Why does corporate governance matter? Local authority pension funds in the UK are trustees of funds worth billions of pounds. A significant proportion of those assets are in the form of equities. As such, the local government pension scheme is a major owner of UK plc.
Shareholders enjoy many rights, but equally ownership brings responsibilities, mainly to act as “good stewards” to help ensure the long-term success of the companies in which they are invested.
The development of corporate governance standards has been linked to a series of catastrophic stock market events and failures of management oversight. The failure of Polly Peck, Maxwell and the Bank of Credit and Commerce International, resulted in a series of blue ribbon committees that have focused on companies and shareholders and their need to work together.
For years, market wisdom said that it was far easier for a major shareholder to simply sell an underperforming company. Transaction costs, however, can act as a significant drag on performance and for many investors that hold the majority of their assets through index-tracker portfolios selling simply isn’t an option. So we are left with active ownership as the only realistic alternative.
The role of shareholders
Some investors have been more willing than others to engage with companies. Most recently, following Sir David Walker’s review of the bank failures, it has been suggested that shareholders really needed a code of their own to bring governance and ownership to the heart of the investment process.
The UK is now leading the world with the introduction of the national Stewardship Code which, for the first time, lays out investor responsibilities. For fund managers, it will become part of their Financial Services Authority obligations and they will have to think hard about their approach to ownership rather than take a ‘tick the box’ approach. Just as the Cadbury Code was groundbreaking, the Stewardship Code has the potential to become the best practice principles for global investors.
So what will the new code bring to the table? Voting of shares and a high level of engagement are considered the most fundamental components.
Share voting decisions must be based on best possible practices and integrated with the portfolio management process. Voting must be combined with research to make the most of the ownership rights. Pension fund voting records should be disclosed, with companies advised ahead of stakeholder meetings of voting intentions (and associated reasons) to be more influential.
One dichotomy with regard to share voting is how it can be integrated into the portfolio management process. If a local authority fund delegates governance to its fund managers, it is feasible that those managers can vote against each other with regard to a specific share voting resolution.
That makes no sense and can be avoided by the local authority taking control of the voting process, combining all the portfolios into one and voting all the shares according to its policy. At one level that seems sensible as the fund is the ultimate owner. The downside is the process can end up too far removed from the portfolio management process.
Where to start?
- Refer to the Chartered Institute of Public Finance & Accountancy/Myners Principle Number 5. This requires local authority pension funds adopt, or ensure investment managers adopt, the Institutional Shareholders’ Committee Statement of Principles on the responsibilities of shareholders and agents.
- Make yourself thoroughly conversant with the Financial Reporting Council’s UK Corporate Governance Code.
- Refer to the pending Stewardship Code (also FRC) to be published later this year.
- The United Nations Principles for Responsible Investment reflect environmental, social and governance issues. This represents the standard best practice. Note there is a substantial workload involved.
Finally, Jean-Paul Sartre wrote: “I am abandoned in the world, in the sense that I find myself suddenly alone and without help, engaged in a world for which I bear the whole responsibility without being able, whatever I do, to tear myself away from this responsibility for an instant.” Any local authority pension fund manager working on corporate governance can relate to this cry for help.
Phil Triggs is treasury and pension fund manager, Warwickshire CC