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Sean Geraghty, Partner, Dechert  LLP

Comment: UK Stewardship Code for Institutional Investors

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The Financial Reporting Council (the FRC) published the first UK Stewardship Code (the Code) for institutional investors on 2 July 2010. Sean Geraghty, Partner with Dechert LLP’s Corporate and Securities Group, outlines the purpose and implications of the Code.

In 2009, following Sir David Walker’s recommendation and a request from the Government at that time, the FRC agreed to publish a code for institutional investors and take responsibility for its oversight and future development.
 
After a detailed consultation process, it was decided that the new code should be based on the code on the responsibilities of institutional investors, issued by the Institutional Shareholders Committee (ISC) in 2009.
 
Introducing the Code, Baroness Hogg, FRC Chairman, said, “We hope this new Code will be a catalyst for better engagement between shareholders and companies and create a stronger link between governance and the investment process”.
 
Application of the Code
As with the UK Corporate Governance Code, the Code will be applied on a “comply or explain” basis. Reports made in accordance with the Code should include a description of how the Code has been applied and disclosure of the specific information required under Principles 1, 5, 6 and 7 (see below) or an explanation as to why these elements have not been complied with. The Code applies to the following bodies:
 
Asset managers
The Code is addressed in the first instance to firms who manage assets on behalf of institutional investors, such as pension funds, insurance companies, investment trusts and other collective investment vehicles. The FRC expects such firms to disclose both the extent and manner in which they have complied with the Code. On 6 July 2010 the Financial Services Authority published its quarterly consultation paper (CP10/15) which includes a proposal to introduce a requirement for UK-authorised firms managing investments on behalf of professional clients to “comply or explain”.
 
Institutional investors
The FRC strongly encourages all institutional investors to publish a statement on their website on the extent to which they have applied the Code by the end of September 2010.
 
Pension funds and other owners
The FRC notes that although pension funds and other owners may not wish to be directly involved in engagement, they can contribute by mandating their fund managers to do so on their behalf and scrutinising with care their reports on engagement.
 
 
Foreign investors
The FRC hopes investors based outside the UK will commit to the Code. However, it does recognise that, in practice, local institutions usually take the lead in engagement.
 
Proxy voting and other advisory services
The FRC believes that it would be desirable for agencies to act in a way that is consistent with the Code and encourages them to disclose how they have carried out the wishes of their clients by applying the principles of the Code that are relevant to their activities.
 
From the end of September 2010, the FRC will maintain on its website a list of all investors which have published a statement on their compliance or otherwise.
 
Code Principles and Guidance
The FRC has largely adopted the ISC code. It has made minor amendments to incorporate the guidance for institutional investors which was previously set out in Section E of the Combined Code (now the UK Corporate Governance Code), and to align the code with the current provisions on engagement in the UK Corporate Governance Code. The Code contains seven main principles and associated guidance. The main principles of the Code are:
 
1. Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities. The guidance to Principle 1 provides that disclosures should include, inter alia, how investee companies will be monitored, the strategy of intervention, the policy on voting and the policy on considering explanations made in relation to the UK Corporate Governance Code.
 
2. Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed. The guidance to Principle 2 emphasises that it is an institutional investor’s duty to act in the interests of all clients and/or beneficiaries when considering matters such as engagement and voting. It notes that conflicts of interest will inevitably arise and a policy should be put in place for their management.
 
3. Institutional investors should monitor their investee companies. The guidance to Principle 3 provides that as part of the regular monitoring, institutional investors should:
– satisfy themselves that the investee company’s board and committees are effective and that independent directors provide appropriate oversight by meeting the chair and, where appropriate, other board members;
– maintain a clear audit trail including records of private meetings held with companies and of votes cast; and
– attend the general meetings of companies in which they have a major holding, where appropriate and practicable.
                   
Institutional investors should consider carefully departures from the UK Corporate Governance Code and make reasoned judgments in each case. They should give a timely explanation to the company and be prepared to en-ter into a dialogue if they do not accept the company’s position.
 
4. Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value. The guidance to Principle 4 provides that institutional investors should set out the circumstances when they will actively intervene. Instances when institutional investors may want to intervene include when they have concerns about the company’s strategy, its governance or its approach to risk arising from social or environmental matters. The guidance sets out various ways in which institutional investors may wish to escalate their action.
 
5. Institutional investors should be willing to act collectively with other investors where appropriate. The guidance to Principle 5 explains that this may be most appropriate at times of significant corporate or wider economic stress, or when the risks posed threaten the ability of the company to con-tinue. Institutional investors should disclose their policy on collective engagement.
 
6. Institutional investors should have a clear policy on voting and disclosure of voting activity. The guidance to Principle 6 provides that institutional investors should seek to vote all shares held and should not automatically support the board. Institutional investors should disclose publicly their voting records and if they do not, they should explain why.
 
7. Institutional investors should report periodically on their stewardship and voting activities. The guidance to Principle 7 provides that those who act as agents should regularly report to their clients details as to how they have discharged their responsibilities and those who act as principles, or represent the interests of the end investor, should report at least annually to those to whom they are accountable. The guidance emphasises that investors should consider an independent audit opinion on their engagement and voting processes.
 
Next Steps
The FRC has noted that a number of significant issues were raised by the consultation that have not been addressed in the Code, for example whether institutional investors should disclose their policies on stock lending and arrangements for voting pooled funds. The FRC has stated that it intends to carry out further work on these issues and regularly monitor the take-up and application of the Code. A decision on the timing of the first review of the Code will be taken in late 2011. 

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