Speech by Sir Winfried Bischoff at the NAPF "Being Responsible Owners" seminar
News types: Speeches
Published: 2 October 2014
On 16 September, Sir Winfried Bischoff spoke at the NAPF's seminar - "Being Responsible Owners". The plain text version of Sir Winfried's speech can be found below. Read or download the formatted version
Sir Winfried Bischoff
Chairman, Financial Reporting Council
Keynote Address
NAPF Stewardship Seminar - "Being Responsible Owners"
16 September 2014
138 Cheapside
Our mission statement is to promote high quality financial reporting and governance to foster investment. The key part of this mission statement, for me, is the aim to “foster investment” - we believe that trustworthy information engenders trustworthy behaviour, which in turn encourages investors to continue providing long term capital in UK markets. We are, uniquely, able to combine our work on governance, with our regulation of auditors and accountants to enhance the quality of corporate reports and accounts that investors rely on to make an informed decision about where they want to invest their money.
I’m here today to talk about stewardship, but I think that can be quite a wide concept. In the UK Stewardship Code, we define it as being “the promotion of the long term success of companies in such a way that the ultimate providers of capital also prosper”. Essentially, effective stewardship benefits companies, investors and the economy as a whole.
In publicly listed companies responsibility for stewardship is shared. The board of the company oversees the actions of its management; and the investors in the company hold the board to account for the fulfilment of its responsibilities.
The UK Corporate Governance Code, which the FRC sets and monitors, identifies the principles that underlie an effective board. The UK Stewardship Code, the Corporate Governance Code’s younger sister first issued in 2010, sets out the principles of effective stewardship by investors. In so doing, the Code assists institutional investors better to exercise their stewardship responsibilities, which in turn gives force to the “comply or explain” system.
For investors, stewardship should be more than just voting. Activities may include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, and corporate governance, including culture and remuneration. Engagement is purposeful dialogue with companies on these matters as well as on issues that are the immediate subject of votes at general meetings.
I’m here today to talk about stewardship, but I think that can be quite a wide concept. In the UK Stewardship Code, we define it as being “the promotion of the long term success of companies in such a way that the ultimate providers of capital also prosper”. Essentially, effective stewardship benefits companies, investors and the economy as a whole.
In publicly listed companies responsibility for stewardship is shared. The board of the company oversees the actions of its management; and the investors in the company hold the board to account for the fulfilment of its responsibilities.
The UK Corporate Governance Code, which the FRC sets and monitors, identifies the principles that underlie an effective board. The UK Stewardship Code, the Corporate Governance Code’s younger sister first issued in 2010, sets out the principles of effective stewardship by investors. In so doing, the Code assists institutional investors better to exercise their stewardship responsibilities, which in turn gives force to the “comply or explain” system.
For investors, stewardship should be more than just voting. Activities may include monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure, and corporate governance, including culture and remuneration. Engagement is purposeful dialogue with companies on these matters as well as on issues that are the immediate subject of votes at general meetings.
The UK Stewardship Code
We direct the Code at two key groups in the investment chain: asset managers and asset owners.
We had two objectives when we set it up:
Firstly to increase the quantity and quality of engagement between companies and investors
And secondly to help clients of asset managers differentiate between managers by judging how they carry out their stewardship responsibilities. So, in practice, clients can set adherence to the Stewardship Code as part of their mandate for managers.
It’s still early days for the Code. And of course, there are many issues, such as lack of resource or even lack of willing, that the Code won’t be able to fix.
But so far we have seen some encouraging progress on our first objective, to increase engagement between companies and investors.
The larger companies in the FTSE 100 report generally positive engagement with their top investors. 60 per cent of members of the GC100 – the group representing the company secretaries of large FTSE companies - considered that they were able to have discussions on strategy with all of their ten largest shareholders, with an additional 25 per cent (taking the total to 85) able to engage in this way with eight or nine of the top ten shareholders.
These encouraging signs are primarily to be seen at the top end of the market. Some smaller companies with concentrated registers also reported positive experience. However, there appears to be an “engagement deficit” for medium-sized companies, starting from the lower end of the FTSE100 Index. This may reflect the resource constraints I mentioned, particularly when investors hold shares in a large number of companies.
That is the view from the companies’ side of the table. What does it look like to investors?
IMA Stewardship Survey
The IMA carries out an annual survey on Adherence to the Code. The aim is to capture the activities that support institutional investors’ commitment in practice. It has been useful in quantifying progress made since the introduction of the Code, and the year on year momentum of change.
Highlights from last year’s report indicate positive change:
Highlights from last year’s report indicate positive change:
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More respondents to the survey give advance notice when they intend to abstain or vote against a resolution
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Voting records were disclosed publicly by 66 per cent of respondents
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There is particular engagement with companies on business strategy, board leadership, board composition and remuneration
Of course remuneration will always be an issue on which shareholders are ready and willing to raise their voices – we particularly saw that in this year’s AGM season - but other issues that contribute to the long-term productivity and sustainability of a company, such as setting in place plans for board succession and the long-term organisational strategy, are hugely important, and deserve further thought and engagement.
Next week sees the launch of this year’s IMA survey – now in its fifth year. Participation is of course voluntary, but it is concerning that we have seen the percentage of signatories who respond decline over the years. So this year we will be looking for all Stewardship signatories to complete the survey and I strongly urge them to do so.
The survey has been shortened and changed to encourage more forthcoming answers on the purpose and quality of that dialogue.
Next week sees the launch of this year’s IMA survey – now in its fifth year. Participation is of course voluntary, but it is concerning that we have seen the percentage of signatories who respond decline over the years. So this year we will be looking for all Stewardship signatories to complete the survey and I strongly urge them to do so.
The survey has been shortened and changed to encourage more forthcoming answers on the purpose and quality of that dialogue.
Law Commission and Investor Forum
But other initiatives should encourage further engagement.
The Law Commission also clarified that owners can take ethical or environmental, social or governance issues that are financially material into account. We see the Commission’s report: “Fiduciary Duties of Investment Intermediaries” as a useful document for helping owners understand their responsibilities.
We’ve welcomed the creation this year of the Investor Forum, a project advocated by John Kay in his 2012 review of Equity markets. The Investor Forum, a discussion vehicle that will engage collectively on issues of concern for investors should help facilitate more productive conversations between investors and public companies to support long-term value creation.
However, we have some way to go in achieving our second goal of giving asset owners greater insight into the ways managers are considering their stewardship responsibilities.
It’s apparent that there are some organisations who are signing up to the Code, but are failing to properly comply with its requirements, or to adhere to the spirit of the principles.
It is true that the Code was never intended to create an official ‘ranking system’ for signatories, but the market can, and should, challenge managers to follow-up on their commitment.
Adherence to the Code
Clients and companies have the right to expect a certain standard of those who have signed up to the Code and issued a public statement of their intention to comply. But we see too often that managers have signed up to the Code just to ensure their place on owner shortlists.
It’s obviously hard for us to know this conclusively, but the fact that some signatories have failed to regularly update their statements, implies that, for some, signing up is merely part of a ‘tick-box’ process, rather than a basis for good quality engagement.
We hear from managers that many clients/owners have stewardship as criteria for selection but rarely question stewardship commitments once they have awarded the mandate. If this is true, it is no wonder that some managers feel they are justified in treating the Code as a ‘tick-box’ exercise.
We need to find a fair, transparent means of encouraging managers to properly implement the Code. One option we have considered is to delist those who fail to update their statement annually – admittedly a drastic solution.
Duties of Asset Owners
There are currently almost 300 signatories to the Code, of which the majority are asset managers, and less than a third are asset owners. However, these latter, as the providers of capital, set the tone for stewardship and can influence behavioural changes that lead to better outcomes.
Because of this, we’d like to see more asset owners making the commitment to engage with managers and apply the principles of stewardship. The more sign up, the bigger signal we send to the market that stewardship is important.
NAPF Stewardship Disclosure Framework
One of the ways we examine compliance is through the product of the NAPF’s Stewardship Disclosure Framework, published last year, which works alongside the Code to provide a simple way for pension funds to see how asset managers apply their stewardship responsibilities. The Disclosure Framework builds on the principles of the Code and challenges asset managers to identify how they have complied with the guidance, providing them with an opportunity to show their commitment to good stewardship.
The Framework has been in operation for just over a year now, and the regular progress reports issued by the NAPF have been valuable in ascertaining progress, but also in naming and shaming those managers who have failed to make use of the framework.
Shareholder Rights Directive
The European Commission’s proposed Shareholder Rights Directive, on the other hand, might introduce a level of prescription which goes beyond what we currently have in place in the UK.
Depending on how it’s implemented, it might be that all managers and owners are required to become signatories to the Code, or instead that the directive will bring in new legal requirements that will mean the Code is a best practice document.
We generally support the EU’s approach to Stewardship, but we do have some reservations about the level of prescription as opposed to the principles-based approach used in the UK.
We don’t believe that owners should be compelled to adopt any one particular approach to stewardship – if it’s forced on them, it will only create more work for advisers and intermediaries.
But it’s all very well that we hand down admonitions to managers to be responsive to client’s demands; nothing will change in practice unless clients really do demand evidence and explanations. Owners must put managers under the spotlight. And if our principle-based system is found wanting, then we will only have ourselves to blame if European legislation takes its place.
Depending on how it’s implemented, it might be that all managers and owners are required to become signatories to the Code, or instead that the directive will bring in new legal requirements that will mean the Code is a best practice document.
We generally support the EU’s approach to Stewardship, but we do have some reservations about the level of prescription as opposed to the principles-based approach used in the UK.
We don’t believe that owners should be compelled to adopt any one particular approach to stewardship – if it’s forced on them, it will only create more work for advisers and intermediaries.
But it’s all very well that we hand down admonitions to managers to be responsive to client’s demands; nothing will change in practice unless clients really do demand evidence and explanations. Owners must put managers under the spotlight. And if our principle-based system is found wanting, then we will only have ourselves to blame if European legislation takes its place.
Going Concern changes
I mentioned earlier that stewardship is a broad church. Before I open up to questions, I’d like to touch on another couple of areas where I believe it is essential that companies, as well as investors show good stewardship. It has been argued that boards are the true stewards of companies – steering their business and acting in its best interests on behalf of its owners.
Within the UK Corporate Governance Code there is the underlying theme that boards should have a long term focus. In this context it is essential that boards look forward to strategic risks that could affect the company as well as its long term viability. For investors, as providers of risk capital, knowing how the board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that providers of capital seek.
For this reason, in 2011, we commissioned a report on the quality of information that companies provide on their financial health and their ability to withstand stresses in the short to medium-term. Undertaken by Lord Sharman, the report made recommendations on how we can raise the bar for risk management by boards and communication to shareholders, or potential shareholders, about the risks faced by the companies and how they are managed or mitigated.
When we issued consultation updates to the UK Corporate Governance Code in April we included proposed guidance setting out boards’ responsibilities for setting the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organisation, by which we mean assessing and managing the principal risks facing the company, including risks to its solvency and liquidity. As now, boards are charged with summarising how they reviewed the effectiveness of their system of risk management. Following the changes they will also be asked to explain what actions have been taken to remedy any weaknesses identified from that review.
We will soon issue guidance that will set out the need for a robust assessment of whether risks give rise to material uncertainties that should be taken into account and reported on in relation to the companies’ going concern basis of accounting. We will create a new type of viability assessment - one that is focussed not only on the narrow meaning of assessing going concern, but that also gives a broader integrated assessment and description of solvency and liquidity, specifying the period covered by this statement and why directors consider that period appropriate.
Companies will be asked to state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks,. It is expected that the period assessed will be significantly longer than 12 months.
Within the UK Corporate Governance Code there is the underlying theme that boards should have a long term focus. In this context it is essential that boards look forward to strategic risks that could affect the company as well as its long term viability. For investors, as providers of risk capital, knowing how the board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that providers of capital seek.
For this reason, in 2011, we commissioned a report on the quality of information that companies provide on their financial health and their ability to withstand stresses in the short to medium-term. Undertaken by Lord Sharman, the report made recommendations on how we can raise the bar for risk management by boards and communication to shareholders, or potential shareholders, about the risks faced by the companies and how they are managed or mitigated.
When we issued consultation updates to the UK Corporate Governance Code in April we included proposed guidance setting out boards’ responsibilities for setting the company’s risk appetite, ensuring there is an appropriate risk culture throughout the organisation, by which we mean assessing and managing the principal risks facing the company, including risks to its solvency and liquidity. As now, boards are charged with summarising how they reviewed the effectiveness of their system of risk management. Following the changes they will also be asked to explain what actions have been taken to remedy any weaknesses identified from that review.
We will soon issue guidance that will set out the need for a robust assessment of whether risks give rise to material uncertainties that should be taken into account and reported on in relation to the companies’ going concern basis of accounting. We will create a new type of viability assessment - one that is focussed not only on the narrow meaning of assessing going concern, but that also gives a broader integrated assessment and description of solvency and liquidity, specifying the period covered by this statement and why directors consider that period appropriate.
Companies will be asked to state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks,. It is expected that the period assessed will be significantly longer than 12 months.
Conclusion
Ultimately, the role of the board is to ensure the sustained success of their company and to exercise responsible stewardship on behalf of their shareholders. To do this effectively they need to understand and manage the risks to the future health of the company.
Stewardship is just one element of a number of components that lead to growth in capital markets. But engagement between investors and companies can only be a good thing: exchange of information and open lines of communication engender confidence and this ensures a beneficial circle of engagement.
Stewardship is just one element of a number of components that lead to growth in capital markets. But engagement between investors and companies can only be a good thing: exchange of information and open lines of communication engender confidence and this ensures a beneficial circle of engagement.