Following the financial crisis, corporate governance became a major talking point. Had shareholders somehow caused or exacerbated the economic meltdown?
Some commentators pinned the blame on institutional investors, who control as much as 70% of the UK stock market
, for their, in some cases, passive approach to corporate governance and focus on short-term gains. Instead, the critics argued, increased shareholder participation was essential to creating sustainable, long-term corporate value by holding boards of directors accountable for their actions.
Thus, the Stewardship Code
was born in 2010 with the UK’s independent regulator responsible for promoting high quality corporate governance, the Financial Reporting Council (FRC), acting as its overall guardian. Adherence meant added responsibilities for the investor and investee communities.
How asset owners and managers can meet their stewardship obligations
– Publicly disclose their policy on how they will discharge their stewardship responsibilities.
– Have a robust policy on managing conflicts of interest in relation to stewardship, which should be publicly disclosed.
– Monitor their investee companies.
– Establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.
– Be willing to act collectively with other investors where appropriate.
– Have a clear policy on voting and disclosure of voting activity.
– Report periodically on their stewardship and voting activities.
Source: The UK Stewardship Code
However, the code came to be viewed by some fund managers and institutional investors as a mere ‘box-ticking’ exercise, rather than a way to vote and engage directly with firms on issues such as executive pay, board diversity and climate change.
To give more credence to the code, in 2016 the FRC introduced a public tiering system
whereby fund managers and institutional investors – in their role as stewards of other people’s money – would be named and shamed
if they failed to engage properly with companies.
By demonstrating a quality and transparent approach to stewardship, asset managers are now awarded a ‘tier one’ ranking. Those that don’t rank lower. These fund managers can now be held to account and must improve or face removal as signatories. The FRC says around 90% of assets under management of members of the Investment Association now sit in this top tier. There were three tiers under the Stewardship Code, however the FRC recently announced
that it had removed the ‘tier three’ category.
What is currently happening at the FRC in relation to stewardship?
We now have a more independent and forward-looking code that seeks to take it out of box-ticking land – fully integrating it with the investment process.
Where previously monitoring was left to the fund manager membership bodies, the FRC has been able to allocate more resources and independent oversight, as well as acting as a facilitator.
will also look at Section 172 of the Companies Act 2006
, which covers the duty to promote the success of a company, and how to bring that into narrative reporting – making it less dependent on the accounting profession. Furthermore, the FRC will be home to some elements of the Shareholder Rights Directive. They have a busy few years ahead.
This new tiering exercise has been helpful not only for the FRC but for investors, too. There is now a better understanding of what the expectations are.
How should firms be developing a culture of stewardship?
If we are talking about the company perspective, the most important thing is to understand the shareholder register – know who is on your list and get to know how they approach governance. Is it integrated? Is it a separate function? Does it take place in an office in San Francisco, or are the environmental, social and governance people sitting right there with the portfolio managers? There isn’t a one-size-fits-all answer.
There’s still a lot of new information for companies to take on board. Once upon a time, they assumed the corporate broker would take care of these relationships. There was some confusion and distrust about the element of the role – ‘governance wonks’ as they were often unhelpfully described. This is beginning to change, and the updated Markets in Financial Instruments Directive (MiFID II) is only going to accelerate that change.
And how about institutional investors?
In the recent past there was a perception that stewardship was an overhead, but stewardship isn’t expensive. There is an opportunity to reshape the agenda for better dialogue with companies. As more investors become index owners, it brings a whole new set of challenges – they are owning many more stocks than before.
About the expert
Sarah Wilson is the CEO of Manifest, a proxy voting agency that helps investors fulfil their stewardship responsibilities. Manifest has been a voluntary signatory of the FRC’s stewardship code since its launch in 2010.
We also have asset owners who have new guidance in terms of their policies. The asset owner will have legal duties; they will have to question what their fund managers are doing. So there will be more intense scrutiny than there has previously been.
How do you see this issue playing out?
There’s so much to do in the next five years, allied to an enormous reform agenda. If you take the current backdrop, there is a lot of turmoil. The EU is issuing new guidance on the Shareholder Rights Directive, there are MiFID II, Brexit and climate change issues to deal with, more narrative reporting, and expectations from the FCA around the Asset management market study
of more transparency for shareholders. The FRC is probably where it could be given the circumstances.
Furthermore, I don’t rule out Prime Minister Theresa May revisiting her plan to put workers on boards. My hunch is people will expect things to happen on a voluntary basis, but if they don’t then secondary legislation will be brought in.
But it is worth remembering investment failures cost a lot of money. It is a societal failure as much as anything. There are a lot of people who say to me – prove that governance or stewardship makes a difference. I can’t do that. But if you are going to take a scientific approach, prove to me it doesn’t make a difference. And nobody has yet been able to prove it doesn’t make a difference.
Read what Guy Jubb, former global head of governance and stewardship at Standard Life Investments, has to say about the Stewardship Code in our colourful profile of him in the latest print edition of The Review, out soon.