Archive for the ‘investors’ Category

Share Ownership in the UK

Increasing ownership by ‘rest of the world’

At the end of 2012, the UK stock market was valued at £1,756.3 billion. The ownership of UK shares has changed dramatically over a 40 year period. The Office of National Statistics (ONS) surveys indicate that the ownership of UK shares by individuals has fallen from 54% in 1963 to under 11% in 2012. On the other hand, the ‘rest of the world’, which held just 7% of UK shares in 1963, now own over 53% of UK quoted shares. This decrease in individual share ownership and increase in the ‘rest of the world’ ownership is perhaps the most notable change in the overall share ownership figures reported by the ONS in its publication ‘Ownership of UK Quoted Shares, 2012’ which is available at:

http://www.ons.gov.uk/ons/rel/pnfc1/share-ownership—share-register-survey-report/2012/stb-share-ownership-2012.html

The ONS analysis of the ‘rest of the world’ shareholding of 53% of UK quoted shares finds that some 48% of this is owned by investors in North America, just under 26% by European investors and around 10% by investors in Asia. The balance is made up of investors from various regions including Africa and the Middle East.

Corporate governance activism

One of the possible implications of the increase in ‘rest of the world’ ownership, and particularly ownership by investors in North America, is in relation to corporate governance activism. Such investors may tend to be more pro-active than many UK institutional investors have traditionally been and may engage more in their investee companies especially where these are underperforming or where there are corporate governance issues. The California Public Employees’ Retirement System (CalPERS) is a well-known example of a US pension fund which actively engages with underperforming companies and/or with those where there are corporate governance issues. In years gone by its strategy was to ‘name and shame’ with its focus lists but these days it concentrates more on a particular issue, for example, executive remuneration, and engages privately with the company to try to bring about improvements before then progressing to any more public approach.

Improved Investor Engagement

Nonetheless the UK’s ‘vanguard’ institutional investors including Hermes, Aviva, and Standard Life all have a high corporate governance profile and actively engage with their investee companies. Moreover the Investment Management Association (IMA) reported increased levels of monitoring and engagement in June 2013 in their survey of ‘Adherence to the FRC’s Stewardship Code, At 30 September 2012’, available at:

http://www.investmentuk.org/research/stewardship-survey/

The report indicated that more institutional investors monitor all their investee companies; that more resources are being put into the stewardship role and that there is ongoing integration of stewardship into the wider investment process. Investors are also prioritising engagement on key issues. Furthermore there has been an increase in voting level with the decision of how to vote the shares being made independently of proxy agencies.

Concluding comments

The UK’s Stewardship Code set the standard in terms of providing a framework for institutional shareholders to monitor, and engage with, their investee companies. There have been a number of encouraging signs that shareholder engagement is on the increase in a number of countries. In her article, ‘Shareholder campaigns more than double in three years’ (FT, Page 20, 11th November 2013), Sam Jones points out that ‘the past 12 months have seen more than 415 instances of corporate activism across the world, up from 172 in 2010’. This trend is expected to continue as institutional investors, with sensitivities highlighted in the aftermath of the financial crisis, increasingly seek to ensure that their investee companies both have appropriate standards of corporate governance and sustainable returns.

Chris Mallin 5th December 2013

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UK Stewardship Code – Compliance

As reported in an earlier blog post (5th July 2010), the Financial Reporting Council (FRC) issued the UK Stewardship Code in the summer of 2010 with the aim of enhancing ‘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 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.

 To what extent have asset managers, asset owners and service providers complied with the recommendations of the Stewardship Code?  Several reports have been produced which detail the level of compliance.

Level of compliance

The FairPensions (2010) survey analysed 29 of the largest asset managers and found that 24 of these had published a formal statement/response with respect to the Stewardship Code. An additional four (Insight, Invesco, Morgan Stanley and State Street) had posted short statements on their website referring to the Code. FairPensions reviewed the 24 compliance statements to assess the quality of disclosures made with respect to the Code.

They were disappointed as they felt that the investors’ statements often gave ‘tick-box’ responses to the Stewardship Code principles whereas it was an opportunity to “tell their story” as to how they monitor companies and incorporate stewardship activity into their wider investment process. http://www.fairpensions.org.uk/sites/default/files/uploaded_files/whatwedo/StewardshipintheSpotlightReport.pdf

The Investment Management Association (IMA) (2011) survey of adherence to the Stewardship Code analysed the questionnaire responses from 41 asset managers, seven asset owners and two service providers. The questionnaire was developed with the oversight of a Steering Group chaired by the FRC’s Chief Executive.  The IMA (2011) survey covered the period to 30 September 2010 and showed widespread adherence by 50 UK institutional investors to the best practice set out in the FRC’s Stewardship Code. The IMA reported:

“Over 90% of major institutional investors now vote all or the great majority of their shares in UK companies; nearly two thirds now publish their voting records.

At the time the survey was conducted, 43 out of 50 respondents had published a statement on adherence to the Code, and another six did so subsequently.

Over 1,300 people focusing on stewardship activities are employed by 43 of the respondents to the survey.”

http://www.investmentfunds.org.uk/research/stewardship-survey

The FRC (2011) published Developments in Corporate Governance 2011, The Impact and Implementation of the UK Corporate Governance and Stewardship Codes, FRC, London.

http://www.frc.org.uk/images/uploaded/documents/Developments%20in%20Corporate%20Governance%2020117.pdf

They reported that, as of December 2011 the Stewardship Code had attracted 234 signatories, including 175 asset managers, 48 asset owners and 12 service providers23. This level of take-up indicates that the concept of stewardship is being taken seriously.  Importantly there has been a wide base of support for the Stewardship Code including from both large and small institutional investors.

There seems to be rather mixed evidence as to whether institutional shareholders are engaging more with their investee companies since the Stewardship Code was introduced. However over time it is to be expected that overall there will be a higher level of engagement.

Reasons for non-compliance

Organisations not complying with the Stewardship Code tend to fall into two groups: (i) those not signing based on their specific investment strategy, and (ii) those who do not commit to codes in individual jurisdictions.

Future developments

The FRC proposes to make limited revisions to both the UK Corporate Governance Code and the Stewardship Code which, subject to consultation, will take effect from 1st October 2012. As far as the Stewardship Code is concerned, they FRC state that it is ‘not currently envisaged that new principles will be introduced but it may be helpful to clarify the language in certain places, for example on the different role of asset managers and asset owners.’

Areas where the FRC might consider strengthening the language include conflicts of interest, collective engagement, and the use of proxy voting agencies, and possibly a recommendation that investors disclose their policy on stock lending.

Finally a Stewardship Working Party has been formed consisting of Aviva Investors, BlackRock, Governance for Owners, Railpen Investments, Ram Trust and USS together with Tomorrow’s Company.  They will determine whether it is possible to devise a “scale of stewardship” which would enable institutions to differentiate themselves.

 Chris Mallin 8th March 2012

The Cultural Dependence of Corporate Governance

In September 2011, the Corporate Secretaries International Association (CSIA) hosted an international corporate governance conference in Shanghai, jointly with the Shanghai Stock Exchange.  CSIA represents over 100,000 governance practitioners worldwide through its 14 company secretarial member organizations. Speakers and panellists from Africa, Australia, mainland China, Hong Kong SAR, India, the UK and the US plus delegates from the 14 CSIA member countries discussed the cultural dependence of corporate governance.  For more information on CSIA see http://www.csiaorg.com

The conference considered whether corporate governance principles and practices around the world were converging.  Would a set of world-wide, generally-accepted corporate governance principles eventually emerge?  Or was differentiation between corporate governance practices inevitable because of fundamental differences in country cultures?  

Speaking at the conference the writer of this blog suggested that:

“A decade or so ago, it was widely thought that corporate governance practices around the world would gradually converge on the United States model.   After all, the US Securities and Exchange Commission had existed since 1934, sound corporate regulation and reporting practices had evolved, and American governance practices were being promulgated globally by institutional investors.  But that was before the collapse of Enron, Arthur Andersen, the sub-prime financial catastrophe, and the ongoing global economic crisis.  A decade ago it was also believed that the world would converge with US practices because the world needed access to American capital. That is no longer the case. So the convergence or differentiation question remains unanswered. 

Forces for convergence

“Consider first some forces that are leading corporate governance practices around the world to convergence.

Corporate governance codes of good practice around the world have a striking similarity, which is not surprising given the way they influence each other.  Though different in detail, all emphasise corporate transparency, accountability, reporting, and the independence of the governing body from management, and many now include strategic risk assessment and corporate social responsibility.  The codes published by international bodies, such as the World Bank, the Commonwealth of Nations, and OECD, clearly encourage convergence.  The corporate governance policies and practices of major corporations operating around the world also influence convergence.

Securities regulations for the world’s listed companies are certainly converging.  The International Organisation of Securities Commissions (IOSCO), which now has the bulk of the world’s securities regulatory bodies in membership, encourages convergence.  For example, its members have agreed to exchange information on unusual trades, thus making the activities of global insider trading more hazardous. 

International accounting standards are also leading towards convergence.  The International Accounting Standards Committee (IASC) and the International Auditing Practices Committee (IPAC) have close links with IOSCO and are further forces working towards international harmonization and standardization of financial reporting and auditing standards.   US General Accepted Accounting Principles (GAAP), though some way from harmonization, are clearly moving in that direction.

In 2007, The US Securities and Exchange Commission announced that US companies could adopt international accounting standards in lieu of US GAAPs.   However, American accountants and regulators are accustomed to a rule-based regime and international standards are principles-based requiring judgement rather than adherence to prescriptive regulations.

Global concentration of audit for major companies in just four firms, since the demise of Arthur Andersen, encourages convergence.  Major corporations in most countries, wanting to have the name of one of the four principal firms on their audit reports, are then inevitably locked into that firm’s world-wide audit, risk analysis and other governance practices.

Globalisation of companies is also, obviously, a force for convergence. Firms that are truly global in strategic outlook, with world-wide production, service provision, added-value chain, markets and customers, which call on international sources of finance, whose investors are located around the world, are moving towards common governance practices. 

Raising capital on overseas stock exchanges, also encourages convergence as listing companies are required to conform to the listing rules of that market. Although the governance requirements of stock exchanges around the world differ in detail, they are moving towards internationally accepted norms through IOSCO.

International institutional investors, such as CalPers, have explicitly demanded various corporate governance practices if they are to invest in a specific country or company. Institutional investors with an international portfolio have been an important force for convergence.  Of course, as developing and transitional countries grow, generate and plough back their own funds, the call for inward investment will decline, along with the influence of the overseas institutions.

Private equity funding is changing the investment scene.  Owners of significant private companies may decide not to list in the first place. Major investors in public companies may find an incentive to privatise. Overall the existence of private equity funds challenges boards of listed companies by sharpening the market for corporate control. 

Cross-border mergers of stock markets could also have an impact on country-centric investment dealing and could influence corporate governance expectations; as could the development of electronic trading in stocks by promoting international securities trading.

Research publications, international conferences and professional journals can also be significant contributors to the convergence of corporate governance thinking and practice.            

Forces for differentiation

“However, despite all these forces pushing towards convergence, consider others which, if not direct factors for divergence, at least cause differentiation between countries, jurisdictions and financial markets.

Legal differences in company law, contract law and bankruptcy law between jurisdictions affect corporate governance practices.  Differences between the case law traditions of the US, UK and Commonwealth countries and the codified law of Continental Europe, Japan, Latin America and China distinguish corporate governance outcomes.

Standards in legal processes, too, can differ.   Some countries have weak judicial systems. Their courts may have limited powers and be unreliable.  Not all judiciaries are independent of the legislature.  The state and political activities can be involved in jurisprudence. In some countries bringing a company law case can be difficult and, even with a favourable judgement, obtaining satisfaction may be well nigh impossible.                

Stock market differences in market capitalisation, liquidity, and markets for corporate control affect governance practices.  Obviously, financial markets vary significantly in their scale and sophistication, affecting their governance influence.

Ownership structures also vary between countries, with some countries having predominantly family-based firms, others have blocks of external investors who may act together, whilst some adopt complex networked, leveraged chains, or pyramid structures.

History, culture and ethnic groupings have produced different board structures and governance practices. Contrasts between corporate governance in Japan with her keiretsu, Continental European countries, with the two-tier board structures and worker co-determination, and the family domination of overseas Chinese, even in listed companies in countries throughout the Far East, emphasise such differences.  Views differ on ownership rights and the basis of shareholder power.

The concept of the company was Western, rooted in the notion of shareholder democracy, the stewardship of directors, and trust – the belief that directors recognise a fiduciary duty to their company.  But today’s corporate structures have outgrown that simple notion.  The corporate concept is now rooted in law, and the legitimacy of the corporate entity rests on regulation and litigation. The Western world has created the most expensive and litigious corporate regulatory regime the world has yet seen.  This is not the only approach; and certainly not necessarily the best.  The Asian reliance on relationships and trust in governing the enterprise may be closer to the original concept.   There is a need to rethink the underlying idea of the corporation, contingent with the reality of power that can (or could) be wielded.  Such a concept would need to be built on a pluralistic, rather than an ethnocentric, foundation if it is to be applicable to the corporate groups and strategic alliance networks that are now emerging as the basis of the business world of  the future. 

Around the world, the Anglo-Saxon model is far from the norm. A truly global model of corporate governance would need to recognise alternative concepts including:

  • the networks of influence in the Japanese keiretsu
  • the governance of state-owned enterprises in China, where the China Securities and Regulatory Commission (CSRC) and the State-owned Assets Supervision and Administration Commission (SASAC) can override economic objectives, acting in the interests of the people, the party, and the state, to influence strategies, determine prices, and appoint chief executives
  • the partnership between labour and capital in Germany’s co-determination rules
  • the financially-leveraged chains of corporate ownership in Italy, Hong Kong and elsewhere
  • the power of investment block-holders in some European countries
  • the traditional powers of family-owned and state-owned companies in Brazil
  • the domination of spheres of listed companies in Sweden, through successive generations of a family, preserved in power by dual-class shares
  • the paternalistic familial leadership in companies created throughout Southeast Asia by successive Diaspora from mainland China
  • the governance power of the dominant families in the South Korean chaebol, and
  • the need to overcome the paralysis of corruption from shop floor, through boardroom, to government officials in the BRIC and other nations.

The forces for convergence in corporate governance are strong. At a high level of abstraction some fundamental concepts have already emerged, including the need to separate governance from management, the importance of accountability to legitimate stakeholders, and the responsibility to recognize strategic risk. These could be more widely promulgated and adopted. But a global convergence of corporate governance systems at any greater depth would need a convergence of cultures and that seems a long way away.

Bob Tricker

5.11.2011

 

Is director independence so important?

The New York Stock Exchange Commission on Corporate Governance has reported.

In autumn 2009, the New York Stock Exchange (NYSE) formed an independent commission to examine core governance principles in the light of changes that had occurred in governance over the past decade, and to make recommendations which could be widely supported by listed companies, directors and investors. Chaired by Larry W. Sonsini, Chairman of Wilson Sonsini Goodrich & Rosat, a US law firm specializing in business and securities law, the commission members represented investors, listed companies, broker-dealers, and governance experts. On 23 September, 2010 the NYSE Euronext (NYX) published the Commission’s final report which identified 10 core principles of corporate governance covering the scope of the board’s authority, management’s responsibility for governance and the relationship between shareholders’ trading activities, voting decisions and governance.

The Commission argued that a board’s fundamental objective is to build long-term sustainable growth in shareholder value, so corporate policies that encourage excessive risk-taking for the sake of short-term increases in stock price are inconsistent with sound corporate governance. Corporate management has a critical role in corporate governance, the Commission concluded, as management has the primary responsibility for creating an environment in which a culture of performance with integrity can flourish.
Consistent with business opinion in many other parts of the world, the Commission felt that while legislation and agency rule-making are important to establish the basic tenets of corporate governance, over-reliance on legislation may not be in the best interests of shareholders, companies or society. The Commission, therefore, called for market-based governance solutions whenever possible.

The 10 core principles outlined by the Commission on Governance were:
1. The Board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation
2. Successful corporate governance depends upon successful management of the company, as management has the primary responsibility for creating a culture of performance with integrity and ethical behaviour
3. Good corporate governance should be integrated with the company’s business strategy and not viewed as simply a compliance obligation
4. Shareholders have a responsibility and long-term economic interest to vote their shares in a reasoned and responsible manner, and should engage in a dialogue with companies thoughtful manner
5. While legislation and agency rule-making are important to establish the basic tenets of corporate governance, corporate governance issues are generally best solved through collaboration and market-based reforms
6. A critical component of good governance is transparency, as well governed companies should ensure that they have appropriate disclosure policies and practices and investors should also be held to appropriate levels of transparency, including disclosure of derivative or other security ownership on a timely basis
7. The Commission supports the NYSE’s listing requirements generally providing for a majority of independent directors, but also believes that companies can have additional non-independent directors so that there is an appropriate range and mix of expertise, diversity and knowledge on the board
8. The Commission recognizes the influence that proxy advisory firms have on the markets, and believes that it is important that such firms be held to appropriate standards of transparency and accountability
9. The SEC should work with exchanges to ease the burden of proxy voting while encouraging greater participation by individual investors in the proxy voting process
10. The SEC and/or the NYSE should periodically assess the impact of major governance reforms to determine if these reforms are achieving their goals, and in light of the many reforms adopted over the last decade the SEC should consider the expanded use of “pilot” programs, including the use of “sunset provisions” to help identify any implementation problems before a program is fully rolled out

Principle #7 has raised some eyebrows in the United States. “While independence is an important attribute for board members”, the Commission said, “boards should seek an appropriate balance between independent and non-independent directors to ensure an appropriate mix of expertise, diversity and knowledge. The NYSE’s Listing Standards do not limit a board to just one non-independent director.”

The US-based Corporate Governance Alliance Digest, December 1, 2010, asked “Is this a good idea? Including more non-independent members on an issuer’s board may be a very hard sell to investors, given the fact that in all markets investors rank board independence as the most important governance topic. Is adding non-independent members an irritant worth creating?”

On the unitary board of a listed company, directors are responsible for both the performance of the enterprise and its conformance. In other words, the board is expected to be involved in strategy formulation and policy making, whilst also supervising management performance and ensuring appropriate accountability and compliance with regulations. It has been suggested that this means the unitary board is effectively trying to mark its own examination papers. Of course, the two-tier board structure avoids this problem by having the executive board responsible for performance and the supervisory board for conformance, with no common membership allowed between the two boards.

Typically, corporate governance codes and stock exchange listing rules call for independent outside (non-executive) directors to play a vital role in the unitary board. Independence is precisely defined to ensure that these directors have no interest in the company that could adversely affect genuine independent and objective judgement. The number or percentage of independent board members on listed company board is usually specified. Audit, remuneration and nomination committees of the board must be mainly or wholly comprised of these independent, outside directors.

The definition of independence in most corporate governance codes is exhaustive. To be considered independent a director must have no relationship with any firm in the up-stream or down-stream added-value chains, must not have previously been an employee of the company, nor be a nominee for a shareholder or any other supplier of finance to the company. Indeed, the definition of independence is so strict that an independent director who has served on the board for a long period is often assumed to have become close to the company and is no longer considered independent.

Herein lays a dilemma. The more independent directors are, the less they are likely to know about the company, its business and its industry. Conversely, the more directors know about the company’s business, organization, strategies, markets, competitors, and technologies, the less independent they become. Yet such people are exactly what top management needs to contribute to its strategy, policy making and enterprise risk assessment.

This argument looks set to run a long way.

Bob Tricker 6 December 2010

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.

 

Other issues

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

Concluding comments

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:

http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf

http://www.frc.org.uk/images/uploaded/documents/Implementation%20of%20Stewardship%20Code%20July%2020103.pdf

Chris Mallin 5th July 2010

Institutional Investors and Corporate Governance Reform

Corporate governance codes and guidelines have long recognised the important role that institutional investors have to play in corporate governance.  As well as being influential in their home countries, institutional investors have increasingly become a more significant force in other countries through their cross-border holdings. Recent corporate governance reforms motivated by the global financial crisis have placed even more emphasis on the role of institutional investors.

Role of Institutional Investors

Back in 1992, the Cadbury Report recognised the role played by institutional investors  stating that ‘we look to the institutions in particular ‘ to use their influence as owners to ensure that the companies in which they have invested comply with the Code’.  Various codes since then have emphasised the importance of the role.  The Financial Reporting Council (FRC) publishes the UK’s Combined Code on Corporate Governance (commonly known as the Combined Code).  The Combined Code (2008), in Section E, identifies three main principles.  Firstly it states that ‘institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives’; secondly ‘when evaluating companies’ governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention’; thirdly, ‘institutional shareholders have a responsibility to make considered use of their votes http://www.frc.org.uk/corporate/combinedcode.cfm The first and third principles relate to two of the tools of governance being dialogue and voting.  All three principles essentially require institutional investors to behave in a responsible and conscientious way, taking all relevant factors into account and making considered decisions.

Corporate Governance Reform

The UK Treasury commissioned the Walker Review of Corporate Governance of UK Banking Industry which reported in November 2009. The Walker Review recommends ‘strengthening the role of non-executives and giving them new responsibilities to monitor risk and remuneration; it also recommends a stewardship duty on institutional shareholders to play a more active role as owners of businesses.’ http://www.hm-treasury.gov.uk/walker_review_information.htm  Kate Burgess and Brooke Masters in their article ‘Institutions urged to adopt tougher stance’  (FT, Pg 21, 26th November 2009) states ‘Institutional investors are being urged to be tougher on company boards by Sir David Walker, as the City grandee adds his weight to pressure for them to take their responsibilities more seriously.’

The FRC’s statement welcoming the Walker Report can be found at: http://www.frc.org.uk/press/pub2174.html. The FRC has agreed to implement those recommendations that it considers should apply to all listed companies. In addition the FRC has agreed to consult on adoption of a Stewardship Code for institutional investors as recommended by Sir David.   

A recent review of the Combined Code http://www.frc.org.uk/corporate/reviewCombined.cfm has however recommended that Section E of the Code (addressed to institutional shareholders) be removed, ‘subject to sufficient progress being made on the Stewardship Code for institutional investors and its associated governance arrangements.’  The Stewardship Code for institutional investors as was proposed by Sir David Walker, and is an area on which the Financial Reporting Council (FRC) will be consulting separately http://www.frc.org.uk/corporate/walker.cfm

The final report on the review of the Combined Code (2008) makes various recommendations which include, inter alia, annual re-election of the chairman or the whole board; new principles for the roles of the chairman and non-executive directors.  Kate Burgess in her article ‘Sir Christopher misses out on succession planning’ (Pg 21, FT, 2nd December 2009) highlights that more emphasis should have been put on succession planning in companies as this tends to be a weakness in many firms.  Moreover it would be beneficial to investors in their stewardship role to have more knowledge of the process in place for succession planning.

Stewardship Code

The Institutional Shareholders’ Committee (ISC) membership comprises the Association of British Insurers, the Association of Investment Trust Companies, the National Association of Pension Funds, and the Investment Management Association.  The ISC has previously published guidance on the responsibilities of institutional investors in 2002, 2005 and 2007.  In November 2009, the ISC published its Code on the Responsibilities of Institutional Investors which is included as an Annex in the Walker Review and which is widely viewed as the basis for the Stewardship Code which will be monitored for the adherence of institutional investors on a ‘comply or explain’ basis.  The ISC states 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.’ http://www.institutionalshareholderscommittee.org.uk/ The Code discusses the stewardship responsibilities of institutional investors which include effective monitoring of investee companies and voting of all shares held. 

Effective Stewardship

Of course in order to carry out their responsibilities as shareholders, institutional investors need to be able to exercise their rights effectively – if they cannot, then they may be tempted to exit, i.e. to sell their shares.  An article in the Financial Times, ‘Shareholder rights’ (FT, page 12, 30th November 2009) points out that ‘if selling the shares is a blunt instrument, then removing board members is the sharpest.  More than nine in 10 international investors say the ability to nominate, appoint and remove directors is the most valuable shareholder right.  It is wrong that efforts to boost this power in the US have been delayed by the business lobby.’  Clearly it is in the interests of effective stewardship for institutional investors to be able to exercise their rights.  This will enable them to take action on prominent topical issues such as having a ‘say on pay’ in relation to directors’ remuneration, and removing underperforming directors from the board. 

However another dimension to consider is that of free riders.  Ruth Sullivan in her article ‘Walker plan points finger at freeriders’ (FTfm Pg 3, 30th November 2009) points out that some institutional investors will not engage more with their investee companies and be active owners, rather they will save their time and money and free ride on the efforts of other institutional investors. 

Concluding comments

The recent reforms mooted by the Walker Review and the Review of the Combined Code have made recommendations which will help to strengthen corporate governance in the UK.  The role of institutional investors is seen an important one and institutional investors are being encouraged to engage more fully in their role as owners and adhere to the ISC Code of Responsibility for Investors. 

Chris Mallin 2nd December 2009

Divide and Conquer? Splitting the Roles of Chair and CEO

 It is widely recognised that corporate scandals and collapses often occur when there is a single powerful individual in control of a company.  This is exacerbated when there is a lack of independent non-executive directors on the board.  Therefore it seems axiomatic that powerful individuals can be constrained, and the temptations they may face conquered, by having in place a sound corporate governance structure achieved through dividing the roles of Chair and CEO.

UK Context

Back in 1992, the much lauded Report of the Committee on the Financial Aspects of Corporate  Governance, often referred to as the Cadbury Report after the Chair of the Committee, Sir Adrian Cadbury, identified the potential danger of combining the roles of Chair and CEO in one person.  The Cadbury report recommended ‘there should be a clearly accepted division of responsibilities at the head of a company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision’.  This principle was embodied in corporate governance best practice in the UK, with the Combined Code on Corporate Governance (2008) stating ‘there should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision’, and furthermore the Combined Code explicitly states ‘the roles of chairman and chief executive should not be exercised by the same individual.’

Whilst combining the roles of Chair and CEO is rare in the UK’s largest companies, Marks and Spencer PLC is a notable exception.  In May 2004 Sir Stuart Rose was appointed to the position of Chief Executive and subsequently in 2008 he became both chairman and CEO until July 2011.  This combination of roles goes against the Combined Code’s recommendations of best practice.  As a result in 2008 some 22 per cent of the shareholders did not support the appointment of Sir Stuart Rose as chairman.  Nonetheless he remains in the combined role although there is still considerable shareholder unrest and 2009 has seen more dissent by shareholders on this issue.

US Context

In the US, the roles of Chair and CEO have often been combined but now more and more companies are appointing separate individuals to the two roles.  A recent example of a US company which has decided to appoint an independent chairman is Sara Lee, the famous producer of gateaux, beverages and body care products.  Sara Lee has decided to make this change as a response to investor pressure and also the growing trend in the US to split the two roles.  Kate Burgess (FT Page 27, 9th October 09) in her article ‘Sara Lee to separate executive roles’ explores this case in more detail.

Institutional Investor Pressure

In the UK there has long been pressure brought to bear by institutional investors on companies which have tried to combine these roles.  This pressure, together with the long history in UK corporate governance codes against the combination of roles, means that few large companies seek to combine the roles (although as noted above, Marks and Spencer plc is an exception).

Recently Norges Bank Investment Management (NBIM), a separate part of the Norwegian central bank (Norges Bank) and responsible for investing the international assets of the Norwegian Government Pension Fund, has started a campaign to convince US companies to split the roles of Chair and CEO and appoint independent chairmen.   Kate Burgess (FTfm Page 10, 12th October 09) in her article ‘Norwegian fund steps up campaign’ highlights how NBIM has submitted resolutions to four US companies calling on them to appoint independent chairmen.  The four companies are Harris Corporation, Parker Hannifin, Cardinal Health Inc, and Clorox.  In addition NBIM has also voted against combined Chair/CEOs at some 700 US companies.  Interestingly Sara Lee had also been the focus of action by NBIM before agreeing to appoint separate individuals to the roles in future. Also in Kate Burgess’ article, Nell Minow of The Corporate Library http://www.thecorporatelibrary.com/ states ‘NBIM can leverage a lot of shareholder frustration and a widespread sense that this is a sensible, meaningful but not disruptive initiative’.

Concluding comments

It seems to be only a matter of time before the vast majority of companies will split the roles of Chair and CEO.   Of course the individuals appointed to those roles must be both capable of fulfilling the tasks expected of them, and of ensuring that ultimately the two roles, carried out by separate individuals, unite the company under a common leadership approach.  That may prove more difficult than many imagine and so the appointments process must consider fully the many traits needed to ensure success.

 Chris Mallin 16th October 2009

UN Principles for Responsible Investment (PRI)

The UN Principles for Responsible Investment (PRI) were issued in 2006. The PRI were developed by an international group of institutional investors reflecting the increasing relevance of environmental, social and corporate governance issues to investment practices. The process was convened by the United Nations Secretary-General.  The PRI state: “As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time). We also recognise that applying these Principles may better align investors with broader objectives of society”.  http://www.unpri.org/principles/

Signatories to the PRI commit to incorporating ESG issues into investment analysis and decision-making processes; being active owners and incorporating ESG issues into ownership policies and practice; seeking appropriate disclosure on ESG issues by the entities in which they invest; promoting acceptance and implementation of the Principles within the investment industry; working together to enhance their effectiveness in implementing the Principles and reporting on their activities and progress towards implementing the Principles.

PRI Report on Progress (2008)

The ‘PRI Report on Progress 2008’ was published.  The report highlights progress made to date, special initiatives that have been undertaken, and areas for improvement.  Interestingly the PRI encourages signatories to disclose their responses to the annual Reporting and Assessment survey, and every year a number of signatories agree to make their responses publicly available.  The responses can be viewed at: http://www.unpri.org/report09/

One of the questions on the annual Reporting and Assessment survey asks respondents to rank the six principles on the level of difficulty of implementation of the principles.

There are currently 574 signatories to the Principles, comprising 183 asset owners, 282 investment managers, and 109 professional service partners. 

Aviva Investors is one of the signatories and their Head of Research and Engagement, Steve Waygood is quoted as saying: “There is now a critical mass of institutional investors who believe management of corporate responsibility or ESG issues is highly relevant to the long-term financial success of their investments”.

UN PRI Delists Members

The UN PRI recently delisted five of its signatories after they failed to report on their activities.  Sophia Grene (FTfm Page 6, 24th August 09) in her article ‘UN Principles need sharper teeth’ states ‘it is a significant step forward for the UNPRI to demonstrate there are consequences to treating the principles as nothing but a brand-enhancer’.

Concluding thoughts

The UN PRI have taken some clear steps to hold its members (signatories) to account.  The UN PRI are also working on a transparency framework which, according to Grene, will give  ‘clients, customers, members and other stakeholders…a clear sense of their responsible investment processes, activities and capabilities’.   It will be interesting to see how the UN PRI evolve over time given the growing interest in this area.

Chris Mallin 24th August  2009