On 30 January, on the same day that the Financial Reporting Council (FRC) published its ‘Proposed Revision to the UK Stewardship Code’, the Financial Conduct Authority (FCA) published a consultation on proposals to improve shareholder engagement and both regulators published a joint discussion paper entitled ‘Building a regulatory framework for effective stewardship’.
Stewardship is finally receiving the joined-up, cross-regulatory attention that it deserves and Stewardship 2.0 looks set to hold investors to account more stringently than before, with all signatories required to make public disclosures about their stewardship activities and their assessment of how effectively they have achieved their stated objectives.
Following the launch of the original Code in 2010, it has been a requirement under the FCA’s Conduct of Business Rules that all UK authorised asset managers produce a statement of commitment to the UK Stewardship Code or explain why not. This initial approach met with limited success and, in 2016, the FRC categorised signatories into tiers based on the quality of their Code statements, with 120 out of 300 signatories being categorised as Tier 1 signatories for demonstrating a good quality and transparent approach to stewardship.
Asset managers failing to achieve at least Tier 2 status after six months are removed from the list of signatories due to a lack of commitment to the objectives of the Code.
Whilst efforts to set standards for investors for monitoring and engaging with companies are laudable, the Code has been criticised as being weak and lacking in sanctions, not least by Sir John Kingman who concluded, in his recent review of the FRC, that the Stewardship Code is not effective in practice.
He believes that “A fundamental shift in approach is needed to ensure that the revised Stewardship Code more clearly differentiates excellence in stewardship. It should focus on outcomes and effectiveness, not on policy statements. If this cannot be achieved, and the Code remains simply a driver of boilerplate reporting, serious consideration should be given to its abolition.”
On this latter point, I must disagree with Sir John. The Code has been adopted in a number of other countries since it was first introduced and abolition would be short-sighted. Surely if something is good enough to be copied, it makes more sense to update the Code to reflect the altered needs of the market rather than to simply abolish it. Similarly, if one of the criticisms is that it lacks teeth, it would be better to increase its effectiveness by making sure that asset managers and owners actually comply.
Proposed revisions to the UK Stewardship Code
The new Code aims to “increase demand for more effective stewardship and investment decision-making which is aligned to the needs of institutional investors and clients” by raising the standard required of investors and devoting more resource to evaluating the quality of disclosure of both policies and activities.
The definition of stewardship has also been changed to focus more on the primary purpose of looking after the assets of beneficiaries that have been entrusted to the care of others. Consequently, investors will need to ensure that they have a clear organisational purpose, strategy, values and culture in place that will allow then to fulfil their stewardship obligations.
The scope of the Code has also been broadened to include investment decision-making and assets other than listed equities, such as fixed income bonds and infrastructure equity. This means that investors will need to integrate their stewardship responsibilities into their investment processes, including investment-decision making, mandate design and other activities.
Signatories are now also expected to take into account material environmental, social and governance (ESG) factors, including climate change, when fulfilling their stewardship responsibilities in recognition of the importance of ESG factors in investment decision making with the rise of sustainable finance and responsible investment initiatives since 2012.
Proposals to improve shareholder engagement
The FCA’s consultation looks at the UK implementation of the Revised Shareholder Rights Directive (SRD II), which the Government has undertaken to implement despite the UK’s plans to leave the EU. While current UK market practices go beyond most SRD II requirements, in order to be fully compliant, the FCA will require asset managers to make disclosures relating to their shareholder engagement policies, as well as their arrangements with asset owners.
They will also need to show how their investment strategies are consistent with the medium- and long-term performance of the assets of the asset owner or fund. Life insurer disclosures will also be improved and UK-listed companies will be required to disclose and seek board approval for related party transactions.
A regulatory framework for effective stewardship
Poor corporate governance and a lack of shareholder engagement are cited in the FRC and FCA joint discussion paper as contributing to a culture of short-termism and to high-profile corporate failures. The two regulators are, therefore, seeking the views of the market on “what constitutes effective stewardship; the challenges in delivering an effective regulatory framework for stewardship in the UK; and how to strike the right balance between regulatory rules and voluntary codes of best practice”.
Finding a consensus of opinion is likely to be a challenge as there are plenty of market participants who will undoubtedly seek to protect their own working practices and cost structures. For example, questions might arise around whether or not investors should have sufficient staff to effectively oversee the governance at all their investee firms.
Some might say yes, but that would mean significantly increasing costs, which would then be passed on to clients, or limiting investments to those for whom they do have oversight resources, which would reduce portfolio diversity.
Clearly, there needs to be a balance, but that might be easier said than done. One thing that is sure, however, is that stewardship is going to be given far greater emphasis in the future than it has been given in the past. As the FCA states in its consultation document “Stewardship will be an area of focus for the FCA’s supervisory engagement, which reflects its importance to the FCA’s objectives.”
Far greater attention is going to be paid to how companies are engaging in stewardship and how that stewardship contributes to the fulfilment of a company’s stated purpose. Companies will need to ensure that their claims to engage in stewardship actually live up to the reality, which can only be a good thing for investors and companies alike.