Political and regulatory news
Issue 2 - 19 May 09
Investors challenged over their stewardship responsibilities
Following the banking crisis, the role of institutional investors is in the spotlight.
The role of institutional investors has come under increasing political and media scrutiny as the current economic crisis has evolved, particularly in relation to high profile failures in the banking sector. Questions are being asked about the failure of institutional shareholders to adequately scrutinise and monitor decisions made by the boards of various banks and to hold directors accountable for their performance. Evidence presented at the Treasury Select Committee on the banking crisis argued that bank boards failed to address serious concerns raised by shareholders. As a result, a number of UK and European-wide measures to improve the effectiveness of the relationship between institutional shareholders and the board are in the pipeline.
The corporate governance regime in the UK already envisages an ongoing relationship between boards and investors designed to promote dialogue. How effectively this is working was questioned by Lord Myners, Financial Services Secretary. He suggested that institutional investors have not intervened successfully because they have lacked co-ordination, which has resulted in conflicting views being put to boards. He also claimed that too many investors were passive and failed to engage at all. Consequently, the minister called upon institutional investors to take the lead to achieve higher governance standards by devoting more time and money to constructively challenging boards. If a more open and constructive debate could be achieved between shareholders and non-executive directors, he feels this would “promote a greater understanding of the realities that each side faces” and allow the board to “discharge its duties in the best interests of shareholders, thus delivering shareholder value over the longer term”.
This sentiment was echoed by Hector Sants, Chief Executive of the FSA. In a recent speech he argued that shareholders should “take responsibility to be active individually and more importantly, in collaboration with other investors, to engage with senior management and Non-Executive Directors in companies and question the effectiveness of the construction of their boards”. He also said that institutional shareholders should be less reliant on the standard forms of information provided by companies such as the annual report and accounts. They should be more challenging about how the company is managed and pay greater attention to assessing the adequacy of risk management processes.
Lord Myners explored these issues further in his speech to the AIC conference, saying, “Boards of investment companies need to ask their manager to account for how they exert proper challenge and discipline on investee companies; and boards should, in turn, account in a similar manner to their shareholders”. He identified an opportunity for boards to emphasise the value of the investment company model over other types of investment products through the non-executive directors’ independent oversight of managers and their managerial role on behalf of shareholders.
These comments provide the background to what is likely to be a comprehensive review of existing practice. The Financial Reporting Council is examining the Combined Code (for more information please see Political and Regulatory News article called “Director obligations under scrutiny in governance review” here). This will complement a review by Sir David Walker into corporate governance in the banking sector and other financial services institutions.
Consideration of how boards operate is running in parallel with scrutiny of the involvement of institutional shareholders in the affairs of their investee companies, with a focus on issues such as management remuneration. Lord Myners has called for remuneration committees to be more open to a wider range of views, including those of investors, and has suggested they might formally seek their views. Hector Sants said shareholders should be concerned with the “quantum of remuneration as well as the structure”. The responsibility of non-executive directors for setting executive director pay is also under review. For example, the European Corporate Governance Forum has published best practice principles on directors’ remuneration for incorporation into national corporate governance codes.
Failures highlighted by the current economic crisis are expected to result in reforms which have far wider implications than the banking sector. In response to political and wider concerns being raised. the Institutional Shareholders Committee, comprised of the AIC, ABI, NAPF and IMA, is preparing views on how best practice can be developed for discussion in the investment management industry and for consideration by the Government. If voluntary initiatives are not satisfactory there may even be legislative intervention by the Government to compel more active involvement by investors in protecting shareholder value where they have serious concerns about the strategy of investee companies.
In the current environment it seems inevitable that higher expectations will be placed on institutional investors to demonstrate their commitment to effective governance. Investment companies have a unique role in this regard as both issuers of shares held by institutional shareholders and as investors and the AIC will seek to inform this debate to ensure that any policy response is proportionate, without imposing too high an administrative or regulatory cost. The most productive approach is likely to involve encouraging transparency and best practice in relation to the most significant UK plcs rather than compulsory action across the waterfront. The AIC will be focussed on securing this outcome and will continue to engage in the evolving debate.
Lord Myner’s comments (to the NAPF Annual Investment conference) can be found here. His speech to the AIC Annual Conference for Directors can be found here.
Hector Sants speech (at the NAPF Investment Conference) can be found here.
This is the last article in this edition.
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