Claudia Chapman of the Financial Reporting Council talks about the revised Stewardship Code, asset classes and investor engagement

After spending nine years in business development roles at the Association of Chartered Certified Accountants (ACCA) Claudia Chapman led a campaign to raise corporate governance standards in developing markets and bring together finance and HR to address inclusion and diversity in organisations.

In 2015 she joined the corporate governance and stewardship team at the Financial Reporting Council to deliver a report on Corporate culture and the role of boards, which led to revisions of the UK Corporate Governance Code and most recently she led the review and update to the UK Stewardship Code which was published in October 2019. "Stewardship is traditionally thought of as the activities of engagement and voting by shareholders who hold listed equity assets. However, all assets under management are important, so we felt the Stewardship Code needed to change" she said.

Since the first Stewardship Code was published, the investment market has changed, what do you think the main factors of change have been since 2012?

The Walker Review of corporate governance in UK banks and other financial institutions recommended that the FRC take over responsibility for the Statement of Principles from the Institution Shareholders Committee. This then became the UK Stewardship Code. The 2012 Code was chiefly about making the UK Corporate Governance Code more effective and holding companies to account. Since then the way in which capital is invested has significantly changed. At the time, investment by UK investors in UK companies was a greater proportion of assets under management. UK companies are no longer predominantly owned by UK institutional investors and there's a greater proportion of UK equity owned overseas. Investment in other asset classes, including fixed income, private equity, infrastructure, real estate, property, derivatives and alternatives has increased.

People's expectations of investors have also changed and the public is starting to become more aware about where their money is invested. A company called Quiet Room videoed Londoners asking if they knew how their pensions were invested. Many were surprised to find out how their pensions were invested and wanted to know more about the companies and the contribution they make to the environment and society.

Can you further explain the expansion of the Stewardship Code to cover all asset classes invested by UK beneficiaries?

Stewardship is traditionally thought of as the activities of engagement and voting by shareholders who hold listed equity assets. However, all assets under management are important, so we felt the Stewardship Code needed to change. The underlying principle, of allocating, managing and overseeing capital applies irrespective of the way in which capital is invested. Engagement, monitoring, collaboration, the governance structures and resourcing that we set out in the principles, apply across asset classes. We recognise it is more difficult in some instances for investors to exercise their stewardship role outside of the UK or outside of listed equity because they may not have the mechanisms or influence to do so. However, they should certainly try. Analysis and due diligence prior to acquiring an asset and through holding, is important and they should be considering all the ways they can influence and engage.

The new code heavily focuses on making asset managers and owners more accountable to their clients, and this is going to have an impact on companies. How do you think the new code will change the nature of how asset managers engage with companies?

One of the things that we're trying to achieve is better quality engagement. Engagement needs to be purposeful. It's also about being very clear about what you're trying to achieve with an engagement and setting out to achieve that. Then thinking about whether or not you have succeeded and what you're going to do differently in the future. It's not only about engagement, but engagement is still a core tenet of the new Stewardship Code.

In some circumstances, having exhausted all the opportunities to make a change in a company, investors may feel that to sell their position is in the best interest of beneficiaries and clients. That may absolutely be the right thing in terms of stewardship.

We spoke about what has changed but one of the things to talk about is what hasn't changed. Some of the issues that had been identified in the Kay Review about the misalignment of incentives in the institutional investment community remain today – what we're doing with the Code is to try and realign those objectives and incentives. The objective of the ultimate provider of capital being aligned with the asset owner – in many cases a pension fund. That then needs to be communicated through their investment consultants, to the asset manager, then to be aligned with the objectives of the company where the capital is invested.

Do you think this could lead some investors to focus less on the engagement with companies?

I would be surprised if there's less engagement. What I would like to see is the quality of that engagement improving. In the interest of time for companies and for investors, it is absolutely right that they prioritise. We're not saying you must engage with every company you hold. That may not be feasible. It's about being clear about what your priorities are and communicating those so that there's transparency.

There are other ways that investors can, and do, monitor their holdings. It does not simply have to be through engagement with the senior independent director, the chairman or the chief executive in the company. There are many sources of information available for them to keep an eye on things as well.

Do you see the new code as being an equivalent to Section 172 for investors?

Section 172 has existed within the Companies Act since 2006 but it had a reinvigoration around the time we worked on Corporate culture and the role of boards which the Institute was involved with. There was a significant focus on workers' rights and representation, employee representation on the board and the consumer and stakeholder input.

There's not a direct legal equivalent but there is a read-across to the Code, and that is simply because societal expectations and the market is demanding it. Environmental, social, and governance (ESG) issues are becoming much more important to investors and to those who are providing the capital in the first place. People are wanting to have better information and make responsible choices.

In addition, the review of fiduciary duty that the Law Commission undertook in 2014, which led to the DWP clarifying trustees' duties, determined material ESG factors should be taken into account by pension trustees.

There's been a number of questions being raised about the issue of resources, what impact will this bigger set of expectations have on already over stretched resources?

It depends on how well resourced these teams are in asset managers and asset owners already. We do expect there to be a greater commitment to resourcing stewardship and it's not just about resource volume, but it's also about the accountability of those involved in stewardship in the organisations. We need to get buy-in and stewardship decision-making taking place at a more senior level.

We're clear in the Code that that it's about clarity of purpose. In current stewardship reporting, we have organisations saying, "I sent 'X' number of letters to these companies and that, therefore, fulfils my stewardship role".What were you seeking to achieve with that activity, and how does it fulfil that?  It is about being purposeful, and so may not necessarily increase the number of engagement meetings. There are opportunities for companies and investors to think about how they engage. For example, they might see an increase on the debt side. If you have a company that primarily engages with its shareholders, then we do expect to see an increase in engagement demand from bondholders and expect companies to be providing more information and opportunities to do so.

Although there are principles within the code, how can the new code ensure the reporting is sufficient, and how can companies ensure that they are properly implemented?

I don't think it's necessarily going to be the role of companies to see whether or not reporting has been sufficient.

Reporting by asset managers will be primarily useful to asset owners; those who are choosing an institutional investor through which to invest. And, investment consultants who are making those recommendations. For asset owners, it is the beneficiaries and the organisations that they serve, to have greater levels of transparency about what those organisations do to fulfil their stewardship and fiduciary responsibilities.

We have an assessment framework to support the code, and we'll be using that to assess the quality of reporting once investors and service providers make their first submissions, which would be from the end of March 2021. We will be looking for prospective signatories to have addressed most of the reporting expectations of the code, in order to become a signatory, and to be able to demonstrate through examples, data and information how they have fulfilled those principles.

We're also looking for reporting to be fair, balanced, and understandable. We don't want this to just be simply a marketing document to shed good light on all the work that investors and service providers do. For example, if they have a long-standing objective of engagement with a company that's not been successful, we would expect to see those unsuccessful case studies coming through and with some rationale and what they could do differently in the next instance. It's not always going to be in their gift to affect change, particularly where they have a smaller investment.

Investors may need to start thinking differently and do things differently in relation to stewardship. It's not just the case of changing their reporting, there's going to need to be some change in practice as well.

How do you guard against the risk of the focus of reporting provoking more policy statements, rather than outcomes of effectiveness?

One of the observations we made as a result of a tiering exercise of disclosures against the code in 2015, and one of the criticisms of the existing code is that it was very focused on policy statements. However, what we've heard from asset owners is they value those policy statements, because they want to know what the intention is in the first place. And then they want to measure or assess the asset managers on those policy statements.

Nevertheless, we have reduced the number of policy statements that we require, compared to the 2012 Code. We will be focusing much more on the activities and outcomes of stewardship, but that is going to take time. And we also recognise that it's difficult, in some instances, for individual investors to be able to attribute an outcome, to an action only they have taken.

Often success will be as a result of collaboration with others. It is fine to disclose this, and the role an investor has played. 

Interview by Sonia Sharma, editor of Governance and Compliance

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