Corporate governance remains at the top of the political and business agenda. There are several consultations about to close or, having recently closed, the Government's response published. In this update we will highlight the key developments in this area, in particular, the recently published interim report of Professor John Kay on his review of UK equity markets and long-term decision making, the results of the Financial Reporting Council's discussions with companies and investors as to what constitutes a 'meaningful explanation' under comply-or-explain, the Government’s initiatives on executive pay, and the next steps of reforming narrative reporting.
Kay Review of UK equity markets and long-term decision making – the interim report
In February 2012 Professor John Kay published the interim report of his review of UK equity markets and long-term decision making (the Interim Report)1. The Interim Report sets out the submissions received in response to the call for evidence launched in September 2011 and the discussions and research conducted by the review team.
The report states that “the long term public goal for equity markets is in securing the public purposes of high performing companies and strong returns to savers through an effective asset management industry, and in ensuring that the profits earned by companies are as far as possible translated into returns to beneficiaries by minimising the costs of intermediation.” To that end, the report focuses on the following areas:
- The company and the board
- Measurement and reporting
- Market practice
- Asset managers, and
Given the broad remit of the review, the Interim Report is attempting to cover a wide spectrum of policy issues affecting the effective functioning of UK equity markets and long-term decision making. It does not contain conclusions or recommendations but instead outlines the issues which will be considered in the second phase of the review leading up to the submission of the final report (the Final Report) which is due this summer.
However, based on the findings of the Interim Report, the Final Report may make recommendations for reform in the following key areas:
The company and the board
- Directors’ duties. The Final Report may recommend putting a greater emphasis on the directors’ duty to promote the long-term success of the company. It may even recommend that the Takeover Panel consider offering greater opportunity for boards to reject bids which do not promote the long term success of either the acquirer or the acquire. It is unlikely, however, that the Final Report will recommend that long-term shareholders should receive enhanced voting rights as such differential rights between shareholders are traditionally strongly opposed by large institutional shareholders. Such measures could of course be implemented by companies themselves.
- CREST membership. The Final Report may recommend changes to enable personal CREST membership to become the normal means by which UK private individuals hold UK equities as a means to strengthen the position of beneficial owners of shares held through a nominee account. Currently, personal CREST membership requires sponsorship by a broker.
Measurement and reporting
- Quarterly reporting and interim management statements. It seems likely that the Final Report will recommend removing the requirement for companies to report quarterly and produce interim management statements. The removal of the requirement for listed companies to publish interim management statements has already been proposed by the European Commission in its review of the Transparency Directive.
- Tax treatment of corporate debt and equity. The Interim Report recognizes that any reform of the preferential tax treatment of debt over equity by, for instance restricting the deductibility of debt interest or increasing the attractiveness of equity financing or a combination of the two can only be achieved by international agreement.
- High frequency trading. High frequency trading has been criticised by a majority of the respondents. The Government Office for Science is currently examining the future of computerised trading in financial markets and the recommendations in the Final Report will reflect the conclusions of that examination.
- Insider trading and concert party rules. Both sets of rules have been criticised by some respondents for inhibiting shareholder engagement. The Takeover Panel clarified in a 2009 Practice Statement that the concert party rule “is not intended to restrict the ability of major shareholders or asset managers to act together to improve company performance” and will give clearance in such cases2. The Final Report may recommend strengthening minority shareholder protection to address possible abuse by shareholders using such control to advance their own interests rather than those of shareholders as a whole.
- Trading versus investing. The Interim Report points out that the average holding period of shares has fallen steeply due to the expansion of the volume of trading relative to investing. This may be one of the factors which, along with the increased fragmentation of share ownership, contribute to the current lack of incentive for shareholder engagement. Measures the Final Report may recommend to counteract this development include offering enhanced rights to engaged and long-term shareholders, requiring shareholders to act collectively, and encouraging fund managers to hold more concentrated positions.
- Fees and charges. In response to the “widespread and vehement criticism of investment banking fees” and excessive costs of intermediation generally, the Final Report may recommend requiring greater transparency and disclosure about charges of certain intermediaries. Greater transparency of fees was recently introduced in the context of takeovers (see the April and October 2011 In Counsel updates).
- Fiduciary relationship. The Final Report may recommend extending the concept of fiduciary duty to the relationship between fund manager and client, and applying a version of the ‘enlightened shareholder value’ concept of the Companies Act 2006 in relation to directors’ duties to certain intermediaries.