How passive managers are changing governance in Asia
Asia's largest passive fund managers feel they are fighting against a perception that they don't do enough to engage with the companies they hold in their portfolios.
It's a fair question to ask: can a passive manager be an active owner? If the word 'passive' means these giant fund groups just sit back and do nothing to force better standards of management in the companies they invest in, then that is mistaken impression. It is one that frustrates experienced corporate governance professionals such as BlackRock’s Pru Bennett.
Hong Kong-based Bennett is due to retire as managing director of BlackRock's Asia Pacific stewardship division at the end of 2018. But she has locked horns with listed company boards across the region and has a growing team that reflects the importance passive managers such Blackrock, Vanguard and State Street Global Advisors (SSGA) are placing on engagement.
Between them, those three fund groups – the world’s biggest – manage $13.6 trillion of assets globally and about $1 trillion in Asia Pacific, much of it passively.
"We vote at all our meetings but the most important thing we do is engagement," Bennett told AsianInvestor.
Voting numbers alone do not fully explain the work that passive investors do, she said: “Measuring how active a passive manager is by voting outcomes is simply wrong and undermines the engagement work we do.”
The nature of that engagement varies across the Asia-Pacific region.
In Australia, ASX companies are widely held by individuals and institutions – there are very few family-held businesses. “Institutional investors are holding over 50% and you’ve got voting levels of around 60% to 70%,” Bennett said. “In the ASX we would probably hold 5% of most of the big companies and we are probably their biggest shareholder.”
BlackRock will engage with the chairman of a company directly. "Our focus is on governance and one of our priorities is around the structure of the board; looking at a good diverse skill set. Do we need an independent director with a background in that industry?"
On that issue, there have been "a couple of blow-ups in Australia", Bennett said.
Take global diversified miner BHP in the 1990s: it "ticked all the governance boxes, but none of the independent directors had a background in resources." In the collapse of insurer HIH in 2001, also, she said, none of the independent directors had a background in insurance.
"You can’t legislate for competence, so it’s only engagement by shareholders that will effect change," said Bennett. "Being long term, you are building a relationship with the company, which is really important. We are supporting management while holding boards accountable."
In Asia, the shareholder structure is very different, with block shareholders and family estates dominating.
"Getting access to the board is difficult, but increasingly we are getting there," Bennett said.
"We use it as an opportunity for a broader discussion. To explain to them what passive investing is, because they don’t know that we are long term shareholders. Like the family, we can't sell out, so our interests are aligned. And that’s a wake-up call for families."
There are independent voices who broadly echo Bennett's comments. Jamie Allen, secretary general of the Asian Corporate Governance Association (ACGA), said: "Passive investors can be active owners, if they want to, and if they put the resources in and select their targets."
SSGA’s Benjamin Colton, head of asset stewardship for Asia Pacific, told AsianInvestor his firm also believes index fund managers have a key role to play in engaging to promote long-term sustainable returns. The firm has been focusing its stewardship efforts on improving board quality in its portfolio companies, which can be further strengthened by increasing board accountability.
While Colton argued that corporate governance across the region is improving, he said there are still governance practices in certain markets that are "problematic".
"For example, we highlight the challenges in holding directors accountable in Australia, given the staggered board structure that most companies have in place.”
The asset manager's preferred structure is an annual director-election process, which allows shareholders to hold individual directors accountable, as compared to a staggered board structure, where individual directors stand for elections periodically and, once elected, serve for multiple years before standing for re-election.
SSGA expressed its concern in a July letter to the ASX Corporate Governance Council. The submission stated that under the current system in Australia: “no matter how dissatisfied shareholders are with director performance, they have to either wait several years to hold the appropriate board members accountable or take action against the directors standing for election in a given year, which may lead to unintended consequences in the long term."
"Changing market practice," it added, "would allow shareholders to hold board members accountable in a timely manner and thereby help improve the quality of board oversight."
The ASX council is currently considering submissions and a new edition of the Corporate Governance Principles and Recommendations is expected to be finalised and published later this year or in early 2019, and come into effect on July 1, 2019, according to an ASX spokesman.
The council’s chair, Elizabeth Johnstone, said in a council communique this week: “Each new edition of the principles and recommendations has been widely regarded as contributing significantly to an uplift in governance standards in Australia.”
In Japan, SSGA's discussions with corporate boards has emphasised the importance of independent directors, to oversee the development of strategy and provide robust oversight of management.
“Through our discussions, we have learned how Japanese companies are amending their practices to create stronger, more diverse boards,” Colton said.
"We are trying to drive change in these conversations," said Bennett of BlackRock's own efforts in Japan and elsewhere. "It’s going to take time, because sometimes we are the only voice."
And in China, she said for state-owned enterprises, "it is still a new thing for them to be meeting foreign shareholders."
Bennett confirmed a belief that change is happening in Asia, but added "I still believe that most companies treat corporate governance as a compliance issue rather than strategic. There’s no point picking on the compensation or nomination of directors if it’s still in that compliance bucket, because it’s not going to add value."
As the structure of boards around the Western model develops, Bennett suggested that there needs to be more training for directors and investors. "I’m not convinced that directors really understand their role and their fiduciary duty to all shareholders," she said.
Another area where passive managers are particularly active is in discussions with regulators. Indeed, Bennett feels "we’ve probably got more influence through our engagement with regulators than one on one with companies." Recently, when [the] weighted voting rights issue was live in Hong Kong and Singapore, although the outcome was "unfortunate" from BlackRock's point of view, "we did engage a lot around that in both Hong Kong and Singapore," Bennett said.
AsianInvestor also approached Vanguard for comment but received no response.
A separate article on this topic is featured in the September print edition of AsianInvestor