The global focus on responsible business practices has blossomed over the past decade. With that growth has come a greater awareness of concepts such as corporate governance, ESG integration, financial transparency, and fiduciary duty. Stewardship codes have become a tool to formalize the roles and obligations of corporations and investors alike. Administered by a variety of governmental agencies or independent regulators, stewardship codes now exist in over 20 countries worldwide, as well as in international associations like the OECD and ICGN.
The United Kingdom was the first nation to adopt its own stewardship code in 2010, a response to a review of corporate governance practices within its financial institutions. According to the Financial Reporting Council (FRC), an independent regulator, the UK Stewardship Code was first published to “improve long-term returns to beneficiaries by enhancing the quantity and quality of engagement between investors and companies.” Now the FRC is proposing updates to the code to better reflect the changing landscape of institutional investment, based on discussions and input from a variety of sources, including FCLTGlobal research.
FCLTGlobal’s comments draw from our recent research, including Institutional Investment Mandates: Anchors for Long-Term Performance, a 2017 report on effective investment mandate provisions. As you’d expect, our recommendations are grounded in our view of the importance of “clearly reinforcing the principle that investors take a long-term approach in their stewardship of their beneficiaries’ assets.” In particular, four proposed changes have the potential to reinforce this principle:
Purpose, values and culture
Signatories will be asked to establish an “organisational purpose, strategy, values and culture that enable them to fulfil their stewardship objectives”. Our ongoing work to identify and measure the predictors of long-term value creation highlights the importance of long-term governance and culture as a positive predictor of greater long-term value creation for both asset owners and asset managers.
Integration of stewardship and investment approach
The draft 2019 Code sets higher standards for asset owners and asset managers regarding how they integrate their stewardship responsibilities into their investment processes, including investment decision-making, mandate design and other activities. Asset owners play a central role in promoting effective stewardship practice, as well as in the selection, monitoring and evaluation of the performance of asset managers who act on their behalf. In Institutional Investment Mandates: Anchors for Long-Term Performance, we note that active ownership or engagement with investee companies can be advanced through mandate process. For example, owners can ask managers to detail their current practices for engaging with portfolio companies and for casting proxy votes. In doing so, they can ensure the manager’s approach matches their own long-term goals.
Recognizing the importance of ESG issues
Signatories are expected to take into account material ESG factors, including climate change, when fulfilling their stewardship responsibilities. Our research on long-term predictors found that a lack of ESG-related controversies is a significant predictor of cumulative five-year ROIC. As investment horizons lengthen, investors are more likely to need to integrate ESG factors into their strategies. Investing for the future means considering shifting global demographics, climate change, and any number of factors that would not have been considered material twenty years ago.
Aligning incentives with investment strategy and stewardship codes
Signatories are asked to ensure how incentives align with investment strategy and stewardship objectives. Both our research and that of other academic sources reflects the importance of alignment of interests and incentives with an organization. Institutional Investment Mandates: Anchors for Long-Term Performance further emphasizes the significance of incorporating and aligning incentives that will guide asset owners and asset managers alike toward shared long-term objectives.
FCLTGlobal always welcomes the opportunity to share our research in a way that will impact real change, and appreciates the chance to weigh in on these important changes to the UK Stewardship Code. The FRC plans to publish the new code in July 2019. Until that time, please feel free to read the entirety of our comments here.