Should investors trust proxy advisors and rating agencies?
The Financial Reporting Council (FRC), published an in-depth analysis of the impact of proxy advisors and ESG rating agencies on the behaviour of FTSE 350 companies and the votes of their shareholders.
The main takeaways of this study include:
- Almost all investors use the services of proxy advisors, but 75% of them ask for voting research to be based on their in-house voting policies rather than the advisor's standard ones.
- Recommendations and ratings given by proxy advisors and ESG rating agencies have some influence on behaviour and voting decisions, but the nature and extent of this influence may be more nuanced and less clear-cut than is commonly believed.
- Similarly, there is some evidence of correlation between negative voting recommendations and voting outcomes, but it appears to be less extensive than is sometimes asserted.
- UK-based investors and asset owners seem to be more often in line with their proxy advisors than non-UK ones and asset managers respectively. The investor size and choice of advisor do not have significant effects on these observations.
- Companies' desire to engage with their major shareholders are often undermined by those shareholders' willingness or ability to do so, in addition to time and resource constraints during the AGM season.
- 48% of companies declared they were dissatisfied with the quality of the research reports prepared by proxy advisors, against only 6% of investors.
- Most companies are concerned that investors may place reliance on a headline rating that does not fairly reflect their actions or performance when making voting decisions.
- Most investors do not use headline ratings and rather buy granular data to feed internal models, but their clients tend to be interested in these ratings.
- Both companies and investors would welcome greater transparency on the methodologies used by ESG rating agencies, including more information on the specific ESG factors covered and how they are weighted, the extent to which the model takes account of national and sectoral differences, and the quality assurance process.
This study has implications for how investment professionals evaluate and manage their investments, with a potential shift towards a greater emphasis on the reliability of the research and the approach taken to collecting and interpreting data by ESG rating agencies.
It would be beneficial to investigate the specific mechanisms through which proxy advisors and ESG rating agencies influence corporate behaviour and voting decisions, and how companies and investors can effectively engage with these parties to achieve their objectives.