The high returns energy MLPs offer now continue to draw investors tired of paltry opportunities elsewhere in the current, low-interest rate environment. But investors should be aware of increased corporate governance risks inherent in the partnerships, according to a new Moody’s Investors Service report.

“The corporate governance structure of MLPs provides less protection to investors than that of a typical public company, a credit negative,” said the report, entitled “Corporate Governance Structure of MLPs Creates Risk for Creditors.”

“There are weaker overall checks and balances, and the MLP’s general partner (GP) wields executive control that far outweighs its ownership stake, raising corporate governance concerns. Weak corporate governance, along with other credit-negative attributes including high distribution payouts, financing risk and acquisition event risk generally result in ratings that are lower for MLPs than they would be otherwise,” it added.

“The central governance risk in the MLP structure is that the GP could use its control to favor its own interests at the expense of common unitholders and creditors,” it said, then added, “The GP board’s primary fiduciary obligations are for the holders of the GP interest—not the common unitholders.”

Moody’s acknowledged the appeal of MLPs, pointing out the organizational structure has expanded beyond midstream operators—where it now dominates—to either end of the oil and gas chain. Upstream and downstream MLPs continue to appear, offering investors higher valuations in those businesses.

Beyond oil and gas, “since mid-2013, this corporate governance model has also been applied to ‘yield-cos,’ a new breed of yield-oriented vehicle, in the power sector,” the report explains.

A typical GP has the potential for far greater management control than would be possible in a typical C-corporation with its more rigid corporate governance model. A GP may have a comparatively minor equity stake in the MLP, usually around 2%, but wields almost complete management control of the partnership, the report pointed out. Moody’s described MLPs as “creatures of contract” in which most investors contribute capital but have no say in operations.

“Because the partnership agreement, which the GP drafts, contains all the key provisions that govern the MLP, understanding an MLP’s key corporate governance structures and processes requires a close reading and understanding of the agreement. However, even with a close reading, the GP can easily amend the agreement, and amendments do not require LP [limited partner] approval,” it said. “An MLP’s common unitholders are essentially passive investors with very limited influence over management, either through voting or litigation.”

In contrast, corporate shareholder accountability is a plus for bondholders and other investors “even when bondholder and shareholder interests differ,” the bond rating agency concluded in the report.

The partnership structure makes the role of a board’s independent directors, “and in particular the independent conflicts committee,” especially important, the report said. Moody’s recommends an MLP conflicts committee:

  • Have three to five members with no material relationships with the company or other parties;
  • Approve transactions, including asset dropdowns, asset sales between MLPs controlled by the same parent, mergers and acquisitions involving a conflict, restructurings, and incentive distribution rights;
  • Satisfy the Sarbanes-Oxley Act’s independence and experience requirements and exchange listing standards;
  • Have members “with relevant skills and experience, who take enough time to make well-informed decisions;”
  • Seek assistance from independent advisors; and
  • Evaluate effectiveness of the board’s conflicts policy annually.

But the interests of a GP and limited partners do generally align due to the nature of MLPs, the report found. “GPs rely on continued access to equity and debt markets for growth capital, so they have substantial incentives to weigh the interests of both common unitholders and bondholders, and to solve potential conflicts through independent directors,” it said.

Moody’s pointed out that some MLPs “have voluntarily adopted more muscular roles for the independent directors, akin to those of a typical public company.” It singled out Magellan Midstream Partners LP and NuStar Energy LP as examples of the trend.

“A more robust role for the independent directors can also help spur MLP boards to make strategic course corrections relatively quickly if the MLP’s performance is suffering,” it added.