Speech by Stephen Haddrill at EIRIS 30th anniversary conference
News types: Speeches
Published: 25 September 2013
Find below the plain text version of Stephen Haddrill's speech at EIRIS's 30th anniversary conference on 25 September 2013.
Good afternoon,
I am very pleased to be here to celebrate EIRIS’s 30th anniversary with you, and thank you for the opportunity to share some thoughts with you on responsible investment and the role the FRC plays in driving forwards this important agenda. It is particularly pleasI am very pleased to ing to be here today with an organisation, which along with your clients, has done so much over the years to raise the profile of responsible investment.
Good afternoon,
I am very pleased to be here to celebrate EIRIS’s 30th anniversary with you, and thank you for the opportunity to share some thoughts with you on responsible investment and the role the FRC plays in driving forwards this important agenda. It is particularly pleasI am very pleased to ing to be here today with an organisation, which along with your clients, has done so much over the years to raise the profile of responsible investment.
ESG
Let me begin by focusing on the prominence that investors now give to environmental, social and governance factors in their decision-making.
One challenge for investor stewardship based on ESG principles is how it actively translates to better corporate performance, and that is a point it is in all our interests to address. I particularly liked the recent analysis carried out by one of the signatories to our Stewardship Code where they noted that combining ESG analysis with fundamental valuation techniques provided important insights for UK equities selection. They concluded, for example, that companies with the best scores for board effectiveness achieved returns many times higher than their peers with the least effective boards. Overall, there is now a significant body of research which supports the thesis that ESG indicators can yield meaningful insights for investors.
A consensus is now also gathering that good corporate governance translates into meaningful benefits for issuers. The QCA and BDO published their small and mid-cap sentiment index last week. This asked a number of companies about their approach to corporate governance. Of the sample, around 85% of companies stated that they saw a tangible benefit in following a Code, and perhaps not coincidentally 85% either followed the UK Corporate Governance Code or the QCA Code, which is modeled on it. Improved risk management was also seen as a key benefit from good governance by half the respondents, while 42 per cent of advisors polled also believed that following a code led to higher levels of institutional investment.
So if we are agreed that taking ESG seriously has benefits for both investors and companies, what then is the role of the FRC?
Stewardship Code
The Financial Reporting Council is the UK’s independent regulator responsible for promoting high quality corporate governance and reporting to foster investment. We promote high standards of corporate governance through the UK Corporate Governance Code and seek to underpin the effectiveness of that Code through the UK Stewardship Code.
The UK Stewardship Code aims to enhance the quality of engagement between asset managers and companies to help improve long-term returns to shareholders. The Code sets out a number of areas of good practice to which the FRC believes institutional investors should aspire. It operates on a 'comply or explain' basis.
Figure 1 outlines the take up of the Stewardship Code which has risen to almost 300 since its inception in 2010.
Those signed up include 205 asset managers, 72 asset owners and 14 service providers. The signatories manage around 40% of UK equities and include nearly all of the top 30 investors in UK plc, with the exception of certain sovereign wealth funds. It is encouraging to see so many international institutional investors prioritising stewardship.
The last twelve months has also seen the global spread of the Codes. Many major international managers have signed up to the Code through their UK operations, and Figure 2 shows the spread of international signatories.
In addition, a Swiss Code was launched last autumn, and there are now Codes operational in South Africa, Canada, the Netherlands and the European Union through the EFAMA code. The Singapore Corporate Governance Code contains a new reference to shareholders’ responsibilities and there have also been consultations on the introduction of codes in Australia and India. Draft codes are currently under development in Italy, Malaysia and Japan.
We absolutely welcome this international engagement and see it as a key indicator that stewardship is on its way to being business as usual. However, we do recognise that a proliferation of national stewardship codes with different requirements could create confusion. We can therefore see some benefit in a set of internationally agreed principles, therefore, as long as they remain high-level and don’t become overly prescriptive.
Stewardship is increasingly applied to other asset classes, both by managers and owners. The latest IMA Stewardship survey was published in June and it reported that 36% of all respondents, all of whom managed UK equities, also engaged with companies in which they had fixed income holdings. Our research aligns with the IMA’s numbers: with around a third of those we asked applying their stewardship approach to global equities and a similar proportion to their fixed income holdings.
The Code was launched in 2010, and revised modestly in 2012. We are currently considering whether any further changes might be helpful, as part of our annual monitoring of developments in corporate governance. Our findings will be published at the end of this year. If changes are required, then we will go out for consultation with the market early next year, but it is important to stress that we seek to minimize changes to the Code unless absolutely necessary.
Success for us is not tinkering with the Code for the sake of it, but seeing sustained behavioural change in the market.
Comply or Explain
One of the aspects of both the Corporate Governance and Stewardship Codes that we believe is of the greatest importance is the principle of “comply or explain.” Comply or explain’ has allowed us to be more aspirational in setting the Codes. Companies and investors have accepted changes more readily knowing they have flexibility to adapt to their own particular situations.
Because of this flexibility, the UK achieved a rapid and high take-up of such initiatives as the annual election of directors, separation of the roles of Chairman and CEO and independent audit committees without the need for regulation.
We therefore welcome the European Commission’s support for the principle of “comply or explain” in the Company Law Action Plan, and their recognition that corporate governance and stewardship codes can play an important role in raising standards and spreading best practice. As part of that Action Plan they propose measures that would require asset managers and owners to report on their voting and engagement policies. As I mentioned that could be helpful if it means some common principles are established across the EU, but would be positively unhelpful if it led to reams of boiler-plate reporting or – worse still – if it attempted to dictate investment strategies.
We think that empowering companies and companies to make their own judgements on governance and stewardship is fundamentally a good thing for markets. The legal duty of company boards is to act in the interests of the shareholders. So it must be right that it is the shareholders, not regulators, who ultimately decide whether the board is doing so. The role of the FRC is to ensure they have the information they need to make that assessment.
Investor engagement
Looking at the UK capital markets, Figure 3 sets out the list of issues on which investors engaged last year. It is evident from this chart that there are high levels of engagement around remuneration, but very little around audit committee issues including risk management. We believe that companies should pay closer attention to all aspects of governance, including a function as important as the audit committee.
Longer Term Focus
For the FRC it is important that the development of governance and stewardship foster a long term view in the market and enhance trust in UK business.
Figure 4 shows that the spread of share ownership is changing and that long term owners are a decreasing percentage of the market as a whole.
The FRC is currently looking at the European Commission’s Green paper on long-term financing of the European economy and has paid close attention to John Kay’s review of long-term financing in the UK.
The Kay Review suggested that the equity market has ceased to be a source of net new capital for companies, and argues that its role is mainly to be the focus for corporate governance control.
We do not agree with this narrow view of the role of the equity market.
The equity market enables savers to share in the growth of the most successful companies, and companies to attract risk-absorbing capital at the lowest possible cost. It is a powerful driver of growth.
Figure 4 shows that the spread of share ownership is changing and that long term owners are a decreasing percentage of the market as a whole.
The FRC is currently looking at the European Commission’s Green paper on long-term financing of the European economy and has paid close attention to John Kay’s review of long-term financing in the UK.
The Kay Review suggested that the equity market has ceased to be a source of net new capital for companies, and argues that its role is mainly to be the focus for corporate governance control.
We do not agree with this narrow view of the role of the equity market.
The equity market enables savers to share in the growth of the most successful companies, and companies to attract risk-absorbing capital at the lowest possible cost. It is a powerful driver of growth.
Asset Owners
I would like to close by sharing a few thoughts on the role of asset owners.
To be clear, signing up to the Code does not mean that an owner, as distinct from a fund manager, has to engage with the companies in its portfolio directly, nor that the owner is encouraged to duplicate the activities of its managers. But what owners should do is ensure stewardship criteria are considered as part of the manager appointment process, and then hold their managers to account during the manager review process to ensure they are undertaking their stewardship responsibilities correctly.
Another misconception we need to clarify is that the Code is just for pension funds. It is true that around three quarters of asset owner signatories are pension funds, but we are keen that other types of owners play their part.
We would particularly like to see more large charitable foundations and endowments following the great lead set by the Wellcome Trust and the Joseph Rowntree Charitable Trust in signing up to the Code. Foundations and Charities clearly played a significant role in the history of EIRIS too, an alliance of churches, NGOs and the Joseph Rowntree Charitable Trust were behind the first ethical unit trust in the UK, the Quaker-based Friends Provident, which became…your first client. A connection to remember on this special day.
So to conclude, at the FRC we are often asked ‘what has the Stewardship Code actually changed?’
We have to be realistic.
The UK Corporate Governance Code reached the grand old age of 20 last year. But the Stewardship Code is in its infancy - a toddler in its terrible twos - and so it should be perfectly reasonable for practice still to be developing.
However, we already see a positive impact from the Code. One of its greatest benefits is to normalize stewardship as something investors feel entitled to ask about. Investors are much less likely to be fobbed off with the line that voting and engagement is a niche subject which “only you care about as no one else is asking these questions.” A message which I imagine sounds quite familiar to a few of you. At the end of the day, the Stewardship Code is a toolkit for investors to use to shape your engagement with companies but it is now up to you all, managers and owners alike, to speak up and use those tools.
To be clear, signing up to the Code does not mean that an owner, as distinct from a fund manager, has to engage with the companies in its portfolio directly, nor that the owner is encouraged to duplicate the activities of its managers. But what owners should do is ensure stewardship criteria are considered as part of the manager appointment process, and then hold their managers to account during the manager review process to ensure they are undertaking their stewardship responsibilities correctly.
Another misconception we need to clarify is that the Code is just for pension funds. It is true that around three quarters of asset owner signatories are pension funds, but we are keen that other types of owners play their part.
We would particularly like to see more large charitable foundations and endowments following the great lead set by the Wellcome Trust and the Joseph Rowntree Charitable Trust in signing up to the Code. Foundations and Charities clearly played a significant role in the history of EIRIS too, an alliance of churches, NGOs and the Joseph Rowntree Charitable Trust were behind the first ethical unit trust in the UK, the Quaker-based Friends Provident, which became…your first client. A connection to remember on this special day.
So to conclude, at the FRC we are often asked ‘what has the Stewardship Code actually changed?’
We have to be realistic.
The UK Corporate Governance Code reached the grand old age of 20 last year. But the Stewardship Code is in its infancy - a toddler in its terrible twos - and so it should be perfectly reasonable for practice still to be developing.
However, we already see a positive impact from the Code. One of its greatest benefits is to normalize stewardship as something investors feel entitled to ask about. Investors are much less likely to be fobbed off with the line that voting and engagement is a niche subject which “only you care about as no one else is asking these questions.” A message which I imagine sounds quite familiar to a few of you. At the end of the day, the Stewardship Code is a toolkit for investors to use to shape your engagement with companies but it is now up to you all, managers and owners alike, to speak up and use those tools.