The Kay Review Department for Business, Innovation and Skills. London, EC2N 2DL

Transcription

1 The Kay Review Department for Business, Innovation and Skills Spur 2, Floor 3 1 Victoria Street London SW1H 0ET BLACKROCK 12 Throgmorton Avenue London, EC2N 2DL London, 18 November 2011 Dear Sirs, We are grateful for the opportunity to comment on the Kay Review's Call for Evidence. Our responses to the individual questions posed in the consultation follow. We take this opportunity to summarise our main views below. BlackRock is a significant long-term investor in the UK equity market: passive investment is long-term by definition; and BlackRock s active investors are also, overall, long-term in approach. We provide data on two of our flagship UK active equity strategies as evidence of this. Several factors explain our approach. The investment horizons set by our clients as well as BlackRock s fees and compensation structures all encourage a focus on the medium to long-term. As important is the fact that, over the medium to long term, the present value of a company's future cash flows is the single most dominant factor influencing share price performance. This ensures a focus on the underlying competitive strengths of individual companies. BlackRock believes that corporate governance is an integral part of the asset manager s fiduciary duty to enhance the value of our clients assets and to ensure management are running the company in the best long-term interest of shareholders. BlackRock is broadly in line with the recommendations of the UK Stewardship Code, specifically those around disclosure and transparency recommendations. We define stewardship as protecting and enhancing the value of the assets entrusted to us by our clients. A subtle but important distinction exists between this and the stewardship responsibilities of board of directors and company executives, namely to protect and enhance the value of the company over time. As shareholders, our stewardship responsibility is to our clients. Yet we perceive a widespread belief that stewardship implies that shareholders have a responsibility to engage with companies and make them better. This confuses the two responsibilities. Sometimes fulfilling our stewardship responsibilities to clients will involve engagement with companies; other times it will necessitate selling or reducing a shareholding if we cannot protect our clients interests through engagement, which should not be seen as a derogation of our duty, but a fulfilment of it. BlackRock considers that the increasing fragmentation of UK share ownership poses a real issue for the quality of engagement. We believe that investors are less likely to be influential where a company's ownership structure is highly fragmented which is often the case for Britain's largest companies. We are supportive of industry bodies playing a greater role in collective engagement. We 1

2 also call for the establishment of a code of conduct for engaging collectively and a European Corporate Governance Forum to advance practices across Europe. Finally, we have highlighted a number of regulatory initiatives that we fear will reduce investment and / or long-term investment in the UK equity market. **** We appreciate the opportunity to address and comment on the issues raised by this Call for Evidence. We are prepared to assist the Department for Business, Innovation and Skills in any way we can, and welcome continued dialogue on these important issues. Please contact either of the undersigned if you have comments or questions regarding BlackRock s views. Sincerely, James Macpherson Managing Director Co-Head of UK Equities +44 (0) james.macpherson@blackrock.com 12 Throgmorton Avenue London, EC2N 2DL Amra Balic Director Corporate Governance & Responsible Investment +44 (0) amra.balic@blackrock.com 12 Throgmorton Avenue London, EC2N 2DL Joanna Cound Managing Director Head of EMEA Government Affairs & Public Policy +44 (0) joanna.cound@blackrock.com 12 Throgmorton Avenue London, EC2N 2DL 2

3 BlackRock is one of the world s preeminent asset management firms and a premier provider of global investment management, risk management and advisory services to institutional and retail clients around the world. As of 30 September 2011, BlackRock s assets under management totalled 2.46 trillion across equity, fixed income, cash management, alternative investment and multi-asset and advisory strategies including the industry-leading ishares exchange traded funds. Through BlackRock Solutions, the firm offers risk management, strategic advisory and enterprise investment system services to a broad base of clients with portfolios totalling more than 7.35 trillion. Our client base includes corporate, public, multi-employer pension plans, insurance companies, thirdparty and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals. BlackRock represents the interests of its clients by acting in every case as a fiduciary. It is from this perspective that we engage on all matters of public policy. BlackRock supports regulatory reform globally where it increases transparency, protects investors, facilitates responsible growth of capital markets and, based on thorough cost-benefit analyses, preserves consumer choice. BlackRock is a member of European Fund and Asset Management Association ( EFAMA ) and a number of national industry associations 1 reflecting our pan-european activities and reach. 1 Association of British Insurers (ABI), AFG, Assogestioni, ASF, ASIP, BVI,DUFAS, Eumedion, Financial Reporting Council (FRC), Irish Association of Fund Funds (IAPF), Irish Funds Industry Association (IFIA), Investment Management Association (IMA), Inverco, National Association of Pension Funds (NAPF), and Swiss Foreign Banks Association (SFA). 3

4 BlackRock: Response to the Call for Evidence of the Kay Review of UK Equity Market and Long-Term Decision Making 1) Whether the timescales considered by boards and senior management in evaluating corporate risks and opportunities, and by institutional shareholders and asset managers in making investment and governance decisions, match the time horizons of the underlying beneficiaries. The timescales considered by institutional shareholders and asset managers in making investment and governance decisions depend primarily on the investment approach, that is whether it is passive or active. Passive Investment Passive investment is by definition long-term, as investors in indices are permanent owners. Passive investors typically take their corporate governance responsibilities seriously as this is the only way in which they can improve the sustainability of long-term earnings for their clients. Many institutional investors regard passive investment as their core holding; and directional evidence shows that the share of UK equity assets managed passively is significant and increasing. Passive mandates across all asset classes, for example, have continued to gain momentum amongst UK institutional investors, from 20% in 2006 to 38% in 2010 according to the Investment Management Association (IMA). In the same vein, the 2011 report of the Greenwich Associates indicates that UK institutional investors elected passive management for 38% of their UK equity holdings in UK equity mutual funds have followed a similar trend towards greater passive management. Comprehensive data for the whole of the UK equity market remains, however, elusive, as we are unable to find information on passive and active investment in UK equities held by non UK institutions. Active Investment BlackRock s active investors are also, overall, long-term in approach. Active portfolios typically invest in fewer companies than are represented in an index. The fund manager is therefore selecting those companies that he or she believes has the best prospects over the long-term. Active UK large cap portfolios will focus on corporate performance over rolling periods of one to two years. Active UK small and mid-cap investment managers typically have holdings of 10% to 15% or more of a company and take a 3 to 5 year investment view. Figure 1.1 on the following page shows that the average holding period of UK stocks in BlackRock s UK All Cap Core portfolio is around 4 years. Figure 2.2 shows the average holding period of UK stocks in BlackRock UK Specialist Fund to be increasing over time to reach more than 5 years in BlackRock defines the age of each stock within a portfolio by how long its shares have been held, time-weighted, on a LIFO (last in, first out) basis and uses the portfolio weights to get a weighted average age for the portfolio. BlackRock s data is consistent with the conclusions of a recent IMA survey which showed that the average holding period of UK stocks by its members was at least four years. The IMA s examination of UK stamp duty substantiates this further. The statistics cover all investors in UK equities, not just UK investment managers, and point to an average holding period of between 30 and 48 months depending on the year of analysis. We believe that it is important to understand fully investment management incentives and commend the focus of the Kay Report on this. Various papers state that active investment managers churn assets to the detriment of the end investor. This is to misunderstand our incentives. An asset manager s profitability derives from the assets under management (AUM) and the net asset value (NAV) of those assets. The AUM depends, in part, on consistently superior investment management and on the quality and length of the client relationships. Unlike banks, asset managers do not earn a spread on transactions. Churning increases transaction costs, which in turn, reduce performances and consequently results in reducing our clients AUM and hence our revenue. The investment managers and clients interests are thus aligned. 4

5 Years Years Furthermore, UK stamp duty exacerbates the cost of trading. For those investment managers that have to invest in UK companies (according to their investment guidelines), stamp duty creates an incentive to hold stock for as long as possible to avoid paying stamp duty. Figure 1.1 UK All Cap Core Equity Source: BlackRock data Figure 1.2 Focus on UK Specialist Source: BlackRock data The time horizon of the underlying beneficiaries tends to be long-term in nature. However, in achieving long-term performance, the intermediary may make decisions on a shorter time frame. Pension fund trustees generally review investment managers on a 3 to 5 year horizon, driven in part 5

6 by regulation and accounting rules. The asset allocation fund selector may rotate between small and large cap funds and growth and value strategies depending on the economic cycle, seeking to achieve consistent long-term performance for the end client. 2) How to ensure that shareholders and their agendas give sufficient emphasis to the underlying competitive strengths of the individual companies in which they invest BlackRock believes that the correlation between share prices and earnings over the longer term coupled with our client s investment horizons ensure a focus on the underlying competitive strengths of individual companies. We would appreciate more clarity on the definition of sufficient in this context, however, as it is problematic to ask shareholders to take into account a company s competitive strengths irrespective of the macroeconomic and market conditions. The investor s decision is based on a number of factors. They give weight to company specific factors such as its competitive strengths (financial performance, growth prospects, strategy, management quality and competitive position) and to specific decisions made by the company (for example a management or strategy change, capital allocation, acquisitions and divestment). However, investment decisions on a short to medium term also reflect macro factors such as market conditions, the macro-economic environment and country risk. The present value of a company s future cash flows is the primary driver of its share price in the medium to longer term but macro drivers and market sentiments also impact a company s stock price over the short-term. Figure 2.1 below shows minimal correlation between earnings and share price exists over a one-year investment horizon, but over the medium to long-term, the correlation increases significantly to become the single most dominant factor influencing share price performance. Figure 2.1 Earnings Predictive Power of Returns FTSE 100 Source: BlackRock data The investment horizons set by our clients as well as BlackRock s fees and compensation structures all encourage fund managers to focus on the medium to long-term. Client investment horizons Clients typically review performance and other objectives on a quarterly and annual basis. However, their investment decisions tend to be based on three to five year performance and on the stability of the investment team and process. Most institutional investors seek performance over three and more years, for example, and assess managers on that basis, not around short-term apparent gains. Similarly, the main requirement to have a top selling retail fund is the top quartile performance over 6

7 three and five years. Clients typically perform full strategic reviews of the manager every three to five years through and formal Request for Proposal (RFP) and tend not to switch managers more frequently than that. Transparency is critical in ensuring both investment manager and client understands the time horizon of a particular strategy and the risk-return profile. For segregated mandates, the Investment Manager Agreement (IMA) details customize guidelines to reflect the client s objectives and risk tolerances for a given mandate. For pooled investments, the Key Investor Information Documents (KIIDs) include clear language in the Objectives and Investment Policy section addressing the investment horizon of the fund. For example, ishares FTSE 100 states, The Fund may not be appropriate for investors who plan to withdraw their money within 5 years. Fee and compensation structure BlackRock s revenues are maximised by the development of long-term relationships and the delivery to our clients of superior and sustainable long-term investment performance. Fees and fund manager compensation are designed to move in line with the performance received by the investor. Clients pay fees based on a percentage of assets under management and, in certain cases, a performance fee, which coupled with high water marks, ensures that such fees are paid only for the direct returns over the life of an investment. The majority of BlackRock s fees well over 90% - derive from the amount of AUM (rather than from performance fees) and are therefore directly linked to BlackRock s ability to attract and retain investors. Similarly, for non-passive equity managers, BlackRock s performance assessment for remuneration purposes is in all cases based on performance over an extended period (85% linked to performance 3 years and longer). Further information on our approach to compensation is detailed in the response to question six. 3) Whether the current functioning of equity markets gives sufficient encouragement to boards to focus on the long-term development of their business A strong correlation exists between an individual company s equity returns and its earnings over a 10 year horizon. Nevertheless, as we have demonstrated in our response to question 2 above, little correlation exists over shorter time investment horizons. It is the responsibility of the board to set a long-term view on the fundamental value of the company and its business. In recent years, the demand for greater disclosure, such as quarterly reporting and the operating review, has helped boards to communicate better their long-term strategic objectives. However, quarterly reporting does increase news flow and potentially attracts undue focus on shortterm developments that may have little material impact over the longer term. Too frequent disclosure can make the market lose sight of the longer term objectives and judge the company on its short-term achievements. This, in turn, might make it more difficult for boards to focus on the long-term development of their business. Figure 3.1 below demonstrates that between 30% and 60% of share price movements are explained by factors independent of management and that that this percentage depends on the scale of market events. In benign market conditions, the proportion of the movement in share price independent of company specific factors is closer to 30% and in stressed conditions - such as the financial crisis of 2008 and 2009 and the Eurozone crisis - it is closer to 60%. It should be noted that investment managers act as fiduciaries on behalf of their clients. They will find it difficult to take a long-term view towards highly levered companies during stressed market conditions. 7

8 Jan-89 Aug-89 Mar-90 Oct-90 May-91 Dec-91 Jul-92 Feb-93 Sep-93 Apr-94 Nov-94 Jun-95 Jan-96 Aug-96 Mar-97 Oct-97 May-98 Dec-98 Jul-99 Feb-00 Sep-00 Apr-01 Nov-01 Jun-02 Jan-03 Aug-03 Mar-04 Oct-04 May-05 Dec-05 Jul-06 Feb-07 Sep-07 Apr-08 Nov-08 Jun-09 Jan-10 Aug-10 Mar-11 Explanatory Power From Styles & Industry Exposures over the Following Month's Returns Figure % 60% 50% 40% During the Internet Bubble, style and industry exposures could explain over 60% of a stock s return. During the Junk Rally which started in March 09, style and industry exposures could explain over 60% of a stock s returns. 30% 20% 10% 0% Monthly Explanatory Power from Styles & Industries on Stock Returns 3 Month Moving Average Source: BlackRock data 4) Whether Government policies directly relevant to individual quoted companies (such as regulation and procurement) sufficiently encourage boards to focus on the long-term development of their businesses. No response 5) Whether Government policies directly relevant to institutional shareholders and fund managers promote long-term time horizons and effective collective engagement It is important to ensure the regulatory framework in place does not impede the UK s market position as a leading financial centre. We highlight the following legislations, already implemented or to be implemented by the EU, that might impede a long-term perspective: Accounting standards some standards have resulted in some long-term investors, such as insurance funds, decreasing their investment in equities in favour of bonds. Solvency II the new capital and liquidity requirements for insurance companies will make them reduce their investment in UK equities which are not considered as eligible high quality liquid assets by Solvency II. This will be detrimental to long-term investment in the UK equity market given UK insurance companies are a key source of finance for the UK companies. Institutional Occupational Retirement Provision Directive (IORPD) review the EIOPA consultation on the IORPD review indicates an intent to apply Solvency II principles to pension funds. This will reduce investments by UK pension funds in UK equities. The Confederation of British Industry (CBI) is very vocal on this issue, urging the UK government to help pension funds keep investing in the UK companies. 8

9 Quarterly reporting we would suggest further investigation into the impact of quarterly reporting might be worthwhile. Consideration might be given to whether there should be more flexibility in reporting requirements, which can be disproportionately costly for smaller companies. Investor pragmatism and engagement would ensure that the right balance is achieved between meeting shareholder expectations and not unduly burdening smaller companies. Acting in concert and mandatory bid regulations although anecdotal evidence is mixed, these regulations do seem to deter certain investors from cooperating in their engagements with companies, particularly across borders. Guidance could usefully be provided on the scope for shareholders to communicate with one another and to engage with companies collaboratively on matters of strategy, board composition and governance matters more generally within the regulations. Collective engagement is all the more important where a company share ownership structure is highly fragmented. We are supportive of industry bodies playing a greater role in collective engagement. The Institutional Investors Committee ( and its Advisory Council consisting of senior investment professionals (BlackRock s James Charrington is a member of the Council) has a role in providing a mechanism for collective engagement with companies where necessary. We are also supportive of the ABI and NAPF case committee processes by which they coordinate an engagement involving those members who are interested in engaging collectively with a company. BlackRock would support the establishment of a code of conduct or modus operandi for engaging collaboratively so that all parties have a common understanding of how shareholders and companies need to conduct themselves. Such a code should cover issues such as the rules around confidentiality of views exchanged and the respective roles of various external parties. In addition, we would support the creation of a Europe-wide Corporate Governance Forum through which we convene meetings of major institutional investors and asset managers interested in governance and engagement. Experiences and lessons learned could be taken back to domestic markets to advance practices across Europe. Concentration of holdings by Market Capitalisation We believe that investors are less likely to be influential where a company s share ownership structure is highly fragmented which is often the case with Britain s largest and most systemically important companies. In contrast, small and mid-cap companies with concentrated ownerships have to compete harder to attract investors and are often more interested in the views of their shareholders. The charts below show the average percentage of shares held by the top 10 institutional holders, broken down by market cap buckets. Figure 5.1 shows the breakdown by market value, with the market cap of each bucket equal and representing approximately 10% of the value of the whole market. Figure 5.2 shows the buckets broken down by market cap decile with an equal number of stocks per bucket. 9

10 Figure 5.1 Source: BlackRock data Figure 5.2 Source: BlackRock data 10

11 Companies in the FTSE All Share Figure 5.3 shows the proportion of shares held by the top 10 institutional holders is largely skewed. Around 33% of the FTSE All Shares companies are more than 50% owned by the top 10 institutional holders showing the significant influence that these holders may have. Around 80% of the FTSE All Shares companies are 33% owned by the top 10 institutional holders. Figure 5.3 Distribution of the ownership of the FTSE All Shares 16% 14% 12% 10% 8% 6% 4% 2% 0% 0 to 5 5 to to to to to to to to to to to to 65 Percentage of Company Owned by Top 10 Institutions 65 to to to to to to to 100 Source: BlackRock data Tax regulations - We would suggest that governments need to review their tax structures to ensure that long-term investors are not unduly penalised but rather encouraged to invest. Stamp Duty in the UK Stamp duty in the UK resulted in a shift from cash equity investment to investing in Contracts for Difference (CFD). As swap volume and spread betting increases as a proportion of turnover, the link between investors and shareholder registers breaks down and become confused. CFD investors obtain the economic rights, but not the legal privileges that come from direct ownership of shares themselves, nor do such investors have a say in corporate governance. Stamp duty also causes a performance drag and has a detrimental impact on the share price. The Financial Transaction Tax (FTT) The FTT proposal, if passed, will introduce a tax on all financial transactions creating unintended investment incentives and undermining sound investment management principles. Active portfolios will be forced to take higher levels of risk and/or invest to a greater extent in derivatives in order to deliver the same level of return to clients. This tax will discourage corporate governance if investment managers invest less in equities and more in derivatives as a result of its bias in favour of derivatives. 11

12 6) Whether current legal duties and responsibilities of asset owners and fund managers, and the fee and pay structures in the investment chain, are consistent with these long-term objectives? Investment managers are hired by clients to invest assets on their behalf. In this role, asset managers act as fiduciaries and agents, investing within the guidelines specified by their clients for a given mandate. The client decides the specific time horizon and risk-return objectives of individual mandates. Responsibilities of investment managers acting as fiduciaries are well defined and understood. As a result, investment managers act to protect the long-term interest of their clients. The Investment Management Association has developed an industry wide standard Investment Manager Agreement (for segregated mandates. The Investment Manager Agreement outlines the managers legal duties and responsibilities to their clients. Some areas covered in the agreement are: Provision of services (Investment Discretion, Nature of Investments and Risk Disclosures, Uninvested cash, Securities Lending, Borrowing and Overdrafts etc.) Material Interests (Conflicts of Interest and Disclosures, Disclosure of Manager s Dealing Arrangements) General (Disclosure of Fees, Charges, and Other Payments, Taxation, Liability of Manager, Termination of Agreement, Custody, Confidentiality and Data Protection etc.) Individual managers can further customise the agreement based on specific guidelines and restrictions agreed between the manager and the client such as exclusions of certain sectors/ individual stocks or adherence to a specified level of risk. BlackRock believes that corporate governance is an integral part of the asset manager s fiduciary duty to enhance the value of our clients assets and to ensure management are running the company in the best long-term interest of shareholders. In observance of our fiduciary duties to our clients, we: (i) engage with companies we invest in on a number of corporate governance and performance related issues; (ii) vote at shareholder meetings (for those clients who have given us a legal right through the Investment Management Agreement to vote on their behalf) year-to-date, BlackRock has voted in 699 annual and extraordinary general meetings in the UK and 14,110 internationally; and (iii) engage on wider policy issues that are in our view fundamental to protection of investors and their rights as shareholders. For our part, we define stewardship as protecting and enhancing the value of the assets entrusted to us by our clients. A subtle but important distinction exists between this and the stewardship responsibilities of board of directors and company executives, namely to protect and enhance the value of the company over time. As shareholders, our stewardship responsibility is to our clients. Yet we perceive a widespread belief that stewardship implies that shareholders have a responsibility to engage with companies and make them better. This confuses the two responsibilities. Sometimes fulfilling our stewardship responsibilities to clients will involve engagement with companies; other times it will necessitate selling or reducing a shareholding if we cannot protect our clients interests through engagement, which should not be seen as a derogation of our duty, but a fulfilment of it. We believe that BlackRock s approach to compensation correctly incentivises investment managers to focus on medium and long-term performance. BlackRock s approach to compensation reflects the value senior management places on its clients, employees and shareholders. Consequently, the compensation structure has been designed to align with client and shareholder interests, to reflect performance, to facilitate employees sharing in BlackRock s success, to attract and retain the best talent and to reinforce stability through the organization. The predominant compensation model includes a salary and a discretionary bonus reflecting firm, business area, and individual performance. For most investment professionals, compensation reflects investment performance and the success of the business or product area. Total variable employee compensation (i.e. BlackRock s bonus pool) is paid out annually from revenues actually received by the asset manager during the prior year. As indicated above, given the nature of BlackRock s revenue stream, these revenues inherently reflect longer term performance. Variable compensation deferred from annual bonus awards is paid out in BlackRock s stock which vests over three years (with the first tranche falling due one year after grant). Variable compensation 12

13 will therefore reduce in value if the value of BlackRock stock falls during that period. The value of BlackRock. Inc. stock is a good indicator of the long-term performance of the firm and the funds it manages. In addition, a percentage of manager s annual bonus awards are redirected into the funds that the manager manages further aligning the interests of the manager and clients. The effect of the deferred awards is to ensure that employees variable remuneration reflects performance over a period of at least 4 years from the end of the financial year. For portfolio managers whose performance is assessed over 3 to 5 year periods, this means that their final remuneration may reflect performance over a 7 to 8 year period. 7) Whether there is sufficient transparency in the activities of fund managers, clients, and their advisors, and companies themselves, and in the relationships between them BlackRock supports transparency where it protects our clients, facilitates responsible growth of capital markets and preserves client choice. We believe that general business activities and the industry s interactions with regulators (FSA in the UK) demonstrate commitment to ensuring a sufficient level of transparency of manager activity. These activities and interactions include, but are not limited to: Treating clients fairly (TCF) Fund governance and providing adequate disclosure of brokers Product development process Interaction with the local regulator regarding all new products Prospectuses for all retail funds and IMA agreements for all segregated accounts Client Asset Sourcebook (CASS) requirements Further, European Union Directives, such as MiFID, require fund managers to operate and publish policies on dealing with conflicts of interest. Conflicts of interest arise between the clients, the firm and its clients and the firm s staff and its clients. The emphasis is on identifying potential conflicts and on avoiding and managing conflicts as and when they do arise. Disclosure is also important. Our conflicts of interest policy is made available to clients before we enter into contract negotiations. BlackRock is broadly in line with the recommendations of the UK Stewardship Code, specifically those around disclosure and transparency recommendations. As per the UK Stewardship Code, BlackRock s publicly discloses on our website the Global Corporate Governance and Engagement Principles, as well as our market-specific voting guidelines. In these we explain our philosophy on stewardship (including how we monitor and engage with companies), our voting policy, our integrated approach to stewardship matters and how we deal with conflicts of interest. The same document covers our approach to reporting to clients. Although we use a different terminology to that in the Code, we address most of its guidance either in the Principles, which are applied internationally, or our market-specific voting guidelines. We also disclose our voting publicly each year in a filing with the US Securities and Exchange Commission, which is posted to our website. More specifically, BlackRock maintains policies and procedures that are designed to prevent undue influence on BlackRock s proxy voting activity that might stem from any relationship between the issuer of a proxy (or any dissident shareholder) and BlackRock, BlackRock s affiliates, a fund or a fund s affiliates. Some of the steps BlackRock has taken to prevent conflicts include, but are not limited to: BlackRock has adopted a proxy voting oversight structure whereby the Corporate Governance Committees oversee the voting decisions and other activities of the Global Corporate Governance Group, and particularly its activities with respect to voting in the relevant region of each committee s jurisdiction. The Corporate Governance Committees have adopted Guidelines for each region, which set forth the firm s views with respect to certain corporate governance and other issues that typically arise in the proxy voting context. BlackRock s Global Corporate Governance Committee oversees the Global Head, the Corporate Governance Group and the Corporate Governance Committees. The Global Corporate Governance Committee conducts a review, at least annually, of the proxy voting process to ensure compliance with BlackRock s risk policies and procedures. BlackRock maintains a reporting structure that separates the Global Head and Corporate Governance Group from employees with sales responsibilities. 13

14 In certain instances, BlackRock may determine to engage an independent fiduciary to vote proxies as a further safeguard to avoid potential conflicts of interest or as otherwise required by applicable law. Finally, we support disclosure standards that require all companies to provide sufficient information for shareholders and others to assess the merits of the approach taken to corporate governance. We also support disclosure by all those investing on behalf of others (i.e. asset managers, pension funds and other institutional investors) to set out their approach to active shareholder engagement including their: approach to using rights attached to shareholdings (e.g. voting), approach to other shareholder responsibilities (e.g. engagement), and approach to responsibilities to clients (e.g. managing conflicts, reporting on activities). These standards should be consistent across Europe to allow comparison between companies. 8) The quality of engagement between institutional investors and fund managers and UK quoted companies, and the importance attached to such engagement, building on the success of the Stewardship Code BlackRock s fundamental equity portfolio managers and the Corporate Governance and Responsible Investment team monitor and, when appropriate, engage with investee companies. BlackRock views engagement as an important investment activity as it gives us the opportunity to improve our understanding of investee companies and their governance structures and to better inform our voting and investment decisions. Engagement also allows us to share our philosophy and approach to investment and corporate governance with issuers and enhance their understanding of our objectives. We view engagement as the continued consideration of Environmental, Social and Governance (ESG) factors once we have made an investment in a company. We prefer to engage with companies rather than exclude them from our investment universe because investors have influence and access. The context for our engagements is to sustain and improve economic performance. The CGRI team collaborates or consults with fundamental portfolio managers who have market-, sector- and company-specific expertise. We assess each company s case on its merits and are pragmatic unless we believe that an immediate response is requires. We focus our efforts on what we consider to be material to the longterm sustainability of the company concerned. Engagement covers a spectrum of activity including: voting at general meetings of shareholders; telephone conversations with management to clarify / explain a particular issue; letters to set out specific concerns or our stance on an emerging trend for the board; meetings to exchange views with management or board members; a series of meetings over an extended period to achieve fundamental change. Our approach to engagement has long been one of having a private dialogue with companies, setting out our views and any concerns and discussing ways these could be addressed. Where we have sizable holdings we believe it is even more important to engage in a discrete manner and to build relationships with companies that will enable us to effect change when necessary Our approach is explained in our Global Corporate Governance and Engagement Principles and our UK voting guidelines. Although we might occasionally attend general meetings of investee companies, we do not attend a significant number of AGMs as we believe we serve our clients interests better by dedicating our time to one-to-one meetings. 9) The impact of greater fragmentation and internationalisation of UK share ownership, and other developments in global equity markets, on quality of engagement between shareholders and quoted companies While we have seen a rise in engagement activities by investors over the last months, increasing shareholder fragmentation is potentially problematic. It can be further exacerbated by acting in concert rules which can discourage cooperation between investors who interpret the rules 14

15 conservatively. This cooperation is crucial particularly for investors with smaller holdings as acting collectively can enhance their effectiveness. As explained in our UK voting guidelines, when we believe it is likely to enhance our ability to engage with a company, and it is permitted by law and regulation, BlackRock will work with other investors. To that end, BlackRock is an active member of nearly 40 formal groups and initiatives internationally that facilitate communication between shareholders and companies on corporate governance and social, ethical and environmental matters. We will also engage collectively on matters of public policy. Internationalisation is we believe less of a concern. Large global investment managers tend to have a local presence in the UK and to be active in corporate governance. Smaller international managers and those institutional investors who see a benefit in engagement will in our experience do so, possibly through connections with local investors, 10) Likely trends in international investment and in the international regulatory framework, and their possible long-term impact on UK equity markets and UK business BlackRock believes it is important to ensure regulatory framework does not impede the UK s market position. We have highlighted below eight initiatives that will impact UK markets, some potentially negatively. According to the most recent ONS Share Ownership Survey (2008), UK pension funds and insurance companies held approximately 26% of the UK equity market in 2008 down from 41% in A number of initiatives below is likely to accelerate this trend. Finally, as investing becomes more international, the importance of local stock exchanges diminishes. The UK stock market is the third largest in the world (FTSE), but the UK may struggle to continue to attract issuers. Ultimately, stock exchanges will all deliver 24 hour trading. We must ensure that the UK stock exchange remains competitive/ attractive through this evolution. Initiative & Aim Possible Impacts on Equity Solvency II IORPD Revision Foreign Account Tax Compliance Act (FATCA) Combat tax evasion by US taxpayers by forcing non-us financial institutions to identify and report US account holders to IRS. Financial Transaction Tax (FTT) A tax to curb financial speculation and regulate shadow banking. Negative Will reduce the extent that insurance companies can invest in UK shares. Insurance companies will have to invest more in cash and bonds to the detriment of equities. Insurance companies could be forced to sell shares to get cash in period of stress. Negative The application of Solvency II principles to pension funds will also be detrimental to the UK equity market: The requirement for pension funds to have a holistic balance sheet will discourage pension funds to invest in UK equities. Negative Will hurt segregated and pooled funds globally If institutions fail to comply, then the entity receives a 30% gross proceeds reduction. May lead to greater division of product ranges between US and non-us investors. Negative Will hit performance significantly, both directly and indirectly. Current proposal will make some investment strategies typically invalid. 15

16 Active managers will be forced to take higher levels of risk and/or invest to a greater extent in derivatives to protect post FTT returns (FTT is biased in favour of derivatives). Corporate Governance Commissioner Barnier convinced poor corporate governance was a significant contributor to the severity of the crisis Markets in Financial Instruments Directive (MiFID) EU Legislative framework governing market structure and investor protection. Main focuses of the MiFID Review: Investor Protection, Market Structure, Transparency Requirements, Regulation of Commodity Markets, Corporate Governance, 3rd Country Issues Short Selling Regulation aims to harmonise regulatory regime in Europe and certain aspects of CDS Market Abuse Directive Review (MAD) Intended to strengthen market abuse provisions and introduce measures allowing for effective deterrent of market abuse behaviors Positive Will encourage investment: Transparency of board positions, clearly defined responsibilities and nominating procedures Board evaluations to ensure board members have the requisite time and experience Minority shareholder protection Negative Binding vote on director remuneration Mandating a max of 3 board positions per person Gender quotas Positive The European Consolidated Tape will improve the post-trade transparency of the equity market. Negative The liquidity of the market may be impacted by: Inter alia public disclosure of pre-trade quotes Continuous liquidity provision requirement for HFTs Positive: Greater predictability and coordination of temporary ban on certain aspects of short selling Reduction of settlement failure from locate regime Negative: Restrictions on trading uncovered sovereign CDS Compliance costs from new marking regime Negative liquidity impact of the public disclosure regime Neutral/Positive Enhance powers given to regulators Ensure criminal sanction are applied, bolster the deterrent effect of sanctions for committing market abuse New focus on market abuse in algorithmic/ high frequency trading Extension of definition to include attempts/ intension to manipulate 16