Summary and implications

The Financial Reporting Council (FRC) has published the first version of the UK Stewardship Code. The Stewardship Code sets out good practice for institutional investors on engagement with investee companies.

This briefing looks at the principles contained in the Stewardship Code and their implications for institutional investors. Points to note are:

  • The 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 investment vehicles.
  • The Stewardship Code does not constitute a requirement to engage, instead the FRC encourages all institutional investors to apply the Stewardship Code on a “comply or explain” basis.
  • The FRC suggests that institutional investors should publish a statement of compliance with the Stewardship Code on their website by the end of September 2010.

Background

The publication of the Stewardship Code represents another milestone in the shake-up of corporate governance in the UK following the financial crisis. As recommended by the Walker Review, the FRC now has dual responsibility for the Stewardship Code and the UK Corporate Governance Code. The two Codes are designed to be complementary sets of good practice for institutional investors and company boards respectively, with the aim of fostering more robust accountability.

The new Stewardship Code is based on the code on the responsibilities of institutional investors which was issued by the Institutional Shareholders Committee (ISC) in late 2009. Following consultation with the market, the FRC has adopted the ISC code with only minimal changes (the most notable one being to encourage investors to engage with companies on an ongoing basis, not just when they have concerns).

The principles in the Stewardship Code

1. Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities

The policy should cover how investee companies are monitored, the investor’s intervention strategy, voting policy and policy on Corporate Governance Code compliance as well as how stewardship interacts with the wider investment process.

2. Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed

Institutional investors should have a policy for managing conflicts of interest which may arise, such as when voting on matters affecting a parent company or client.

3. Institutional investors should monitor their investee companies

Investors are encouraged to meet the chairman of investee companies (and other board members, where appropriate) as part of an ongoing monitoring process and not just when they have concerns. Where appropriate and practicable investors should attend the general meetings of companies in which they have a major holding. Investors should consider carefully any explanations given by investee companies for departure from the Corporate Governance Code, and advise the company where they do not accept its position.

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

Institutional investors should set out when they expect to actively intervene in an investee company, whether or not the investor’s investment policy is active or passive. The Stewardship Code sets out an list of escalating actions which institutional investors should consider if boards do not respond constructively, ranging from holding meetings with management to discuss specific concerns to convening general meetings to propose board changes.

5. Institutional investors should be willing to act collectively with other investors where appropriate

The Stewardship Code encourages institutional investors to collaborate where appropriate and to have a policy on collective engagement. Where investors intend taking some form of collective action, they should also consider recent guidance from the FSA on whether such action could constitute market abuse or result in other regulatory consequences.

6. Institutional investors should have a clear policy on voting and disclosure of voting activity

Institutional investors are expected to vote their shares in a considered way, not necessarily always in support of the investee company board. The Stewardship Code regards it as good practice that investors should explain to companies in advance if and why they either abstain from voting or vote against any particular matter. Investors are expected to publicly disclose their voting records or explain why they do not.

7. Institutional investors should report periodically on their stewardship and voting activities

Institutional investors should report on their stewardship and voting activities to their clients or end-beneficiaries on both a qualitative and quantitative basis. Although transparency is an important aspect of the Stewardship Code, investors should however remain alert to counterproductive disclosures, for example where maintaining confidentiality is more likely to deliver a positive outcome.

 Future developments

The FRC encourages institutional investors to publish a statement of compliance with the Stewardship Code on their website by the end of September 2010.

The FRC has indicated that this inaugural version of the Stewardship Code will be given at least a year to bed in, with annual monitoring of the take-up and application of the Stewardship Code likely to begin in late 2011.

Meanwhile, the European Commission has recently published a Green Paper on corporate governance in financial institutions, with a second Green Paper on corporate governance in listed companies expected to follow in early 2011. Both of these Green Papers may lead to action at EU level in relation to stewardship codes and other measures designed to foster shareholder engagement.