Mapping transparency: A world tour of shareholder ID

From IR Magazine:

A prerequisite for good investor relations is knowing who your shareholders are. In an ideally transparent world, companies and investors would be able to reach out to each other for AGMs, corporate actions or simple feedback through direct communication lines. In reality, large-scale institutional ownership added to the custodial holding model make the identification process highly complex, and in most countries there is little legislation to underpin this often arduous task.

An attempt at transparency was made in the 1970s when the US introduced 13F filings, whereby funds make their holdings public every quarter. This data is then published into the Edgar repository and repackaged for the likes of Bloomberg or Thomson Reuters.

The system presents a certain number of flaws, highlights Mark Simms, CEO of London-based advisory CMi2i. First of all, funds are unhappy about their holding positions being made available not only to corporates but also to their competitors. The statement, which can be made up to 45 days after filing, is more often than not an outdated snapshot, especially if the fund has high turnover. In addition, there are variations in terms of filing for international securities, with some quarters dealing with ordinary stock and some with ADRs. If a US issuer struggles to know who owns its shares, being a non-US firm just adds to the complexity.

This is why most service providers in the arena are highly specialized geographically. ‘Having a depth of knowledge of the share register landscape and regional ownership patterns – including knowing where the bones are buried – provides 90 percent of what is typically needed to perform effective shareholder ID in a non-disclosure market,’ explains Lucas Scheer, president of New York-based LS Global, which caters mostly to Asian firms. ‘Being able to conduct an effective research campaign and targeting the appropriate institutions to contact during a short timeframe provides the rest.’

Full disclosure zones The UK legislation, created in the mid-1980s and replicated in nearly a dozen countries, aims to counter those inadequacies by giving issuers the legal right to know who has a beneficial interest in their company. The problem lies in how shares are held, Simms explains.

What appears on a company share register is the nominee, usually a custodian hired to hold shares on behalf of institutions. A global custodian may have 4,000 or 5,000 different funds as clients, and they’re not obliged to disclose more than the minimum information: what the shares are and what the account is, sometimes just in the form of a code. ‘And what you may be sitting on is not a fund at all but another layer of custody, and another…’ Simms warns.

Once you’ve gone through the custody channel, the fund identified may be a pooled account, holding on behalf of numerous different funds, a designated account or a one-on-one account. ‘Take the British Airways pension fund, for example, where money is managed internally: British Airways would be the beneficial holder,’ Simms says. ‘At Dutch pension fund APG, some of the money is externally multi-managed, which means APG is not the investment decisionmaker, so there’s no use interacting with it.’

Establishing where the vote goes can be equally challenging. ‘The votes could go to the beneficial holder, to the asset manager or to the multi-managed fund,’ Simms says. ‘They could be loaned out with a contract for difference or tied up in a prop desk, in a prime brokerage account. So you have to create this mapping table that goes through layers of complexity.’

Once the identification is done, the information has to be reconciled through the clearing houses and the layers of custody back to lists on the vote or share register, a lengthy process that at least has the benefit of being supported by a legal framework. ‘If you’re a US corporate, you can’t do any of this,’ Simms notes.

Most advisers take a mechanical approach to the analysis work by putting in place a straightforward process. ‘We make it easy for the custodians to respond to us,’ explains Alison Owers, CEO of Orient Capital, a global IR consultancy. ‘Getting the granularity is not a problem because of our methodology around it. If there’s a challenge for us as a business, it’s the demand, so we have to make sure we can maintain the quality. For the industry, the issue is often about ensuring the custodians can – and do – comply.’

How hard is it to get to the bottom of your investor base? Part two

Sitting between the fully transparent markets and the more opaque ones are a large number of countries with share registers and sometimes relevant legislation, but often no penalties to enforce them. For those jurisdictions, consultants perform shareholder ID rather than global shareholder analysis, which is possible only in countries with full disclosure laws.

‘France is one of the better countries, with the domestic funds visible on the Titre au Porteur Identifiable register, and the Nouvelles Regulations Economiques legislation, which applies to international funds,’ Simms says.

Companies in Belgium, Greece, the Netherlands, Spain and Sweden have their shares held in a domestic central securities depository, which is structured around directly registered nominee accounts. Issuers can request a list of their shareholders from the depository, some of which proactively send out regular reports to companies. Again, however, the way shares are held can compromise transparency.

In Sweden, for instance, the disclosure obligation does not extend beyond the second layer of nominee account ownership, so there is no legal way to get the name of the beneficial owner. In Italy, there is a disclosure law with no penalties, and issuers can request identification only in the context of a corporate action. In Spain, firms enjoy a daily brief from the local clearing house about trading activity in their shares – but only domestic investors are named, and intermediaries appear without mention of the underlying foreign owners.

Some visibility on international investors can be gained in Spain and Italy, where investors need to register if they want to vote at an AGM. ‘In Switzerland, where no share register is available, you have very little to work with other than filings, so that’s rebuilding the ownership structure without a map,’ Scheer points out.

In Germany, there are two different systems depending on the type of stock. ‘Companies with registered shares – usually in strategic sectors such as banking, infrastructure or industrials – can adopt the disclosure regime of Section 67, whereas bearer shares need to follow the shareholder ID route,’ Owers says, adding that the country has been more hesitant in adopting the legislation. ‘It’s a powerful tool that IR teams could really benefit from but it’s not being used as widely as it could be.’

Mainland China has a unique market structure where all shares are held in a state-controlled depository that requires both retail and institutional domestic investors to register by name. Corporates receive a monthly report on movements in their shareholder base, though investors trading through the Qualified Foreign Institutional Investor program don’t appear, as only the name of custodial intermediaries is disclosed.

Shareholder ID is a less rigorous methodology than shareholder analysis, in the sense that research is carried out top-down instead of bottom-up: the process starts with a register, then works its way through the nominees to the beneficial owners, and is finally completed with data from various information sources to bring it together in the form of an analysis. ‘There’s a challenge in ensuring all the sources you get are accurate and that you’ve got the right team in place to be able to understand, read and ultimately translate the data into really useful information for the company,’ Owers says. ‘So there’s always more of a caveat attached to it.’

Stock surveillance versus shareholder ID

In the US stock surveillance looks at movement of money through the Edgar filing mechanism and voluntary disclosure from the institutions, which are quarterly positions from the funds filed up to 45 days later. The surveillance method compensates for the time lapse by directly interrogating portfolio managers on their positions.

‘Compliance departments of most major custodian banks long ago ceased to provide bank lists or shareowner records following heightened pressure from their institutional customers to discontinue doing so,’ explains Lucas Scheer of LS Global. ‘But numerous global asset managers that we contact for share positions in our client companies have their compliance departments regularly respond to our requests if we provide proper authorization from them.’

In the UK, the equivalent of stock surveillance is daily transaction monitoring. ‘Most of our clients from the FTSE 100 run a monthly analysis,’ says Alison Owers of Orient Capital. ‘We also provide it on a daily basis for companies that may have had some interesting movements in their shareholder base and want to actively monitor it.’

Because information comes from front-office contacts and not from compliance, stock surveillance can often be viewed as an art form. ‘You can extrapolate and make assumptions but it’s not scientific, in my opinion,’ says Mark Simms of CMi2i.

How hard is it to get to the bottom of your investor base? Part three

Here is a recap of how issuers can identify their shareholders in different zones:

Fully transparent: Shareholder analysis – The legal way

Australia, Hong Kong, Ireland, New Zealand, Nigeria, Norway, Singapore, South Africa, UK

These countries have adopted a variant of the UK’s legislation based on Section 793 of the Companies Act, a law designed to give an issuer the legal right to know exactly who has a beneficial interest in its shares at a given time. A company can approach any body it thinks might be a shareholder anywhere in the world and require it to disclose its position within three working days. Noncompliance is a criminal offense that can result in a disenfranchising penalty (withdrawal of voting rights and dividend) and in some cases a buyback of shares. Based on this legal framework, advisers hired by issuers can perform accurate, disclosure-enabled shareholder analysis.

Highly to moderately transparent: Shareholder ID – Working from the register

Belgium, China, Denmark, Finland, France, Germany, Greece, India, Portugal, Russia, Spain, Sweden, Switzerland

There is relative transparency for issuers in these countries, where shares are commonly held in a domestic central securities depository. But while some countries have introduced proper laws – though often without penalties attached – others haven’t put disclosure obligations into legislation. Access to the register may require a tedious process, and identifying foreign shareholders can be difficult when only custodial intermediaries are made visible without any mention of the beneficial owner. Uncovering the names of those investors requires additional information gained through detective work.

Low transparency: Stock surveillance – Digging into the filings

Canada (National Instrument 54-101), Japan, US (13F)

US companies get information on their shareholder base via the quarterly Edgar filing made by investment funds. There is no disclosure law, so companies rely on data from the public domain and elective disclosure from a minority of non-objecting holders. Different filing rules apply for mutual funds, pension funds and insurance funds, which can lead to companies overlooking important holdings. Canadian firms are in a similar situation, although there is no filing requirement for investors. Japan is another non-disclosure country. While shares are directly registered in nominee accounts at the domestic depository, issuers have no legal recourse for requesting identification of the underlying beneficial owners. The foreign shareholders behind the nominees are often hard to uncover and shareholder ID will be a process of identifying the custodian or nominee name change made by the investor. As a result, performing shareholder ID in non-disclosure markets will rely even more on direct contact with the buy side.#

How hard is it to get to the bottom of your shareholder base? Part four

Most companies will engage in shareholder ID at least once a year when their fiscal year ends, three months prior to their annual general meeting, in order to capture the voting rights. This approach means any activist shareholders may also be identified, and any potential problematic issues or threats coming to the meeting can be overseen in advance by the board.

‘We can understand when an activist investor may be amassing a small stake and give our clients a probability as to whether [the activist is] holding a position or not, based on the ownership patterns we recognize,’ Scheer says. ‘Different hedge funds use certain prime brokers in certain markets and seeing the group of them come up and leave together is certainly one strong indication, pointing to a name that might be a threat. It’s something that’s so very nuanced and specialized that you need to be an expert in a certain market.’

About a third of Simms’ work is commissioned in the context of a transaction, be it a hostile takeover, activist attack, straightforward M&A deal, spin-off or delisting. ‘If you’re in a deal, you can have percentages making the difference as to whether it goes through or not,’ he stresses. ‘Without this forensic analysis, you can lose out on a technicality because someone hasn’t been identified. But you could need ID for as simple an event as a company moving sectors, or reaching the top of its growth curve: when that happens, all the sector or growth funds, respectively, will sell out.’

Thanks to the impact of corporate governance and initiatives such as the European Union’s newly updated Shareholders’ Rights Directive, the market should get more and more transparent for the issuer over time, Simms believes. Eventually companies may get to a point where they have a full view of their investor base.

‘That’s the golden goose, what everybody’s after,’ he says. ‘The best [others] will see is in the public domain but I wouldn’t rely on that. What they’re never going to see is who’s got it and how they’re holding it: that will only be available to the corporate itself.’

Beneficial interest: The big short

Short positions are notoriously hard to get disclosed, though there has recently been a push for more transparency about derivatives such as contracts for difference. ‘Our approach allows us to spot the clues to what could be going on behind it,’ says Alison Owers of Orient Capital, who regrets there isn’t more disclosure around short positions. ‘There are rare examples of disclosure but unfortunately, that’s not the way the legislation is set up to work right now.’

Analysis of the share register can help confirm shorting suspicions. Several institutions, especially passive investors, are renowned for lending their shares for a profit, explains LS Global’s Lucas Scheer.

‘We can tell the difference between stock lending and actual stock selling by a fund when the filing reveals a much larger position than the custodian shows in the share register,’ he says. ‘We recognize when a popular sovereign wealth fund has its shares loaned, for instance, when its shares are not fully voted at an AGM because many of them are on loan at the time of record date. It’s a matter of interpreting the patterns we see in numerous cases.’