The UK backed Kay Review of UK Equity Markets and Long-Term Decision Making was commissioned by Business Secretary Vince Cable after the takeover of Cadbury by Kraft, which many thought was driven by short-term investors. After examination the Report made several recommendations that could improve the long-term focus fund returns if properly implemented.
Kay told Reuters: “We have a problem of fragmentation in the asset management industry. And what we want is a collective forum that will give shareholders a single voice to address issues within companies.” (UK review calls for investor body to tackle boards, 7/23/2012)
The key is ensuring that pension funds, fund managers and companies address conflicts of interests through fiduciary standards that put the interests of savers and customers first. The UK Stewardship Code is due to be updated in October to include an investors’ forum to promote collective action. Fiduciary standards are to be applied throughout the investment chain, focusing on the role and incentivisation of asset managers.
Kay also recommended director pay linked to long-term business performance, with incentives to be provided only in the form of company shares to be held until after retirement.
Alan MacDougall, managing director of corporate governance lobby group Pensions Investment Research Consultants (Pirc), told Reuters:
The existing architecture for bringing together investors, now called the Institutional Investor Committee, has morphed from an original purpose not far from Kay’s vision into a collective of trade bodies principally concerned with coordinating industry lobbying activity. A fresh start here would be very welcome.
The Kay Review includes a wide range of recommendations aimed at investors, issuers, intermediaries and regulators and is intended to promote an expanded concept of stewardship, simplify the equity market ecosystem, and replace the current short-term “trading culture” with relationships based on long-term trust.
The Institute of Chartered Secretaries and Adminstrators and 2020 Stewardship Working Party, a group of institutional investors, wasted no time in responding to the Review’s recommendation that Good Practice Statements on stewardship be adopted. The groups announced that Sir John Egan, former chairman of Severn Trent plc, would lead the process of developing a good practice guide on engagement intended to provide
…a much needed catalyst in ensuring that the UK Stewardship Code goes beyond a box-ticking exercise…
The guide, which is expected to be published in March 2013, follows up on the 2020 Stewardship Working Party’s March report on Improving the Quality of Investor Stewardship, which raised concerns regarding both the quality and quantity of engagement between companies and investors.
Recommendations from the Kay Report include the following:
- The Stewardship Code should be developed to incorporate a more expansive form of stewardship, focussing on strategic issues as well as questions of corporate governance.
- Company directors, asset managers and asset holders should adopt Good Practice Statements that promote stewardship and long-term decision making. Regulators and industry groups should takes steps to align existing standards, guidance and codes of practice with the Review’s Good Practice Statements.
- An investors’ forum should be established to facilitate collective engagement by investors in UK companies.
- The scale and effectiveness of merger activity of and by UK companies should be kept under careful review by BIS and by companies themselves.
- Companies should consult their major long-term investors over major board appointments.
- Companies should seek to disengage from the process of managing short term earnings expectations and announcements.
- Regulatory authorities at EU and domestic level should apply fiduciary standards to all relationships in the investment chain which involve discretion over the investments of others, or advice on investment decisions. These obligations should be independent of the classification of the client, and should not be capable of being contractually overridden.
- Asset managers should make full disclosure of all costs, including actual or estimated transaction costs, and performance fees charged to the fund.
- The Law Commission should be asked to review the legal concept of fiduciary duty as applied to investment to address uncertainties and misunderstandings on the part of trustees and their advisers.
- All income from stock lending should be disclosed and rebated to investors.
- Mandatory IMS (quarterly reporting) obligations should be removed.
- High quality, succinct narrative reporting should be strongly encouraged.
- The Government and relevant regulators should commission an independent review of metrics and models employed in the investment chain to highlight their uses and limitations.
- Regulators should avoid the implicit or explicit prescription of a specific model in valuation or risk assessment and instead encourage the exercise of informed judgment.
- Companies should structure directors’ remuneration to relate incentives to sustainable long-term business performance. Long-term performance incentives should be provided only in the form of company shares to be held at least until after the executive has retired from the business.
- Asset management firms should similarly structure managers’ remuneration so as to align the interests of asset managers with the interests and timescales of their clients. Pay should therefore not be related to short-term performance of the investment fund or asset management firm. Rather a long-term performance incentive should be provided in the form of an interest in the fund (either directly or via the firm) to be held at least until the manager is no longer responsible for that fund.
- The Government should explore the most cost effective means for individual investors to hold shares directly on an electronic register.
The last point is one I hope will not get overlooked, especially as these ideas are discussed in the United States. Direct registration would solve a myriad of problems, such as obtaining evidence of ownership and disenfranchisement through use of voter information forms. Let’s hope discussion moves across the pond.