A resurgence in global activism looks to be on the cards after a somnolent couple of years during which the financial crisis rocked every aspect of investments, even hobbling the once high-flying managers of hedge funds. They, along with two other classes of activists, had the wind taken out of their sails by the roiling markets, in which both investors and companies shied from anything but defensive activity and regulatory bodies were focused on how to calm and restore trading markets.
Now, activists of every stripe are mapping out where and how to manoeuvre once again. And while the field couldn’t be more ripe for action in some ways, regulators have stepped up their demands for greater governance reform and transparency. On the one hand, this means that in most developed countries, regulators are putting pressure on companies to perform to higher standards than ever before. This is a plus for investors, but it also has the effect of encouraging both institutional investors and hedge fund activists to be more bold.
In Europe, a major new requirement came into force at the beginning of 2011 as a result of the long-running uproar over excessive compensation packages. Demand for reform echoed across the continent and reverberated with similar calls in the US. It took four years to get regulation and a framework for its implementation into position for the European Union, but the Capital Requirements Directive (CRD), first promulgated in 2006, is operational as of January 1, 2011.
Covering financial institutions, the CRD is a broad-ranging document in direct response to the issue of what many saw as out-of-control compensation packages for senior executives. It was described at the time of its introduction by the European Parliament as having ‘some of the strictest rules in the world on bankers’ bonuses.’
A growing storm
Attention to this topic has done nothing but intensify in recent years.
‘Compensation is an aspect of governance that has attracted a great many shareholder proposals,’ observes Reena Aggarwal, professor of finance at the McDonough School of Business, Georgetown University, and a specialist in international investment and governance. ‘It is becoming more and more prevalent as an issue. Now it’s not just about pay for performance but also about clawback provisions and further details. Shareowners are starting to ask for more detail and demanding to have a voice on how executives are being compensated.’
‘Clawback’ refers to building terms into compensation agreements that require money to be paid back if performance targets are not met. In the US, the clawback concept has attracted popular support but no sweeping action such as that seen in the EU has been implemented. Responding to the continental initiative, the UK’s Financial Services Authority (FSA) has chosen to apply EU rules to 2,500 financial firms. The FSA says these companies must also publish specific information about their remuneration practices by December 31, 2011 and annually thereafter.
According to its website, the regulator recognises that these rules can be a burden on mid-cap and small-cap companies. The FSA has created a tiered system to relieve the pressure on small companies, making the point that ‘the new rules vary depending on the size and nature of the firm, with larger, more complex firms having to meet more onerous requirements than smaller firms.’
In the US, the Federal Deposit Insurance Corporation, which has oversight for most deposit-taking financial institutions, has revealed compensation rules that would hold back part of bonuses at firms with more than $50 billion in assets.
They – and smaller companies – have additional requirements, one of which calls for responsible incentive schemes for other workers whose roles pose ‘material risk’ to the financial system. Other US regulators are expected to go along with the plan.
Meanwhile, under the Dodd-Frank Act passed by Congress last year, companies are now required to hold a ‘say on pay’ vote and a ‘say when’ frequency vote at this year’s annual meetings. The SEC acted quickly to establish rules on the matter and, as a result, companies were required to have policies in front of shareholders for the 2011 proxy season. Many companies with annual meetings early in the season were recommending a triennial vote, but annual votes were being supported by a number of shareowner groups. The first Fortune 500 company to have a meeting – Monsanto – saw its shareholders prevail over management’s three-year proposal, voting instead for annual reviews.
The US and the UK tend to set the pace in regulatory governance actions, and have also led with shareholder activism. The overall trend for activism by institutions is growing across the globe. For instance, making headlines in February, Swiss biotech company Actelion – the largest biotech firm in Europe – came under direct attack from a hedge fund calling for the board resignations of both the company’s chairman and its chief executive.
Elliott Associates, a $17 billion US-based fund, claimed the board’s failure to act on ‘strategic direction and corporate governance’ had resulted in a stock valuation that was as much as 50 per cent below what it could have been.
As the 2011 proxy season opened in the US, a major activist organisation began pressing companies for change. In late January the American Federation of State County and Municipal Employees (AFSCME) – which is affiliated with the AFL-CIO – announced that it was filing 27 shareholder proposals at public companies ‘to foster greater transparency concerning risk, director accountability and independent board leadership.’ AFSCME’s targets cover several companies whose activities span the world, including Dell, aluminium giant Alcoa, Citigroup, Lockheed Martin, Amazon and Wal-Mart.
All about activism
Activists come in many shapes and forms. In addition to high-profile funds, there are shareowner groups such as unions, pension fund managers and a variety of money and asset managers. Their motivations fall into three main categories. Hedge funds have often been said to be ‘quick buck’ artists, playing opportunistically on a variety of tricky situations in which corporations find themselves. Other types of activists look for strategic advantage through undervaluation, as claimed in the Actelion case, or act to change the way corporations respond to shareholder interests.
The negative characterization of hedge funds has arguably been blown out of proportion. Indeed, you will find more than one capital markets expert saying hedge funds are much more likely to be the solution to – rather than the cause of – any market imbalances.
John Laide, a product manager for FactSet in the US, says that only about 100 funds are truly activist, and that is from a total of well over 10,000 now. This is a far cry from the situation in 1950, when an Australianborn financial journalist by the name of Jones created the first hedging vehicle as an alternative to the still young mutual funds. It would be another 15 years before the first of the modern-era hedge funds arose, in the mid-1960s. There were only a few on offer in those days, but by 1990 they were a recognised market factor.
For corporate secretaries working with their investor relations (IR) colleagues, it is useful to know that for IR professionals, hedge funds are an important category that most larger companies track carefully. While there are obvious negative possibilities, hedge funds which engage in activities that upset the corporate applecart are relatively few in number, though often very loud in their campaign demands.
The rest of the funds play a very important role in overall market stability, and if their strategies tend to produce long-term results, they can actually be a valuable part of the listed corporation’s constituency.
A global business
One of the significant changes such funds have brought to the lives of senior company officers is an upsurge in demand for meetings with management. As roadshows are a key ingredient in an active shareholder relations program, the intrusion of new players that may have a threatening reputation is not welcome. Even unthreatening funds are a problem because they steal time.
The bottom line is that these funds are now part of the fabric of global business. Not only are they buying into mergers and acquisitions and a broad range of asset types, as well as involving themselves in trading mortgage derivatives, but they have also found a place in portfolios managed by the most conservative of buy-side players. It is not unusual, therefore, for a company to find that some of its pension fund shareholders nowadays may also have an interest in the company via a big hedge fund.
In Asia and many other parts of the world, activism has been relatively mild – with a few notable exceptions. The idea of ‘quiet engagement’, rather than raising a public furor, has held sway in markets such as Japan. The Financial Times reported in early 2011 that there has been talk of activism having completely disappeared from the scene but, on February 7, Tokio Marine Asset Management and UK-based advocacy group Governance for Owners announced the launch of the Japan Engagement Fund, which the Financial Times said is the first such move by a large Japanese asset manager. Tokio Marine ranks fourth among Japanese asset managers, with $60 billion under management.
Whether this marks a new surge in such activity remains to be seen, but long-time activist David Webb, working from a Hong Kong base, says there are massive limitations in many Asian markets. That said, Asia is still much less active than the US or the UK.
In several countries there are closed systems, with tycoons controlling most of the shares and naming their friends to board positions. The rules, Webb says, simply don’t cater to individual shareholders.
Larger companies that are cross-listed in big western markets, or in Australia, which Webb characterises as an extension of the UK system, are a different matter. ‘They already conform to high governance standards,’ he says.
It is rare for investment managers to speak publicly about any activist or engagement activities, Webb contends, and on top of that, special situations apply in various markets. ‘In Singapore, you really can’t do it – there is a highly litigious environment,’ he adds.
In other smaller or less open societies, governance gets written into codes of practice, but real activists like Webb can’t operate in many of these countries. ‘It would have been too dangerous to do what I do here,’ he states. ‘I would have been dead by now.’
This doesn’t mean there isn’t vigorous trading in local shares, however. ‘There is a certain amount of value to lose from bad governance,’ says Webb. ‘It is a competitive issue: if you have high costs of capital, it is very hard to compete with companies that have better corporate governance because they can be held accountable in a court of law.’ Of course, this doesn’t keep people out of the markets.
‘Investors price in the risks,’ Webb maintains. ‘Yes, activism will rise. In Hong Kong, investors are much more aware of their rights than they used to be. They tend to speak up more. When I go to meetings, there are more questions.’