Christine Chow, Associate Director, Hermes EOS, Hermes Investment Management, takes a look at the benefits of a constructive dialogue between investors and companies.

Have you ever wondered what happens to the mandatory provident fund contributions that are deducted from your monthly salary? Of course we understand that they go into a provident fund scheme and its underlying investment funds, but what kind of companies are those funds invested in? Do you have a say in that? And if those companies are not well managed, would you want to know how that could be changed? Is that even possible?

These were the questions that intrigued me 18 years ago when I was working as a graduate trainee in a global fund management firm. To a certain extent they still do, except now I have a better understanding of what the answers to them could be.

Two decades ago, asset managers did not engage with their investee companies, nor did they feel that they had the responsibility to do so. They or their representatives, if they appointed any representatives at all, rarely took active voting decisions. Company directors’ views tended to be: ‘If you don’t like my company, sell the stock’.

This posed a significant problem. In a multi-stage investment chain, there was a complete disconnect between asset owners (collectively known as investors), the asset managers they appointed and their investee companies. This disconnect arose from the lack of communication between investors and companies. Asset managers lacked a deeper understanding of the corporate culture and strategic outlook that shapes a sustainable company. This contributed to a trading culture that got out of control, damaging the long-term development of capital markets and the economy.

Today, the relationships between investors and companies have moved forward significantly. I am fortunate to have had the opportunity to work closely with investors, asset managers and companies over the years, advising them on environmental, social and governance (ESG) issues. Intelligent voting and corporate engagement are becoming mainstream and, even in Asia where companies have traditionally resisted speaking with investors, we are seeing increased board-level interest in shareholder engagement.

It takes two to tango

April Chan, former Company Secretary of CLP Holdings, points out that the success of the dialogue between investors and companies depends greatly on the willingness of both parties to engage with each other. ‘It takes two to tango,’ she said at a recent HKICS shareholder engagement forum. ‘To do the dance well, we need regular communications so that companies and shareholders understand each other’s expectations.’

On the investor side, since 2010 when the UK launched its Stewardship Code, we have seen the concepts of ‘stewardship’ and ‘responsible ownership’ gain ground around the world. We have seen an increased willingness by shareholders to exercise their ownership rights and this means more than simply voting in shareholder meetings. The UK Financial Reporting Council, which revised the UK’s Stewardship Code in September 2012, points out that, in addition to voting, responsible ownership activities may include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, remuneration, corporate culture and corporate governance.

Moreover, responsible ownership is no longer the domain of the West. This is reflected in the growing number of Asian codes and guidance on best practice in this area. The Japanese Principles for Responsible Institutional Investors and the Malaysian Code for Institutional Investors, both launched in 2014, aim to support the long-term success of companies so that the ultimate capital providers also benefit. Hong Kong is poised to join this trend with the imminent introduction of the Securities and Futures Commission’s (SFC) Principles of Responsible Ownership. Last month, the SFC published its revised principles, incorporating revisions based on submissions received during the consultation held from March to June 2015 (see this month’s second cover story for a review of the revised principles).

Admittedly, in practice the level of engagement in the dialogue between investors and companies varies immensely. Among investors, the philosophy of responsible investment has only just begun to enter the mainstream. Companies that actively engage with investors often find that those making voting decisions do so under time pressure. However, many investors do ask for more information when they need to make a decision. Investors should understand that companies will only put an item on the meeting agenda when it has material impact on the company and that it is the responsibility of shareholders to vote dutifully and carefully.

On the company side, there remains a degree of suspicion of investor requests for dialogue. This is sometimes seen as ‘interference’. Some feel that they are under constant surveillance by those who do not understand their business, while others feel unprepared when investors ask to meet board directors, especially independent non-executive directors.
Established global companies can ask internal staff to prepare briefing packs for independent directors and provide these directors with training in how to interact with investors, however smaller listed companies have fewer resources and less expertise to do the same. In the extreme, companies may feel this dialogue is completely unnecessary. Professional managers and industry specialists are employed to manage the business on behalf of shareholders – why don’t they trust us?
The truth of the matter is that we have long left behind an era when business was conducted with a good, solid handshake – with simplicity. We now operate in an environment where transparency, accountability and fairness are required to support the social licence to operate. This means developing a new status quo towards supporting a comprehensive governance system with robust checks and balances, clear reporting standards and key performance indicators. When checks and balances are deployed appropriately and thoughtfully, without over-burdening a business, they enhance a company’s ability to excel and expand.

The view from Hong Kong

As mentioned above, Hong Kong is poised to introduce its own code setting out the basic principles for responsible ownership (the SFC’s Principles of Responsible Ownership), but what do executives and board members of companies listed in Hong Kong expect from responsible shareowners? I recently visited a number of company executives in Hong Kong to discuss responsible ownership and shareholder engagement and some of the key issues to emerge from these discussions are highlighted below.

Is there anybody out there?

Some executives I spoke to were excited about the shareholder engagement trend because, as one respondent put it, ‘We have the support of our investors to explore better ways to add value to the business’. Other executives were frustrated by a lack of engagement from the investor side. One respondent said that his biggest challenge is getting investors to read the circulated information and set aside sufficient time to make voting decisions. ‘Many investors will vote against management without even engaging with us ahead of time to discuss the matter.’ he said.

This frustration is felt on both sides of the dialogue. On numerous occasions, I have contacted an investor relations manager for further information ahead of an annual general meeting and received no response. It is surprising, but some listed companies do not even display contact information for the investor relations department on their websites. Even if they do, there may be no reply. I acknowledge that some investors may not carry out intelligent voting and tend to follow third-party advice at all times, but a company could plan to engage with shareholders ahead of time to ensure that sufficient communication takes place prior to shareholder meetings.

Minority rights

The executives I spoke to were working in diverse sectors of the economy and for companies with different shareholding structures ranging from state-, founder- or family-controlled companies, to those with an institutional shareholding structure. These shareholding structures often influence the approach taken to shareholder engagement. One respondent made the point that, for state-controlled companies ‘shareholder engagement’ has historically been seen as a question of reporting to their largest shareholder – the state – on their business activities. ‘As engagement becomes mainstream,’ he said, ‘we are familiarising ourselves with the Western style of communication and seeking ways to protect minority shareholder rights in a state-controlled setting. There are practical challenges, but I think open and fair communication with all shareholders is the first step. Under the current reforms, shareholders and the board will become more international over time. As a result, our leadership’s commitment to protecting minority shareholder rights and their ability to do so, becomes vitally important to the survival of our business.’

Independent directors

Independent directors can often play an important role in shareholder engagement. One respondent pointed out that in China the appointment of senior executives in state-owned enterprises is still likely to be determined by the state. One way to improve the dynamics and effectiveness of the board is therefore to create lead independent director roles. The tasks of a lead independent director is to communicate with minority shareholders, consolidate the views of other board directors, and manage the various committees and government investigations – if there are any – as a non-executive but informed party. More detailed succession plans for, and better disclosure of, succession and director candidates meanwhile will improve transparency. ‘Culturally, we must learn to respect minority shareholders as part of the audit and monitoring process because we are responsible for other people’s capital,’ he said.

Another respondent pointed out that appointing a lead independent director to work with investors is not common practice in Hong Kong at the moment but that this practice would be beneficial – particularly for companies with an executive chair. ‘The appointment of an independent non-executive lead director would provide a way to obtain the views of investors. After all, this is why we go on roadshows – to speak to investors and to understand their views. It would be great to create a mechanism that enables us to do this more easily and effectively,’ he said.

The constructive challenge

Where investors are prepared to engage with companies, they can provide a constructive challenge to the status quo. Having one leg in the investment industry and another in academia allows me to come up with the following comparison: companies should expect from responsible investors committed to stewardship what we should expect from a good teacher. A good teacher appreciates the efforts made by the best students, but to avoid complacency and a self-congratulating attitude, he or she continues to challenge them in a constructive manner and pushes them to perform and excel beyond their imagination.A good teacher also listens and respects individuality.

Moreover, a good teacher cares for the students who are not top performers and tries to find ways that will help them realise their potential. Sometimes, underperformance can be caused by the complicated family situation of the student, which can be compared to a company operating in a highly regulated industry and a high-risk and complex environment.

Underperformance can also be caused by having resources in the wrong places. For example, a student can focus too much on getting the work done without thinking through the lessons he or she should learn. This is akin to a company trying to fill in various industry questionnaires for rating and awards purposes. The lessons learned from completing questionnaires, such as discovering the areas in which the company could improve and how to prioritise resources is a far better
way to support improvement and business excellence.

I would like to highlight a couple of examples of what can happen when the constructive challenge provided by engaged investors is ignored.

The BP case

Between 2000 and 2008, as responsible ownership gained momentum in the UK, oil major BP steadily increased engagement activities with its shareholders. These investors voiced their concerns over the company’s environmental performance and health and safety standards. Unfortunately, the company did not respond sufficiently to what proved to be prescient concerns of investors. The subsequent 2010 Deepwater Horizon oil spill in the Gulf of Mexico, led to BP incurring fines of US$20bn. Following this crisis, BP significantly increased its dialogue with investors and launched a much deeper investigation into health and safety practices at the company. While some may say that this is an isolated case, it can also be argued that this case demonstrates that proper engagement with responsible owners gives companies insights into future risks and outcomes.

The Volkswagen case

In September 2015, the US Environmental Protection Agency discovered that Volkswagen had installed defeat devices that caused the nitrogen oxide output of its vehicles to meet US standards during regulatory testing, but breached the standards in real life driving. Hermes EOS has been engaging with Volkswagen since 2006. On multiple occasions, we raised concerns about the corporate governance standards of the company – including the composition and effectiveness of its board and the lack of efficient and independent oversight.

Our Global Equities investment team uses an ESG-risk rating system that measures a company’s holistic performance and had observed the decline of Volkswagen’s governance rating. This example also serves a warning that investors must monitor and if appropriate, engage with single or multiple party-controlled companies – in this case, the Porsche/Piëch families and the State of Lower Saxony – to verify that the board is taking into account the interests of all shareholders for the long-term success of the company. Family, personal and corporate interests must align for this type of business leadership to work. Investors should also maintain a dialogue with other controlling shareholders to ensure that ongoing strategic and governance concerns are discussed and addressed in a timely manner.

Christine Chow
Associate Director, Hermes EOS, Hermes Investment Management
Christine Chow is also Adjunct Associate Professor, Department of Finance, Hong Kong University of Science and

Technology, and a member of the Investment Committee of the London School of Economics.
This communication is directed at professional recipients only. The activities referred to in this document are not regulated activities under the Financial Services and Markets Act. This document is for information purposes only. It pays no regard to any specific investment objectives, financial situation or particular needs of any specific recipient. Hermes Equity Ownership Services Ltd (HEOS) does not provide investment advice and no action should be taken or omitted to be taken in reliance upon information in this document. Any opinions expressed may change. This document may include a list of HEOS clients. Please note that inclusion on this list should not be construed as an endorsement of HEOS’ services. HEOS has its registered office at Lloyds Chambers, 1 Portsoken Street, London, E1 8HZ.

The final draft of the SFC’s proposed ‘Principles of Responsible Ownership’ is available on its website:


Environmental, social and governance (ESG) risk management is fast becoming a crucial part of investment analyses and investment decisions made purely on the basis of financial data are increasingly regarded as incomplete. At Hermes, our investment teams take into account a proprietary ESG rating of companies, based on external data and the engagement findings of Hermes EOS, in their investment decisions. We typically believe that it is better to engage than divest, as engagement provides the opportunity to work constructively with a company to enhance its long-term returns to shareholders through a better strategic focus and management of ESG risks. ESG analysis helps our teams value companies more accurately, by identifying risks that may not appear in traditional financial analysis, as well as opportunities. Through our engagement, we may identify clear improvements in a company’s corporate governance that are not broadly recognised by the market and initiate a position at an attractive valuation.