Last year, Royal London Asset Management (RLAM) sent 141 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.
Sophie Johnson of the RLAM Responsible Investment team explains:
This was one of the most generous long-term bonus plans in the UK. 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.
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.
Description: Suncor is Canada’s largest oil and gas company, with major exposure to Albertan Oil Sands.
Investment opportunity: Suncor’s longevity and history of investing it’s money strategically provided a strong case for our investment, with a promising risk-reward ratio.
E S or G issue: Suncor’s carbon footprint and environmental pollution are material risks to the investment case and business.
RLAM’s Engagement: In October 2019, RLAM met Suncor’s CEO to argue that reducing environmental and carbon risks would not only be beneficial to wider society, but would also improve the long-term profitability of Suncor, making it more appealing to shareholders.
Engagement outcome: In the last 12 months, and since the meeting, Suncor have announced projects that will reduce group CO2e emissions by 10% in the next two years. This is equivalent to the 48 lowest emitting FTSE100 companies going net zero in that same time frame.
Summary: Our engagement contributed to major reduction in carbon emissions, improved wealth creation for shareholders, and provided us with more confidence in Suncor’s top management being ready and able to take proactive steps to address environmental risk.
Company description: Maeda Road is a Japanese paving company with over 60% of its market value held in cash and short term investments.
Investment opportunity: The company had a very attractive risk-reward pay off, as RLAM’s investment process identified a significant valuation anomaly. This opportunity however, was reliant on management returning significant amounts of cash (that ultimately belongs to the shareholders) to the shareholders.
E S or G issue: RLAM felt that poor governance was restricting our ability as shareholders to realise the value of cash held on Maeda Road’s balance sheet.
RLAM’s Engagement: After RLAM failed to get the company to meet with them, they met with the CEO of Maeda Road’s largest shareholder Maeda Corp, another listed Japanese company. They expressed support for steps that would improve governance at Maeda Road (Maeda Corp regularly meet with Maeda Road management).
Engagement outcome: Indirectly linked to RLAM’s push for governance reform at Maeda Road, Maeda Corp announced a hostile takeover of Maeda Road to improve governance of the business. The hostile takeover was at a 50% valuation premium, but needed support from other shareholders; when this takeover occurred, RLAM generated about £15m of gains (alpha) for our customers.
Summary: RLAM’s engagement ultimately improved corporate governance, and resulted in significant investment gains for our customers and members.
Description: Anglo American is the UK’s fourth largest diversified mining company, operating world class diamond, copper, and precious metal assets.
Investment opportunity: RLAM felt there was a high risk reward-pay off driven by Anglo American’s commitment to operational efficiency, and historic investments in high quality assets.
E S or G issue: This standpoint was however undermined by an environmental issue, specifically Anglo American’s coal assets.
RLAM’s Engagement: In September 2019, RLAM met with Anglo American’s CEO to discuss the best ways to manage environmental and carbon risks.
Engagement outcome: RLAM decided to support the argument of Anglo American’s management - that taking money out of coal assets wouldn’t result in a positive environmental and financial outcome. The buying candidates are currently all Chinese entities that would seek to expand coal production, not scale it back, and so removing money from coal would simply result in a financial loss for our customers while the practice continued.
Instead, Anglo American has committed to running these assets responsibly for cash, and reallocating capital into commodities that support the electric revolution.
Since RLAM met with Anglo American, they have announced a £405m acquisition of Sirius Minerals, a mining company focused on the development of sustainable potash mines. These mines are responsible for manufacturing fertiliser that is essential to the global food supply.
Summary: RLAM’s work resulted in Anglo American choosing to take a more environmentally responsible approach when allocating capital, while still keeping the long-term interests of our customers and members in mind.