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Newsroom & speeches
19 May 2009
Check against delivery
1. Thank you and good evening. I am a past member of the Executive Committee of the IFMA, the predecessor to the IMA.
2. I am sure that you expect me to talk about Governance, and I will not disappoint. But there are other issues that I would also like to cover.
3. Asset Management is a business in which the UK excels. The UK is the leading centre in Europe and a global hub for the industry worldwide. We have a wealth of talent in this sector and that is something about which we should rightly be proud.
4. The Government recognises this – the importance of a strong, successful and responsible investor community that contributes to the UK’s leadership in financial services is of paramount importance, not least to meeting saver expectations and investing capital efficiently.
5. Over the last few years we have strengthened our dialogue with the investment management industry, particularly the IMA, to identify sustainable reforms to the tax regime.
6. Since the IMA published its report “Taxation and the competitiveness of UK funds” in 2006, which showed that an increasing number of funds were choosing to domicile in Dublin and Luxembourg, we have listened, we have taken note, and we have worked in partnership with industry to better understand concerns and deliver tangible changes to the treatment of Authorised Investment Funds in the UK.
7. The concluding parts of this work were announced in the Budget and mean that you now have the ability to locate in the UK and invest tax efficiently in property.
8. You can sell to sophisticated investors without being impeded by complex tax rules.
9. You have legislative certainty that a wide range of transactions will be treated as investment, not trading.
10. And you can market competitively from the UK to overseas investors.
11. This is an important shared achievement and I would like to thank the industry and the IMA for their work in support of this.
12. I also want to mention the excellent collaborative work between Government and industry on the insolvency arrangements for investment banks.
13. Last week we published proposals, which will, when implemented, form a key component making up an attractive landscape for fund management in the UK. The IMA were key both in contributing to the advisory panel and the technical working groups that informed this report.
14. On the point of engagement, I would like to make a quick comment on Europe. I very much welcome Bob’s stance that you have nothing to fear from sound regulation, and I agree that you must act to help shape EU regulatory proposals to get the best outcome for the industry in the UK and its clients. To that effect, can I encourage you, alongside the Government, to actively engage with your contacts in the European institutions to make the case for constructive and informed reform.
15. Let me turn now to governance, and in particular shareholder and investor responsibility.
16. The UK is a global leader in terms of empowering shareholders with the ability to act as owners, particularly in giving shareholders the right to convene company meetings, propose resolutions and vote on the basis of one share, one vote.
17. But statute law only enables, it does not ensure good shareholder governance. It is a necessary, but not sufficient condition. As you are only too well aware, market pressures and the structure of corporate share ownership present major challenges for shareholder engagement.
18. The chain linking the ultimate beneficial owners, for instance an investor in an open architecture variable annuity, can involve multiple parties. This intermediation involves a subtle but critical transition in which the focus of behaviour moves from that of an “owner” to that of an “investor”.
19. The focus of an “owner”, with an emphasis on creating long-term value, does not sit comfortably with the commercial pressures on an “investor” obliged to produce short-term returns.
20. Institutional investors are expected to exert the influence and exhibit the values of “owners” but are incentivised to behave as “investors”, with performance scrutinised on a quarterly, monthly or even a daily basis.
21. In this context, we have almost certainly understated the profound challenges faced by the majority of institutional fund managers in fulfilling expectations in respect of the broader definitions of governance where they relate to ownership (here I exclude those fund managers who place governance at the core of their commercial offering).
22. To put it simply: most institutions are not set up to act as owners; they don’t have the mindset of owners and are not incentivised by their clients to act as owners. They are investors- leaseholders rather than freeholders.
23. Just about all major commercial fund managers now include a governance team, but the reality for many members of this governance community is that their views and values frequently sit somewhat uncomfortably with those of the front line fund managers who are having to respond to a completely different and far more immediate set of performance objectives. It is not surprising that in many commercial fund management groups the governance folk lack voice at the highest level of their firm, or lacking in credibility in front of corporate directors.
24. The picture I paint is one that has led us in the direction of what I have characterised as “the ownerless corporation”, reflected in fragmented share registers and inconsistent investor engagement. The true owners, for instance pension fund trustees, have been intermediated out of the story.
25. This outcome reflects the combination of a number of factors, including: tax, regulatory and cost factors, which have pushed investment in to institutional hands, and the combination of Modern Portfolio Theory and the work of actuaries which has promoted high portfolio diversification and the predominance of low conviction portfolio construction. These approaches are an entirely rationale response to commercial incentives, the selection of benchmarks, and perceived client behaviour.
26. Any change that will lead to fund managers behaving more like “owners” and less like “investors” will have to come from the end client.
27. Short termism, as practised by pension funds, is self-defeating for those charged with delivering pensions over many decades in to the future, and yet it remains a predominant form of behaviour.
28. A focus on “shareholder value”, as measured by relative share price performance over quite short time periods lies at the heart of a number of behaviours which have delivered less than ideal outcomes, such as:
29. In the Review of Institutional Investment I produced for the Treasury in March 2001, I drew attention to these issues. I specifically recommended that pension fund trustees and their agents should be required under law to have an explicit strategy for discharging the duties of ownership and promoting good governance. I modelled my proposals on the United States’ Employment Retirement Income Security Act 1974 which codified fiduciary responsibilities. The fund management industry resisted this proposal and instead persuaded the Treasury to support the creation of a new set of principles by the Institutional Shareholders Committee.
30. The ISC has developed as a rather low profile entity. It enjoys the support of a number of trade associations, including the IMA, but has no permanent secretariat or budget. The Combined Code of Corporate Governance (E.1.) states that institutional shareholders should apply ISC principles and goes on to say that these principles “should be reflected in fund manager contracts”. Reality has fallen somewhat short of ambition. The ISC has made little progress in reviewing compliance and achievement or revisiting its core principles in the light of experience, and pension fund trustees have been slow in pressing for progress, including inserting formal and binding obligations in all their agreements with their fund managers (or, at a minimum, codifying what can and cannot be expected from their fund managers in respect of governance).
31. The ISC will shortly be publishing its reflections on the financial sector crisis and its key conclusions in respect of shareholder responsibility and governance. The ISC has quite rightly avoided the temptation to rush to conclusion.
32. I look forward to a weighty and evidence rich assessment with clear indications as to the direction of travel that we need to follow if we are to avoid similar failures ever happening again in the future. The publication of this report in early June should be a significant event in the story of corporate governance in the UK.
33. I hope that the ISC’s report will include an assessment of its own performance and future role.
34. I find myself wondering whether a body funded by and controlled by industry trade bodies and without a budget or permanent secretariat is necessarily the best model?
35. I hope the ISC might consider something more radical, perhaps more in line with the FRC, a body which could provide an unfettered focus on investor interests and responsibilities. Such an upgraded ISC would not be short of issues to examine, including:
36. It is possible, of course, that the FRC could provide the host for such an investor body. At the very least, the FRC, in its current review, should ask whether the balance of its present Combined Code is right in devoting only one an a half pages of its current twenty two pages to the responsibilities of shareholders
37. These may also be issues for Sir David Walker in his review of corporate governance in the UK financial services which includes the role of institutional investors and questions as to the effectiveness of engagement.
38. I should emphasise here the word 'effectiveness'. Good governance cannot be proven by the number of meetings held or letters written. Good governance will be evident in outcomes rather than activity. Good governance will set reference points for the future behaviour of others. Good Governance cannot acquiesce to "a tendency to be ignored".
39. A fortnight ago the FT suggested I had “lambasted” institutional investors. I feel that this somewhat misrepresented what I was saying. I simply said that there is a challenge here- and who will rise to it, if not you? I believe that much good work is being carried out in the governance area by people like Peter Chambers, Keith Skeoch, Huw Jones, Daniel Summerfield and Peter Montagnon, but they can only go so far. They have made huge personal efforts and have achieved a great deal. To travel further we need to ask some fundamental questions about investment objectives, time horizons and performance metrics and address the impediments consequent on our present understanding of “shareholder value” and fragmented ownership. And we have to ask whether we are doing enough to engage clients in informed debate in these issues and putting enough resource and commitment behind presenting an unfettered voice for owners and investors in British public companies.
40. Thank you.
