The recent publication of the UK Stewardship Code 2020 by the Financial Reporting Council (FRC) provides further evidence that ESG factors have moved into the mainstream for investors. The introduction to the new Code makes it clear that: 'Environmental, particularly climate change, and social factors, in addition to governance, have become material issues for investors to consider when making investment decisions and undertaking stewardship'.
The FRC has defined stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society. Although the term itself is defined, the new Code does not prescribe a single approach to effective stewardship.
The new Code contains 12 principles for asset owners and asset managers and six separate principles for service providers. Each principle is supported by reporting expectations which indicate the information which a signatory to the Code should include in its Stewardship Report. The structure is different from that adopted by the UK Corporate Governance Code (which relies on principles and supporting provisions).
The new Code will replace the 2012 UK Stewardship Code.
How does the new Code approach ESG factors?
Principle seven requires signatories to 'systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities'.
What are the specific ESG reporting expectations?
The reporting expectations underpinning principle seven require signatories to:
- disclose the issues they have prioritised for assessing investments, prior to holding, monitoring through holding and exiting. This should include the ESG issues of importance to them;
- how integration of stewardship and investment has differed for funds, asset classes and geographies;
- how they have ensured:
- tenders have included a requirement to integrate stewardship and investment, including material ESG issues;
- the design and award of mandates include requirements to integrate stewardship and investment to align with the investment time horizons of clients and beneficiaries; or
- the processes they have used to:
- integrate stewardship and investment, including material ESG issues, to align with the investment time horizons of clients and/or beneficiaries; and
- ensure service providers have received clear and actionable criteria to support integration of stewardship and investment, including material ESG issues.
What else should signatories consider when applying the principles?
Signatories to the UK Stewardship Code 2020 will need to consider the following, among other matters:
- the effective application of the UK Corporate Governance Code and other governance codes;
- directors’ duties, particularly those matters to which they should have regard under section 172 of the Companies Act 2006;
- capital structure, risk, strategy and performance;
- diversity, remuneration and workforce interests;
- audit quality;
- environmental and social issues, including climate change; and
- compliance with covenants and contracts.
When does the new Code take effect?
The new Code takes effect from 1 January 2020. Organisations must submit a final Stewardship Report to the FRC by 31 March 2021 if they want to be included in the first list of signatories to the UK Stewardship Code 2020. Existing signatories to the 2012 Stewardship Code will need to submit a Stewardship Report which meets the FRC’s reporting expectations set out in the UK Stewardship Code 2020 if they want to be listed as signatories to the new Code.
The Financial Conduct Authority (FCA) will continue to work with the FRC as the UK Stewardship Code 2020 is introduced. It will consider the need for any further action as the new Code takes effect, so that the regulatory framework continues to support effective stewardship. See FS19/7 for further details of the FCA’s approach.
What does this mean for enlightened shareholder value?
There is no formal direct link between stewardship as defined by the FRC and 'enlightened shareholder value' which provides the conceptual underpinning for section 172 of the Companies Act 2006. However the parallels are clear. If section 172 of the Companies Act 2006 is revisited it seems clear that greater emphasis will be given in that section to ESG factors and climate change even if a different formulation is used.