By Kerrie Waring – Executive Director, International Corporate Governance Network (ICGN)
Last month, Thailand and the US became the latest markets to publish ‘stewardship principles’.
This brings the tally to 18 known codes around the world since the publication of the International Corporate Governance Network (ICGN) Statement of Institutional Investor Responsibilities in 2003. Over the coming years we expect to see this number double. Codes in India and South Korea are already underway and ICGN has established an informal Network of Stewardship Code Developers to help foster effective implementation.
As we begin to gain critical mass of national codes, it is important to take stock of progress and consider next steps to ensure that stewardship codes are embraced, not just in principle, but in practice. This was the theme of our opening plenary at the ICGN Conference in Washington DC in March when a number of useful observations were made.
Encouraging stewardship code application
Firstly, there is no ‘one size fits all’ approach to stewardship code development or application. The extent to which code enforcement relies on a market-based approach or a rules-based approach depends largely on political priorities, economic climate and the degree to which there is a body of shareholders willing (and able) to effectively embrace stewardship responsibilities.
The UK Stewardship Code, published in 2010 by the Financial Reporting Council (FRC), was derived from an existing set of principles developed by the Institutional Shareholders Committee in 2003, which had largely been adopted by UK investors. This meant that there was broad and immediate acceptance of the FRC code when it was introduced – the difference was that it now had regulatory bite. Financial Conduct Authority rules require asset managers to disclose the ‘nature of their commitment’ to the code or alternative investment strategy under a ‘comply or explain’ mechanism. This is monitored by the UK FRC, which maintains a list of code signatories.
More recently, in November 2016, the FRC introduced a tier system that aims to strengthen the quality of signatory reporting by distinguishing between those who report well and those where improvements could be made. As such it aims to help asset owners in their deliberations when selecting and awarding investment mandates. It is early days, but the initial impact has been an improvement in the quality of stewardship disclosures. There are around 140 signatories in Tier One, 80 signatories in Tier Two and a further 30 signatories in Tier Three. This latter camp is subject to imminent de-listing if improvements are not forthcoming.
The Japanese system also follows a ‘comply or explain’ mechanism under the auspices of the Financial Services Authority (FSA). At the time of writing, the Japan Stewardship Code is subject to review and we expect to see a strengthening of the role of asset owners, enhanced requirements around conflicts of interest and more granularity around vote disclosure, similar to what is prescribed in ICGN’s Global Stewardship Principles. The FSA is successfully positioning Japan, along with the UK, as a leading market in promoting the application of stewardship among its investment community. This is complemented by prominent championing by one of the world’s largest asset owners, the Government Pension Investment Fund and others, such as the Pension Fund Association.
Most other markets rely purely on voluntary mechanisms to oversee and implement respective national codes. This is no small task and, regardless of the lack of regulatory teeth, the presence of clearly defined principles around company monitoring, voting and engagement provides a helpful roadmap for investors and companies alike. More challenging is the application of stewardship in markets that are dominated by controlled companies. For stewardship to take proper effect here minority investors must be able to influence the governance of investee companies though adequate voting rights. Engagement tactics should focus not just on dialogue with company boards but also with the controlling owner constituent in efforts to align interests.
In some regions we are likely to see change towards a more mandatory approach. The passing of the European Shareholder Rights Directive in March was a watershed moment. All 27 member states (with probably the exception of the UK) will require the mandatory disclosure of stewardship policies. Asset owners will need to report publicly on how their investment strategy and stewardship approach contributes to the long-term performance of their assets and it requires asset managers to report to their clients on the same issue.
Understanding stewardship in practice
Assuming there is a sound mechanism in place to promote and encourage investor stewardship, it is incumbent on all of us to help raise awareness of what ‘stewardship’ actually means in practice. Nearly 250 years ago Adam Smith defined the problem that corporate governance seeks to address in his seminal publication The Wealth of Nations: “The directors of companies, being managers of other people’s money cannot be expected to watch over it with the same anxious vigilance with which they might watch over their own money…. negligence and profusion therefore prevails in the management of the affairs of such a company.”
So, at a basic level, corporate governance is about keeping in check any ‘negligence and profusion’. It is the responsibility of shareholders, in their role as fiduciaries on behalf of the investing public to provide that ‘check’ by holding boards to account in promoting the long-term success of the companies for the benefit of its members while having regard to a wider constituency of stakeholders.
Fast forward to 1992 when Sir Adrian Cadbury and his committee introduced the world’s first corporate governance code. What is often overlooked is the fact that this code included inaugural stewardship principles. Section B had specific recommendations for investors to enter into constructive dialogue with companies and to make considered use of their votes. Both recommendations remain core principles of modern stewardship codes.
In essence, stewardship is about the proper use of entrusted power. In an investment context, this means using share-ownership rights responsibly to effectively oversee investee companies to protect and enhance value. In a company context, stewardship relates to the accountability of the board of directors to investors in ensuring good corporate governance and the long-term corporate success.
Stewardship and long-term value creation
The concept of stewardship is not just for the realm of corporate governance oversight. It has become synonymous with today’s financial market challenges in meeting the Sustainable Development Goals (SDGs) set out by the United Nations in September 2015.
Achieving successful dialogue between companies and shareholders, with a consensus to focus on long-term value creation, will yield an environment in which good corporate governance and investor stewardship can thrive
The SDGs define ‘17 goals to transform our world’ and aim to ‘end poverty, protect the planet and ensure prosperity for all’. Two months later, 195 countries pledged to deal with the effects of climate change by limiting global warming to well below 2°C as part of the Paris Agreement.
We are also living in a time of radical uncertainty. This is true, both economically and politically. High levels of income inequality between the top one per cent of earners and those at the bottom is a priority issue on both sides of the Atlantic. The perceived disconnect between the ‘privileged few’ and ordinary society, as characterised by the British Prime Minister Theresa May, has led to a review of the UK corporate governance system and the effectiveness of investor stewardship.
One possible outcome is to further empower shareholders to have a greater voice and influence around areas such as executive remuneration. Also under the spotlight is the degree to which stakeholders in society should play a role in governance oversight. In stewardship terms this is translated into a range of actions, which are described in Principle 6 of the ICGN Global Stewardship Principles:
Firstly, we encourage asset owners to align their investment strategies with the profile and duration of their liabilities – particularly long-term liabilities. This should be incorporated into the asset manager selection process and included in contractual mandates. Crucially, this also calls for monitoring the performance of asset managers in meeting this obligation.
Secondly, we advocate for awareness of environment, social and corporate governance (ESG) factors that influence risks and opportunities affecting a company’s long-term performance. Company engagement is no longer just around financial returns but also around issues such as demographics, technological change, water scarcity, climate change and so on. It is imperative that boards and investors alike understand these issues to the degree they affect the long-term success of the company.
Thirdly, we support integrated reporting that puts historical performance into context and portrays the risks, opportunities and prospects for the company in the future. This helps highlight a company’s strategic objectives and its progress towards sustainable value creation.
Other guidance points relate to ESG integration through the investment decision-making process as well as taking into account systemic threats that can impact overall economic development, financial market efficiency and stability.
There is no silver bullet to achieving a perfect stewardship ecosystem. What is vitally important is that we continue the momentum of promoting investor stewardship and corporate governance around the world. Ultimately, achieving successful dialogue between companies and shareholders, with a consensus to focus on long-term value creation, will yield an environment in which good corporate governance and investor stewardship can thrive for the benefit of all.
About the Author:
Kerrie Waring is responsible for delivering ICGN’s extensive work programme of policy representation, international conferences, education and guidance across 50 markets. She has been instrumental in shaping ICGN’s strategy to drive global governance reform over the past decade and has led rapid membership growth which today includes investors responsible for assets under management in excess of US$26 trillion.
Prior to ICGN, Kerrie directed high-profile governance initiatives at the ICAEW where she led a cross-Atlantic initiative focused on US-UK corporate governance; and the IoD where she established IoD International. She is a lead author of the IFC’s Global Director Training Toolkit which has helped establish governance associations around the world and is co-author of the Handbook on International Corporate Governance (2004). In February 2017, Kerrie was appointed to the Japan Financial Services Council of Experts on revisions to the Japan Stewardship Code.
1The ICGN Statement of Institutional Investor Responsibilities
2The ICGN Global Stewardship Codes Network
3UK Stewardship Code
4Japan Stewardship Code