21 January 2004
Speech by the FINANCIAL SECRETARY to the Treasury, RUTH KELLY MP, at NAPF conference on corporate governance
1. I am delighted to be here today…and I’d like to thank NAPF for asking me to speak to you, and for putting on what is, I think, an extremely valuable conference. Corporate governance – or rather sound corporate governance – is one of the keys to maintaining a healthy financial services industry, healthy capital markets and indeed a healthy economy.2. This country already benefits from having both strong and liquid capital markets…these markets do their job: they finance investment and give powerful signals and incentives to corporate management…they are a considerable national asset.
3. But they have historically been coupled with evidence of under investment in the UK economy. And it is clear that they do not always work as efficiently as they could. These issues have been the focus of a great deal of government work in recent years...some of which I’d like to discuss with you today.
4. Partnership and open dialogue with the industry is absolutely critical… another reason that I am so pleased to have this chance to address you all. It is also good to see industry initiatives – such as NAPF’s recently published corporate governance policy.
Improving the investment chain
5. Our capital markets have a vital role to play in efficiently allocating capital in the economy, thereby meeting the needs of millions of savers and thousands of businesses.
6. And a good framework for investment decisions and corporate governance ensures not only that this capital is put to its most effective use, but also that it is reallocated on a timely basis. This helps to promote better company performance, higher returns to investors and a lower cost of capital.
7. Corporate governance will naturally be strongest when the interests of the owners and the interests of the managers are most closely aligned. And yet a key feature of modern economies is the dispersion of company ownership – and the separation of owners from management by a complex chain of intermediaries.
8. As we have found, each link in this chain raises its own complex policy issues about competition, incentives and accountability. And the separation, and the complexity of the investment chain, can result in the interests of the owners and the managers being, at times, loosely aligned.
9. Elements within the chain may have poor incentives to act in the interests of the owners; often transaction costs can be high; and it can be particularly difficult to hold agents accountable for desired performance – indeed owners may not even have the information needed to hold agents accountable.
10. The Government has taken a series of steps on these issues, particularly through promoting greater accountability and transparency in the links between investors and companies.
11. These steps have affected many, if not most, of the links in the investment chain.
12. For example, we have undertaken the Higgs review, and endorsed its incorporation in the new Combined Code – which took effect last November.
13. The changes to the Combined Code represent a big step forward in improving accountability – by strengthening boards’ capacity to act independently and effectively, and by enhancing dialogue with shareholders. We very much welcome that, as indeed we welcome the consensus-based philosophy that emerged during the FRC’s consultation on the new Code.
14. The challenge now is for both companies and shareholders to make the new Code work. Boards need to use Higgs as a template for improvement. Shareholders need to engage with boards and consider seriously the reasons they give for any non-compliance. As Derek recommended, we will be looking to see concrete improvements over the next couple of years.
15. And there are other measures that help improve the scope and quality of corporate governance:
16. Coming out of the CGAA and Smith reviews, we have introduced legislation– and driven non-legislative measures – to enhance auditor independence and to strengthen financial reporting. This includes the bill amending the Companies Act currently before Parliament.
- We have worked on measures to improve the competence of pension fund trustees – which will be included in the forthcoming Pensions bill.
- We have endorsed the Myners principles that came out of the Myners Review – and these have been incorporated into the ISC’s best practice principles.
- The FSA is consulting on its proposals to improve the independence of stock broking research and the transparency and management of broker commissions.
- We have introduced regulations that give shareholders an advisory vote on directors’ remuneration reports, letting them signal their approval or concerns over pay and policy to the board.
- And we will shortly be consulting on regulations to introduce an operating and financial review.
- We are also pleased to see the industry taking steps to accelerate progress on tackling the problem of ‘lost votes’ and encouraging electronic voting, through Paul Myners’ appointment as the head of the Shareholder Voting Working Group.
17. Taken together, I believe these steps represent a new and coherent approach towards policymaking as it affects the investment industry – one that is rooted in a clear understanding of the chain of relationships in the investment industry and how all the decision-makers and incentives fit together.
18. In this package of reforms, we have tried to create an environment in which a sound system can run better. Hence, our interventions have been carefully targeted, and focused on those areas where benefits outweigh potential costs. And many of these interventions have been non-legislative or voluntary, which allows more flexibility.
Progress on Myners
19. Let me now turn to the Myners agenda, which is the key to much of this. The qualitative survey, which was published last November as a part of Myners two-year review, has made it clear that while progress has been made – particularly by larger schemes – there are areas where further progress is needed.
20. We have already engaged with the industry on issues that are still outstanding from the Myners review – but I would like to take this chance to mention a couple of them today…
21. The first is the issue of time horizons. As Paul Myners noted in his review, there is a striking mismatch between the day-to-day, quarter-by-quarter world of fund management in practice – and the long investment horizons of most of their customers, pension and life funds.
22. Such a mismatch is not obviously efficient. But it is difficult to know how to resolve it? Fund managers say that as long as clients insist on the right to terminate a mandate after any quarter’s performance, then performance quarter-by-quarter is something that they have no alternative but to prioritise.
23. Hence one of the “Myners principles” - that pension funds should provide fund managers with more clarity about the period over which their performance will be judged. And that managers should not lose their mandate during that period for reasons of underperformance alone.
24. I have the impression that, in the industry, this is amongst the more contentious of Paul’s proposals. As a result it may turn out that the take-up of his practical suggestion in this area has been quite low.
25. Certainly the findings of the qualitative survey suggest that my impression is not baseless. But the expectations and priorities of shareholders – which in the UK context means especially institutional shareholders – are clearly crucial. Rightly, shareholders determine the incentives that run through the entire system. We would very much welcome imaginative thinking in this area.
Shareholder Activism
26. And this brings me on to the second issue that we believe is crucial for long-term value – Shareholder Activism.
27. In this area, there has certainly been some progress – not least through the development of the Institutional Shareholders’ Committee code of principles, which we have very much welcomed.
28. These principles on shareholder activism provide good, sound guidance on how institutions should monitor and engage with companies, and then report back to their principals - the clients.
29. But the key test of these principles has always been how far they are put into effect and how they impact on behaviour. In particular, how far they have been incorporated into individual fund management mandates – as the ISC and its members committed to.
Concluding remarks
30. There are other areas with room for improvement, which have been identified by the Myners 2 year review. These include:
- Enhancing the expertise trustees are able to bring to bear on investment issues;
- Clarifying the respective roles of trustees and investment consultants; and
- Increasing the proportion of resources devoted by pensions funds to asset allocation decisions
31. This is a challenge for investors and for corporate management. It is also a challenge for the Government - to continue to create a stable and attractive climate in which long-term investment can flourish.
32. The work we have done has already provided us with a much better understanding within Government of the commercial realities of the workings of our capital markets than ever before. This is good for the long-term future of the investment and savings industry in Britain – and certainly for a better and more intelligent foundation for government policy…
33. However, effective implementation – of both legislative and non-legislative measures – require active cooperation and partnership with you, the industry.
34. Nowhere is this truer than in resolving some of the more complex issues behind sound corporate governance and investment decision-making. Progress has been made in taking forward the Myners agenda, and I’m sure more will become obvious over the next few months.
35. It is also important that we await the findings from the large-scale quantitative survey that is currently being undertaken on Myners implementation, before considering the full policy implications of the review.
36. Thank you.