11 November 2019 by Peter Swabey
The revised UK Stewardship Code is not perfect, but offers a great improvement on what has come before
“Art any more than a steward? Dost thou think, because thou art virtuous, there shall be no more cakes and ale?” - Twelfth Night, Act 2 Scene 3.
I don’t know about cakes and ale – although obviously either would be welcome – but we certainly have an opportunity to significantly improve the quality of stewardship in the UK.
On 24 October, the Financial Reporting Council (FRC) published the revised UK Stewardship Code 2020 (the Code), which takes effect from 1 January 2020. Described by the FRC as ‘substantial and ambitious’, this represents a significant strengthening of the obligations placed upon signatories to the Code, reflecting the changing needs of asset owners and changing public expectations, and carries an enhanced focus on their responsibilities to asset owners.
There are a number of new features to the Code which draws, in part, on the recommendations of Sir John Kingman’s independent review of the FRC and his feedback on the previous Code – “The Stewardship Code, whilst a major and well-intentioned intervention, is not effective in practice...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”.
In our original response to Sir John Kingman, we observed that the Stewardship Code has had a positive impact on UK corporate governance through its encouragement of improved engagement between companies and their institutional shareholders. When the Department for Business, Energy and Industrial Strategy (BEIS) consulted on the implementation of the Kingman review, we felt that the proposals made to amend the Stewardship Code did not go far enough to address the concerns expressed by Sir John Kingman. The new version is much improved in this regard.
The FRC have created a clear focus in the Code on how asset managers invest money on behalf of their asset owner clients. To quote the press announcement, “In particular, the new Code establishes a clear benchmark for stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society … [it] … focuses on protecting 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”.
In practice, of course, this has required a number of changes to the Code to reflect the new, wider focus on asset owners and service providers, as well as asset managers, and the increased emphasis on asset manager reporting to asset owners. Of course, the Code still retains all the existing requirements for engagement with investee companies, but the intention is that the wider focus will create greater alignment throughout the investment chain in the interests of asset owners, be they end-investors or beneficiaries.
Some of the changes that will drive this alignment include a requirement to report on stewardship activity and its outcomes, including how stewardship responsibilities have been exercised across all asset classes and explaining how their organisation’s purpose, strategy, culture and investment beliefs support the exercise of stewardship responsibilities.
The report on stewardship is probably the most significant new requirement, expected to “show what has actually been done in the previous year, and what the outcome was, including their engagement with the assets they invest in, their voting records and how they have protected and enhanced the value of their investments”. This will be helpful and will allow asset owners to see more effectively how their interests are being served by giving them greater insight in to what is actually being done on their behalf.
Greater transparency of how stewardship has been exercised beyond listed equity – examples given include “fixed income, private equity and infrastructure, and in investments outside the UK”– will also help some investors, but it is important to remember that different asset classes have different associated rights and not all carry the same ability to engage. In our response to BEIS, we suggested that this area of the Code should focus more on listed equity, where investors have control rights and so are better able to mandate change and enable companies to hold companies and their management teams to account for compliance with the UK Corporate Governance Code.
The requirement to make disclosures about organisational purpose, strategy, culture and investment beliefs may sound like an invitation to boiler-plate, but is actually rather important as asset managers and service providers will be required to demonstrate “appropriate governance, resourcing and staff incentives” which will, surely, include evidence of staff training and competence – a perennial complaint from some companies, especially about some service providers.
Finally, one of the features of the new Code is a recognition of the public interest in ESG factors and an explicit requirement that “Signatories will be expected to take environmental, social and governance factors, including climate change, into account and to ensure their investment decisions are aligned with the needs of their clients”. As the FRC observe, this “sets a substantially higher standard, reflecting the changing expectations of investors and the significant developments in sustainable and responsible investment and stewardship since the Code was last revised in 2012”.
On the whole, the Code is a welcome development of the existing requirements. The Stewardship Code introduced in 2010 created a helpful focus on the importance of stewardship by asset managers and their engagement with investee companies. Although updated in 2012, it has been clear over recent years that the shifting needs of asset owners and changing public expectations necessitate further change.
The FRC is to be congratulated for tackling that need head-on rather than tinkering and we now have a much more robust document, reflecting these changed requirements.
Of course, any change will bring with it suggestions of opportunities missed or areas that have received overmuch focus and the Code is no different. It may be that the focus on reporting to asset owners may have an impact on the quality and quantity of engagement with companies unless resourcing is increased.
Similarly, as we observed in our response to the consultation earlier this year, the increased emphasis on ESG issues, reflecting increased public concern, risks provoking more ‘policy statements’ rather than the ‘outcomes and effectiveness’ focus recommended by Sir John Kingman’s review despite the Code’s emphasis on outcomes. It is crucial that the FRC and its successor monitor asset manager reporting and activity robustly in order to avoid the tick-box approach that the FRC is clearly so keen to avoid.
All in all, however, the revised Code is a great improvement on its predecessor and we look forward to seeing its implementation in the coming year.