SRDII Compliance Burden May Limit Proxy Competition

ESMA maintains that industry’s monitored self-regulation regime should continue, amid persistent concerns over conflicts of interest.

Recommendations by the European Securities and Markets Authority (ESMA) for a basic registration mechanism for proxy advisors could limit competition in an already deeply consolidated market.  

According to ESMA, a basic registration mechanism would improve “clarity” on market players subject to SRDII, as well as their specific business model and type of services offered.   

This registration mechanism could introduce more bureaucracy and likely increase costs for [proxy advisors], which could potentially act as a deterrent for new entrants, as the higher requirements and increased oversight create a more challenging barrier to entry,” Virginie O’Shea, Founder of capital markets consultancy firm Firebrand Research told ESG Investor. 

In a joint report with the European Banking Authority (EBA) on the implementation of the EU’s Shareholder Rights Directive (SRDII), ESMA also revealed that market participants remain concerned around conflicts of interest, given that proxy advisors offer services to asset owners and investee firms.  

 According to O’Shea, regulators in the EU and beyond are “deeply concerned” about potential conflicts of interest because the proxy advisory industry is “dominated” by two major providers – namely Institutional Shareholder Services (ISS) and Glass Lewis. 

“These providers are often perceived as forming an oligopoly in the advice-giving space, and as such it is suggested that they hold considerable sway in influencing investment decisions,” she said. 

While proxy advisors maintain what are known as ‘Chinese Walls’ between various divisions, according to O’Shea there remains potential for conflicts due to these dual business lines falling under the same umbrella.  

“Regulatory concerns also revolve around ESG ratings,” she said. “If a proxy advisor is being compensated by an issuer to enhance its ESG ratings, while simultaneously advising institutional investors which vote on shareholder proposals and gain insights through this process, there is a legitimate worry among regulators that information could be misused or manipulated in some manner.  

“There are Chinese Walls in place at these firms but that doesn’t seem to fully allay these concerns.” 

Proxy advice is not currently regulated in Europe, with providers instead submitting to self-regulation by signing up to the best practice principles established by the Best Practice Principles for Shareholder Voting Research Group. 

The two major international proxy advisors, US-based ISS and Glass Lewis, have a combined global market share that exceeds 90%.  

New entrants to the market have emerged, including Segal Marco Advisors, Egan-Jones Proxy Services and ProxyVotePlus. The industry has also been reshaped by merger and acquisition (M&A) activity, such as Glass Lewis’ acquisition of German-based proxy advisor IVOX in 2015 and French-based Proxinvest in 2022.  

The two leading global market players also changed their ownership structure in recent years, as a stock exchange group purchased a majority stake in ISS in 2020, while Glass Lewis was acquired by a private equity firm and an individual entrepreneur in 2021. 

“Robust” self-regulation 

In June, the UK Financial Reporting Council (FRC) surveyed companies and investors on how proxy advisors and ESG ratings providers impact shareholder voting.  

The study into the proxy voting advisory industry found that, while its voting recommendations “undoubtedly have some influence on behaviour and voting decisions”, the “nature and extent of the influence may be more nuanced and less clearcut” than many companies, stakeholders and other commentators believe it to be. 

It also noted that an overwhelming majority of clients used customised voting policies, based on their own preferences and priorities, rather than utilising ‘off-the-shelf’ policies created by proxy advisors.  

 Nevertheless, due to the industry securing funding from both asset owners and investee firms, which may have conflicting interests, a “persistent desire” for oversight remains, said O’Shea, which may eventually lead to regulators requiring the proxy advisors to separate their various business lines. 

“This consideration seems to persist regardless of the findings from the FRC, and it centres on whether an entity should be involved in advising both sides or not,” she said, adding that despite data indicating that there is no bias in how votes are influenced there continues to be an “underlying theme of doubt”, especially in the US market. 

To address conflict of interest concerns, ESMA recommended that disclosure requirements could be enhanced “in cases where proxy advisers render consultancy services to issuers and advise investor on those same entities”. 

The financial regulator’s report also noted that stakeholders view the current self-regulatory framework for the industry is “robust”, with its application “gradually improving” and concluded that the “present approach of ‘monitored self-regulation’ should be maintained”.

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