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September 03, 2010
Eurosif Recommends Improvements in Corporate Governance
    by Robert Kropp

Invited by the European Commission to offer remedies for weaknesses in corporate governance, Eurosif responds with recommendations to increase transparency and strengthen shareowner rights.

In response to the global economic damage caused by the financial crisis, the European Commission (EC) published earlier this year a green paper entitled Corporate governance in financial institutions and remuneration policies in an effort to "remedy any weaknesses in the corporate governance system" of the financial institutions whose behaviors led to the crisis.

Sustainable investors have observed that many of the causes of the financial crisis could have been avoided, had the concerns they have been raising for years been addressed by the financial institutions at the heart of the crisis. It comes as no surprise to those who raised early warnings that the EC's green paper addresses many of those concerns, such as poor corporate governance, excessive risk-taking, and ineffective shareowner oversight.

The EC invited organizations to respond to its green paper with recommendations of their own.
Eurosif, the European association of national Social Investment Forums (SIFs), took the authors of the green paper up on their invitation, and responded with two position papers that addressed the main concerns of sustainable investors.

Describing the financial crisis as "an historic opportunity to adopt policies encouraging longer-term thinking in financial markets," Eurosif's position papers include responses to the green paper that address the responsibilities of boards of directors, shareowner engagement in corporate governance of financial institutions, and corporate executive compensation policies.

Asking the EC to "create a framework that strengthens the role and responsibilities of the Board of Directors especially on risk supervision and management," Eurosif recommended mandatory disclosure of environmental, social, and corporate governance (ESG) information by public and large companies.

"Should investors conclude that companies with thoughtful long-term management of ESG issues are better-run companies," Eurosif stated, "A sort of virtuous circle could be created...investors would reward stock prices where sustainability is integrated, and companies would respond by further improving their sustainability performance."

A second mechanism that could control risk-taking in financial institutions is board diversity. According to Matt Christensen, the Executive Director of Eurosif, "We've never set out policies for diversity of boards before, but we think that the impact would be a greater review of risk, by bringing in discussions that would not have been there otherwise."

Specific impediments to the adoption of board diversity by financial institutions, Christensen told, "Are the arcane jargon and the unique Wall Street culture. Diversity would bring a different type of board member who doesn't just go along with the conversation."

"Diversity won't happen overnight," Christensen said. "But if the Commission lays the foundation of law, then we can then begin pushing for specific solutions."

Asserting that the "European Commission should continue regarding shareholder engagement as a model for mitigating future governance failures," Eurosif devoted a number of recommendations to the role of shareowners and institutional investors in the prevention of future crises. Describing the
U K Stewardship Code as a useful starting point, Eurosif recommended that the Code be taken one step further in the EU, by "including the responsibilities of proxy-agencies, research providers and investment consultants within an enlarged framework."

The UK Stewardship Code recommends that institutional investors publicly disclose stewardship policies, manage conflict of interest, monitor their investee companies, act collectively with other investors, have a policy on voting, and disclose their voting records.

"We're recommending that the UK stewardship code be looked at as something that can be developed," Christensen said, "But we can do more than what the UK code says."

Asked to describe the role played by institutional investors in the financial crisis, Christensen said, "A lot of institutional investors went along for the ride, and didn't exercise their rights as owners of these companies. We're asking for greater transparency in voting. If you have accountability on how you vote, people are going to take it more seriously."

Regarding the roles of custodian banks and proxy voting agencies, Eurosif called for a clear reporting by those agents of how shares are voted. Christensen said, "At a minimum, investors should have a voting guideline for advisors that goes beyond whatever you guys say, we will follow."

The need for "fixing the plumbing" of the proxy process was addressed in the US by the Securities and Exchange Commission (SEC) recently, when it adopted new rules for proxy access. A proxy plumbing issue specific to the EU, which includes in its membership 27 independent countries, is cross-border voting. According to Eurosif, "By the end of 2007 foreign investors owned 37% of total market capitalization in EC countries." Existing barriers to cross-border voting have significant negative impacts on voting turnout at annual general meetings, Eurosif stated.

"The plumbing needs to be fixed," Christensen said, "Because the voting chain is very important."

Regarding the issue of transparency of annual general meetings themselves, Eurosif called attention to recent legislation in France, where companies now must post results of proxy votes as well as the number of votes cast and the number of shareowners present.

"There has to be a better way of finding out what happens in annual general meetings," Christensen said.

Finally, to discourage risk-taking in the pursuit of short-term profits, Eurosif recommended that executive compensation packages be aligned with ESG performance.

In conclusion, Eurosif recommended that the EC adopt mandatory requirements for financial institutions to better disclose their practices. Mandatory disclosure, Eurosif stated, "Is an essential aspect of avoiding future financial crises caused by short-termism, inadequate use of governance powers by investors, poor shareholder engagement, unenforced regulation, misaligned compensation and/or incentive systems and a lack of transparency."

Noting that Eurosif received supportive statements from many of those involved in the green paper, Christensen concluded, "They get a lot of papers from people who want to keep the status quo."


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