The decision by South Korea’s National Pension Service (NPS), which was embroiled in a political scandal involving its former chairman earlier this year, to adopt the country's stewardship code is likely to face some tough challenges in implementation, experts have told AsianInvestor.
The second-largest pension fund in Asia by assets under management according to AsianInvestor’s 2017 list of the top 300 asset owners in the region, announced on December 1 that it would adopt the stewardship code in the second half of next year.
“This is a significant move and reflects a global trend seen across institutional asset owners,” Jon Allen, head of institutional sales of Asia Pacific at Columbia Threadneedle, told AsianInvestor.
It is also likely to encourage other South Korean institutional investors to follow suit, according to Andrew Shin, head of investments for Korea at Willis Towers Watson.
“Public pensions are the likely candidates," he said. Shin added that they would take some time to observe how NPS, which had W558 trillion ($462.4 billion) in AUM as of December 31, 2016, handles and implements the code.
That, in turn, could prompt asset managers investing in domestic equities to adopt the code as well, he added.
That Korean institutional investors don’t always act in the interests of their minority investors came roaring back into the headlines earlier this year, when NPS became embroiled in a high-profile political scandal involving minister of health and welfare Moon Hyung-pyo.
Moon, who was also chairman of the NPS at the time of his arrest last December, was sentenced to two and a half years in jail in June for pushing the NPS to vote for a merger of two Samsung group divisions in 2015 that prosecutors said allowed Jay Y. Lee, grandson of Samsung founder Lee Byung-chul, to tighten his grip over the group.
It’s a perfect example of why local listed entities have typically faced a “Korea discount” in their valuations, attributed to the overly cozy relationship between the government and large family-owned businesses that have often led to corporate decisions not always in the best interests of minority shareholders.
Tough to adopt
While the adoption of a corporate governance code by NPS is welcome, implementation won’t be easy.
“There are people who think the NPS is not well prepared for this because there isn’t much independence and strong governance,” Willis Towers Watson’s Shin said, noting that there will need to be several rounds of discussions around how to improve NPS’s governance and increase its independence from the government, even after the stewardship code is embraced in the second half of 2018.
An August 18 report by the Korea Capital Market Institute noted that it would be tricky for the NPS to totally avoid any potential conflict of interest that could arise from implementing its fiduciary responsibilities.
“Although the code is a self-regulation, a stewardship code, if not objectively monitored by an independent agency that has no conflicts of interest, will end up being a mere formality incurring costs with no benefits.”
The report highlighted the fact that NPS works with multiple proxy advisory firms to exercise its voting rights.
NPS works with 38 external managers for equities alone, each of which endorses its own stewardship code and also subject to adherence monitoring. The pension fund also invests in 98% of Korea socially responsible investing (SRI) funds, the report said.
“The capabilities of proxy advisory services those funds use become an important evaluation standard when the NPS selects an external manager for SRI funds,” it noted.
“Taken altogether, it is neither realistic nor easy to find an independent agency that has proven expertise in adherence monitoring without any conflict of interest with the NPS.”
Fear of lower returns
Another challenge will be addressing the lingering perception that adopting corporate governance standards or a stewardship code requires sacrificing some investment returns, noted Willis Towers Watson’s Shin.
In fact, investors need to note that improved corporate governance standards are likely to lead to superior capital allocation decisions and business risk mitigation, added Columbia Threadneedle’s Allen.
However, as Allen noted, “Adopting a stewardship code and improved corporate governance in general drives superior risk adjusted returns and represent the kind of companies we want to be exposed to as an active fund manager.”
The stewardship code was released last December by the Korea Corporate Governance Service and encourages institutional investors to exercise voting rights that are in the best interests of their shareholders.
Local companies have been relatively slow to embracing the stewardship code, with only five companies adopting the code as of the end of this August.