Institutional Shareholder Services Comments on ESMA Principles for Proxy Advisors

Rockville, MD; March 18, 2013

1. Identifying, disclosing and managing conflicts of interest
Principle: Proxy advisors should seek to avoid conflicts of interest with their clients. Where a conflict effectively or potentially arises the proxy advisor should adequately disclose this conflict and the steps which it has taken to mitigate the conflict, in order that the client can make a properly informed assessment of the proxy advisor’s advice.

Rationale: Considering their important role in the voting process, proxy advisors can, like many intermediaries, be subject to conflicts of interest. They should therefore identify, disclose and manage these conflicts to ensure the independence of their advice. ESMA learned from the market consultation that market participants are concerned regarding potential conflicts of interests, in particular about circumstances where: (i) the proxy advisor provides services both to the investor and to the issuer; and (ii) where the proxy advisor is owned by an institutional investor or by a listed company to whom, or about whom, the proxy advisor may be providing advice.

ISS Response: First, Institutional Shareholder Services (ISS) is a Registered Investment Advisor (RIA) pursuant to the Investment Advisers Act of 1940, subject to the regulatory oversight of the U.S. Securities & Exchange Commission.

Recognizing that our business model, with ISS providing corporate governance research and proxy voting recommendations to institutional investors, and our ISS Corporate Services (ICS) subsidiary providing corporate governance-related data, analytics and tools to companies, could potentially result in conflicts of interest, ISS has robust conflict management policies and procedures in place to ensure that potential conflicts of interest do not become actual conflicts.

The research and ICS businesses are separately managed. The analysts who perform proxy analyses and make voting recommendations are completely separate from the ICS employees who work with companies to implement corporate governance best practices. ISS enforces strict physical and electronic information barriers between our corporate and investor services groups, with the ICS staff residing in a separate passcard-controlled suite. ISS has a detailed Regulatory Code of Ethics that all employees are trained on several times a year. Additionally, all employees must annually certify to the ISS Regulatory Code of Ethics.

Every ISS proxy analysis provides disclosure language to alert institutional investors to the nature of our business model and the potential conflicts. Any and all institutional investor clients can, upon request through the ISS Compliance Department, obtain a current list of ICS corporate clients in order that the investor can make an informed assessment of the proxy advisor’s advice.
ISS’ conflict management and compliance measures can be accessed here.

Finally, because ISS is owned by MSCI, Inc, a publicly-traded company, ISS recuses itself from performing analysis of MSCI’s proxy and from issuing vote recommendations to MSCI’s shareholders.

2. Fostering transparency to ensure the accuracy and reliability of the advice
Principle: Proxy advisors should provide investors with information on the process they have used in making their general and specific recommendations and any limitations or conditions to be taken into account on the advice provided so that investors can make appropriate use of the proxy advice.

Rationale: Proxy advisors may have systems and controls in place that guarantee proper and sound advice. These systems and controls may increase the reliability of the advice and enlarge accuracy. ESMA learned from the market consultation that the market would specifically favour greater transparency of these systems and controls, including, but not limited to (i) disclosure of general voting policies and methodologies, (ii) consideration of local market conditions and (iii) providing information on engagement with issuers.

ISS Response: ISS makes its benchmark voting policies publicly available through its web site, along with regularly updated FAQs. Additionally, the firm’s annual policy formulation process is the most transparent and inclusive in the proxy advisory industry globally. Each year, since 2005, ISS has undertaken a fully transparent and inclusive policy formulation process that consists of a broad-based global survey, issue and market-specific roundtables and an open comment period. During the process, institutional investors, corporate issuers and industry constituents are encouraged to provide their views on key governance issues likely to impact the upcoming proxy season. ISS then formulates its global proxy voting policies to reflect this collective thinking, supported by empirical research on market practice. ISS’ policy formulation process, its policies and other information is available here.

Understanding that corporate disclosure requirements, regulatory requirements and corporate governance practices vary across the world, ISS maintains multiple voting policies that reflect regional and/or local market standards and practices. ISS’ global research team, which resides in fourteen offices around the world, is uniquely capable of understanding and applying local market practices to ISS’ policies, research and recommendations.

ISS encourages issuer engagement and strongly believes that its willingness to engage with issuers helps to inform its research and vote recommendations to shareholders. Engagement details are included in ISS’ proxy analyses.

2.i. Disclosing general voting policies and methodologies
Principle: Proxy advisors should, where appropriate in each context, disclose both publicly and to client investors the methodology and the nature of the specific information sources they use in making their voting recommendations, and how their voting policies and guidelines are applied to produce voting recommendations.

Rationale: To allow all stakeholders, especially investors and issuers, to better assess the accuracy and reliability of the proxy advisor’s services, proxy advisors are expected to be transparent on their voting policy and on the main characteristics of the methodology they apply, which form the rationale of their recommendations. This is also in line with the overall message that ESMA received from the market consultation for greater transparency, where appropriate, by proxy advisors about their activities and processes.

ISS Response: As stated above, ISS makes its benchmark voting policies publicly available through its web site and also carries out a transparent and inclusive global annual policy formulation process.  ISS also conducts in-person briefings with institutions and issuers to further explain its policies and its processes for analysis. ISS has a large data procurement operation that supports its research but where third party data or information is used in the preparation of an analysis, the source(s) is disclosed to clients within the analysis.

2.ii. Considering local market conditions
Principle: Proxy advisors should be aware of the local market, legal and regulatory conditions to which issuers are subject, and disclose whether/how these conditions are taken into due account in the proxy advisor’s advice.

Rationale: Proxy advice generally is a cross-border activity which requires the awareness of different laws, rules and regulations governing issuers’ activities in each relevant jurisdiction. Therefore proxy advisors, as ESMA also learned from the market consultation, are expected to have a proper knowledge of the national and regional context, irrespective of whether proxy advisors choose to apply an international benchmark, or their client’s own preferences/policies, in forming their opinion of individual meeting resolutions. Such knowledge of local/regional conditions is needed in order to develop an accurate voting policy, and, as a result, an appropriate advice.

ISS Response: As stated above, ISS understands that corporate governance is a cross-border activity which requires the awareness of different laws, rules and regulations governing issuers’ activities in each relevant jurisdiction. For that reason, ISS maintains multiple voting policies that reflect regional and/or local market standards and practices.  ISS’ global research team, which resides in fourteen offices around the world, is uniquely suited to understand and apply local market practices to ISS’ policies, research and recommendations, in addition to doing the same for clients using custom voting policies.

ISS encourages issuer engagement and believes strongly that its willingness to engage with issuers helps to inform its research and vote recommendations to shareholders.  Engagement details are included in ISS’ proxy analyses.

2.iii. Providing information on engagement with issuers.
Principle: Proxy advisors should inform investors about their dialogue with issuers, and of the nature of that dialogue.

Rationale: Proxy advisors can choose whether or not to have a dialogue with issuers. If they do choose to have such a dialogue, it is up to the proxy advisor what should be the timing, frequency, intensity and format for this dialogue. A proxy advisor should disclose to investors whether there is a dialogue between the proxy advisor and an issuer. Where such a dialogue takes place, it should inform investors about the nature of the dialogue, which may also include informing his clients of the outcome of that dialogue. ESMA learned from the market consultation that some proxy advisors do not conduct dialogue with issuers. When there is dialogue, the nature and degree of that dialogue differs significantly among proxy advisors, as well as the level of transparency on the fact that dialogue is taking place.

ISS Response: One of ISS‘ hallmarks is its willingness to engage with issuers.  Because every company is unique and corporate governance is complex, ISS strongly believes that meaningful dialogue between companies and their shareholders  (and/or proxy advisors) results in a higher level of understanding around board decision-making and governance structures and practices, leading to more informed decision-making on the part of shareholders.  Each year, ISS hosts in-person meetings and/or group calls with hundreds of companies across multiple markets. In some cases, the engagement discussions are initiated by ISS, while in most cases ISS responds to engagement requests made by specific companies.  ISS incorporates the perspectives gained from these meetings in its proxy research that is delivered to its institutional clients.