The Financial Reporting Council (FRC) has said the debate on the role of proxy advisors and environmental social and governance (ESG) ratings agencies is “more complex and nuanced” than thought.

Recent research from the FRC revealed that while almost all investors use the services of proxy advisors, an increasing number (75 per cent) ask for voting research to be based on the investor’s own in-house voting policies rather than the advisor’s standard policies.

It also found that, due to limited resources, most investors will issue voting instructions based on recommendations from proxy advisors without manual intervention where the resolution is uncontroversial.

However, all investor interviewees said that they always review recommendations to vote against management and other resolutions that met certain criteria. For example, all companies above a certain size or in which they own more than a certain percentage of the shares, or with which they have previously engaged about governance concerns.

Despite this, the research suggested that while there is some evidence of correlation between negative voting recommendations and voting outcomes in FTSE 350 companies, it appears to be less extensive than is sometimes asserted.

The research also looked at the influence of ESG ratings, revealing that whilst the fear of receiving an adverse ESG rating was not a significant consideration for most companies when setting strategy to address ESG-related issues, the majority of companies felt they needed to ‘play the game’ by providing the information used by rating agencies in their methodologies, in the hope that they would receive a positive rating.

This was due to concern that investors may place reliance on the headline ratings when making voting decisions, and that the potential existed for the company to be penalised on the basis of a rating that, in their opinion, did not fairly reflect the company’s actions or performance.

Indeed, whilst most investors said that they primarily used ESG rating agencies as a source of data rather than relying on the rating itself to inform voting decisions, some investors acknowledged that their clients may place more weight on the headline ratings from the rating agencies than they do themselves.

Companies also identified a number of concerns about the data-gathering techniques used by some ESG rating agencies and data providers, in particular the use of ‘data scraping’ and controversy reports.

In addition to this, both companies and some investors raised concerns about the timeliness and timing of ESG rating agencies’ updates to their ratings and research reports, which do not always align with reporting and voting cycles, meaning that the information on which investors draw when making decisions may be out-of-date.

FRC executive director of regulatory standards, Mark Babington, stated: “There’s an ongoing debate on the role of proxy advisors and increasingly ESG ratings agencies and it’s clear from the research we’re publishing that the topic is a more complex and nuanced one that some have led us to believe.

“Proxy advisors, voting agencies, and ESG ratings agencies are an important resource for fund managers; however, there are always ways to improve engagement, stewardship, and shareholder communications for a better, more efficient, and competitive market.

“This is a timely piece of research which provides some interesting insights from our stakeholder universe on this important topic. We’re grateful to our many stakeholders for their contributions.”

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