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Newsroom & speeches
01 December 2009
I have made repeated calls for a wide and open debate on the issues of governance and stewardship which currently face institutional investors.
I regard the current chasms that divide end investors, fund managers and companies as an acute weakness in the private economy.
As such I welcome the opportunity to participate in this event and would like to thank the LSE for providing a platform for this forum.
I think we will all agree that governance shortcomings throughout the financial services sector had a part to play in causing the financial crisis.
These problems were not restricted to the investment management sector: responsibility must also lie with the lack of effective oversight within the banking industry, and inadequate supervision.
However, any participant who has a commercial interest in the wellbeing of the financial economy owes a duty both to themselves and to the system to ask, in hindsight, what they might have done differently.
Speaking as a former investment manager myself, I know that there are shareholders out there who will rightly admit that they could and should have paid closer attention to the strategies and activities of the companies they owned, the motives of their senior management, and competence of their boards and chairmen.
I believe professional investors have a duty to address such issues on behalf of their clients.
This is the fundamental message I have tried to communicate.
Buying a share does not simply give you the right to claim a return, subject to inherent risks and uncertain outcomes, like striking a bet on a horse race; unlike the punter, shareholders have the opportunity, indeed responsibility, to get involved in the race.
As an investor you can have an opinion on every material decision that is made in the boardroom of your company and voicing your opinions will make a difference.
Ownership of assets brings the potential for reward, but at the same time bestows duties and responsibilities.
Engagement and good stewardship will be of benefit to you as an owner, and you will see this in the returns generated.
Bad governance and weak engagement at best free-rides on the efforts of others, or at worst, if no-one participates, puts everyone’s welfare at risk, including, importantly, those employed in the businesses you own.
We owe a duty of care to those people whose lives are systemically linked to the welfare of the corporate sector.
Why is engagement not already a matter of priority with institutional investors?
It is not immediately obvious why so much time and money is devoted to stock-picking, which is at best a zero-sum game, whilst only a fraction of the same resource and commitment goes into governance, which has the opportunity to add real value.
Nor is it clear why the clients of fund managers, the people paying the piper, are willing to pay high fees for an aggregate zero outcome (the negative alpha effect) while requiring little or no resources to be devoted to enhancing the value of owned assets.
I would be very surprised if many generalist fund managers had as much as 5% of their total fund manager headcount devoted to stewardship, and even less than that of fund manager cost.
The reasons cited for this lack of attention are numerous:
I do not pretend that it is easy for shareholders to apply pressure, and even harder for them to join forces and apply more pressure.
I agree with the editorial in yesterday’s Financial Times, which says that ‘it is hard for investors to apply concerted pressure, even where they agree what to do. Many shareholders do not want to commit money and time to corporate relations if other, larger, investors are doing that already’.
These problems may explain the situation, but they do not excuse it: there may always be the incentive to free ride on others’ good intentions, but the risk is that this results in our corporate entities becoming effectively ownerless.
Self-interest should be a motivating factor here. Long-term investors should make sure that they really understand the company’s aims, their strategy for achieving them, and that this can be achieved.
Similarly, the management of the company should welcome such engagement, and the opportunity it provides to build a strong relationship between the company and its owners.
The benefits of good governance may not always be immediately clear, but the costs attached to weak governance are evident.
In addressing these challenges, we need to work together and embed considerations of governance in the operational model of the industry standard investor.
So how do we move forward?
I have already said that anyone who has an interest in the wellbeing of the financial system has a duty to act and I would like to reiterate this.
The Government has a key role to play and we are already acting: Sir David Walker released his final report and recommendations last week.
We strongly support his views and will look to implement his recommendations, particularly as regards the role of institutional investors. I regard this as Walker’s most significant contribution to the governance debate.
We are taking powers in the recently introduced Financial Services Bill that will make the architecture of remuneration more transparent and enable investors to take better oversight in this area.
And as the Chancellor said yesterday in the debate on the Second Reading of the Bill, we will go further in some areas than Sir David suggests. We will consult on regulations for narrower disclosure bands than he proposed, starting with remuneration packages below the £1 million floor that he suggested.
As the Chancellor said “most people are convinced that far more disclosure is important, because they will then be able to see precise remuneration practices”.
I believe that we need greater granularity than proposed by Walker, starting at a lower number, and moving in smaller and steady steps to the highest levels of pay.
I also welcome Sir Christopher Hogg’s announcement today of the overhaul of the Combined Code of corporate governance.
I welcome his support for the idea that the chairman of listed companies, and possibly all board members, should offer themselves for annual election.
I support the FRC’s intention to adopt the recommendations of the Walker Report which "it considers, after consultation, are appropriate to all listed companies."
Last, but certainly not least, I am delighted with the emphasis that the FRC have placed on the responsibilities of shareholders. Their Code says that “satisfactory engagement between company boards and investors is crucial to the health of the UK’s corporate governance regime”.
I could not agree more.
The FRC has agreed to take responsibility for a Stewardship Code, which will be subject to separate consultation and monitoring.
The Code will require that institutional investors agree to engage with companies, that they broadly agree with the company’s strategy, and that they support the company’s management team.
Events like this evening provide the platform from which to launch reform.
Overcoming the obstacles I have outlined will require collaboration on a scale that hasn’t really been seen in and around the fund management sector.
Those who speak for the end investor – pension fund trustees and others – need to ask whether they are fully fulfilling their fiduciary responsibilities to hold assets in good care if they do not pay and evidence proper regard for stewardship and governance.
I believe end investors are likely to find the right solutions if they also revisit their approach to setting investment objectives which have so often sacrificed long-term value creation to the pursuit of the short-term.
I am not suggesting that all fund managers should ‘do governance’ – far from it – for no one is claiming to have discovered an unquestionably superior way of investing.
But pension trustees do need to ask whether they are meeting their obligations if they are not placing a clear and explicit stewardship responsibility on at least some of their fund managers, and assessing and measuring, in an appropriate manner, the effectiveness of these managers.
Investors will have to work together to get past the free rider problem and will need to make some commitment to one another, and provide the mutual assurance that all will do their bit, or will be frank about why they have opted out of ownership responsibility.
This will require nothing short of a revolution in the industry and a cultural shift in the mindset of the end investor.
I know that these reforms will not materialise overnight.
What else can you do?
Most people at this event are drawn from academia or the world of professional governance.
I would hazard a guess that most of you are converts to the cause and that you welcome Sir David Walker’s recent report and the FRC’s publication. You are ready and willing to act in the promotion of good governance and better stewardship.
You are the supply side of the equation. Sometimes suppliers have to work to create demand.
I believe that there is more that you could be doing to promote the case for good governance, both in your own fund management organisations – where you do not always have the most influential of voices – and in taking the cause to end investors, by making the case to them that they are putting value at risk and foregoing value opportunities by not ensuring that they are appropriately equipped in governance awareness and skills.
There is tremendous opportunity here to work with the academic world to develop a contemporary evidence base and, importantly, to develop targets and frameworks for future engagement.
For instance, how much work has been done to encourage investors to ask the right questions of their fund managers about the lessons they have learnt in the governance space from the global financial crisis, and what fund managers are going to be doing differently in the future?
This again speaks to the need for an organisation for which the sole modus operandi is to speak and act on behalf of end investors rather than, as currently, leaving leadership in governance and stewardship to trade organisations whose primary interest must always be that of their member firms.
A really good starting place would be for trustees to let their fund managers know now that they will be asking searching questions about what their fund managers have done to challenge inappropriate remuneration practices and unwarranted payments across a swathe of the world’s major banks.
Clients have every right to expect their fund managers to be taking a leading role in challenging all aspects of board and high-level remuneration, making it clear that they will not hesitate to act if they feel they are being let down by directors or fund managers.
In the future, governance and stewardship will feature at the heart of investment decision-making and I welcome the opportunity to make my contribution in bringing that future into the present.
