The UK Stewardship Code
The Financial Reporting Council (FRC) has issued the UK Stewardship Code which ‘aims to enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’.
The UK Corporate Governance Code has traditionally emphasised the value of a constructive dialogue between institutional shareholders and companies based on a ‘mutual understanding of objectives’. Now, in the Stewardship Code, the FRC sets out the good practice on engagement with investee companies which it believes institutional shareholders should aspire to.
Kate Burgess and Miles Johnson in their article ‘FRC’s blueprint for investor engagement’ (FT, page 18, 2nd July 2010) describe the Stewardship Code as ‘the first of its type in the world and designed to sit side by side with the UK’s code on corporate governance recently reworked by the FRC’.
Background to the UK Stewardship Code
The Institutional Shareholders’ Committee (ISC) is a forum which allows the UK’s institutional shareholding community to exchange views and, on occasion, coordinate their activities in support of the interests of UK investors. Its constituent members are: The Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Management Association (IMA) and the National Association of Pension Funds (NAPF) http://www.institutionalshareholderscommittee.org.uk/
In November 2009, the ISC issued the ‘Code on the Responsibilities of Institutional Investors’. The ISC stated that ‘the Code aims to enhance the quality of the dialogue of institutional investors with companies to help improve long-term returns to shareholders, reduce the risk of catastrophic outcomes due to bad strategic decisions, and help with the efficient exercise of governance responsibilities’ and ‘the Code sets out best practice for institutional investors that choose to engage with the companies in which they invest. The Code does not constitute an obligation to micro-manage the affairs of investee companies or preclude a decision to sell a holding, where this is considered the most effective response to concerns’.
Further detail is available at: http://institutionalshareholderscommittee.org.uk/sitebuildercontent/sitebuilderfiles/ISCCode161109.pdf
UK Stewardship Code Principles
Following a consultation earlier this year, the FRC assumed responsibility for the oversight of the Stewardship Code. The ISC Code discussed above contained seven principles which now form the basis for the Stewardship Code and indeed the Principles were adopted with only minor amendments. The minor amendments relate to Principle 3 about the monitoring of companies. In the Stewardship Code, institutional investors are encouraged to meet the chairman of investee companies, and other board members as appropriate, as part of the ongoing monitoring, and not only when they have concerns; attend, where appropriate and practicable, the general meetings of companies in which they have a major holding; and give careful consideration the any explanations given by investee companies for departures from the UK Corporate Governance Code, advising the company where they do not accept its stance.
The principles of the UK Stewardship Code are:
Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.
Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.
Principle 3: Institutional investors should monitor their investee companies.
Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.
Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.
Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.
Principle 7: Institutional investors should report periodically on their stewardship and voting activities.
Who the UK Stewardship Code applies to
The Stewardship Code is to be applied on a ‘comply or explain’ basis. The UK Stewardship Code is ‘addressed in the first instance to firms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts, and other collective vehicles’. The FRC expects such firms to disclose on their websites how they have applied the Stewardship Code or to explain why it has not been complied with.
However it has been pointed out that it is not the responsibility of fund managers alone to monitor company performance ‘as pension fund trustees and other owners can also do so either directly or indirectly through the mandates given to fund managers’. Therefore the FRC encourages all institutional investors to report whether, and how, they have complied with the Stewardship Code.
The FRC plans to list on its website all investors who have published a statement indicating the extent to which they have complied with the Stewardship Code. This list will be made available from October 2010.
Monitoring and review of the application of the Stewardship Code will be in two phases. As an interim measure, the Investment Management Association (IMA), will carry out its regular engagement survey which will also cover adherence to the Stewardship Code in 2010. The first full monitoring exercise will then take place in the second half of 2011.
The FRC points out that there are a number of significant issues which were raised during the consultation phase which are not addressed in the UK Stewardship Code. These include disclosure by institutional investors of their policies in relation to stock lending; arrangements for voting pooled funds; and the information to be disclosed in relation to voting records. The FRC will undertake additional work in relation to these areas prior to the monitoring exercise in 2011.
A recent EU Green Paper ‘Corporate governance in financial institutions and remuneration policies’ (June 2010) may also have ramifications for the UK Stewardship Code as in section 5.5, the Green Paper mentions that the Commission intends to carry out a review centred around, inter alia, ‘institutional investors adherence to ‘stewardship codes’ of best practice’. http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf
It is apposite to conclude with a comment from Bob Campion in his article ‘Managers on alert to comply or explain’ (FTfm Page 5, 5th July 2010) ‘The new code is a timely opportunity for pension trustees to finally get to grips with their role as institutional shareholders. If they do, it will be up to fund managers to demonstrate their own expertise in this area or risk losing business’.
The UK Stewardship Code, together with a report on its implementation, can be found at:
Chris Mallin 5th July 2010