Briefing Document / Nov. 22, 2011

Global Witness enters debate on London's listing rules in City AM

A shorter version of this article appeared in City AM

Read Risky Business report on this issue 

Zhezkazgan, Sverdlovsk, Pavlodar. Not names your average investor will have heard of, but all of them are places of operation in Kazakhstan and Russia of an ever-increasing number of companies from overseas that have listed in London and become a member of the prestigious FTSE 100 share index. The inclusion of such companies with operations in emerging economies would seem on the surface to be good for British investors – but the seemingly open door to natural resource companies from countries where corporate transparency is not held in high regard is beginning to cause increasing concern.

The LSE’s main market should represent the highest standards of corporate accountability, transparency and good governance, especially those companies in the FTSE100, not least because the pensions of millions of people are dependent on the long-term performance of London’s blue-chip index. It is vital, therefore, that minority shareholders and ordinary pension holders know how the companies they invest in are governed and who exerts control over them.

Autocratic leaders in the former republics of the Soviet Union are often able to exert undue influence on companies that originated in their countries. On the face of it, this might be attractive to investors: the backing of an autocratic president might help the company to hang onto its assets. But as recent events in Libya and elsewhere in the Arab world have shown, autocratic governments have a nasty habit of ending messily. And what happens when they do? Oligarchs who were once in favour with the last regime could find themselves out in the cold and privatisations that occurred in the wild post-Soviet years of the 90s could be re-examined – with or without justification. Companies currently in favour could be sidelined, with other now more preferred companies taking their place. The effect of this confluence of events on a company’s share price could be disastrous. As the leaders of Russia and Kazakhstan grow older with no clear path of succession, there could be some unpleasant surprises in store.

In short, there are a bundle of related risks that can affect companies operating in an environment like this and these must be addressed in a better way than current practice dictates. Yet the UK Listings Authority (UKLA) appears to have little interest in addressing this issue. Recently Marc Teasdale, the head of the UKLA, said that it was the job of shareholders to police corporate governance: “We don’t see our role as one to ensure or underwrite best practice … and nor do we have the powers to do so.” But what is the point of the UKLA if not to do this? After all, it is the UKLA which sets appropriate norms for companies intending to list in London and at the moment these norms are set too low and are ill-equipped to deal with these issues.

The LSE has been much too eager to attract issuers from developing economies and investors, equally keen to buy these shares, are placing their money-making ability ahead of concerns regarding how these companies are actually owned and run. In the case of the Kazakh mining company ENRC investors are finding out that the majority shareholders have their own ideas about how to run the company. This is why the current discussion about the size of free floats is most timely. The problem for minority shareholders is huge: small free floats lead to decisions being made without the need for EGMs, and other decisions made by the board can be overturned with ease. There is an argument for the mandatory free float size to be greater than the 25% currently proposed in order to block special resolutions – to 40% or even higher.

Yet in City AM (25 October), one of the recently dismissed ENRC non-execs, Ken Olisa, argued that the free float size was irrelevant and that a smaller float allows the minority to drive the share price down if they do not like what they see. But this is not about whether you can punish a share. Rather it is about whether it is sensible in the first place to include such companies in an index that exchange-traded and tracker funds then replicate. The greater the risk, the greater the volatility, and the more erratic an index, the less credible it becomes.

Olisa also argued that it is conformance to the UK Governance Code that should differentiate companies from the rest, not place of origin. Agreed, but institutional investors have little power to hold boards to account if shareholders can team up and oust independent board members who are asking difficult questions. Such independence and a high regard for good governance must be present when a company lists; governance is important in its own right as a key measure of risk assessment. However, the Code’s toothless ‘comply or explain’ model is unlikely to resolve such problems post-IPO.

Investors, including pension fund holders, have a right to insist on independent boards that take decisions in the long-term interests of the company, rather than being pressured by owners railroading their wishes through simply by virtue of owning the majority of the company. The UKLA should therefore assess companies that intend to list more rigorously according to their corporate governance in practice. It should also require a much higher degree of transparency about any links with political elites in places where the rule of law is weak, including publicly available verification of the company’s main shareholders. The FTSE Group should assess potential 100 companies on a case-by-case basis; those that fall short of governance norms should be allowed to list but prevented from joining this index, or removed if they are already a member.

This is a question that will become increasingly pertinent as more former Soviet companies turn to London as a place to list. We therefore have to ensure that these companies are truly ‘public’ and as free as possible from undue influence, with all risk factors fully documented. Insisting on a larger free float and on high standards of corporate governance must be the first steps toward achieving this. 

By Tom Mayne, Global Witness Oil and Gas Campaigner.