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PRIMER: the UK Stewardship Code

In IFLR’s latest primer, we look at the significance of the UK Stewardship Code and how recent changes will impact asset management

The Stewardship Code is a part of UK company law and underlines the principles that institutional investors are expected to follow. Managed by the Financial Reporting Council (FRC), its goal is to make institutional investors be proactive and engage with stakeholders.

What does the UK Stewardship Code do?

The first Stewardship Code was published in 2010, and was further updated in 2012. This included the clarification of the respective responsibilities of asset managers and asset owners for stewardship and clearer explanations concerning conflicts of interest.

A much strengthened set of requirements were then introduced in a 2020 update.

“The Stewardship Code is all about education and the importance of being responsible,” said Sturgeon Ventures founder and managing partner, Seonaid Mackenzie. “To be really engaged with something like the stewardship statement in general you need to be an out of the box thinker, but following these principles shouldn’t be a differentiator for firms.”

What has changed since 2012?

“The 2012 code got some criticism in the Kingman review. The focus was on investors having policies," said Baker Mckenzie partner, Robert E. Adam. "Once you had policies, you got a tick from the FRC and whether you were using that policy effectively was not assessed.”

Now, the code requires asset managers and owners to report on specific stewardship activities and outcomes over a one year period.

One of the reasons why this was introduced was because there have been significant developments in stewardship and investment in the UK and globally. For example, there has been growth in investment in assets other than listed equity, such as fixed-income bonds and infrastructure equity, and an increase in UK capital invested internationally.

Another change has been engagement with environmental, social and corporate governance (ESG) issues: “These have rapidly risen up the agenda of investors,” said Claudia Chapman, head of stewardship at the FRC. “It is now widely recognised that ESG issues can pose both risks and opportunities to the value of investments.”

Chapman added that for savers and pensioners – the ultimate beneficiaries of investment – ESG shapes the world that they live in and retire into.

The code makes explicit reference to ESG factors and climate. For example, the seventh principle asks that “signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities”.

“There is a much greater focus on the activities and outcomes of stewardship, rather than just the policy,” Chapman continued.

Hogan Lovells partner, Nicola Evans, agreed: “Simply telling the reader of a report that you have an environmental policy isn’t the same as actually going into the detail of implementation,” she said, welcoming the new focus on ESG disclosure.

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What do companies struggle with most?

Firms are gearing up for the first round of reporting, due in March 2021. Along the way, there will inevitably be struggles as firms get to grips with new requirements.

New clauses are likely to challenge investors – with Chapman stating firms need to be able to clearly state their purpose, beliefs and strategy and how these enable their stewardship. “There is a similar requirement in the UK Corporate Governance Code, so indications are that it may take investors time to reflect and articulate this meaningfully.”

She remained optimistic that evidence indicates companies with a clear purpose create greater value over the long-term.

“It will be interesting to see how signatories deal with disclosure on confidential or sensitive matters, such as when investee companies seek their views on an approach from a shareholder activist,” said Baker McKenzie partner, Helen Bradley. “These discussions can be effective and add a lot of value but are often behind closed doors. Disclosure requirements risk making this more challenging to do.”

With the tiering process having fallen away, asset managers face a further new reality. Whereas asset managers were tiered between one and three – dependent on the standard of their reporting – they are now only allowed to become a signatory of the code if they have submitted a quality document.

“It will be interesting to see how many firms comply successfully and it will be a costly exercise for many. In order to have good reporting and governance, firms will need to incur costs to ensure compliance,” said Evans. “What we could see is market leaders becoming signatories to the Code, while some others may sit back and copy the frameworks.”

How effective is soft law?

In spite of its significance, the code remains soft law. Companies won’t face the consequences that they would if they decided to not comply with regulation. Rather, the soft law aspect incentivises companies to comply and for the market to decide.

“The expectation is that if the market thinks that it is significant a firm does not comply with the Code, the market will move away from the firm, meaning that the asset manager will have to begin complying if they want to remain competitive,” said Evans. “People’s perceptions are changing. We should expect that good stewardship will be forced by clients as well as codes and law.”

In addition, many asset owners require their asset managers to be signatories to the code. “Investment consultants are increasingly supporting their clients by analysing the stewardship commitment of asset managers, so there is a commercial driver to become a signatory,” said Chapman.

Industry standards providing stepping stone for ESG regulation

Guidance from the Pensions Regulator and the Local Government Pension Scheme (LGPS) advisory board also encourages asset owners/pension funds to meet the requirements. This is likely to grow as societal expectations and ESG related legislation grows.

In spite of the sense of the urgency that finance has about ESG related issues, market participants remain positive that soft law is effective.

“Regardless of this being a voluntary model, my sense is that you will see change. In particular, on ESG you will have to see it, otherwise signatories will face heavy criticism on issues such as climate change. I hope that we don’t need mandatory legislation to get there,” said Bradley.

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