On June 7, 2024, the Financial Services Agency (FSA) disclosed a document regarding the “Action Program 2024 for Implementing Corporate Governance Reform.” I would like to provide an overview of “Substantiation of Stewardship Activities” in this document below and discuss the points raised in this document.
Substantiation of stewardship activities
Issues:
⚫It is pointed out that formal dialogues, such as checking boxes, are conducted, and that dialogues with constructive objectives based on a deep understanding of the portfolio company and two-way dialogues are not being conducted. Regarding collaborative engagement, it is also pointed out that it is important not only to collaborate but also to have meaningful dialogues focused on specific themes.
⚫It is also pointed out that effective engagement that integrates dialogue and exercise of voting rights is not being conducted, for example, because the divisions in charge of dialogue, exercise of voting rights, and investment management are separated and do not work together sufficiently.
⚫The report also pointed out that the authorities need to inspect actual efforts to comply with the Stewardship Code, since compliance with the Code has not been verified.
Future Directions:
⚫In order to make engagement even more effective, the Stewardship Code should be revised to promote collaborative engagement that contributes to dialogue with constructive objectives and to ensure transparency for real shareholders, based on the recommendations made in the report by the Financial System Council. In doing so, attention should be paid to the viewpoint that the exercise of voting rights and dialogue have a point-and-line relationship, and that it is important to have an awareness of what kind of dialogue is important in the process of dialogue (line) leading up to the exercise of voting rights (point), and to be aware of and verify the results of engagement.
⚫In addition, in order to resolve the above issues, it would be useful to share specific examples and certain perspectives on desirable and undesirable engagement, taking into account the opinions of investors, companies, and other relevant parties.
⚫In light of these perspectives, and with the aim of realizing even more effective engagement, the FSA, in cooperation with relevant parties, should examine the status of compliance with the Stewardship Code by investment management institutions, asset owners, voting advisory firms, etc.
Discussion Point 1: “There are indications that formal dialogue is taking place and that constructive, purposeful dialogue based on a deep understanding of the portfolio and two-way dialogue is not taking place.”
As I have mentioned several times in my previous articles, one of the characteristics of companies that have improved their return on capital and increased valuations is that they have high foreign ownership. Such companies also tend to have superior board practice ratings, which can be inferred to be due to overseas investor engagement. If engagement by domestic institutional investors is not effective, the following reasons could be considered. (1) Domestic institutional investors have only been engaging for a short period of time. (2) The majority of domestic institutional investors’ AUM is in passive funds, so they cannot spend time and effort on engagement. For this reason, we believe that the template questions call for engagement and use the number of times of engagement rather than effectiveness as a performance measure. （Regarding (1), it is expected that the effectiveness will be seen over time in the future. （Regarding (2), company management can only seriously confront investors with proposals that emerge from deep analysis, so asset management companies need to spend money and resources to have a dialogue with substance. For this purpose, deep analysis is not possible without increasing the active funds. Because voting rights come after investors, company management has to be present in the dialogue. It would be a shame to waste a precious opportunity to have a dialogue with substance to enhance corporate and shareholder value.
Discussion Point 2: “The Stewardship Code should be revised to promote collaborative engagement and ensure transparency for real shareholders.”
When government agencies, not just the FSA, revise their systems, they often try to make sure that the revisions do not favor one side or the other, so that both sides win or lose the same amounts. This time, too, instead of allowing the cooperative engagement that investors have been asking for, the system will be amended to help listed companies determine the real shareholders they want. These amendments should make it easier for both investors and listed companies to proceed with engagement and identification of substantial shareholders than it has been in the past. There is one more important thing to be considered when promoting engagement. It is for the company to dissolve cross-shareholdings. When cross-shareholdings, which give unconditional support to company proposals, are reduced, the weight of voting rights held by investors will increase, and the company will be more willing to listen to investors’ proposals.
In summary, I have considered the overview of “Substantiation of Stewardship Activities” in the “Action Program 2024 for Implementing Corporate Governance Reform” disclosed by the FSA on June 7.
As I have mentioned several times in my previous articles, one of the characteristics of companies that have improved their return on capital and increased valuations is a high percentage of foreign ownership. This is thought to be an effect of overseas investor engagement.
The reason why engagement by domestic institutional investors has not been effective is that they have only been engaging for a short period of time, and because the majority of AUM of domestic institutional investors is in passive funds, they are unable to spend time and effort on engagement. More active funds are needed for engagement with substance.
If the system is revised to help investors seek the collaborative engagement that investors have been asking for and the identification of substantial shareholders that listed companies want, some of the challenges for both parties will be eliminated.
Another important point is that when a company reduces its cross-shareholdings, the engagement will be more effective because the weight of voting rights held by investors will increase.
http://www.metrical.co.jp/cg-ranking-top100/
Aki Matsumoto, CFA
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Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
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