Institutional investors are acknowledged as a force to be reckoned with worldwide as a result of their large shareholdings and ownership of public equity.Footnote 1 The growth in financial intermediation can be seen in jurisdictions worldwide including the United States of America (USA), the United Kingdom (UK), Australia, Hong Kong, and Singapore. The influence of institutional investors has led to an increased focus on their investing and shareholding practices and their engagement with their investee companies, as well as their impact on the broader economy.
Cognizant of the growing emphasis on the role of institutional investors, a stewardship code for institutional investors was introduced in the UK in 2010. Malaysia then followed suit with the Malaysian Code for Institutional Investors (MCII) in 2014.Footnote 2 It has been argued that the growth of stewardship codes stems from a positive view of shareholders as ‘good activists’ with the power to participate constructively in the corporate governance of their investee companies, which is integral to accountability.Footnote 3 This positive view is contrasted with a negative perception of institutional shareholders, where they are seen as unfaithful participants in the corporate enterprise,Footnote 4 with most of the vitriol aimed at hedge fund activists.Footnote 5
The key objective of this article is to evaluate the theoretical and practical issues pertaining to institutional investor stewardship in Malaysia through functional and contextual lenses, as juxtaposed against more established stewardship practices in the UK. The UK was chosen as a basis for comparison because the MCII used the United Kingdom Stewardship Code (UKSC)Footnote 6 as one of its reference points,Footnote 7 and the UKSC has been a model for stewardship codes worldwide.Footnote 8
It is argued that, notwithstanding an analogous legal framework for shareholder rights and the textual similarities of the UKSC and MCII, the dominance of government-linked investment companies and government-linked companies results in a distinct set of issues in relation to institutional investor stewardship. This article then argues that the stewardship codes are in themselves insufficient in increasing the quality and scope of institutional investor engagement, as they fail to address the underlying agency conflicts between the institutional investors and ultimate beneficiaries or clients. In learning from the UK's experience, it is therefore important that Malaysian policymakers and industry pay attention to the overarching structural factors and incentives driving institutional investor engagement, alongside encouraging the development of an institutional investor code.
This article will proceed as follows. Part I will examine the foundations of stewardship by institutional investors. It will begin with a brief exposition of the legal framework of shareholder rights which forms the basis for stewardship. This part will also set out the theoretical underpinnings of the role of institutional investors as monitors and activists, which preceded the development of the concept of institutional investors as stewards. Part II will set out the background and chronology of the UKSC and MCII. Part III will provide a comparison of the UKSC and MCII's principles, and its oversight and supervisory mechanisms. Part IV will evaluate stewardship practices in the UK and Malaysia, and analyze the contextual factors which have impacted institutional investor stewardship, particularly in Malaysia. Part V will reflect on the concept of stewardship and its limitations, as well as what Malaysian policymakers and industry can learn from the UK experience and what they may consider doing to enhance stewardship practices and engagement. The article concludes with a summary, reiterating the structural constraints militating against the effectiveness of the MCII and the need to address these limitations holistically.
I. AN OVERVIEW OF THE FOUNDATIONS OF INSTITUTIONAL INVESTOR STEWARDSHIP
A. The Legal Framework of Shareholder Rights
The ownership of shares in a corporation gives rise to rights generally established in company law, which may be modified by the constituent documents of a corporation, where applicable. Shareholder rights are an important determinant of the structure and process of corporate governance, particularly in determining the key relationships between shareholders and other stakeholders (such as creditors), and between shareholders and the board of directors.Footnote 9
Section 541 of the UK Companies Act 2006 provides that shares or other interests of a member in a company are personal property (or moveable property in Scotland). Similarly, section 70 of the Malaysian Companies Act 2016 Footnote 10 describes shares as personal property and transferable in accordance with the requirements set out in section 105.
Further, section 71(1) of the Malaysian Companies Act 2016 provides more details on shareholder rights, stating that:
A share in a company, other than preference shares, confers on the holder
(a) the right to attend, participate and speak at a meeting;
(b) the right to vote on a show of hands on any resolution of the company;
(c) the right to one vote for each share on a poll on any resolution of the company;
(d) the right to an equal share in the distribution of the surplus assets of the company; or
(e) the right to an equal share in dividends authorised by the Board.Footnote 11
The rights set out in section 71(1) may be characterized as intervention rights of shareholders to challenge the view of the board of directors on particular issues.Footnote 12 Shareholders also have the right to call for a general meeting at the company's expense, as prescribed in section 305 of the UK Companies Act 2006 and section 313 of the Malaysian Companies Act 2016 respectively. Shareholders may also request that the company circulate their proposed resolutions or statements as provided for under section 314 of the UK Companies Act 2006 and section 323 of the Malaysian Companies Act 2016, although it is noted that the Malaysian section is only confined to public companies. Section 319A of the UK Companies Act 2006 also imposes an obligation on traded companies to answer members’ questions on the business discussed at the general meeting, which is not found in the Malaysian Companies Act 2016, although this is alluded to in the Malaysian Code on Corporate Governance 2017.Footnote 13
The shareholder rights enumerated above should be viewed in light of the division of powers between management and shareholders. Although the remit of directors’ powers is usually broad, there is a wide range of powers reserved to shareholders.Footnote 14 Therefore, shareholders exercise their statutory rights during the general meeting, but the exercise of such rights is subject to limitations (eg the inability to override management decisionsFootnote 15 and prescribed limitations as stated in the articles of association or the constitution of the company).Footnote 16 In summary, while directors have great power in determining the fate of a company, shareholders are an important check and balance on their powers which the law recognizes and empowers, particularly institutional shareholders acting as stewards of their investee corporations.
B. Institutional Investors as Corporate Monitors and Shareholder Activists
The growth of the institutional investor – which was widely perceived to have resources and clout because of its ownership size and access to resources in the capital markets – gave rise to exciting possibilities for the exercise of its shareholding rights as a corporate monitor and an activist.Footnote 17 This was vividly illustrated in a germinal article by Black and Coffee on the British experience of institutional investor monitoring, its limits, and its implications on the American institutional investor landscape.Footnote 18 The key takeaway of this article was the observation that UK institutions were more involved in corporate governance than their US counterparts. However, UK institutions were constrained by the cost factor in managing shareholder coalitions and restricted incentives for money managers to invest in monitoring, which thus dampened their effectiveness.
It followed that institutional investor intervention was primarily seen as a way of addressing the classic agency problem first propounded by Berle and MeansFootnote 19 and developed further by Jensen and Meckling,Footnote 20 in which the separation of ownership and control leads to the managers of the company (the agent) making decisions which are not in the best interests of the shareholders (the principal) and in conflict with the shareholders’ goals. Such decisions may be inconsistent with the value maximization of the company's assets,Footnote 21 or pertain to the pursuit of wealth, security, and prestige at the expense of the company as manifested by excessive executive compensation.Footnote 22 The conflict of interest between shareholders and managers is exacerbated by the information asymmetry between both parties, making it difficult for shareholders to verify the behaviour of the managers.Footnote 23
Agency conflicts occur in both dispersed and concentrated ownership scenarios.Footnote 24 Agency conflicts arise in a dispersed ownership scenario where shareholders have little direct control over management – a situation commonly associated with the USA and the UK. The lack of a dominant or single owner holding sufficient shares to exercise ownership rights results in shareholders being less able to remove poor managers, and it reduces the incentives and ability of shareholders to monitor managerial activity.Footnote 25 Shareholders are also described as suffering from the classic free-rider problem, where the costs of monitoring are borne by a particular shareholder but the benefits are shared by all shareholders, resulting in so-called ‘rational apathy’. Under such circumstances, shareholders will typically leave the monitoring to others rather than taking it upon themselves.Footnote 26
By contrast, agency conflicts may also arise in firms with concentrated ownership, where there are blockholders or owners holding a single block or several large blocks of shares in the firms. Firms with concentrated ownership are more typically found in Europe and in East Asian countries,Footnote 27 including Malaysia.Footnote 28 The combination of concentrated ownership and the government ownership of public listed companies as well as weak investor protection is reflective of an insider model of corporate governance, which has been linked to minimized transparency and limited responsibility on the part of the companies.Footnote 29
The existence of external blockholders could arguably mitigate agency conflicts and thus promote better corporate governance, as they would have greater incentive to monitor the management in view of their bearing a greater portion of the losses arising from managerial opportunism.Footnote 30 Thus, it is believed that they would be able to overcome the free-rider problem described earlier.Footnote 31 Nevertheless, the optimism surrounding blockholders is tempered by the existence of conflicts of interest between such blockholders and minority shareholders, whereby the interests of the blockholders could very well be in opposition to those of minority shareholders.Footnote 32
It is noted that the study of agency conflicts has tended to focus on the relationships between managers and shareholders, and between majority shareholders (or blockholders) and minority shareholders. As stewardship brings into focus the distinct roles played by asset owners and asset managers within the investment management framework, an issue that arises is whether there are agency conflicts between asset owners and asset managers, and what the implications of these agency conflicts are. This point will be developed in greater detail in Parts III and IV below.
Institutional monitoring and shareholder activism may be regarded as conceptually similar although their scope may be said to differ. In this regard, institutional monitoring seeks to reduce the divergence between shareholder and managerial interests through a variety of devices including the mandatory disclosure of information and regulatory intervention.Footnote 33 Shareholder activism has been defined as the range of actions which may be taken by shareholders to influence corporate management and boards without a change in control.Footnote 34 These actions may be classified as ‘exit’ or ‘voice’ in accordance with the model developed by Hirschman, in which they may either sell their shares (exit) or make their dissatisfaction with management known via participative, interactive, or combative means (voice), underpinned by the concept of loyalty to the organization that the shareholders have invested in.Footnote 35
Alternatively, shareholder activism may be viewed as encompassing two distinct approaches, the first being where long-term investors engage with portfolio companies to improve long-term returns to shareholders, and the second where investments are made in undervalued companies on the basis that the intervention may result in changes that lead to a rise in the share price.Footnote 36 The first approach is more closely associated with traditional or mainstream institutional investors and stewardship, while the second approach is more commonly employed by hedge funds.Footnote 37
C. Institutional Investor Stewardship Emerges
Despite the promise shown in relation to the activist and monitoring roles of institutional shareholders, these institutional shareholders in the USA and the UK did not manage to rise to the occasion from the late 1970s to the 1990s.Footnote 38 Cheffins elaborates on this point by explaining that institutional investor involvement was constrained as a result of diversification of the investment portfolio.Footnote 39 Investment managers acting on behalf of institutional shareholders were concerned that intervention in the affairs of underperforming companies would be time consuming and unlikely to have a significant impact on a diversified investment portfolio.Footnote 40 There were also obstacles preventing institutional investor activism which were a result of regulations creating an incentive to diversify.Footnote 41
Nevertheless, in the wake of the global financial crisis of 2007–2008, the spotlight shifted to the role of shareholders in governance to prevent the recurrence of future crises. The UK House of Commons Treasury stated that ‘investors have failed in one of their core tasks, namely the effective scrutiny and monitoring the decisions of boards and executive management in the banking sector.’Footnote 42 This observation was supported by empirical findings that institutional investors in the UK generally refrained from qualitative shareholder engagement, and that they did not have a significant impact on the market reaction to purchase and sales of shares.Footnote 43 The Organisation for Economic Co-operation and Development (OECD) also noted that institutional shareholders tended to be reactive rather than proactive, and seldom challenged boards in sufficient numbers to make a difference.Footnote 44 Moreover, the excessive focus of shareholders on short-term proceeds or short-termism and the insufficient engagement of shareholders in corporate governance,Footnote 45 which were related concerns,Footnote 46 were highlighted as the two major complaints against shareholders and their role in the global financial crisis.Footnote 47
Be that as it may, it is noted that these criticisms were largely levelled at mainstream institutional investors, such as pension funds, rather than the emerging hedge funds which specialized in targeting underperforming companies and lobbying for changes to boost shareholder returns.Footnote 48 Despite a battering from the financial crisis, activist hedge funds came back at full strength with campaigns at more than 20 per cent of companies in the S&P 500 between 2009 and 2014.Footnote 49 While the role of hedge fund activists in corporate governance is set to grow in light of the increasing willingness of mainstream institutional investors to back their proposals,Footnote 50 the focus of this article will be on traditional institutional investors and their role in stewardship, particularly since there is no comparable equivalent to hedge fund activists in Malaysia at present and as will be observed subsequently, the major players in Malaysia are traditional institutional investors.
Concurrent with these developments, policymakers also began to draw upon ideas of a commitment-focused approach to ownership and universal ownership to encourage investors to engage with the corporations and to look at the long-term.Footnote 51 From an external perspective, institutional investor stewardship emerged as a result of the growth of privatization and deregulation, greater reliance on private savings to fund the retirement of the workforce at large, as well as the strengthening of shareholder rights and an increased scrutiny of the actions of institutional investors as shareowners.Footnote 52
II. A CHRONOLOGICAL ACCOUNT OF THE UKSC AND MCII
A. From Industry Statement to Code
The UKSC began its life as an industry-sponsored standard-setting norm that differed from statutory governance provisions and company articles of association in terms of its flexibility and arrangements for monitoring and compliance.Footnote 53 There was no formal legal status ascribed to these norms, which remained a matter between shareholders and the company, as well as the scope to permit non-compliance in appropriate cases.Footnote 54
As early as 1991, the Institutional Shareholders Committee (ISC) published a statement on ‘The Responsibilities of Institutional Shareholders in the UK’, which functioned as a form of collective standard-setting by institutional investors and a way of overcoming the collective action problem to monitor and discipline companies.Footnote 55 In the following year, the Cadbury Report lauded the ISC statement as part of efforts to develop a constructive relationship between companies and their owners.Footnote 56 The Cadbury Report highlighted the need for institutional shareholders to maintain regular, systematic contact with senior management, make positive use of their voting rights, and take a positive interest in the composition of the board of directors of the companies invested in, and it hoped that market-based regulation would be able to realize these proposals.Footnote 57
Despite the Cadbury Report's sanguineness about a positive market response to these proposals, the 2001 report on ‘Institutional Investment in the United Kingdom: A Review’ led by Lord Myners noted that fund managers remained ‘unnecessarily reluctant to take an activist stance in relation to corporate underperformance, even where this would be in their clients’ financial interests’.Footnote 58 Lord Myners later commented that they behaved more akin to absentee landlords rather than long-term shareholders committed to the growth and development of the company which they invested in.Footnote 59
Pursuant to the Myners Report, the ISC embedded shareholders’ activism into fund-management mandates and published a statement titled ‘The Responsibilities of Institutional Shareholders and Agents: Statement of Principles’ in 2002.Footnote 60 The statement was reviewed and reissued in 2004 and 2007, and published as a code (the ‘Code on the Responsibilities of Institutional Investors’) in November 2009.Footnote 61
In 2009, the Walker Report, which reviewed corporate governance in UK banks and other financial industry entities, recommended that the mandate of the Financial Reporting Council (FRC) be broadened to cover the development and adherence to best practices in the stewardship of UK-listed companies. Sir David Walker, who spearheaded this review, also highlighted that the board and director shortcomings discussed in the report would have been tackled more effectively had there been more vigorous scrutiny and persistence by major investors acting as owners.Footnote 62
Among the key recommendations in the Walker Report were the decision to separate the then Combined Code into a separate Corporate Governance Code and the UKSC,Footnote 63 and to make the FRC the sponsor of the UKSC to give more material weight to the code.Footnote 64 It also recommended that the ISC Code should be ratified by the FRC to become the UKSC, which would give ‘materially greater weight to the Stewardship Code’ and place the UKSC on par with the Combined Code as a statement of best practice and observance on a similar ‘comply or explain’ basis.Footnote 65 Following a six-month consultation period, the UKSC was published in a form substantially similar to the earlier ISC Code in 2010. The UKSC was then revised in 2012, and it became the subject of a high-level consultation in 2017 and a detailed consultation in 2019.Footnote 66
B. The Malaysian Vision of Stewardship
Early steps toward the MCII were taken via the issuance of the ‘Guide of Best Practices for Institutional Investors’ by the Institutional Investor Committee and the Minority Shareholder Watchdog Group (MSWG)Footnote 67 jointly, which adopted the recommendations in the Capital Market Masterplan in line with the Corporate Governance Code and the ‘Green Book – Enhancing Board Effectiveness’.Footnote 68 The Employees Provident Fund (EPF), the primary retirement fund in Malaysia, took the lead in 2010 by introducing the Corporate Governance Principles and Voting Guidelines, which focused on the size and composition of the board, separation of power between chairman and CEO, re-election of directors, related party transactions, and dividend policy.Footnote 69
In addition, the positive relationship between corporate governance and institutional investors was established in an empirical study published in 2008, which also found evidence that corporate governance influenced pressure-insensitive investors, although the relationship became less positive after the 2001 reforms, which implied that the monitoring role of both corporate governance and institutional investors could arise simultaneously and endogenously.Footnote 70 The findings of this study suggested that the reform was successful in catalyzing the role of institutional investors and the Malaysian Code on Corporate Governance.Footnote 71
As preparatory groundwork for the MCII, the Securities Commission of Malaysia (SC) in its Corporate Governance Blueprint (CG Blueprint) referenced the existence of various international codes, guidelines, and principles pertaining to the role of institutional investors, particularly the International Corporate Governance Network (ICGN) Statement of Principles on Institutional Shareholder Responsibilities and the UKSC.Footnote 72
The CG Blueprint also set out a case for change in the prevailing practices of institutional investors, focusing on the effective exercise of ownership rights, which was to be manifested via the expected best practices under the new code for institutional investors.Footnote 73 The document also mooted the creation of a network of institutional investors to represent the common interest of all institutional investors and serve as a platform to shape and influence a wider sphere of corporate governance culture.Footnote 74 Here, the CG Blueprint referred to the UK and Australian experiences, and highlighted the Institutional Investor Committee in the UK as an example of an institutional investor representative group. In summary, the CG Blueprint proposed two recommendations – that institutional investors drive the formulation of a new code and publish their commitment to the new code for institutional investors, and create an industry driven umbrella body for institutional investors.Footnote 75
The next leg of the stewardship journey was taken up by the MSWG, which oversaw the formation of a Steering Committee comprising chief executive officers and key representatives of Malaysian institutional investors and the publication of a consultation paper jointly with the SC.Footnote 76 After incorporating the comments from the public, the MCII was launched in 2014 as one of the deliverables of the CG Blueprint.Footnote 77 This code was intended to give institutional investors guidance on the effective exercise of stewardship responsibilities to ensure the delivery of sustainable long-term value to their ultimate beneficiaries or clients. It is noted that the MCII substantially adopted the provisions of the 2012 version of the UKSC.
III. THE UKSC AND MCII THROUGH FUNCTIONAL LENSES
By way of introduction, the term ‘stewardship’ was given a brief description in the UKSC, with an allusion to its aim to ‘promote the long-term success of companies in such a way that the ultimate providers of capital also prosper’, and a statement that effective stewardship benefits companies, investors, and the economy as a whole. The MCII's definition section provides:Footnote 78
Stewardship is investor stewardship from the perspective of a long-term institutional investor in particular asset owners such as pension funds. It includes the responsible management and oversight of assets for the benefit of the institutional investors’ ultimate beneficiaries or clients. The discharge of effective stewardship responsibilities would include development of a set of principles/policies, application of the principles/policies, oversight of agents, communications of expectations and reporting to their clients or beneficiaries. These activities also include monitoring and engagement with the investee companies on matters relating to strategy, performance, risk management, voting, corporate governance or sustainability issues.
While both the UKSC and MCII's concept of stewardship alluded to a long-term investment horizon, the MCII is more explicit in stating that it is for the benefit of the institutional investors’ ultimate beneficiaries or clients, as compared to the UKSC's more general expression of ‘ultimate providers of capital’.Footnote 79 Additionally, the MCII is framed from the perspective of a long-term institutional investor, particularly asset owners such as pension funds.Footnote 80
The specific focus on asset owners in the MCII's definition of stewardship, which was absent in the UKSC, is unusual given that the definition of institutional investors in the MCII refers to both asset owners and asset managers. Nevertheless, a subsequent section of the MCII explains how asset owners may show their commitment to the MCII. They may apply the principles of the code either directly to their investee companies, or indirectly through the mandates given to asset managers.Footnote 81 However, the MCII appears to have omitted to state how asset managers may do so. In this regard, the MCII should consider clarifying the manner in which asset managers should display their commitment to the code, as provided for in the UKSC,Footnote 82 as asset managers may choose to sign up to the MCII independently of asset owners. More importantly, this ensures that the MCII is scoped appropriately to clarify the roles of the asset owner and asset manager in the investment intermediation chain vis-à-vis stewardship.
The principles pertaining to disclosure of stewardship responsibilities, management of conflicts of interest in relation to stewardship, and monitoring and engagement with investee companies are present in both the UKSC and MCII.Footnote 83 With regard to the principle of managing conflicts of interest, both the UKSC and MCII appear to tacitly accept the presence of conflicts of interest situations, rather than mandating the disclosure of potential conflicts of interest situations and the explanation of methods of dealing with these situations. This appears to be the case notwithstanding the limited requirement for institutional investors to communicate to their service providers on the need to disclose all known potential conflicts of interest, and to explain how such conflicts are managed. It is believed that the latter approach would be more useful and significant to the clients and beneficiaries intended to be the recipients of stewardship practices, and would strengthen the impact of the USKC and MCII. Here, the 2011 South Africa Code for Responsible Investing may be a useful reference point as its Principle 4 requires institutional investors to recognize circumstances and relationships which may hold potential conflicts of interest, and to proactively manage them.Footnote 84
However, the UKSC principles relating to the escalation of stewardship activities, the willingness to act collectively with other investors where appropriate, and the periodic reporting on stewardship activities were not incorporated into the MCII. It is worth noting that the principle on collective action was previously Principle 7 of the draft MCII issued for consultation. However, this principle was deleted and moved to the preamble of the finalized MCII as a result of the feedback received.Footnote 85 Among the concerns raised from the public consultation exercise were that collective action with other investors could be deemed to be acting in concert to manipulate the market, the difficulty of establishing clear policies on collective engagement, and competition law concerns.Footnote 86 In view of these concerns, the MSWG and SC decided not to include collective action as one of the principles in the MCII.
Where the UKSC requires institutional investors to have a clear policy on voting and disclosure of their voting activities,Footnote 87 MCII Principle 6 only requires institutional investors to publish a voting policy. Nevertheless, the guidance provided in paragraph 6.5 of the MCII states that institutional investors are encouraged to disclose a summary of their voting activities, as it gives the beneficiaries greater clarity on how the votes are cast and is also a way of demonstrating that conflicts of interest are being properly managed. Although a softer stance is adopted in the MCII, the requirements with respect to voting activities in both the UKSC and MCII are similar in substance.
MCII Principle 5 requires institutional investors to incorporate corporate governance and sustainability considerations into the investment decision-making process, while the UKSC does not contain a corresponding principle. The public feedback to the MCII stated that emphasis should be placed on the importance of integrating ESG (Environmental, Social, and Governance) factors into the stewardship activities.Footnote 88 Accordingly, the inclusion of this principle brings the MCII in alignment with the United Nations Principles for Responsible Investment, in which investors are asked to incorporate environmental, social, and governance issues in their investment analysis and decision-making processes,Footnote 89 and the South African Code for Responsible Investing.Footnote 90
The UKSC and the MCII are characterized as soft law as contrasted against a statutory regulatory regime with penalties for non-compliance.Footnote 91 The MCII expressly states that it is a voluntary code.Footnote 92 Although the UKSC is mainly voluntary, the UK Financial Conduct Authority (FCA) Conduct of Business Rule 2.2.3 requires any firm authorized to manage funds, which is not a venture capital firm, and which manages investments for professional clients that are not natural persons, to disclose ‘the nature of its commitment’ to the UKSC or ‘where it does not commit to the UKSC, its alternative investment strategy’, thus rendering it mandatory for this category of asset managers. A breach of Rule 2.2.3 may result in public censure or a financial penalty as imposed by the FCA under section 205 or 206 of the UK Financial Services and Markets Act 2000.
In line with the approach taken in the UK Corporate Governance Code, the UKSC mandates a ‘comply or explain’ approach, whereby a signatory is required to explain why it has not complied with elements of the UKSC or where it has failed to disclose specific information requested in the guidance to the principles.Footnote 93 While the MCII provides that institutional investors should explain how they have applied the principles in the MCII, taking into account the guidance provided under each principle in the form of best practice recommendations, the MCII does not require signatories to explain reasons for the non-observance of a principle, although smaller institutions may judge that some of the principles and guidance are disproportionate, and explain why their business model precludes adherence to certain principles of the MCII.Footnote 94 This is unlike the UK position, which expressly requires explanations for non-compliance with the principles and guidance in the UKSC. The position taken in the MCII may thus weaken the quality of the disclosures made in stewardship statements pursuant to the MCII.
The take-up of the UKSC is currently monitored by the FRC, an independent regulator which has oversight of auditors, accountants, and actuaries, and looks into the Corporate Governance Code and UKSC to promote transparency and integrity in business.Footnote 95 The FRC's position as an independent regulatory body stands in contrast to the industry-driven character of the Institutional Investor Council Malaysia (IICM), which oversees the effective adoption of the MCII among others, and was formally established as a society pursuant to the Societies Act 1966 Footnote 96 on 29 December 2017.Footnote 97 The IICM comprises representatives from statutory bodies, government-linked investment companies (GLICs), the MSWG, government-linked fund managers, and a private fund manager. It replaces the MSWG which was previously tasked with overseeing the implementation of the MCII. The IICM is structurally similar to the UK ISC and has a similarly limited scope of powers, suggesting that any changes to the MCII to harden its soft law principles into regulatory obligations would be more challenging as compared to the current UK regime.
IV. STEWARDSHIP PRACTICE IN THE UK AND MALAYSIA: COMMON CONCERNS AND CONTEXTUAL CHALLENGES
A. Stewardship in the UK: Quality Concerns
An initial concern pertaining to stewardship in the UK was the quality of reporting as contained in the stewardship statements issued by signatories. To this end, the FRC introduced a tiering system based on the quality of the descriptions of signatories’ approaches to stewardship and their explanations in accordance with the ‘comply or explain’ basis of the UKSC in November 2016. Tier 1 referred to signatories which provided a good quality and transparent description of their approaches to stewardship and explanations of an alternative approach where necessary, while Tier 2 described signatories which met many of the reporting expectations but reported less transparently on their approaches to stewardship or did not provide explanations where they departed from provisions of the UKSC.Footnote 98
In relation to the ‘comply or explain’ approach set out in the UKSC, MacNeil highlighted three major issues: first, the fact that institutional investors were left to determine their own policy using the UKSC principles as a guide militated against the credibility of the ‘comply or explain’ approach with regard to self-selected standards; second, the limited nature of the legal obligation of the UKSC, which only applies to fund managers under the remit of the Financial Services and Markets Act 2000, undermined its status as an industry-wide standard; and third, the nature and duration of fund management mandates did not lend themselves easily to disciplinary action by underlying investors who could not ‘exit’ fund management contracts in the same way they may choose to sell their shares in companies subject to the Corporate Governance Code.Footnote 99 Further, as the UKSC provisions were not incorporated into the Listing Rules, non-compliance did not attract any penalties or censure.Footnote 100 Indeed, the admission by the FRC that many statements on the UKSC give little insight into investors’ actual practicesFootnote 101 confirmed the veracity and relevance of these issues.
Against the backdrop of these concerns and as alluded to above, the FRC embarked on a high-level consultation pertaining to the UKSC in December 2017 alongside a detailed consultation on the provisions of the UK Corporate Governance Code. Although the feedback on the UKSC was mostly positive,Footnote 102 it was the collapse of Carillion Limited,Footnote 103 a high-profile government contractor, which really highlighted the inadequacies of stewardship practices. This culminated in a thorough review of the FRC and the resignation of the FRC CEO, Stephen HaddrillFootnote 104 followed by the Kingman Review, an independent review of the FRC led by Sir John Kingman,Footnote 105 which recommended that the FRC be replaced with an independent statutory regulator, accountable to Parliament, with a damning indictment of the UKSC as ineffective in practice ‘whilst a major and well-intentioned intervention.’Footnote 106 This high-level consultation was followed by a more detailed consultation on the UKSC in 2019,Footnote 107 which incorporated the feedback from the 2017 consultation and is set to introduce a considerably more detailed and extensive stewardship code.
The Carillion collapse and its fallout provides a striking illustration of the limitations of the current institutional investor stewardship framework and its interconnectedness with the role of the board of directors, and the need for accurate disclosure of financial information, amid calls for a stronger role of the regulator charged with overseeing stewardship. It is against this backdrop that this article assesses the more recent Malaysian stewardship experience and highlights the unique challenges Malaysia faces on its stewardship journey.
B. Malaysia's Stewardship Journey: Similar Path, Different Obstacles
As at August 2019, there were twenty signatories to the MCII, comprising four asset owners, fifteen asset managers, and one service provider.Footnote 108 Three out of four of the asset owner signatories to the MCII are GLICs, ie Kumpulan Wang Persaraan Diperbadankan [Consolidated Pension Funds Corporation] (KWAP),Footnote 109 Khazanah Nasional Berhad (Khazanah),Footnote 110 and the EPF.Footnote 111 The remaining asset owner signatory, Perkeso (or SOCSO) is not a GLIC, although it is a government body mandated with enforcing social security laws.Footnote 112 The primacy of GLICs in the list of asset owner signatories is noted and its significance will be discussed in Part C below.
Further, other than MCII asset manager signatories which are global fund managers (ie Hermes Fund Managers, Aberdeen Standard Investments (Malaysia) Sdn Bhd, Legal & General Investment Management, BNP Paribas Asset Management Malaysia Sdn Bhd, BNP Paribas Asset Management Najmah Malaysia Sdn Bhd, Nomura Asset Management Malaysia Sdn Bhd, and Nomura Islamic Asset Management Sdn Bhd), the remaining signatories to the MCII are associated with GLICs (with the exception of Kenanga Investors Berhad and Kenanga Islamic Investors Berhad) – ie ValueCAP Sdn Bhd,Footnote 113 VCap Asset Managers Sdn Bhd,Footnote 114 Affin Hwang Asset Management Berhad,Footnote 115 AIIMAN Asset Management Sdn Bhd,Footnote 116 Principal Asset Management Berhad,Footnote 117 and Principal Islamic Asset Management Sdn Bhd.Footnote 118 The prominence of GLICs and entities associated with GLICs in the list of signatories brings into sharp relief the absence of MCII signatories that are not aligned with or linked to the state.
There are presently ten publicly available compliance statements accessible on the IICM website. These have been issued by EPF, KWAP, Legal & General Investment Management, Nomura Asset Management Sdn Bhd, Nomura Islamic Asset Management Sdn Bhd, Khazanah, Affin Hwang Asset Management Berhad, AIIMAN Asset Management Sdn Bhd, Aberdeen Standard Investments (Malaysia) Sdn Bhd, and SOCSO.Footnote 119
A perusal of the compliance statements shows that they suffer from the same issues highlighted by the FRC and addressed through its tiering of stewardship statements based on the disclosures provided. With regard to the asset owner signatories, EPF, KWAP, and SOCSO provide relatively detailed and transparent descriptions of their stewardship approaches, although Khazanah's compliance statement is disappointingly brief, showing every sign that the statement is still very much a work in progress.
As regards asset manager signatories, Nomura Asset Management Sdn Bhd and Nomura Islamic Asset Management Sdn Bhd quite naturally have the same wording in their compliance statements since they belong to the same corporate group, but it is also noted that they are the only signatories to cross-refer to the UN Principles of Responsible Investment and the MCII principles as fundamental to their investment practices. Similarly, the Legal & General Investment Management and Aberdeen Standard Investments’ compliance statements cross-refer to the UKSC and the Japanese Stewardship Code, among other global stewardship codes and principles. It may further be observed that Nomura, Legal & General Investment, and Aberdeen Standard Investments’ compliance statements are fairly detailed, as reflected in their positions in the Tier 1 ranking of UKSC stewardship reportingFootnote 120 and carried through in their stewardship statements for the MCII as part of their global stewardship obligations.
C. Contextual Challenges in Malaysian Stewardship
In analyzing the phenomenon of stewardship in the UK and Malaysia from a comparative standpoint, it is argued that these findings need to be grounded in the institutional and economic context in which Malaysia is situated in order to better understand the forces driving the adoption and implementation of engagement practices among institutional investors. In this context, Malaysia may be characterized as an emerging economyFootnote 121 and a developmental state which prioritizes economic growth, productivity, and technological competitiveness.Footnote 122 Under this model, the state has more autonomous political power and control over the economy, which frees it to plan the economy and prioritize long-term national interests without disruption from the short-term interests of either the corporate or working class.Footnote 123 In short, the state is significantly involved in business thus resulting in a unique set of consequences.
A clear example of state involvement in business may be seen in the role played by GLICs. In this connection, it is noted that the institutional investor sphere in Malaysia is dominated by GLICs, evidenced by their ownership and control of the top 100 companies quoted on the stock exchange, thirty-five of which were identified as government-linked companies (GLCs) and which constituted 42 per cent of the total market capitalization of all listed companies in 2013.Footnote 124
GLICs have been defined by the OECD as follows:
investment companies in which the federal government has influence over the management by appointing and approving board members and senior management, who in turn report directly to the government. The government may also provide funds for operations or to guarantee capital (and some income) placed by unit holders. The Ministry of Finance or the Prime Minister's office are usually the government representatives on the board of GLICs and thereby play a role in the governance and investment decisions of these companies.Footnote 125
The Malaysian Ministry of Finance has classified seven entities as GLICs. They are the Minister of Finance Incorporated,Footnote 126 Khazanah, Permodalan Nasional Berhad,Footnote 127 EPF, KWAP, Lembaga Tabung Haji,Footnote 128 and Lembaga Tabung Angkatan Tentera.Footnote 129 The prominence of GLICs and GLCs in corporate Malaysia stands in stark contrast with the UK's vastly privatized economic landscape,Footnote 130 and encompasses sectors as diverse as the finance, media, plantations, and oil and gas, apart from the utilities sector traditionally associated with state ownership via GLCs.Footnote 131 Furthermore, GLICs play a significant role in carrying out government policyFootnote 132 and are tasked with a greater obligation to comply with government policy.Footnote 133 In this regard, they have a role in national development and the promotion of Bumiputera participation in the economy.Footnote 134 Given their key role, the state exerts control over GLICs through a variety of mechanisms, including the appointment of the boards of GLICs (eg the EPF board is appointed by the relevant minister pursuant to section 4 of the Employees Provident Fund Act 1991).
It is argued that the MCII is a crystallization of the existing practices of Malaysian institutional investors (ie monitoring and engaging with investee companies). A previous study in 2015, predating the MCII, evaluated the role of institutional investors in governing public companies in Malaysia and highlighted the non-homogeneity of Malaysian institutional investors, which consisted of GLICs and those without links to the government (eg banks and insurance companies).Footnote 135
The study noted that extreme forms of shareholder activism (ie media complaints, legal action, and cooperative actions against investee companies) were rarely utilized, with the GLICs’ size of investment often enough for them to handle pressing issues without the need to cooperate, as well as their tendency to initiate actions where issues have been raised. Critically and in summary, it was concluded that GLICs appeared to be the only type of institution which performed a control role in agency conflicts with regard to the governance of the company, as compared with non-GLICs which were more likely to sell off their investments in the open market if any of their investment criteria were impinged on, especially those concerning financial performance,Footnote 136 an action which accords with the Hirschman exit and voice model.Footnote 137
Based on the foregoing, the primacy of GLICs in the corporate governance of its investee companies indicates that they are a key driving force in the development of stewardship in Malaysia, as compared to the UK. Consistent with findings from earlier studies, there is little visible support for the MCII among non-government-linked institutional asset owners such as banks and financial institutions as well as non-government-linked asset managers.
The emergence of the UKSC and MCII can be traced back to industry sponsored guidelines, as Part II of this article illustrates. However, where the UKSC was placed under the aegis of the FRC to strengthen its mandate, the MCII's origins and subsequent development was consciously tagged to industry and intended to be driven by the institutional investors themselves rather than the regulators. Further, it must be noted that in the case of Malaysia, what constitutes industry is inextricably linked to the state by means of its ownership and control of these GLICs and GLCs, in contrast with the more clear-cut distinction between the state and industry in the UK. Although both codes had common origins, it is argued that the decision to situate institutional investor stewardship under the purview of industry in Malaysia, together with the contextual factors in operation, have led to markedly different outcomes with respect to stewardship.Footnote 138
Therefore, with regard to Malaysia, the breadth and depth of state ownership and control in GLICs and GLCs as asset owners and asset managers is essential in evaluating the realization of institutional investor stewardship which seeks to deliver sustainable long-term returns for clients and/or beneficiaries, primarily because the performance of the GLICs is not merely an outcome of business decisions, but also reflects their relationship with the state.Footnote 139 This in turn raises a critical question as to whether the interests of the state are aligned with those of the asset owners, the asset managers, and more importantly, those of the ultimate beneficiaries or clients at the end of the investment chain (ie the agency conflicts between these parties, as contrasted with the typical conceptualization of agency conflicts concerning managers-shareholders and majority-minority shareholders which were detailed in Part I above).
There is presently a global focus on the 1MDB scandal, in which a non-listed GLIC was implicated in gross financial misconduct to the tune of US$4.5 billion, leading to the arrest of the former Prime Minister of MalaysiaFootnote 140 and the purchase of Tun Razak Exchange by Lembaga Tabung Haji, which has been criticized as a bailout of 1MDB in view of its position as an underperforming asset.Footnote 141 Nevertheless, it is worth noting that Malaysian GLICs and GLCs have carried out various controversial corporate actions from as long ago as the 1980s,Footnote 142 evidencing the existence of agency conflicts between GLIC asset owners and ultimate beneficiaries where the GLICs are driven by factors other than those of promoting the interests of the ultimate beneficiaries. This includes the act of taking RM1.5 billion from EPF to fund a housing scheme implemented by the Federal Territories Minister despite not consulting the EPF board of employees representative beforehand.Footnote 143
Thus, it is submitted that apart from concerns about the quality of stewardship statements and ownership engagement of institutional investors which are common to both the UK and Malaysia, structural issues such as the prevalence of the state in the ownership and control of GLICs and GLCs represent an embedded factor which significantly affects stewardship practice and effectiveness in Malaysia.
V. REFLECTIONS AND LESSONS FROM THE UK AND MALAYSIAN EXPERIENCE: THE NEED FOR A DEEPER LOOK
Institutional investor stewardship is currently at a crossroads. Unlike corporate governance, which has developed a firm conceptual basis and practical application via codes and its incorporation into listing requirements, stewardship is still very much at an evolutionary stage, especially in view of the Carillion debacle in the UK as well as the nascent development of stewardship in Malaysia described earlier in this article.
On a philosophical level, the concept of stewardship itself has been criticized as ‘dangerous and misguided’ in its characterization of shareholders as blameless and passive in the global financial crisis.Footnote 144 Other commentators indicate that stewardship's failings in the UK are a function of the relatively low level of equity held by domestic institutional investors in UK listed companies today.Footnote 145
Although the original intention of the Walker Review was to provide more clout to the UKSC by making it a regulator/quasi-regulator sanctioned code rather than an investor-led code,Footnote 146 the UKSC still retains its character as soft law. Similarly, the MCII is decidedly a form of soft law, reflecting the SC's original intention for the formation of an industry-led stewardship and umbrella body to represent institutional investor interests. The soft law nature of these codes is further bolstered by the ‘comply or explain’ approach found in the UKSC, which has been described by earlier writers as a limitation on the UKSC's effectiveness,Footnote 147 or the even softer nature of the MCII which was elaborated on earlier in this article.
Notwithstanding the broader debate about whether shareholders are a positive or negative force in relation to the corporate governance of their investee companies, this article views the concept of stewardship as one of limited effectiveness, as it is unable to address the agency conflicts between asset owners, asset managers, and the ultimate beneficiaries or clients of the asset owners. Although Part I of this article noted the presence of agency conflicts in both dispersed and concentrated ownership scenarios between management and shareholders, agency conflicts within the investment sphere have received relatively less attention in the literature.
In this regard, research in the US context may be instructive. A study conducted by Bebchuk, Cohen, and Hirst in 2017 showed that agency problems exist between investment managers and their beneficial investors, regardless of whether the investment managers were actively managed funds or passive index funds.Footnote 148 Among the sources of the agency problems is the fact that investment managers bear the costs of stewardship activities but only capture a small fraction of the benefits they create.Footnote 149 Investment managers are unable to charge personnel and other management expenses arising from stewardship matters directly to their portfolios by law; payments to cover such expenses would then be taken from fees received from investors while the benefits from stewardship would flow to the portfolio.Footnote 150
A further significant source of agency problems in the separation between investment managers and beneficial owners is the bearing of private costs from taking positions which are against corporate managers.Footnote 151 This issue is exacerbated by the fact that many investment managers provide investment services to corporations, managing both cash and short-term investments as well as the long-term investments of financial corporations such as insurance companies.Footnote 152 Empirical research has shown evidence that business ties with corporations do influence the voting decisions of investment managers,Footnote 153 thus raising the concern that investment managers would be incentivized to be pro-management in stewardship issues.
Ultimately, the foregoing analysis suggests that there is a problem with the incentives of institutional investors to spend on stewardship; thus, stewardship codes which put forward aspirations, principles, or guidelines would be likely to have less of an impact than if investment managers had appropriate incentives.Footnote 154 Given that investment management is similarly structured in most jurisdictions, in which asset owners engage asset managers to invest funds on behalf of their ultimate beneficiaries or clients, it is arguable that the same observations would apply in both the UK and Malaysian contexts. This weakness would thus lend credence to the other criticisms that have been previously levelled against the UKSC in relation to its lack of effectiveness, and vividly illustrated by the Carillion collapse and the subsequent Kingman Review.
Further, within the Malaysian context, it is submitted that the stewardship aspirations of asset owners pursuant to the MCII may not be effective in addressing the agency conflicts between them and the ultimate beneficiaries, as the oversight of the GLICs and GLCs by the Ministry of Finance via the Minister of Finance Incorporated allows controlling shareholders to secure political and business benefits from the GLICs and GLCs.Footnote 155 The further lack of incentives to prioritize the interests of the ultimate beneficiaries or clients over those of controlling shareholders may also be attributable to the lack of security of tenure with regard to the managerial teams of GLICs and GLCs, wherein the Minister of Finance has the prerogative to remove them at will.Footnote 156
It is noted that the argument above has a decidedly state-centric slant, which may prompt questions about the position of non-state asset owners. To this end, it is agreed that non-state asset owners may not be subject to the particular structural issues that affect the incentives of GLICs to act as stewards. However, as indicated by the list of signatories to the MCII, the participation of non-state linked entities has been scant. This observation is consistent with the intervention patterns of non-state linked asset owners, and points to a need to find ways to encourage them to play a more active role in engaging with investee companies for the benefit of their beneficiaries or clients. Given that Malaysia has opted to adopt an industry-led approach rather than a regulatory-sanctioned one, it would thus fall on the IICM to influence practices among Malaysian institutional investors, which may not have the same reach as a regulator-backed code.
While policymaker and industry efforts in Malaysia have been commendable in seeking to systematize institutional investor engagement and advocacy via the introduction of the MCII and the IICM, the structural issues referred to earlier still remain a major hurdle to meaningful and significant engagement on the part of institutional investors.Footnote 157 Therefore, it would bode well for the state and policymakers to evaluate and address these issues to create a fertile environment for the development of a responsible and engaged institutional investor community. While the UK's struggles in the area of stewardship have led many to call for enforcement to have a greater bite and a strengthened regulatory backing, Malaysia may not need to tread a similar path if such reforms are undertaken in tandem with the IICM's initiatives and outreach.
VI. CONCLUSION
Based on the foregoing discussion, both the UKSC and MCII have a high level of functional similarity, which indicates the possibility of convergence. Nevertheless, the underlying agency conflicts between asset owners, asset managers, and ultimate beneficiaries or clients within the investment chain may not be addressed by stewardship codes per se. Moreover, an analysis of the composition and type of signatories to the MCII, as viewed against the background of the entrenched practices and systemic factors, raises the issue of structural constraints affecting stewardship in Malaysia.
From a broader perspective, it is important to ensure that apart from incentivizing the take-up of stewardship codes which are fundamentally voluntary, the development of a long-term and sustainable approach to investments is put in place. Apart from a focus on the overarching structures governing asset owners and asset managers, structural support also includes addressing the role of the individual beneficiary or client to drive demand for better stewardship. In a world that is driven by numbers and financials, the push towards stewardship should not only emanate from the regulator and industry, but also from beneficiaries or clients who can create an impetus for change. In tandem with the growing democratization and empowerment of individual shareholders, perhaps the time has come for a deeper examination into the exercise of individual shareholder rights as a form of check and balance against the actions or omissions of institutional investors.
