21 July 2015
ICSA and the Investment Association have undertaken a review of the Stewardship Code
The Financial Reporting Council (FRC) published the Stewardship Code in July 2010 and revised it in September 2012. This was an effort to enhance the quality of engagement between asset managers and companies, and help improve returns to shareholders. In the words of the FRC, ‘the Code sets out a number of areas of good practice to which … institutional investors should aspire. It also describes steps asset owners can take to protect and enhance the value that accrues to the ultimate beneficiary.’
Questions remain as to how effective it has been and whether the quality of engagement has improved. There is plenty of anecdotal evidence – which tends to reflect the view of those reporting it – but very little in the way of independent and objective analysis.
ICSA has been working with a number of partners to help the FRC review the extent to which the Stewardship Code has begun to have an impact on company and investor engagement:
One of the ways in which we have been trying to do this is through some comparative and complementary surveys. These have been undertaken in an attempt to assess investor and issuer views of the engagement process and to compare and contrast the results. The Investment Association stewardship survey results can be found on their website and the results of ICSA’s survey are summarised below. We are very grateful to those companies who took the trouble to respond to our survey, and especially to those who provided so much detail by way of their narrative comments.
The first question that we asked companies is, what is the purpose of stewardship? The most popular response (85%) is that stewardship is about building a mutual understanding of trust between company and institutional investors. 73% of respondents consider stewardship to be about shareholders holding boards to account for company performance and 67% of companies see stewardship as ‘an essential part of the legal structure through which companies are governed’.
Interestingly, 25% of companies believe that stewardship ‘is about shareholders raising environmental, social and governance (ESG) issues’ and 23% see stewardship as a ‘public duty’. This might reflect the view – held by some in the previous coalition UK Government among others – that it is for investors to demonstrate effective control of companies, for example by controlling executive pay.
In terms of quantity of stewardship, 58% of companies have seen more investor engagement, while 40% say that it is unchanged. With regards to quality, 48% of companies feel that engagement has got ‘a little better’ (2% said a lot better) and 42% that there is no difference. The narrative comments contributed by companies are enlightening – as one respondent says, ‘there is more activity from a minority of investors. Those who did not engage before generally do not do so now’. Another comments that ‘[the quality of engagement] remains patchy, we have some very well-prepared meetings – with indepth discussion of our markets, our strategy and our performance – and others where the research has not been done and the questions have clearly been cribbed at the last minute from the sell side.’
There is also suspicion from companies about the role of the proxy advisers: ‘they merely subcontract out voting intentions to proxy advisers who are ill informed and not best placed to engage.’ The extent that this is true – that investors blindly follow the recommendations, or as some would have it, ‘instructions’ of proxy advisers – is a concern. However, in such situations responsibility should lie with the investor rather than the proxy adviser.
We went on to ask where the responsibilities of stewardship should rest. 63% of companies take the view that this sits with all equity investors and 37% that this rests only with the largest shareholders. This begs the question of how a ‘large shareholder’ is defined – 58% of companies do so by the proportion of company capital held and 26% by the shareholders’ ranking in the register of shareholders. No companies consider the weight of holding in the investor portfolio. However, the Investment Association survey revealed that the proportion of the investment portfolio relating to a given company is the key issue for investors.
This disparity in views may help explain why companies can find it difficult to engage the interest of those whom they believe to be major investors while being approached by investors whom they see as relatively small. If a company represents 5% of their portfolio, however small that holding may be in terms of capital, the investor will want to engage.
If compliance with the Stewardship Code is important, how can this be enforced effectively? We asked companies whether there should be penalties for those investors who sign the Stewardship Code but do not then meet the associated obligations. The majority (60%) of companies say there should not be penalties – of the 40% who did, the overwhelming majority think that such penalties should be limited to naming and shaming or, at worst, delisting as a signatory to the code. There is little support for the imposition of financial penalties by the regulator. Conversely, 67% of companies feel that investors who clearly demonstrate they comply with the code to a high standard should be recognised in some way.
Although some think the FRC, as regulator, might have a role here, the majority view is in favour of some sort of kitemark to an industry recognised standard, that the investors would be able to use in their marketing material. We must remember that not all underlying owners will value stewardship engagement. Many may be prepared to accept an investment manager which does not offer such services if the associated costs are lower.
All that said, the opinion of companies on whether there has been an improvement in their ability to consult or engage with investors is split: 52% say yes and 48% no. The majority of ‘no’ respondents indicate that this is because they already have what they consider to be ‘sufficient’ engagement. Two thirds (67%) of companies feel that there is no improvement in their ability to influence investor voting.
We asked some open-ended questions about what constitutes ‘good’ or ‘bad’ stewardship and what constraints are affecting this issue. The key constraint mentioned is resource. As one company observes, ‘I principally see the impediment being resource, both in terms of governance teams who appear very stretched, and the PMs/analysts who … do not have sufficient time to consider the issues across all their investments – therefore the focus has been very much on the offenders, with most other companies unlikely to receive much attention beyond a couple of meetings with management a year. Clearly a more continuous dialogue would be helpful to both sides.’ This is a different position from that highlighted in the investors responses to their survey, which note the increased and increasing resource that they are devoting to this area.
The Investment Association reports a 19% rise on last year in the number of individuals responsible for stewardship, with 2,090 being engaged in this way. More than 80% of these are portfolio managers and analysts, suggesting that stewardship is more integrated into the investment process than anecdotal evidence would suggest. There are still companies who complain that fund managers are ‘not joined up’.
Another issue raised by respondents is of attitude and willingness to discuss the company view of positions – ‘having a clear understanding that it needs action not tick box compliance.’
Some companies do assume that an investor listening to their explanation for some issue will result in that the investor agreeing with them. This is a point that will always tend to distort survey responses. An investor not voting in accordance with board proposals does not, necessarily, mean that the investor has failed to take into account or pay attention to the corporate message – it may simply be that they disagree – which is their right.
That said, there is a clear impression from companies that there is too much investor reliance on ‘policy’ – whether or not generated by proxy advisers – and too little on open discussion with companies about their particular situation.
What is more worrying is the tendency highlighted by companies for some investors to conflate engagement, with sending the company a link to a policy on their website to explain an ‘against’ vote. The Investment Association survey revealed that ‘fewer respondents notify companies in advance of intention to vote against or abstain’ and the reasons for this need further examination.
One of the most positive responses from companies is to the question of whether investor engagement has helped the company to make better decisions. Only 10% of companies argue that this is never the case, and although 77% say only that it helps some of the time, the fact remains that 90% of companies think that investor engagement is helpful.
We asked companies what they want to discuss with their investors and what issues they think that investors want to discuss with them. Most companies say their priority is to discuss issues of strategy and performance with their investors, but the majority of investors want to focus on issues of remuneration. This contrasts starkly with the Investment Association survey – which suggests that investors wish to focus on strategy and other long-term issues and companies seek to focus on pay. If neither ‘side’ really wants to talk about pay, why is there such an emphasis? Perhaps because of the political, press and public attention on pay issues, or simply because both sides feel that this is an elephant in the room that they must address. As one investor commented last year, ‘if we pay management a few million pounds too much, shareholders lose a few million pounds. If we appoint the wrong management, or they pursue the wrong strategy, we risk losing much more than that.’
Finally, we asked companies to rate the quality of stewardship delivered by their investors. Despite all that has been said before, the ratings reveal that 50% of companies rate investor engagement as good or excellent, with a further 40% rating it ‘average’. Only 10% of companies consider engagement to be poor and this is in line with the Investment Association result that ‘almost 90% of respondents are satisfied with the outcome of their engagement and welcome companies’ responsiveness and openness to dialogue.’
There is much work still to be done and a number of the responses have begged further exploration, which we will undertake in the coming months. Our intention is to develop helpful responses into a more comprehensive piece of guidance to build on the success of ‘Enhancing Stewardship Dialogue’.
The Investment Association’s report is available on their website at www.theinvestmentassociation.org
The results of ICSA’s review of the Stewardship Code will be published on the website in the near future.
Peter Swabey is Policy and Research Director at ICSA