Last year, Royal London Asset Management (RLAM) sent 106 letters to companies to explain why they were voting against or abstaining on proposals at annual general meetings (AGMs). The main topics of concern were around executive pay, energy use and climate change, and corporate governance.
As Ashley Hamilton Claxton, RLAM’s Head of Responsible Investment, puts it: “Our ultimate goal is to use our position as shareholders or bondholders to have a positive influence on behaviour because we think that is in the best long-term interests of our clients.”
Here, we look at some case studies that demonstrate the work of RLAM’s Responsible Investment (RI) team:
Metro Bank is a UK challenger bank that was launched in 2010. It offers retail and corporate banking and was the UK’s first new high street bank in 150 years. RLAM holds shares in the bank passively – this means they’ve not made an active choice to invest in the bank, but hold the shares through our passive tracker funds. These funds are a key building block in our multi asset funds – including the Governed Range that many of our members and clients’ pensions are invested in.
Initially the concern was the fact that the bank was using InterArch – a company run by the wife of the Chairman and founder – to design the bank’s branches and branding services. This raised a red flag – how did the bank manage this conflict of interest? RLAM’s RI team wanted to know who was questioning and evaluating the contract to make sure it was appropriate for the business. If this wasn’t being subjected to proper scrutiny, was there anything else that was being overlooked?
At the company’s annual meeting in 2018, they decided to vote against the Chair of the Audit Committee and voiced their concerns publicly. They also voted against the pay report and against the re-election of the founder and Chairman, as well as a number of other board directors because they weren’t happy with the company’s overall corporate governance.
The team was invited to a meeting with the company’s directors so they could explain their approach. The directors told them more about the relationships with InterArch, they toured the offices to see evidence of the design work, and had an open discussion about corporate governance at the bank. Although the company was willing to speak to the RI team, when they asked questions about procedures around monitoring these contracts and the details of the annual contract reviews, they weren’t satisfied with the answers.
They also discussed suggestions around improving shareholder communication and disclosure. They held a follow-up call with their investor relations team on how to improve disclosure in the Annual Report and provide more details on the contracts with the Chairman’s wife. In addition, the RI team pushed the company to improve its disclosure on executive pay, as the company would not disclose the performance measures that executives were being judged against in order to receive bonuses.
At the start of 2019, a £300m ‘hole’ appeared in the bank’s accounts, when it admitted that an accounting error had led to the miscalculation of the risk of a number of commercial loans.
It was deeply concerning that no one had picked it up, which the RI team viewed as yet more evidence of weak governance controls and oversight by the board.
Throughout this process the company’s share price has fallen significantly due to investors’ concerns about the hole in the accounts. “I think they were genuinely surprised by the scrutiny and the media attention,” explains Sophie Johnson, from RLAM’s Responsible Investment Team. “We hold a very small amount of the company’s shares in our passive funds. But at the end of the day, our clients have money invested with this company and they have lost out as a result of the issues at the bank, so of course we’re going to engage.”
Since the initial meetings with the company, some changes are now starting to take place. The Chairman and founder has announced that he will be stepping down; the contract with InterArch will be put out to tender for the first time, and positive board changes are being made, including the appointment of an independent Chairman. Although the company’s financial position is tenuous and there is a long way to go to restore investor trust, the RI team does feel the bank is finally taking some steps to improve corporate governance.
Ashley Hamilton Claxton, Head of Responsible Investment at RLAM, welcomed the result:
“We hope this change in leadership will help the Board draw a line under the governance issues at Metro Bank and focus on restoring shareholder trust and improving financial performance. Pension savers, who are invested in listed companies through their workplace pensions, have suffered significantly as a result of the over 90% drop in Metro Bank’s share price since April 2018 when we first raised governance concerns, so we welcome this announcement.”
Persimmon Homes Plc is one of the UK’s largest house builders.
Back in 2012, a long-term bonus plan was approved by the company’s shareholders. The aim of the plan was to return a lot of money to shareholders; if they did, executives would be rewarded. The problem was, there was no upper limit on those rewards. Fast-forward to 2018, the plan paid out an astonishingly large amount of money which caught the attention of the newspapers and plunged the company into the spotlight.
So how did this happen?
In 2013, the government introduced the Help to Buy scheme, and house builder share prices have been performing very well since then. The scheme is designed to help people onto the housing ladder, and essentially boosted demand in a sector where supply is limited, helping house prices rise.
As a result, the company performed exceptionally well, easily hitting the targets they set for themselves. This created a bonanza of over £200 million worth of payouts for senior executives, including nearly £100m earmarked for the CEO.
“This was one of the most generous long-term bonus plans in the UK,” explains Sophie Johnson of the RLAM Responsible Investment team. “Many of our funds voted against it in 2012 and have done so every year since. There was no upper limit to the bonus; we knew payments had the potential to be astronomical.
We were opposed to paying out these huge amounts. Not because we are opposed to all large payouts, but because we feel that exceptional pay should reflect exceptional performance. In this case, because Help to Buy was in place, house prices had shot up and all house builders were making a fortune. It wasn’t management that drove exceptional performance, but government policy,” says Sophie.
After Royal London and other shareholders complained, the executives volunteered to reduce their payouts, but the CEO, Jeff Fairburn, still received £75 million in 2018.
He subsequently resigned, after the media furore, in November 2018. Several directors linked to the initial plan also resigned, and the Remuneration Committee has a new Chairman. The company has also changed its pay structure to prevent something similar happening in future.
Ferroglobe is a mining and metals company that produces metal alloys, silicone-based alloys and other products.
When RLAM’s high yield team was considering an investment in the company’s bonds in August 2018, the credit analysts were concerned – the financial side of the investment looked fine, but they found a problem and decided to look into it further.
Working with colleagues in the RLAM Responsible Investment team, the Global High Yield team found a series of issues that needed to be considered when deciding whether to invest.
They described the company’s ownership structure as ‘opaque’ and with ‘limited financial flexibility’. They highlighted concerns around accounting and reporting transparency. They questioned the financing and payment history to affiliates of the company, including the former Chairman, and pointed out that raw materials were sourced from challenging emerging markets.
At the time, the Ferroglobe bonds were performing well, and the company’s commentaries suggested everything was going well and that there were no problems.
However, with the information provided by the RI team to hand, the Global High Yield team took a different view and decided not to invest.
The following quarter, unexpectedly, Ferroglobe’s reported financial statistics (such as revenues and profits) that were much weaker than the market had been expecting.
This indicated that there was in fact a transparency issue, and raised questions around how open the management was being with investors. Since then, the bonds have moved down considerably and have, as yet, to make a full recovery.
To us, this shows the clear link between responsible investing issues and their potential financial impact. While Ferroglobe didn’t have glaring ESG issues – such as pollution or the exploitation of workers – they did have more nuanced ones around a company’s reporting and openness. This is still just as key to consider, and is an example of why the ‘governance’ factor in ESG is important.