There are some concerns as to whether Sovereign Wealth Funds (SWFs) will become activist shareholders because of an equivocation of the term “activist”, notes Harvard Law School Forum.
June Rhee, Co-editor of HLS Forum on Corporate Governance and Financial Regulation in the recent post dated August 7, 2014 titled: “Sovereign Shareholder Activism: How SWFs Can Engage in Corporate Governance” notes activism is linked to the increasing importance of corporate governance.
Sovereign Wealth Funds differ along many dimensions
The author notes with respect to equity investments in publicly traded firms, there are some concerns that Sovereign Wealth Funds will become ‘activist’ shareholders. The author points out there are primarily two threshold issues that need to be addressed before one develops policy responses to sovereign shareholder activism.
The author points out SWFs differ along many dimensions including the way in which they are organized, their legal status and their stated policies. As an example, the author highlights that Australia may view an investment by China’s CIC differently from an investment by Norway’s GPF-G, even if the investment is for an identical 3% interest in an Australian company.
Offensive Vs Defensive activism
Hedge funds tend to engage in “offensive” shareholder activism which is event-driven, as they agitate for changes at the company by squeezing out value that may be locked up in a subsidiary or in cash reserves.
On the contrary, the author notes, “defensive” activism as engaged by some large institutional investors would involve monitoring to ensure the firm doesn’t seek ways to force value-creating changes, but to prevent losses from mismanagement.
Thus the author notes while offensive activism is designed to produce wealth in the short to medium term, defensive activism would protect wealth in the long term. The author points out large public pension funds and even some sovereign wealth funds adopt this type of “accountability” activism.
The author points out that the difference between offensive and defensive activism is important to highlight when considering how sovereigns could engage in corporate governance.
Sovereign Wealth Funds are largely passive
The co-editor of HLS form notes most shareholders are largely passive and many Sovereign Wealth Funds may choose not to exercise their shareholder rights at all, or simply to follow any management proposal. The author notes as ‘Constrained Foreign State Investors”, Sovereign Wealth Funds “will refrain from taking an active corporate governance role in target companies in order not to generate political opposition”. As an example, the author points out a SWF that pressures a poorly-performing CEO to step down could subject its investment in the company to review and even divestment under U.S. law.
However, the author notes Sovereign Wealth Funds typically need not worry about initiating governance engagement, at least with firms that have significant institutional investor ownership. Considering they are often large but passive blockholders, SWFs can exert significant influence simply through the exercise of their voting rights.
The author points out Sovereign Wealth Funds should be as transparent as possible about how they intend to use corporate governance rights. The author suggests SWFs can publish governance and voting policies on the Internet and in annual reports to signal to the sponsor sovereign and its citizens of the quality of governance at the SWF itself.