a company meeting remains the responsibility of the client, as we believe it should, in keeping with their fiduciary responsibilities. It is common among our clients who subscribe to our benchmark policy recommendations to focus their attention on the factual analysis but ultimately decide to vote differently from these recommendations, in line with their own investment and governance philosophy and company engagement activities in any particular situation.

  • PRINCIPLE 2:  Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.

Our mission is to enable the financial community to manage governance risk for the benefit of shareholders. In pursuit of this mission, we operate our business to the highest ethical and publish our Ethics Policy, Engagement Policy and Conflict of Interests Policy on our public website. Please see http://www.issgovernance.com/practices to see the applicable policies in full. 

Complex ownership and business relationships in the financial services industry can place asset managers in a challenging fiduciary position. For example, a manager may have significant share holdings in an auditor who is required to apply independent judgment on the fund's accounts. Or a fund may own shares in its parent company as part of a passive investment strategy. Cases like these can create the potential of a conflict of interest when the funds vote their proxies. The independence of the proxy vote can appear to be undermined by a fund's ownership, or the vote might appear to have compromised the independence of an auditor's recommendation.

ISS's Fiduciary Voting Services allows institutional investors to clarify fiduciary responsibilities and remedy the appearance of conflict with a set of flexible, automated tools for:

  • Identifying securities where a potential conflict of interest may appear;
  • Specifying the accounts where the appearance of conflict is important; and
  • Defining a workflow for handling the ballots identified as sensitive; for example, do-not-vote, refer to a third party, or apply a different proxy voting policy.

By automating this process, investors take advantage of the efficiency of ISS’s voting agency services, while avoiding even the appearance of a conflict of interest for sensitive meetings and ballots.

ISS does offer governance advisory services to issuers in order to educate and enable them to understand and meet the same governance best practices we apply on behalf of our investor clients. We see this as an effective way of enabling both the corporate and investor constituencies to converge upon good corporate governance practices in the best interests of shareholders. In order to address any potential for conflict, these services are provided through a separate company, with a separate staff, which is divided from our investor business by a robust firewall.  

In addition to our compliance and conflict management policies, we also have in place a SAS 70 Type II audit of our business and ISS is registered with the U.S. Securities and Exchange Commission as a Registered Investment Adviser.  We are therefore organized in a manner entirely consistent with this principle of the Code and, by extension, assist our clients in meeting their mandate in this area.

  • PRINCIPLE 3:  Institutional investors should monitor their investee companies.

In larger markets, our research analysts are organised into industry sector teams and monitor companies in their sector throughout the year.  In the UK alone we meet with approximately 150 companies per year to discuss governance developments of interest to our clients, commonly with the Chairman of the Board, Senior Independent Director or Committee Chairs.  So far in 2010, we have already interacted with 50% more companies than at the same stage last year.

In the preparation of our voting analyses and recommendations, we endeavour to speak directly to a company if any aspect of their disclosure is unclear and to ensure that our understanding of the facts is accurate.  We maintain meeting notes and include a synopsis of the discussions in our voting report to provide clients with an audit trail.

In addition to these direct engagement activities, our monitoring also includes the quarterly assessment of key governance features for over 8,000 companies in the major capital markets, which we publish in the form of our Governance Risk Indicators (GRId) scores.  GRId scores can be used by clients to identify key governance risks within their portfolios as a starting point for their own engagement activities. Please see http://www.issgovernance.com/grid-info for more information about GRId.

  • PRINCIPLE 4:  Institutional investors should establish clear guidelines on when and how they escalate their activities as a method of protecting and enhancing shareholder value.

We do not consider Principle 4 to have direct application to ISS as a proxy advisor, as this speaks to the internal escalation procedures of institutional investors.  However, we do play a role in drawing the attention of our clients to governance issues at their portfolio companies, whether that be through identifying risks through GRId scores (as explained above), or via our proxy analyses and voting recommendations.  Whether the ISS vote recommendation is ultimately for or against management, we ‘flag’ any controversial or particularly complex items on our reports in order to direct the attention of our clients to issues which may bear further scrutiny in advance of any final voting decision.  Our reports are typically published between 2 and 3 weeks prior to the meeting date, giving a further opportunity for our clients and the subject company to consult in advance of the voting deadline.

  •  PRINCIPLE 5:  Institutional investors should be willing to act collectively with other investors where appropriate.

We participate frequently in company-facilitated shareholder engagement forums and actively provide feedback and, where necessary, challenge, companies on governance practices within the framework of ISS’ benchmark policies.  This year, shareholder engagement forums in which ISS has participated in the UK (where we hold a single share for information purposes in every FTSE All Share Index company) included British Airways Plc, Investec plc, Lloyds Banking Group plc, ReckittBenckinserGroup plc and Royal Dutch Shell plc.

Our client community is central to our value proposition and we provide a forum for clients to debate and collaborate with one another on governance issues through our regular roundtables and conferences.  We also provide an online platform,Governance Exchange, which brings together the key governance constituencies of investors, non-executive directors and executives alongside academics, legal and other professional experts as a resource for the education, debate and exchange of views that helps drive greater understanding and effective collaboration in the continuing evolution of best practices in corporate governance.Please see http://www.issgovernance.com/governance_exchange for more information on Governance Exchange.

  • PRINCIPLE 6: Institutional investors should have a clear policy on voting and disclosure of voting activity

Voting

We have highlighted our role in the policy process in our response to Principle 1.

The ultimate sanction underpinning the engagement process is shareholders having the effective means to exercise their voting rights. The Code highlights that shareholders should seek to vote all shares held and that they should not automatically support the board. If shareholders have been unable to reach a satisfactory outcome through active dialogue on a particular matter then they should register an abstention or vote against the resolution.

ISS enables its clients to meet this principle of the Code in practice through our proprietary voting platform, ISS ProxyExchange. ProxyExchange is unique in that, via a single integrated platform, an institutional shareholder can vote all their shares, across all markets. The same platform also provides clients with ISS research to aid their voting decision. Our global research covers more than 40,000 meetings each year- every holding within our clients' portfolios in over 100 developed and emerging markets worldwide. As previously noted, prior to publication of our benchmark vote recommendations, we do our best (having regard to client deadlines and voting cut-offs and contentious situations where advance disclosure of our recommendation may be viewed as price sensitive) to provide companies with an advance copy of the proxy report in order for them to check it for any factual errors and to understand the rationale for any recommendation against a management proposal.

Disclosure of Voting Activity

As we made clear in our response to Principle 1, ISS does not take voting decisions on behalf our clients, but, rather, we provide voting recommendations. Voting decisions remain the responsibility of our clients.  As such, we do not consider our recommendations to be analogous to the votes themselves and disclosure of those recommendations would not serve the expressed purpose of Principle 6, nor would the recommendations necessarily be representative of the votes ultimately cast by our clients.

We therefore believe that, at present, the most useful ex post market disclosure ISS can provide is in the form of our post-season voting results trends reports which highlight shareholders’ ultimate final voting decisions in aggregate at contentious meetings and place ISS’ standard voting recommendations in the appropriate ancillary context. We release our post-season reports publicly on our website on an annual basis and the underlying data is available on request (please see our 2010 survey of European vote results). We will of course keep this position under review and look at alternative ways of serving the goals of the Code in this area.

We do, however, provide the infrastructure and reporting capabilities to enable our clients to comply with their disclosure and reporting obligations under Principle 6. This includes the ability to make public disclosure of the voting decisions on a client’s own website or directly to its underlying clients. ProxyExchange provides qualitative and quantitative reporting services, which include automated audit functionality.

  • PRINCIPLE 7:Institutional investors should report periodically on their stewardship and voting activities

ISS is registered with the U.S. Securities and Exchange Commission as a Registered Investment Adviser and we have in place a SAS 70 Type II audit of our business.  Our transparent, policy-based approach offers a robust audit trail for stewardship reporting and our flexible reporting infrastructure provides clients with many of the tools required to meet their reporting obligations under the Code.

ISS trusts that the above disclosure complies with the spirit of the Code. We remain at your disposal if the FRC or other market participants would like to discuss anything in further detail.

 

Rob Dinning
Head of International Research
ISS

Jean-Nicolas Caprasse
Head of Governance Business, EMEA
ISS