The Covid-19 global pandemic is already having profound ramifications upon companies, the economy and society at large. Shareholders, stakeholders (employees, customers, NGOs and others) as well as ultimate beneficiaries are becoming increasingly interested in how institutional investors (asset managers and asset owners) engage with companies during these times, especially on ESG issues. Rendering institutional investors and asset managers good monitors of their investee companies and improving their accountability to both companies and their own beneficiaries and clients is today among the key challenges around the world.
In our paper, we investigate this issue focusing on the availability (or not) of mechanisms to enforce shareholder stewardship around the world. Shareholder stewardship on the part of institutional shareholders, being strongly associated with both good corporate governance and socially approved responsible investing, has been mainly promoted in recent years through voluntary, soft, and flexible stewardship norms (stewardship codes and best practice principles) which are most of the times self-regulatory in nature (consider, for instance, The Investor Stewardship Group’s Framework for US Stewardship and Governance). At the same time, hard law, in the form of disclosure obligations or expansive fiduciary duties, are being increasingly introduced to address certain aspects of the broader stewardship role (related to both corporate governance and investment management aspects) of specific market actors (consider for instance, Article 3g of the EU Shareholder Rights Directive II [SRD II]). This co-existence of soft-law and (semi)hard-law across the globe raises important questions about the future of stewardship frameworks and their enforcement.
A broad enforcement taxonomy
In our paper, we adopt a broad approach to enforcement mechanisms in the area of shareholder stewardship and set out a simple conceptual enforcement taxonomy based on three dimensions.
Our enforcement taxonomy takes into account the nature of the norm-enforcer and distinguishes between self-enforcement and third-party enforcement. Self-enforcement in Covid-19 times will prove to be highly innovatory as we consider it will incentivize more and more investors to assume a ‘resilience-gatekeeper’ role in relation to companies (consider, for instance, the engagement priorities of Blackrock). In relation to third-party enforcement, we consider public, quasi-public, private, market and social norm-enforcers. These actors may or not be the standard setters of the relevant soft or hard rules.
We then distinguish between formal and informal enforcement mechanisms so as to highlight the wide variety of enforcement options that all these actors have at their disposal.
Formal enforcement includes the obvious (judicial or quasi-judicial) mechanisms. In our enforcement taxonomy, we accord—for the first time—a new dimension to formal enforcement mechanisms by also including membership sanctions and adherence procedures that target an individual norm-follower which is member of a (stewardship) network. Such a network may be more or less institutionalised, and membership may or may not be completely voluntary (consider, for instance, investor associations or the UK Financial Reporting Council tiering exercise in relation the UK Stewardship Code). This broadening of what can be perceived as formal enforcement is due to the expansive reach of soft-law norms which often operate within networks with enforcement capacities. The new definition also depicts the crucial role that such networks will play during and after Covid-19, nudging actors to act as sound stewards in a more efficient way than the traditional (quasi)judicial mechanisms.
Informal enforcement mechanisms, on the other hand, consist of information diffusion mechanisms such as annual reports and guidelines, reputational mechanisms such as public shaming and public warning (but also naming and faming so as to reward sound practices), and measures taking place in private such as dialogue and private meetings. Indeed, examining the enforcement mode of 25 stewardship codes around the world we confirm that informal enforcement by market actors is the preferred option. This will become even more accentuated during and after the Covid-19 pandemic as investors are seeking more than ever social legitimacy with the aim to consolidate their public profile as safeguards of corporate resilience and sustainability. Indeed, over the last weeks, Federated Hermes, State Street, Vanguard, and the UN’s Principles for Responsible Investing (PRI) have issued statements emphasizing the need to focus on ESG, stakeholder issues and long-term business strategy. In an even bolder statement, Philipp Hildebrand, Vice-Chairman of BlackRock, characterised the Covid-19 pandemic as a sustainability crisis and a ‘Gray Rhino’, denoting its ‘highly obvious, highly probable, but still neglected danger’. If institutional investors and asset managers are about to scale up their public profile to become the long-sought-after stewards and safeguards of sustainability, activating enforcement mechanisms that can mobilise and strengthen such social legitimacy should become the key priority in any stewardship regulatory design.
Finally, we take into account the temporal dimension of enforcement and distinguish between ex ante (monitoring and deterrence) and ex post (compliance). The temporal aspect of our taxonomy (ex ante and ex post mechanisms) highlights a continuum of actions by enforcers of norms (from private guidance and advice to sanctioning a breach) that all aim to attain good stewardship standards. But this distinction based on the time of the intervention is arguably a thin one. An ex post enforcement mechanism that takes place after an action has (not) been taken such as a formal sanction or an informal ‘name and shame’ campaign can trigger future ex ante enforcement: parties subject to ex post enforcement will have to reflect upon the consequences of their past actions and potentially alter their compliance stance for the next (annual) engagement and stewardship disclosure exercise. This temporal facet of enforcement will prove particularly useful in these challenging times as the overall ramifications of the global pandemic will be long-lasting and the corporate resilience that investors will aim to preserve will require ongoing monitoring efforts of their actions.
Mobilising a Multi-Actor and Multi-Modal Enforcement System
Looking forward, we employ our proposed enforcement taxonomy and outline the broad contours of an enforcement framework in the context of shareholder stewardship. Our starting point is that, for institutional investors and asset managers to be able to absorb bottom-up or, most importantly, top-down regulation, flexibility in adapting to best shareholder stewardship practices is needed. We therefore caution against formal public enforcement when shareholder stewardship norms are hard law in nature, and illustrate, as a way of example, the defects of the use of administrative penalties by EU national competent authorities in the context of SRD II.
Nevertheless, we are not agnostic to the enforcement abilities of public or quasi-public actors. We, therefore, see a facilitating role for such actors in two distinct ways. First, where ultimate beneficiaries have suffered damages from deficient disclosure of engagement policies (where hard-law stewardship norms have been established), we support the introduction of a facilitating system of civil claims initiated by public or quasi-public authorities that can serve both restorative-compensatory objectives and public interests. Secondly, and irrespective of the hard- or soft-law nature of the underpinning stewardship norm(s), public and quasi-public actors can support shareholder stewardship enforcement via informal mechanisms (such as public information diffusion, reputational mechanisms such as ‘name and shame’, ongoing dialogue and private meetings).
We also advance the importance of promoting and refining (formal and informal) enforcement by market and social actors, especially through voluntary stewardship networks (consider, for the instance the role of the ICGN). Institutional investors and asset managers need to be enabled and nudged more than ever towards the assumption of a critical role in our society: engaging with companies around vital issues, such as their operational and financial resilience and their ongoing relationship with stakeholders, will require a flexible, malleable and collaborative enforcement spectrum. In other words, it is only under flexibility and collaboration—and not the imposition of sanctions—that shareholder engagement and stewardship can flourish under these unprecedented times.
To sum up, our proposed enforcement taxonomy is multi-actor and multi-modal along a time-continuum, and essentially pertains to a single key point: to enforce shareholder stewardship effectively, various actors, mechanisms and timing in enforcement need to work together. But there is no global ‘one-size-fits-all’ approach to shareholder stewardship enforcement. Rather the specifics will depend on the soft/hard-law nature of the stewardship norm that is to be enforced and on the country’s quality of institutions, economic history and culture.
Dionysia Katelouzou is Senior Lecturer in Corporate Law at The Dickson Poon School of Law, King’s College London.
Konstantinos Sergakis is Professor of Capital Markets Law and Corporate Governance at the University of Glasgow.