UK: Corporate Governance And Local Authority Investment Vehicles

Last Updated: 14 May 2014
Article by Edward Craft

The landscape

Local authority pension funds have an honourable history of seeking to act as positive stewards of their investments in publicly traded companies and work closely with the Pension and Investment Research Consultants ('PIRC'), their preferred shareholder voting advisory agency, as active investors, seeking to apply their investments to make our economy more sustainable. Local authorities as public bodies must conduct themselves in a clear, transparent and accountable manner. Furthermore, there is a plethora of best practice statements and standards setting out modes of behaviours in order to identify how company directors may discharge their responsibilities to act, in good faith, in what they consider to be in the best interests of the members of the company as a whole.

Local authority corporate investments

However, local authorities need to enshrine and promote this best practice into privately owned companies in which they invest. What can be done to better reflect the principles of investor stewardship into local authority investments, both in the boardroom and at shareholder level? This article set out five areas each local authority should consider.

Corporate governance developments

Beyond the public sector, there have been significant developments in the sphere of corporate governance throughout the past decade.

The most significant developments in this area are:

  • the introduction of a codified statement of the general duties of directors in the Companies Act 2006;
  • the regular update by the Financial Reporting Council of the UK Corporate Governance Code (last version September 2012);
  • the Financial Reporting Council's companion volume to the UK Corporate Governance Code, the Stewardship Code;
  • the continuing work on the European Commission Company Law and Corporate Governance Action Plan, including the new proposed Shareholder Rights Directive;
  • the changes to corporate narrative reporting which came into effect on 1 October 2013 under The Companies Act (Strategic Report and Directors' Report) Regulations 2013 (SI 2013/1970);
  • the Quoted Companies Alliance Corporate Governance Code for Small and Mid-Size Quoted Companies 2013 published by the Quoted Companies Alliance on 1 May 2013.

Opportunity for local authorities to show leadership

It is notable that standards of corporate governance best practice applied by most companies outside of the public markets significantly lag behind those in the equity capital markets. It is surprising that, given the public mandate of local authorities, local authorities (and indeed their pension schemes) have not seized the opportunity to demonstrate leadership in this regard. However, there do seem to be signs of movement and the increased public focus on corporate responsibility and corporate governance behaviours are expected to ripple through to the public sector.

In the event that take-up of local authority spin off vehicles and joint ventures increases there will be a growing need and demand for specific governance protocols in this area. How governance best practice is delivered in relation to privately owned vehicles is very different to both the equity capital markets and the council chamber.

1. Trust and Transparency

This is the title of the important consultation issued by the Business Secretary in 2013 which sets the tone for much of government policy in the business arena. Despite what have in more recent years become fairly public disputes between the coalition partners, they are united in a desire to build greater trust of corporate activity and to improve transparency of both decision making and ownership. This initiative shines a light on owners to be more accountable and responsible and this extends to local authorities as investors.

2. Allowing the investment to grow

Local authorities often develop innovative models which can develop into thriving businesses, but too often the ambitions of these fledgling activities are thwarted by a narrow project-focussed mindset that forces the shape and structure of the venture into something of which the authority (and, indeed HM Treasury) is more familiar, thus thwarting ambition.

3. Use of non-executive directors

Non-executive directors can be deployed as very cheap and effective integrated business consultants to a venture. Often, in the context of publicly-backed projects, it will be possible to obtain non-executive experience for little or no cost. Provided you can attract persons of the appropriate calibre and experience this opportunity should not be overlooked.

4. Applying asset management principles to the holding of the investment

Once an investment has been made and a vehicle established the local authority should manage it at a certain distance applying normal investment policies and practices. The investment should be realised with a sale when the opportunity for a full equity price is available to the local authority, regardless of the remaining length of time under service contract or an equivalent arrangement. It is key that the local authority retains the levers it requires in the commercial agreements as much as in the equity documentation because there may be a time when one of those documents is no longer relevant.

5. Developing a better appreciation of risk

In a similar way to many smaller listed companies (and, indeed, the financial crisis of 2008 would indicate, many systemically significant financial institutions), it is necessary for boards of private companies to develop a better understanding and appreciation of risk. Once the relevant risks are truly understood it is then possible to appropriate manage those risks and the support of an investor with the long-term horizon of a local authority can prove invaluable in this regard.

Conclusion

At present some local authorities might be slightly behind current market practice in the promotion of best corporate governance practices into their investee companies, but this is only marginal. There is now a golden opportunity available for local authorities to show real leadership to help build the sustainable economy of the future through their investment behaviours.

Published by the Local Government Lawyer on Thursday 1st May 2014

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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