Taking Stock: SWFs Exercise Their Rights

July 01, 2013 by Loch Adamson

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WHEN SHAREHOLDERS of Swiss mining giant Xstrata ratified the company’s September 2012 takeover by Swiss commodities trader Glencore International, they had one reluctant activist investor to thank: Qatar Holding (QH). The global investment firm, a subsidiary of the emirate’s sovereign wealth fund, Qatar Investment Authority (QIA), played a critical role in getting Glencore to agree to better terms. QH also galvanized efforts by other Xstrata shareholders, including sovereign wealth fund peers Government of Singapore Investment Corp. (GIC) and Norway’s Norges Bank Investment Management (NBIM), to lobby for better management of the combined entity.

This display of activist shareholder power wasn’t the first time that a sovereign wealth fund had exercised its right to influence a corporate takeover, but it was unusual for its high drama and protracted intensity. Most sovereign funds are still reluctant to be seen as activist investors because they don’t want their stock purchases to spark controversy and create resistance in countries where common myths about their political motivations seem to persist. Unwilling to risk reputational damage, many funds hang back, content to remain largely passive investors in listed companies.

"Most of them are still very reluctant about being in the limelight," says Simon Wong, adjunct professor of law at Northwestern University in Chicago and a visiting fellow at the London School of Economics and Political Science. "They are sensitive to their actions being misinterpreted."

But QH’s actions may signal a shift in attitude among some of the world’s largest sovereign wealth funds. Over the past two years, as these funds have begun to make more direct investments, buying sizable stakes in public and private companies, they’ve become increasingly aware of the importance of good governance in achieving positive investment outcomes. That realization has spurred some of them to become more engaged, despite their caution about being perceived as activist investors. "Few of them want to take a board seat," says Wong, "even if their stakes may be large enough to warrant asking for one."

In the Glencore-Xstrata deal, however, QH didn’t need a board seat to influence the outcome of the proposed merger, whose terms benefited all of Xstrata’s minority shareholders by the time the $76 billion deal finally closed in May 2013. In February 2012, when the deal was first announced, QH held slightly more than 3 percent of Xstrata stock, but it began buying more shares in daily transactions through mid-June, eventually accruing a 10.98 percent stake. As the firm’s position grew, QH executives made it clear that the offer on the table from Baar, Switzerland–based Glencore, which would have given Xstrata shareholders 2.8 shares of the merged entity for every share of Xstrata they owned, was too low.

Meanwhile, NBIM, the arm of the Norwegian central bank that manages the $719 billion Government Pension Fund Global (GPFG), began building its own position in Xstrata. By late-summer 2012, QH and NBIM held enough common shares between them to block the merger unless Glencore offered better terms. QH argued that Xstrata shareholders should receive 3.25 shares in the new company for each of their Xstrata shares. Although that ambitious goal was never met, after a remarkable chain of events , Xstrata shareholders ultimately received 3.05 Glencore shares for each Xstrata share.

As fearless an activist investor as QH can be, only Norway’s NBIM consistently puts corporate governance issues at the center of its investment process. In allocating funds on behalf of GPFG, NBIM has developed an extensive program that engages target companies on governance and environmental and social concerns. In November 2012, for example, it filed shareholder proposals for proxy access (which gives shareholders the right to nominate candidates for board elections on company ballot sheets) with six publicly traded U.S. companies. They include San Francisco–based brokerage firm Charles Schwab Corp.; Chicago-based global derivatives trading giant CME Group; Irving, Texas–based natural-gas and oil exploration company Pioneer Natural Resources Co.; Framingham, Massachusetts–based multinational office retailer Staples; and banking and communications group Western Union Co., of Englewood, Colorado.

The right to nominate candidates to the board of a public company is a fundamental principle of good corporate governance. Although supported by U.S. law, the process is burdensome and costly to the nominating shareholders, who must submit alternative agendas at annual meetings and distribute documentation among investors at their own cost. Proxy access simplifies things by letting shareholders put their nominees straight on the company’s agenda. The impetus for such action has only grown since the global financial crisis, which revealed that many boards of financial services firms had failed miserably in their oversight of management.

"Norway’s approach benefits GPFG and the market as a whole," says Cristina Ungureanu, a consultant at Milan-based corporate governance advisory firm Crisci & Partners and a member of the European Corporate Governance Institute.

Depending on their organizational structures, some sovereign wealth funds are better positioned than others to take hold of corporate governance issues. Singapore’s GIC and Temasek Holdings often invest directly in public and private companies, sometimes buying them outright. As a result, they’ve become savvy, well-staffed and highly motivated activist shareholders. In September 2011, for example, $157 billion Temasek installed Goh Yong Siang, its head of strategic relations, as a director of Fort Worth, Texas–based oil field service company FTS International after the sovereign wealth fund led a consortium of investors in taking a combined 70 percent ownership stake in FTS International’s owner, Frac Tech Holdings. And in May 2012, Temasek challenged London-based global bank Standard Chartered by calling for the appointment of more independent directors while abstaining from a vote for the reelection of the company’s nonexecutive directors.

GIC, which also was an investor in Xstrata, has gone beyond mere shareholder activism and now boldly questions regulators in the countries where it invests. In April 2012 the fund challenged British water regulator Ofwat, which had proposed radical changes to the way it managed licensing for all water companies. With more than £5 billion ($7.6 billion) invested in U.K. infrastructure, GIC had a particular stake in the outcome because it owns 33 percent of Kelda Group, the parent company of Yorkshire Water, one of the companies whose profits might have been hurt had Ofwat gained greater freedom to review licensing arrangements and set new price controls.

Although sovereign wealth funds are becoming more outspoken shareholders, not all of them are as brash as GIC and Temasek. Many, including QIA, still seek to strike a balance between guiding their strategic investments and making headlines. QIA, for example, has board seats at British supermarket chain J Sainsbury and German automaker Volkswagen, but it doesn’t tend to take the lead on corporate challenges. Although it fought a fierce corporate battle over better terms in Glencore’s takeover of Xstrata, it has since abstained from voting on the retention of Xstrata’s management.

Sovereign wealth funds are well aware of the reputational risks that may stem from more-direct engagement with their portfolio companies (not to mention regulators), but they’ve woken up to the importance of good governance. Companies following governance best practices make for profitable investments, and companies that ignore investors’ concerns — or are regarded as self-serving in their compensation policies — have been put on notice by the Glencore-Xstrata deal.

"The whole world is now more aware of the fact that lack of corporate governance is one of the key reasons for not investing in a company," says Monique Melis, global head of consulting at London-based regulatory and due diligence consulting firm Kinetic Partners.

Despite QH’s headline-grabbing role in Glencore-Xstrata, few sovereign wealth funds appear eager to engage in the aggressive shareholder activism practiced by some hedge funds and large pension funds. Part of their hesitation is political, but staffing challenges may also play a role, Ungureanu explains. "Some of them still lack expertise and human capital to tackle corporate governance issues," she says. "Their activism will probably never reach the levels of other traditional activist investors."

But sovereign wealth funds are among the prominent financial institutions that have the most to gain by advancing good governance practices — and keeping a watchful eye on the companies in which they invest. As true providers of long-term capital, they have the freedom to buy and hold portfolio companies for years, if not decades, and to realize the incremental gains of greater transparency and accountability.

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