Britain's New Stewardship Code Launches - At A Critical Time
Trust lies at the heart of any belief in better stewardship by investors, and therein lies the good governance draw of financial capital. For trust to be generated, there has to be clearly stated and understood strategic purpose, alongside transparency and the power to hold to account.
Amid widespread consensus that it was high time the UK’s pioneering stewardship code was revamped almost a decade after its launch to global acclaim and emulation, the regulator, the Financial Reporting Council (FRC) today launches a new version for consultation. It marks an important change in both the remit and the extended responsibility of stewardship, but whether it will be effective will depend on the scrutiny.
Signatories are now being asked to develop and be clear on their organisational purpose and, importantly, to report “how their purpose, values and culture enable them to meet their obligations to clients and beneficiaries.”
The Code has been reshaped to set “new and substantially higher expectations.” It now explicitly states the importance of environmental, social and governance (ESG) issues including climate risk - and signatories are expected to take “material ESG issues” into account when fulfilling their stewardship responsibilities, and report on them.
The new Code also broadens the expectation of stewardship beyond UK listed equity assets. Stewardship, it says, “is the responsible allocation and management of capital across the institutional investment community to create sustainable value for beneficiaries, the economy and society.”
This definition identifies “the primary purpose of stewardship as looking after the assets of beneficiaries that have been entrusted to the care of others - a step change that has been called for by a variety of stakeholders, particularly those concerned about pensions.
As financial capital is allocated to a range of asset types, the `code aims to encourage the application of the Principles to private equity holdings, bonds, infrastructure and alternatives. “Signatories should use the resources, rights and influence available to them to exercise stewardship, no matter how capital is invested” says the new Code.
It has been developed for asset owners, asset managers as well as investment consultants, proxy advisers and “other service providers that want to demonstrate their commitment to stewardship. “ Where stewardship activity is outsourced by a business, it remains responsible for it.
Signatories are being asked to actively demonstrate how prospective and current investments are aligned with their stewardship approach - and declare their investment time horizon. This could pose some interesting questions for those investing in some of the technology companies that have attracted attention over their working and business culture, both before and after listing.
Voting records need to be disclosed, and policy on voting shares in listed assets must be set out. Signatories are also expected to explain their policy on non-voting shares in listed assets in detail.
The FRC has abandoned its previous approach of a ‘tier system’ for signatories. All signatories are expected to actively monitor performance of assets, undertake constructive engagement “to maintain or enhance their value” and communicate clearly with clients and beneficiaries.
Since the Stewardship Code was first launched in 2010 after the Walker report on corporate governance commissioned by the UK government, much has changed in the challenges businesses are facing on multiple fronts. Then, it was also the first time that a regulator had pushed asset managers to become better at calling businesses to account. Since then, some 20 countries have followed suit with similar Codes.
The European stewardship code which is overseen by the European Fund and Asset Management Association (EFAMA) was revised last year, with a tougher line on ESG and human rights. The UK Code remains underpinned by the Financial Conduct Authority (FCA) Conduct of Business Sourcebook and incorporates the requirements of the EU Shareholder Rights Directive II (SRD II). Its requirements are “more demanding than SRD II” it says, but “it is the intention of the FRC that in reporting against the Code, signatories will have regard to the relevant reporting requirements of the laws, rules, regulations and adminstrative provisions that transpose SRD II.”
But at the end of the day, the impact of the new Stewardship Code will depend on the quality of oversight by the FRC.
The Kingman Report on the FRC’s future, which was published last month, suggested the government consider whether further powers are needed to assess and promote compliance with the stewardship code. While the ‘principles’ of the Code demand an ‘apply or explain’ the provisions remain ‘comply or explain’ - which offers the chance to offer a credible alternative. Without strong enforcement and auditing (an area still mired in confusion) it could all amount to very little.
As businesses struggle with multiple economic challenges, technological change and new ways of working in 2019, the importance of paying attention to their management of human capital has never been greater, and is an issue being taken up by institutional investors.
It is a shame it has not been named alongside climate risk as a material ESG issue in the Code, particularly as businesses often struggle with obtaining data on the workforce and with real or feigned ignorance of their supply chain.
The Workforce Disclosure Initiative is a good demonstration of the effective power of the collaboration between business, stakeholders and investors needed for change. Articulating social purpose - whether for business or investors - is an excellent place to start.
The public continue to look to business to fill the shortcomings of government, with more than three in four Brits believing that CEOs should take the lead on change rather than waiting for the government to impose it - up 19 percentage points from 2018. Equal pay, prejudice and discrimination, and training for the jobs of tomorrow are listed as the top areas where CEOs can create positive change.
Also interesting is Edelman’s finding that the UK public believes the greatest obligation for business leaders (65%) is to treat employees fairly, far above treating customers well (47 %). Britons are split along memorable lines on whether the way that business works today is good for British society - 48% say it is and 52 % feel it isn’t . But, says Edelman, asked why it isn’t , the most common answer (67%) was that companies thought profit was more important than looking after people, while half (50%) thought that companies did not pay their fair share of tax.
If the purpose of corporate governance, Codes and regulation is to help build better business and a better society based in part on that relationship, then surely poor human capital management is the highest material ESG risk that is in urgent need of attention - and for every business, includes rethinking the role of HR.
When looking at the relationship between employees and employers in the UK, according to Edelman three in four say they trust their employer to do what is right, considerably higher than any other institutional relationship in Britain today.
If it’s trust that we are trying to build on, surely that information is invaluable.