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Newsroom & speeches
18 November 2009
I would like to congratulate ICSA and Hermes Equity Ownership Services for this excellent initiative. I am delighted to see so many people here tonight.
Transparency and openness are an essential part of effective communication with a company’s employees, owners, business partners and other key stakeholders.
All of us here tonight recognise the important role played by Company Secretaries in delivering this agenda, and it is only right that their contribution should be acknowledged. It is also right that we celebrate leadership in corporate governance; this evening is a welcome chance to reflect on the very best practice across industries.
I know that Sir John (Parker) will be making some remarks shortly on the judging process and on how companies can make yet more progress in terms of strengthening corporate governance disclosure in their flagship document.
I would like to talk about governance more widely; its challenges and its future.
As Sir Christopher Hogg has observed, the banking crisis is a story of monumental failures in corporate governance.
It has been an expensive failure.
The philosophy underpinning our market economy has been shown wanting – as Alan Greenspan acknowledged, “I made a mistake in presuming that the self-interests of organisations…were such that they were best capable of protecting their own shareholders and their equity in the firms.”
Shareholders were ‘free-riding’ on their fellow owners; everyone assumed that everyone else was actively managing their companies.
Inadequate governance practices went unchallenged and unchecked.
Employees, directors and even whole companies were not held to account until their performance collapsed and value was destroyed. The inexcusability of this is compounded by the fact that the worst failures were at the heart of the financial sector – a sector that had most to gain from high standards of effectiveness, probity and transparency, and should have been a standard-setter for others.
We cannot simply assume that corporate executives are going to act in the long-term interests of owners. Without a clear articulation of what owners want, without active engagement by intermediaries acting on behalf of owners and without challenge from competent Boards, we will sleepwalk into future governance failures.
Lets start at the beginning. Responsibility for ensuring that change happens lies fairly and squarely with the owners of these companies – the shareholders.
But for too many individual shareholders, shares are little more than betting slips, bought at a low price, with the hope that the bet will come good. They view their shares much like a gambler views the horse they have placed a bet on; they only care about the outcome of the single race. But they are not gamblers, they are owners. They should care about the health and development of the horse. Shares are not betting slips. Shareholders do not believe that they are owners; they don’t feel responsible for the functioning of companies in which they hold shares. They deny their fiduciary obligations.
Many shareholders transfer their ownership to fund managers or institutional investors. But if owners don’t express their interests in the long-term health of the companies in which they have invested, then the institutions who manage shares on their behalf will demonstrate a similar disengagement.
Institutional investors have the power to act and intervene. But most have been very reluctant to step up to the mark. They argue, I think correctly, that their clients show little interest in the concept of investment as ownership, and that that a strong focus on relatively short-term performance reinforces this view. Accordingly, few fund managers take corporate governance seriously – leaving it in the hands of junior employees, with little or no experience in the real world of business.
No-one wants ownerless corporations, run by managers for their own short-term gain. But seemingly, no-one wants to ‘do governance’; they are content to free-ride on the efforts of others to hold Boards to account.
This is nothing new – back in 1990 Rupert Pennant Rea said “What is wrong with the British and American system is that far too many shareholders, both institutional and individual, do not behave like owners”. Put simply, there is an ‘agency gap’.
The Government has had to take action to step in to a situation in which theory would have suggested – and Greenspan expected – enlightened self-interest would have driven the right outcomes. Shareholders did not have to wait for Government to take the lead on driving better and more meaningful disclosure of remuneration, or risk management. Collectively, owners have the power to press for such reforms. But they didn’t.
When I was a young fund manager, there were leaders in the industry who recognised the importance of institutional investors taking a lead and acting as responsible owners; industry leaders who owned the culture of enlightened responsibility, willing to speak up when necessary. I think of David Hopkinson at M&G, Alastair Ross Goobey at Hermes, Mike Sandland of Norwich Union. No one has stepped in to their shoes. The approach of the word ‘fund manager’ in the press is frequently accompanied by the prefix ‘unnamed’. They hide behind anonymity rather than speaking openly on behalf of their client’s interests and deny readers the opportunity of forming a view as to how serious they are in terms of reputation and size of investment. There are thoughtful and concerned people in the fund management industry. But too often they appear reluctant to emulate the leaders of the past; preferring the comfort of the trade associations’ views, subordinating the interests of the ultimate client, a community without its own trade association.
The Government needs to act. Sir David Walker’s review and recommendations on governance in the banking sector will report next week.
But more needs to be done, responsible ownership requires three things.
Firstly, it means engaging actively with Boards, ensuring that they have the skills, the willingness and the incentives to work effectively on behalf of owners.
Secondly, it means ensuring that remuneration policies are aligned with the long-term health of the company and do not contribute to excessive risk.
Finally, it means industry as a whole playing its part and driving up standards so that governance becomes the norm and responsibility of all, not limited to governance geeks.
I agree with Bob Monks when he says that “the core problem has been the disappearance of any practical or legal respect for the fiduciary standards that ensure a beneficiary of the loyal competence of the person responsible for managing his property”.
To properly exercise their fiduciary duties, shareholders must ensure that boards are properly equipped.
Boards must challenge the executive; question their decisions, their risk allocations, and their performance horizons.
Boards must insist on sufficient resource being dedicated to exercising effective oversight, particularly of risk management.
This entails the need for the right people with the right skills and experience, those not afraid to be disruptive and challenge the “gospel” presented by management.
At times, an element of disruption is necessary for effective challenge and innovation.
The ICSA’s contribution to the debate – its publication on Boardroom Behaviours – represents a significant development in the thinking around these issues. Individual companies need to take this forward.
In my business career, I have drafted a number of appointment letters for Non-Executive Directors, in which I have specified the behaviours that will be expected – the need to question intelligently, debate constructively, challenge rigorously and decide dispassionately. This is in the gift of company Chairmen.
Shareholders would be wise to set themselves the task of judging whether their Boards are meeting these expectations; this means active engagement and assessment, which takes time and will require senior resource.
Remuneration should be the test for adequate engagement.
For many years, we have failed that test. Let me read you a quotation: “how long it will be found necessary to pay City men so entirely out of proportion to what other servants of society commonly receive performing social services not less useful or difficult”. Relevant? Topical? It was said by Lord John Maynard Keynes in 1913. Not much has changed.
The FSA is implementing remuneration principles, which will ensure that banking remuneration practices can never again contribute in the way they did to unmanaged risk.
The Financial Services Bill will ensure that banks can no longer hide behind legal obligations ‘forcing’ them to pay out according to risk-promoting remuneration contracts. Any new contracts which contravene prohibited remuneration practices will be automatically void and therefore unenforceable.
Let me be clear – the Bill will not change existing contracts, nor will it give the FSA direct powers over existing contracts. The Bill represents no threat to the major banks and investment banks that have confirmed their support for G20 principles. The UK will continue to be a good place in which to conduct financial transactions.
But executive remuneration in private sector companies should not be a problem for governments to solve; it is a matter for shareholders. We have made great leaps, now shareholders must take up the baton. They must engage with Remuneration Committees and challenge remuneration policies that encourages excessive risk or fail to strike the right balance between rewarding employees and capital.
In an industry that dedicates significant resource to stock picking, by definition a zero sum game, I find it extraordinary that only a moderate level of resource is dedicated to corporate governance.
Non-conviction investors, with perhaps one or two per cent of a company’s equity at best, are tempted to free ride on others’ efforts in the field of governance. The benefits of good governance need to be better understood; and better quantified – including through academic study.
Hermes Equity ownership model presents a good answer for some of the challenges of responsible ownership.
It translates the value deliverable in good governance into a quantifiable return, and thus communicates the importance of stewardship in a language that we can understand.
But much more could be done to understand the role of governance and to develop best practice, and more could be done to educate investors.
If active ownership is to service its intended purpose, there needs, in my view, to be a single responsible and authoritative body to speak for investors.
To date, the only significant effort to address this challenge was the creation of the Institutional Shareholders Committee.
The ISC is making positive steps, for which we should be appreciative.
But fundamentally, the ISC is a coordinating mechanism for trade bodies who themselves operate primarily to promote the interests of their own industries. I question the absence of an organisation in the UK that speaks solely on behalf of institutional investors, not for those who service the agents of investors.
My view is that there would be very real benefit in an industry-wide institute working closely with academic institutions, promoting research and debate on all aspects of governance and stewardship.
I envisage something akin to the US Council of Institutional Investors. I would encourage industry to take this idea seriously. An enlightened and responsible fund management industry could indicate its commitment to good governance and stewardship by offering to endorse such a body, possibly in a major business school and endorse it without strings attached.
I do not dismiss the ISC or the work that they have done particularly on converting engagement principles into a Code. The content of the new Code is not greatly different from its predecessor principles - and those principles put the right obligations on their signatories to monitor and engage with investee companies.
What is needed - what has always been needed - is for the Code to be followed in both its letter and spirit, and for fund managers to commit the resources to make that happen. It also needs compliance with the code to be disclosed on a ‘comply or explain’ basis, inside an FSA framework which assures the clarity of those disclosures, as proposed by Sir David Walker in his interim report. I particularly commend the intention that fund managers should disclose whether they will comply, as this should oblige trustees to be more probing of governance arrangements, and should address aspects of the free-rider effect.
I am encouraged by what the ISC has done with the Code - and even more by its commitment to look at how it can structure itself better.
The ISC, and wider industry efforts, need to focus on shareholders, rather than treating it as a side issue compared with matters relating to companies or boards. Indeed, the Combined Code stands at 40 pages; shareholders receive less than 2 pages. This must change; the engagement issue is now on the table more than ever.
I would like to finish by reiterating my support for these awards.
Having a set of awards which acknowledges those companies whose disclosure on their governance arrangements is evidence of their commitment to becoming better-run companies, is a purposeful step to incentivise necessary changes in behaviour.
The onus is now on companies’ owners to start thinking of ways to strengthen their approach to governance; to set us in good stead for the future; maximising the competitiveness and resilience of firms.
I would like to congratulate ICSA and Hermes for this initiative, and the way you are helping shape new thinking in this vitally important area.
Thank you.
