3.1
Responding appropriately to the phenomenon of common ownership requires not only access to better data, but also a detailed understanding of the mechanisms through which common owners might exert influence. This was underscored by the Australian Competition and Consumer Commission (ACCC) which, in giving evidence before the committee, asserted that ‘what you do about [common ownership] might depend on exactly what the mechanisms are, if there are any, that are leading to harm.’
3.2
To date, research has focused on examining three types of mechanisms: voting, voice, and management incentives.
3.3
The mechanisms of voting and voice are standard features of the stewardship actions taken by investment fund managers aiming to advance their clients’ economic interests. Such stewardship can consider a broad range of issues, including environmental, social, and governance (ESG) factors, and how a company’s board and management are addressing attendant risks within their particular sector.
3.4
Given the size of investment funds in Australia, the committee was interested in whether fund managers exert a disproportional level of influence in promoting certain ESG agendas. Furthermore, the committee sought to determine the extent to which investment fund managers can be shown to influence various aspects of firm behaviour that go beyond the stewardship framework and cross into business strategy matters.
Voting
3.5
Share ownership typically provides investors with a right to vote on certain strategic matters, including the composition of a firm’s board of directors, its corporate structure, and the remuneration of its senior managers. In this context, investors who might wish to reduce competition in a given market could theoretically use their votes to install board members who would implement strategies to pursue that objective.
3.6
The influence that large institutional investors can exert through voting can be decisive, even if they do not hold a majority of voting shares. This can occur in situations where few shareholders attend investor meetings, or where there is low voter engagement among non-institutional investors.
3.7
This phenomenon is illustrated in recent voting patterns of shareholders of Australia’s four major banks.
3.8
At the 2020 Annual General Meeting (AGM) of the Australia and New Zealand Banking Group (ANZ), the number of votes cast represented approximately 50 per cent of issued capital. Among its shareholders, 29 per cent of ‘institutional shareholders’ (defined by ANZ as those with at least 500,000 shares) voted, while just 1.1 per cent of ‘retail shareholders’ (those with fewer than 500,000 shares) cast their votes.
3.9
Similarly, at the 2020 AGM of the National Australia Bank (NAB), the total number of votes cast represented 51.9 per cent of the issued shares. Approximately 49.8 per cent of institutional investors voted, while just 2.1 per cent of retail investors did so.
3.10
For the Commonwealth Bank of Australia (CBA), the total number of votes cast at its 2021 AGM represented approximately 44 per cent of issued shares. More than 95 per cent of these votes were cast by institutional shareholders.
3.11
Westpac advised the committee that at its last AGM 46 per cent of eligible votes were exercised, noting that:
The vast majority of shareholders that vote are institutional investors. We seek to monitor the top 100 beneficial shareholders and of those around 88% vote and make up around 92% of all votes cast at the AGM.
3.12
ANZ also described in more detail to the committee the dynamics of voting patterns at its AGMs:
The total votes voted at an AGM is normally about half. In terms of the number of shareholders, it's quite small. What you tend to find is the largest shareholders will tend to vote, but not all, and retail shareholders tend not to. It does depend on the issue of the day and how strongly people feel about the issue, so it can move around a bit, but about half of the shares get voted at an AGM, I would suspect.
3.13
Throughout the inquiry the use of proxy voting advisors by institutional investors was also raised as a potential mechanism of influence. Proxy voting advisors are market research providers who use their analysis to make recommendations to investors as to how to vote on different items at company meetings. Reliance on a small number of proxy voting advisors is said to increase their voting power.
3.14
It should be noted, however, that in commenting on the influence of proxy votes, institutional investors and proxy advice providers who appeared before the committee emphasised that it is common for investors to rely upon a range of inputs to form their decision, and that proxy advice is usually just one of these inputs.
3.15
Vanguard advised, for example, that in forming a position on voting items, it draws on the analysis conducted both by its own internal research team and on research it procures from several proxy advisors. The ultimate decisions on voting, however, are developed independently by Vanguard’s investment stewardship team.
3.16
This was reiterated in evidence by the proxy advice company Ownership Matters, which informed the committee that its role was to provide services that assist clients ‘to identify governance risks in the companies they hold, to use the shareholder rights to their advantage in company meetings and to monitor, defend and advance their ownership rights.’ The clients ‘are the ultimate arbiters of how they use their votes,’ with market research provided by proxy advisors representing one input into a client’s decision-making processes.
3.17
The Australian Council of Superannuation Investors (ACSI), a proxy advisor that is collectively owned by 27 industry super funds, similarly told the committee that engaging with companies to understand their approach to various issues is an important part of the stewardship process for investors. Accordingly, ACSI runs a year-round program of engagement seeking to understand ESG issues faced by relevant companies, including good governance, board oversight, executive pay, modern slavery, corporate culture and climate risks. ACSI claimed that while it provides research on these issues to its members, each ACSI member ultimately determines its own voting position.
3.18
The influential role that proxy advisers have in corporate governance has, however, attracted interest from policymakers. In April 2021, Treasury launched a consultation process into strengthening the transparency and accountability of proxy advice. The Treasury consultation paper noted that reforms intended to increase the transparency of practices associated with proxy advisors have been undertaken in both the United States and the United Kingdom.
3.19
Overall, the notion that voting practices can serve as a mechanism of influence for institutional investors to encourage anti-competitive behaviour, remains contested. Critics of the common ownership theory have emphasised that large investors often demonstrate a diverse set of priorities and may not be fully aligned in voting, and also note that it is rare to see institutional investors dissent from management recommendations.
3.20
The committee’s view is that the use by funds of proxy advisers such as ACSI can provide a method for coordinating voting on given shareholder issues. While proxies may deny it, the efficiency and availability of the mechanism raises significant potential for anti-competitive behaviour at odds with Section 45 of the Competition and Consumer Act 2010.
3.21
Furthermore, the committee views with great concern the potential for institutional funds to exercise through this mechanism a high degree of control over the nationally significant sectors of the economy in which they operate—take the example of Australia’s major banks, where industry super funds can collectively vote substantial percentages of capital through their owned proxy ACSI. Other highly concentrated major industries in Australia worth mentioning include supermarkets, domestic transport, fuel retail, and liquor retail. The committee notes as well recent research, which indicates that high levels of export intensity in an industry can also be a factor in increasing levels of market concentration – in Australia, mining and manufacturing are two key examples.
Voice
3.22
The notion of ‘voice’ refers to direct engagement by large investors with management and board members of the businesses in which they invest. This often occurs in informal settings—that is, outside of formal shareholder meetings. In addition to informal meetings, investors can make their voices heard by issuing public statements. Such mechanisms provide investors with a means for making their position known, and by extension a platform for influencing the behaviour of businesses within their portfolios.
3.23
Institutional investors maintained to the committee that, when it came to voice as a mechanism of engagement, they operated within defined parameters. Vanguard submitted that its discussions with company managers focus on high level governance, and not on the day-to-day commercial affairs of companies. Similarly, BlackRock’s submission emphasised that any engagement activities undertaken as part of stewardship are ‘focused on broad issues such as governance standards, reporting transparency, ESG risks’ and that business strategy decisions remain the responsibility of individual company boards and management.
3.24
During inquiry hearings the committee, while noting that bank executives will be reluctant to publicly critique their major shareholders, also asked Australia’s major banks about the nature and frequency of engagement between bank executives and investors. Banks acknowledged that they tend to engage more frequently with larger investors, and that higher levels of engagement tend to occur after the conclusion of the half-year and full-year results periods, while engagement with retail shareholders occurs more often during company AGMs. On the nature of discussions between investors and management, the banks reiterated that discussions focus on high-level issues and performance rather than specific strategies and business decisions.
3.25
Giving evidence before the committee, Professor Nancy Rose from the Massachusetts Institute of Technology observed that investment strategies pursued by index funds do not necessarily involve human decision-making:
My sense is that, to the extent that they engage, they engage at a much broader level on something like ESG rather than getting into the nitty-gritty of what particular companies are doing or particular strategies they're engaged in—not in the way that, say, an actively managed fund portfolio manager would be trying to understand company strategies and products markets. I think the evidence is that many index funds, at this point, are managed, basically, by algorithms and not, extensively, people, so that's also going to limit it.
3.26
Voice as a mechanism of harm has been subjected to critique, as it is not clear whether institutional investors have the capacity or inclination to actively engage with all their portfolio firms. According to a study cited in the OECD paper on common ownership, the majority of institutional investors report having five or fewer staff members dedicated to engagement with their portfolio companies, which presents ‘a limitation that could be particularly pronounced for passive investment funds seeking to minimise fees, and which hold shares for hundreds of firms.’
3.27
The need for an enhanced understanding of transmission mechanisms was raised by multiple witnesses as a critical area of further research. Assistant Professor Jennifer Varzaly of Durham University Law School argued that there is a need to learn more about shareholder activism, including whether possessing voting rights at 5 per cent or more of a company’s shares impacts governance in Australian companies, and whether there are other mechanisms through which governance might be affected. Reflecting on her own research, Assistant Professor Varzaly stated that incomplete data on these issues restricts proper analysis of such mechanisms in Australia.
Management incentives
3.28
Influence can also be exerted through management incentives. Firm managers who are, for example, aware of the identity of their shareholders might be sensitive to the view of institutional investors who own substantial blocks of shares. This situation might result in tacit shifts in behaviour when deciding on a firm’s strategy.
3.29
In their submission, Associate Professor Martin Schmalz and Thomas Reyntjens from the University of Oxford noted that:
Formal economic models indeed suggest that if managers care about their vote or odds of re-election, votes by common owners will incentivise managers to compete less.
3.30
Executive compensation may represent another avenue of influence. Executive remuneration packages might be tied to market-wide performance, for example, rather than to the relative performance of the firm. The OECD has noted that the value of stock options, which are a common component of executive remuneration packages, can be tied to both industry and firm performance and thus may ‘not incentivise a manager to pursue strategies that may be detrimental to the former and beneficial to the latter.’ Executive compensation that is based on industry-wide performance measures aligns management incentives with those of institutional investors.
3.31
The principle of investor passivity has also been suggested as a potential factor of influence. Passive investors contribute to a slackening of competition by failing to promote aggressive competition. As Schmalz and Reyntjens explained in their submission:
The default model is not that firms will compete. Only if firms have the right incentives they will compete, and such incentives can come from shareholder pressure.
In the absence of pressure, the argument goes, management might ‘pursue a quiet life’ instead of engaging in aggressive competition.
Critique of the proposed mechanisms of influence
3.32
Critics have noted that these mechanisms of influence can be extremely difficult to substantiate with evidence. In their submission, Professor Jennifer Hill and Dr Tim Bowley from the Faculty of Law at Monash University expressed particular concern about extreme versions of the common ownership theory, which they refer to as the ‘mindreading model’. According to this model, the mere presence of institutional shareholders might provide corporate managers with incentives to engage in anti-competitive conduct. No actual evidence of such conduct is necessary, as the potential for managers to align their strategies with the unstated interest of investors is sufficient to trigger concerns over anti-competitive behaviour. Hill and Bowley warn against developing policy responses based on such hypothetical scenarios.
3.33
In giving evidence before the committee, Professor Rose also raised doubts as to the extent to which passive funds can exert influence. She observed that many businesses are owned not just by passively managed funds, but also by actively managed funds. The presence of actively managed funds provides an incentive for competition, which can offset the passive approach to competition that index funds can enable.
3.34
Investment funds argued that promoting anti-competitive behaviour would not, in any case, be in their long-term interest. Vanguard submitted that encouraging or enabling anti-competitive behaviour by specific companies would likely have a negative impact on other companies and industries in which the funds also invest—for example, entities that are downstream customers of, or upstream suppliers to, certain large firms operating in highly-concentrated markets. It added that directors have an equal fiduciary duty to all shareholders, and that favouring a single subset of shareholders would be a breach of this fiduciary duty.
3.35
There is currently no consensus on the effect of common ownership on competition. As the submission by the ACCC noted:
The potential harm to competition arising from common ownership by an institutional investor is likely to depend on multiple factors including but not limited to: the investor’s incentives and the extent of its common ownership, the other shareholders of the commonly owned companies, and the degree of market concentration in the sector in which those companies operate.
3.36
In this context it is not surprising that the OECD paper on common ownership concluded by emphasising the need for further research and analysis:
Despite the critiques of empirical models estimating the effect of common ownership, as well as the incentive and ability of institutional investors to influence firm behaviour in a manner that benefits their industry-wide ownership interests, the underlying conceptual concerns associated with common ownership remain. This can have profound implications for competition, as well as our understanding of market functioning generally, and therefore merits further academic examination.
3.37
Evidence gathered throughout this inquiry suggests that proxy advisors play a significant role in shaping the voting decisions of investment funds.
Proxy advisors provide institutional investment funds with advice on how to engage with companies that they invest with, which often involves taking positions on remuneration resolutions and matters involving environmental, social, and governance concerns. This in and of itself would not be an issue, however, the current practices of proxy advisory firms requires greater scrutiny.
The committee recommends the Australian government considers measures, such as the publishing of shareholder voting decisions, to ensure asset managers do not use proxy advisors to collude in their voting decisions.
Additionally, the committee recommends the Australian government considers mechanisms to ensure asset managers engage with their owners in making voting decisions.
Further, proxy advisory firms are currently only required to hold financial services licences for general financial product advice for interests in managed investment schemes (excluding investor directed portfolio services) and securities to wholesale clients. Given the full nature of the advisory work that these firms are engaging in, the committee recommends proxy advisors be required to also hold a financial services licence for broader services, including proxy advice, that extends beyond general financial products.