UK Stewardship Code: Implementation matters

Posted by
Chris Hodge
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Companies could be forgiven for having missed the launch of the UK Stewardship Code in late October. Understandably, they were probably paying rather more attention to news from Westminster and Whitehall that from the Financial Reporting Council. Even those who spotted the announcement have probably put the Code near the bottom of their in-tray as they grapple with new regulations and reporting requirements of their own.

It should not be left to linger there too long. While the publicity around the new Code is very much about making asset managers and owners more accountable to their beneficiaries, the impact on companies is potentially significant.

According to the press release that accompanies the Code’s publication, the aim is to “protect the interests of UK savers and pensioners by ensuring that their money is managed responsibly with a new emphasis on creating long-term value and on considering beneficiary and client needs”. The Code itself sets out what this means in terms of the expectations being placed on investors very clearly.

The objective is one to support. John Kay[1] argued in 2012 that the UK equity market operates mainly to the benefit of intermediaries rather than the end investor, and since then the influence of institutional investors has, if anything, increased. According to the OECD[2], the total assets managed by institutional investors have increased by a third since that report was written. If increased accountability helps to give savers and beneficiaries greater influence over how their money is invested, that is to be welcomed.

But what does the new Code mean for companies? That depends on how investors choose to respond. The real test of any code is not how well it is written but how well it is implemented.

In my view, the Code has the potential to be either a help or a hindrance to companies. If it succeeds in its aim of encouraging investors to integrate ESG considerations more fully into their investment approach, then that should be good news for companies as well as clients and beneficiaries.

Companies and institutional investors are on the same journey at the moment. Customer and client demand, backed up by a bit of regulatory pressure, is pushing both to develop a longer-term focus and pay more attention to their respective stakeholders (who are often one and the same).

Hopefully, that means that companies and their institutional shareholders to come together with a common, broader agenda. Companies regularly complain that they find it difficult to get their shareholders interested in anything other than executive pay and a very formulaic approach to compliance with the UK Corporate Governance Code. They say they would welcome the opportunity to have a more strategic discussion about ESG issues than has been the case previously.

While some of those claims may need to be taken with a dose of salt, there are already some signs that the type of conversations that boards and investors are having are changing for the better. This is mainly due to client and public pressure; if the Stewardship Code can give them a nudge in the right direction then that would be a good outcome.

That said, there are some concerns about the potential impact on the quantity and quality of direct engagement between listed companies and investors. They are not caused by the new Code, but it might exacerbate them.

The first is the recommendation that the principles and practice of stewardship be extended to all asset classes, not just listed equities.

According to the Investment Association’s most recent annual survey of investment management in the UK[3], only 36% of UK managed assets were invested in listed equities in 2018, of which only 40% were invested in UK equities – in other words, less than 15% of the total assets under management.

Faced with figures like that, the case for extending stewardship to other asset classes is hard to argue with, certainly from the perspective of the end investor – if it is good practice for the 15% then it should be good practice for the rest.

However, there are long-running concerns about the paucity of the resources that investors have typically been willing to invest in governance and stewardship (there are of course some notable exceptions). Many ESG or governance teams within institutions are already too thinly stretched to engage with more than a handful of their investee companies.

The hope, obviously, is that investor will increase the resources they dedicate to stewardship, and the new Code drops a fairly unsubtle hint by asking signatories to disclose the size and seniority of their teams. But if that doesn’t happen, and the existing resource gets even more stretched, then the consequence will be more not less box-ticking.

The other concern that has been raised is whether the increased obligation on asset managers in particular to ‘prove’ that they are active in the interests of their clients will have an impact on the nature of how they engage with companies.

One of the arguments regularly put forward by companies and many investors is that the most productive and constructive engagement takes place out of the public glare, and that votes against and shareholder resolutions and the like should be the last resort not the first.

Personally, I am all in favour of investors providing more detail of how they act in the interests of their clients and beneficiaries. A weakness of the current Stewardship Code – and I say this as one of its authors – is that it is too easy for signatories to produce a plausible sounding policy statement without having to back it up.

That said, it does need to be acknowledged that some of those investors that now feel under pressure for the first time to ‘show they are doing something’ may do so simply by ticking more ‘against’ boxes when voting, rather than putting the time and resource into a more considered – and I would suggest more productive - approach.

Nothing I have said in this post is intended to be a criticism of the revised Stewardship Code. Its objectives and its content are clear and coherent. But there are many examples of good intentions being undermined by poor implementation. In the interests of investee companies and end-investors alike, let’s hope that institutional investors respond in the spirit which the FRC intends.

[1] ‘The Kay Review of UK Equity Markets and Long-Term Decision-Making’; 2012

[2] ‘Owners of the World’s Listed Companies’; OECD; 2019

[3] ‘Investment Management in the UK 2018-2019’; The Investment Association; 2019

If you liked reading about the Stewardship Code perhaps you will also like to read about the Wates Corporate Governance Principles.