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FRC responds to Kingman criticism with revised UK Stewardship Code

The Financial Reporting Council (FRC) has proposed revisions to the UK Stewardship Code, which is designed to deliver more effective investor stewardship of a wider range of corporate assets.31 Jan 2019

The revised Code incorporates environmental, social and governance (ESG) factors for the first time, encouraging signatories to take material ESG issues, including climate change, into account when fulfilling their stewardship responsibilities. It will be backed by more rigorous reporting requirements and tougher oversight from the FRC. An FRC consultation on the proposed changes closes on 29 March 2019.

Corporate governance expert Martin Webster of Pinsent Masons, the law firm behind Out-Law.com, described the revisions as "the FRC's last throw of the dice for the Code". Sir John Kingman, in his government-commissioned review of the FRC, recommended that the "well-intentioned but ineffective" Code be abolished if it cannot be made more effective.

"The FRC says it has met Kingman's main objective, which is that the Stewardship Code must focus on outcomes and effectiveness," Webster said.

"A new definition of stewardship identifies its primary purpose as looking after the assets of beneficiaries – that is, the investors' end customer," he said. "Criticism from companies often highlights a lack of engagement by investors, and that when investors do get in touch it is only because they have a problem."

"The Code is aimed at institutional investors and their advisers and it looks two ways: at what they do to create value for those on whose behalf they are investing and how they report on that; and at their relationship with the businesses in which they invest, how they engage with companies and how they hold them to account," said Webster. "While the main emphasis of the new Code seems to be on the first of these, there is a separate section for service providers such as proxy agents, who are told they must ensure their workforce has appropriate experience and qualifications. But there is little in the new Code to meet the common complaints of late notification of voting intentions and a refusal to engage in meaningful discussion."

"The new Code calls for investors to articulate their purpose, values, culture and strategy to achieve their objectives – all concepts familiar from the new UK Corporate Governance Code," he said. "It also looks beyond the UK listed equities market and seeks to apply the same standards to other asset classes, such as fixed-income bonds and infrastructure equity."

The UK Stewardship Code was first introduced in 2010 and sets out how institutional investors should engage with the companies in which they invest. The Financial Conduct Authority (FCA) requires UK-authorised asset managers to publish a statement of commitment to the UK Stewardship Code or to explain why it is not appropriate to their business model. The FRC does not require institutional investors to report on their compliance with the code, but it encourages them to do so.

The FRC is now proposing standardising reporting requirements under the Code. Signatories will be required to submit a 'policy and practice statement' to the FRC at the point of signature, setting out how their purpose, values and culture enable them to meet their obligations to clients and beneficiaries. They will also be required to produce an annual 'activities and outcomes report', focusing on how their stewardship activities deliver outcomes against their stewardship objectives.

The provisions in the Code extend beyond stewardship of UK-listed equities to cover any assets over which the investor has influence, wherever in the world they are located. The FRC's view is that signatories "should use the resources, rights and influence available to them to exercise stewardship, no matter how capital is invested".

The proposed revisions to the UK Stewardship Code form part of a wider programme of work by the UK regulators looking at the role played by stewardship in corporate governance, against the backdrop of the Kingman Review and upcoming amendments to the EU's Shareholder Rights Directive (SRD II). The FRC and FCA have published a joint discussion paper in which they consider more broadly what effective stewardship should look like, and what the minimum expectations should be for financial services firms who invest on behalf of clients and beneficiaries.

The FCA has published an additional consultation on its proposed regulatory measures for implementing the provisions of SRD II for FCA-regulated life insurers and asset managers. SRD II, which aims to promote effective stewardship and long-term investment decision-making, covers some of the same ground as the Stewardship Code, although the FRC noted in its consultation paper that the proposed Code revisions are "more demanding" than the requirements of SRD II.

SRD II comes into effect in June 2019, and the UK government has indicated its intention to implement the changes regardless of its agreed future relationship with the EU. The FCA's additional consultation closes on 27 March 2019.

Pinsent Masons pensions and long-term savings expert Carolyn Saunders said that the specific reference to climate change in the revised Code "follows on from a similar reference in new investment requirements for pension scheme trustees".

"These references indicate a growing pressure to restrict global warming and show a direction of travel which will lead to ESG factors, including climate change, being fully integrated into investment decisions," she said.