UK Financial Investments - Environmental Audit Committee Contents


Memorandum submitted by HM Treasury

  UKFI was established by the Government to manage its shares in financial institutions at arm's-length from Government and on a commercial basis. UKFI has been established with an overarching objective to develop and execute an investment strategy for disposing of Government's investments in an orderly and active way, within the context of protecting and creating value for the taxpayer as shareholder, paying due regard to financial stability and promoting competition.

  The Government believes that this objective will be best achieved by UKFI allowing the banks' managements to take operational decisions in the commercial interests of the banks and their shareholders, with UKFI acting as an engaged institutional shareholder, rather than by the Government imposing its wider policy objectives on the banks through UKFI.

  Wider objectives such as environmental policy are more effectively pursued across the economy as a whole and through industry-wide initiatives and incentives. The UK's sustainable development strategy Securing the Future is being delivered both through a range of targeted Government policies, and by integrating the principles of sustainable development into all Government policy, operations and wider society.

  For example, Budget 2009 announced the levels of the first three carbon budgets, ambitious legally-binding limits for UK emissions requiring a 34% reduction in emissions by 2020 relative to 1990 levels. Carbon budgets provide a clear and credible long-term economy-wide framework to encourage investment in energy saving and low carbon technologies. The UK Low Carbon Transition Plan set out how all sectors of the economy would contribute to meeting the carbon budgets. For large non energy-intensive organisations such as banks, the introduction of the Carbon Reduction Commitment from April 2010 will provide incentives to improve energy efficiency. This policy will cover all UK banks which meet the qualification criteria.

  To focus on influencing the policies of the banks in which HMG has shareholdings would put the banks concerned in a more constrained position relative to other major banks, thereby damaging competitiveness and investor confidence. This would threaten the objective of disposing of the shares and achieving value for money for the taxpayer as shareholder through that sale.

  Also, under UK company law, company directors are required to act in the interests of all shareholders; any attempt to require the banks to take action which they do not consider likely to promote the success of the banks for the benefit of their members as a whole would be resisted by the banks' boards and would risk contravening the relevant provisions of the Companies Act[9].

  To ensure that UKFI is fit for purpose, the Treasury has agreed UKFI's high level objectives in the UKFI Investment Mandate and UKFI Shareholder Relationship Framework Document; established a corporate governance structure to reflect UKFI's objectives, while taking account of best practice for a public company; and agreed a UKFI Business Plan 2009/10-2013/14 and reporting mechanisms to ensure rigorous internal policy and procedures, resource management and risk oversight. All of these documents can be found on the UKFI website: www.ukfi.gov.uk.

  Under the terms of its Investment Mandate, UKFI is required to follow best institutional shareholder practice. This includes complying with the Institutional Shareholders' Committee's Statement of Principles and taking on board industry-wide recommendations or guidance contained in the Walker Review or elsewhere. It will monitor each bank's performance and strategy, including the bank's approach to corporate social responsibility, in order to ensure that this is consistent with protecting the value of the bank and its shares.

  Quarterly shareholder meetings are held between the CEO of UKFI and senior officials, weighted towards a forward-looking, risk-based analysis of progress against the UKFI Business Plan and Investment Mandate.

  UKFI Board membership is primarily private sector, reflecting the need for relevant expertise and experience. Treasury appoints a private sector Chairman and two senior Government officials as directors. Responsibility for all other appointments, including Non Executive Directors and a private sector CEO, falls to the Board's Nominations Committee, with a right of authorisation falling to Treasury. There is over 100 years of banking experience on the Board.

1.   What role did the Treasury play in formulating the UKFI's Sustainability Policy (set out on its website)? To what extent were the publicly-owned banks consulted in formulating the Sustainability Policy, and what representations if any did they make about what the Policy should include/exclude?

  UKFI's sustainability policy has been drawn up by UKFI and approved by the UKFI Board. This is in line with the UKFI Board Governance Manual agreed with HM Treasury which sets out that one of the Board's responsibilities is to receive and consider high level reports on matters material to UKFI, including sustainability. Both HM Treasury and investee banks were consulted in advance of publication of the strategy and were in agreement with the UKFI proposed approach.

2.   UKFI's Investment Mandate refers to "Investee Company Conditions". What do these cover? What sanctions does UKFI or the Treasury have if these are breached? What sanctions does UKFI/Treasury have if it is not satisfied with the banks' environmental performance?

  The "Investee Company Conditions" referred to in the UKFI Investment Mandate are conditions of the recapitalisation of Lloyds and RBS. These include, for example, conditions on dividend payments, and the appointment and remuneration of directors.

  These conditions derive from the Government's direct interest in maintaining financial stability and taxpayer value. For example, a focus on remuneration responds to the fact that in the past, variable compensation was often aligned with short-term results, without consideration of the quality or sustainability of these results, or reflecting the risk assumed or an appropriate cost of capital.

  To answer the final question on UKFI's broader engagement with the banks on environmental performance, UKFI will follow in full the Institutional Shareholders' Committee's Statement of Principles in acting as an active and engaged shareholder. These principles set out the possibilities for engagement as follows:

    "Instances when institutional shareholders and/or agents may want to intervene include when they have concerns about:

    — the company's approach to corporate social responsibility.

    If boards do not respond constructively when institutional shareholders and/or agents intervene, then institutional shareholders and/or agents will consider on a case-by-case basis whether to escalate their action, for example, by:

    — holding additional meetings with management specifically to discuss concerns;

    — expressing concern through the company's advisers;

    — meeting with the Chairman, senior independent director, or with all independent directors;

    — intervening jointly with other institutions on particular issues;

    — making a public statement in advance of the AGM or an EGM;

    — submitting resolutions at shareholders' meetings; and

    — requisitioning an EGM, possibly to change the board.

    Institutional shareholders and/or agents should vote all shares held directly or on behalf of clients wherever practicable to do so. They will not automatically support the board; if they have been unable to reach a satisfactory outcome through active dialogue then they will register an abstention or vote against the resolution. In both instances it is good practice to inform the company in advance of their intention and the reasons why."

3.   What is the Treasury's current view of how long significant investments will have to be retained in RBS and Lloyds banks?

  As stated at Treasury Select Committee and Public Accounts Committee hearings, the duration of the Government's investments depends on a number of factors, including Bank and market performance, and any disposal decisions will need to be taken in the context of changing economic and market conditions.

4.   The Treasury and UKFI hold "quarterly relationship meetings" at which the progress of the Government investments is discussed [UKFI Investment Mandate, para 4.2(D)]. Are the minutes of these meetings published, and if not are there any plans to make them publicly available?

  The minutes are not published as they are commercially sensitive to the Government's holdings in the banks.

5.   What if any representations has the Government made to the publicly-owned banks about the type of businesses (and their environmental impact) that the banks have lent to or invested in, and what were the results of such representations?

  None outside of the Lending Commitments that both banks have entered into. UKFI's Investment Mandate requires it to follow best institutional shareholder practice in managing the investments (on behalf of Treasury), as set out above. UKFI was established to manage the banks at arm's length from Government and on a commercial basis, leaving operational decisions to the independent boards of the banks. To impose policy on the banks would damage investor confidence and threaten the objective of achieving value for money for the taxpayer at disposal.

6.   The UKFI website notes that it is "still considering what would be the most robust qualitative and quantitative indicators to use" to measure its performance, potentially in three areas: in relation to the banks' financial performance, investor perceptions, and "strategy in our investee banks". When will the PIs be finalised? What particular indicators does the Treasury wish to see included? Will targets be attached to any of the prospective PIs, and will these be published?

  We understand that UKFI are currently finalising the range of performance measures on which to report in the 2009-10 Annual Report and Accounts. These measures will focus on UKFI's core remit set out in the UKFI Framework Document, Investment Mandate, and UKFI Strategy for Market Investments 2008-09, including the banks' financial performance and UKFI's strategy in relation to investee banks. HMT expects to agree these performance indicators before UKFI finalises its Annual Report and Accounts.

7.   The cost of UKFI's operation (£4.5 million in 2009-10, rising to £5.0 million in 2013-14) is set out in the UKFI Business Plan [para 3.11]. It notes that these costs exclude any transaction costs when investments in the banks are disposed of (which, as AME, will be met directly by the Treasury). What factors or considerations influenced the Treasury's decision to not include shareholding disposal costs in UKFI's budget?

  The £4.5 million covers regular operational costs, such as pay, pensions, rent, IT and travel. In the event of a disposal, UKFI is likely to incur fees in line with comparable private sector transactions. In the event of a successful transaction, this fee will be subsumed within the return achieved by the sale. However, on some occasions, it is possible that all or part of this fee could fall to UKFI. In such a case, Treasury will need to provide extraordinary funding. As these costs are unpredictable and likely to be larger than ongoing operational costs, they are not included explicitly in the budget.

8.   The Treasury has issued an "exposure draft" for consultation on "sustainability reports" in the public sector, which would be produced for 2011-12 onwards. Will UKFI have to produce Sustainability Reports under such proposals? Would the publicly-owned banks, in their own right, have to produce them?

  UKFI is a limited company and classified by the Office for National Statistics as a central government body. Due to its small size, UKFI will not be consolidated into Whole of Government Accounts. As a result, UKFI does not fall within the scope of the Government Financial Reporting Manual and will not be required to produce a sustainability report under HM Treasury's current proposals.

  Similarly, the publicly-owned banks will not be required to produce such reports under current proposals. Government's policy in relation to the disclosure of commercial information by state-controlled limited companies (such as the Royal Mail) is that their approach to disclosure should follow Stock Exchange requirements. UKFI is taking the same approach to the banks in which it has investments, and the banks will therefore report against the relevant private sector requirements rather than public sector requirements.

5 March 2010







9   s. 172 Companies Act 2006 Back


 
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