Dr Mellor's Presentation speech:
According to the Oxford English Dictionary, a ‘steward' is “a person employed to manage another's property”. Its derivation is from the Old English word “stiweard”, so one of the few words in the English language not derived from the French, or German, or even Latin. So to be introducing a report entitled Stewardship to an EU audience is probably not the smartest thing to be doing!
In fact, the phrase “employed to manage another's property” applies to both company management and institutional shareholders. For company management it is about responsible management of the assets entrusted to them as agents of the shareholders. For institutional shareholders it is about responsible and thoughtful ownership as agents for the ultimate owners, i.e. the beneficiaries, savers, pensioners.
This goes some way to answer the question “What is stewardship?”. It follows that stewardship is something that MUST be of concern to both company management and institutional shareholders in their role as agents and custodians of “another's property”. But to what end? Their common objective is the creation of economic value and the value to society which follows.
Stewardship is therefore real and important and the responsibility for it which rests with company management and institutional shareholders arises because of their respective roles within the capitalist system. It can be argued that stewardship is necessary to the functioning of the system, including the preservation of trust in the investment process. Without trust between shareholders and boards, companies' access to the capital markets would be severely constrained with serious implications for economic development. But, from a shareholder's perspective, what is the prime objective of stewardship? It must be to generate the maximum sustainable risk-adjusted returns.
But from a practical standpoint, how is stewardship to be exercised? And what are the impediments?
To put the exercise of stewardship into proper context it might be useful to think in terms of “degrees of stewardship”. Let me explain. We are all aware that a range of investment strategies are deployed throughout out the capital markets and that, by and large, these all have their place in the efficient functioning of the markets, including those, typically with a shorter term investment horizon, which provide important market liquidity. For these investment strategies stewardship might be applied with a ‘light touch', but for those with a longer term perspective, a ‘heavier' touch is required. Put another way, this heavier touch means closer communication, i.e. engagement, between company boards and institutional shareholders. This engagement is also important for another reason, namely, it is fundamental to the ‘comply or explain' regime of the current shareholder-owner model of corporate governance.
In introducing the Report it is important for me to point out that the Project was conducted from the perspective of the United Kingdom but within a European context, i.e. as a contribution to the current debate on EU corporate governance. At an EU level different systems of law and more concentrated share ownership would, for instance, need to be taken into account.
Our Report – An Investigation into Stewardship - is concerned with the engagement between investors and public companies and explores impediments and their resolution.
Charles has mentioned the CFA work preceding this Project. The Foundation for Governance Research and Education – FGRE – which I lead, and which is the publisher of this Report, had hitherto researched and published work on engagement between institutional shareholders and boards of companies in the UK FTSE-250 index. A central theme of that work was the important role shareholders play in the shareholder-owner corporate governance model, and the need for this role to be given greater focus.
The Report, published at the end of June this year, is the culmination of the combined input of a core group of specialists in investment management, governance, fund ownership and relevant law (meeting as a taskforce) coupled with input from a selected group of mainly UK FTSE-100 chairmen. This whole group represents a unique source of expertise and experience covering all relevant inputs to a serious consideration of stewardship. Additional input was gained from meetings with a small group of practitioners which included investment consultants and investment trusts.
To set the scene, the Report focuses on the investment chain and the relationship between ultimate beneficiaries, asset owners, asset managers and investee companies. TRUST lies at the heart of this chain. A key relationship is that between the ultimate beneficiaries, i.e. savers, pensioners, and asset owners, i.e. trustees, etc. Asset owners owe a fiduciary duty to ultimate beneficiaries, which requires them to exercise their responsibilities in the best interests of those beneficiaries. Typically, but not always, asset owners contract with independent asset managers to manage fund portfolios in accordance with the terms of an agreed investment management mandate. Fund managers are therefore acting in an agency capacity upon instruction from asset owners.
The Project focussed on three key impediments to effective stewardship and engagement which were identified as particularly significant:
- Lack of direction: Direction requiring engagement by fund managers is not explicit in investment managements mandates.
- Cost: Engagement requires investment in people with the appropriate skill level and experience to hold constructive dialogue at the board level. This investment in people, in addition to time spent on engagement, adds significant costs to the investment process, but the economic benefits can only be realised over the longer term.
- Cultural and structural barriers underpinning common practice in the investment management sector result in engagement being given a low priority.
The Report focuses on asset owners as the starting point for addressing these impediments by them giving serious consideration as to whether or not engagement is relevant to an investment strategy, and, if it is, for it to be made explicit in investment mandates. At the same time engagement between shareholders and boards is highlighted as important to the investment process, but is not universally of a required standard.
To address these issues, the Report draws two important conclusions.
First, with regard to asset owners, their fiduciary duties require clarification by making more explicit a duty for them to have regard to engagement when in the asset owners independent judgment it is in the best interests of beneficiaries to include this in investment mandates. Matters for engagement could include as essential for consideration:
- corporate strategy
- board composition and effectiveness
- remuneration
- risk management
- environmental and societal impact
Additional matters could be included on a case-by-case basis depending on an investee company's individual circumstances. In UK company law (Section 172(i) Companies Act 2006) a precedent has already been set with regard to directors' general duties to widen matters they need to take into account in their role as directors of the enterprise.
Secondly, steps to improve the standard of dialogue between institutional shareholders and company boards need to address the following:
- a framework for dialogue
- a clearer understanding on the part of issuers and shareholders on expectations
- enhancement of the skills of those engaging from the investment side which recognises the qualities required to conduct dialogue at the most senior levels within companies
- guidelines for asset owners.
This, then, is the nub of our Report. To summarise, the Report proposes two key initiatives to enhance the effectiveness of stewardship and engagement:
- Clarification of the fiduciary duties of asset owners and making explicit in statute their duty to have regard to engagement in investment mandates, and
- Steps to improve the standards of dialogue between company boards and asset managers.
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