The Kay Review of UK Equity Markets and Long-Term Decision Making - Business, Innovation and Skills Committee Contents

6   Measuring success

Moving forward

128. At the beginning of this Report we challenged the Government to ensure progress in the implementation of Professor Kay's recommendations. The Government set out its intentions in its written evidence to us:

    The Government response commits the Government to publish an update, in summer 2014, setting out what further progress has been achieved by government and others, to consider Professor Kay's directions for regulatory policy and to deliver his specific recommendations.[232]

129. Lord Myners was in a similar position to Professor Kay ten years ago. His Review received similar support and promise of follow-up from the Government at the time but many of his recommendations were not implemented. Lord Myners told us that he had been "very disappointed" by that lack of progress.[233] He believed that the Kay Review "relied on the same statements on principles of best practice" that he had relied on, and that little would happen unless there was a "forcing mechanism".[234] In particular he argued that the Government needed to "get much more involved and engaged".[235]

130. Dominic Rossi, Global Chief Investment Officer at Fidelity Worldwide, hoped that the Review would be built on and suggested that the Government and the industry should both be held to account for progress in three specific areas:

·  Stewardship. Too many asset managers, as I have said already, view their responsibility solely to be that of investment performance rather than also improving the performance of the companies in which they invest.

·  Short­termism. By asset managers getting closer to the end client and strengthening our direct relationships with the end client we will improve persistency of assets, and that will have a spin-off in terms of the investment time period.

·  Remuneration. Corporate remuneration is too complex and too short­term.[236]

131. Although the National Association of Pension Funds Limited believed that "by endorsing Professor Kay's recommendations the Government is giving a clear direction of travel",[237] others were more sceptical. For example the UK Shareholders Association told us that:

    Very little is likely to be achieved without a strong push from Government. Moreover any review dependent on 'market participants' will surely be biased towards the interests of the financial services industry, which largely conducts its affairs with other people's money; those whose money it usually is, namely private investors and savers, are usually absent from such reviews and so need the Government to act on their behalf.[238]

It went on to recommend that:

    A positive way forward would have been for the Secretary of State to call industry leaders together to bring their influence to bear in establishing these principles and threatening them with legislation if they failed to do so. [...] There is no indication in the Response of any one individual or Department having been given any power or responsibility to drive this forward. [239]

132. The Association of General Counsel and Company Secretaries of the FTSE 100 appeared to agree, but urged the Government to remember that "in addition to the domestic framework, the UK equity markets are subject to regulation at the European and international level" and that:

    Although we believe that many of the recommendations in the Kay Review and the Government's response are commendable, it is imperative that any specific proposals flowing from the Kay Review be formulated and implemented in this context. [240]

133. We asked the Secretary of State how he saw the market evolving after the Kay Review, and whether he would seek any power to influence the industry if it did not change voluntarily. He replied that "there is no obvious big stick to wave",[241] but went on to explain that he wanted to "encourage" change rather than compel it:

    I would strongly encourage them to participate in that and make sure it works. I would also strongly encourage them to listen to the statements of best practice that have emerged from the representative bodies in the industry, because that is how standards are raised.[242]

He went on to outline the minimum progress that he expected to make by the summer of 2014 (two years after the publication of the Kay Review):

    I would have thought that the minimum is:

    ·  That the investors' forum, which is at the heart of Kay's recommendations, would be up and running and functioning, and we would be able to see a discernible impact.

    ·  That the various statements of good conduct that have been issued by the trade bodies will be in place and will have been visibly acted upon.

    ·  That, at roughly the same time, we would have a clear conclusion from the Law Commission.[243]

134. Lord Myners' Review was published more than a decade ago and yet we find ourselves examining the same issues and principles in the Kay Review today. Professor Kay's findings and proposals must not be 'kicked into the long grass' by the Government or the industry. Professor Kay's specific recommendations need to be acted on and we will hold those responsible to account. Where Professor Kay has provided overarching principles these need to be turned into actions. The Secretary of State has assured us that there is an appetite for change in the Government and we have heard that this is mirrored in the industry. Therefore, there can be no excuse for inaction by either the Government or the industry.

135. We recommend that the Government immediately publishes clear, measurable and achievable targets for implementation of the Kay Review. In particular, in its response to this Report, the Government must outline for each of Professor Kay's 17 recommendations what needs to have been achieved by the Government's review of progress in 2014.

Regulatory or voluntary approach?

136. A recurrent theme in this inquiry was how to get the right balance between regulation and voluntary change in implementing Professor Kay's recommendations and principles. In his Review, Professor Kay was clear that he favoured giving the industry an opportunity to change without calling for legislation:

    We have tried to avoid prescriptive regulation wherever possible in framing these recommendations. We believe the lesson of recent financial crises is that the cultural changes we seek can be achieved only by changing the structure of the industry and the incentives of those who work in it, not by ever more prescriptive rule books of behaviour.[244]

Professor Kay based this view on his belief that regulation could create perverse incentives for players in the equity market and had been a cause for lengthening the chain of investment. He stated that "the existing structure of the investment chain is the product of a highly regulated environment" and that this had spiralled out of control because additional layers of oversight had been required:[245]

    If we want to establish trust relationships as the basis of financial services—and I believe we do—we cannot regulate trust relationships very easily. We need to set up structures and environments in which people can develop them and in which they are encouraged to develop them, rather than the one we have at the moment in which people are going through large amounts of compliance based form filling and box ticking.[246]

137. Professor Kay summarised that while he did "not seek either more or less regulation" he expected the "long-run outcome" of his approach to be "less regulation".[247] He told us that there were two main disadvantages to legislating for change compared to encouraging it on a voluntary basis:

    One is that they are inflexible—not all of these regulations will be applicable to all situations and all companies.

    The other is that people will be inclined to believe that, so long as they have complied in a formal sense, then they have done their job.[248]

The Government agreed:

    The Government response makes clear that the necessary changes in culture cannot simply be achieved through regulation, but rather through the development of good practice in the investment chain. The Government is therefore promoting Professor Kay's Good Practice Statements for company directors, asset managers and asset holders, as the starting point for industry-led standards of good practice.[249]

138. Perhaps unsurprisingly, many of the industry practitioners agreed with Professor Kay and told us that they were concerned about burdening the sector with regulation. For example Neil Woodford, Head of UK Equities in Invesco Perpetual, told us that he was "instinctively concerned about too much regulation".[250] He went on to say that regulation "in and of itself alone" would not deliver the desired outcomes because what was needed was a "whole structural change in terms of incentive structures in the industry".[251] The Chartered Institute of Personnel and Development agreed:

    Changing an organisation's culture fundamentally requires changes in leadership behaviours and cannot happen overnight, but it begins at the top and is reinforced through performance measures and reward practices.[252]

139. Daniel Godfrey, the Chief Executive of the Investment Management Association warned that firms could hide behind compliance with regulation without actually changing their culture:

    We can put in place things that make it look like things are happening really easily through regulation, but real progress will come from belief—people believing it will work—and also pressure from the demand side because they believe it will work, and that is entirely achievable over a period of time.[253]

140. Albion Ventures LLP argued that "changes should be cultural rather than legislative" and asserted that it was essential that investors were "not deterred by excessive regulatory red tape or other investment barriers".[254] Matthew Fell, the Director of Competitive Markets for the CBI, stated that better engagement could not be forced by any Government:

    On the balance between regulation and advocacy, if the task in hand is really to drive up high-quality engagement, I struggle to see how you actually generate those sorts of conversations through regulation.[255]

141. On the other hand, several witnesses told us that the industry had had long enough to enact change for itself and that the Government should now be firmer in its approach. For example, the UK Shareholders Association told us that it was "essential that the Government legislates to remove the obstacles to what should be investors' right to be treated as full shareholders".[256] FairPensions (now ShareAction) took this point further and suggested specific areas where formal change (be it regulation or legislation) was needed:

·  Pension funds should be obliged to report to their beneficiaries not just on their investment and voting policies (as now), but also on how those policies have been implemented on an annual basis.

·  Government should exercise its reserve power to introduce mandatory voting disclosure for institutional investors.

·  Institutional investors could be obliged to hold annual meetings (in the same way that companies must hold annual meetings for their shareholders) offering savers the opportunity to hold their fiduciaries to account.

·  Government could explore ways to support and strengthen the role of member-nominated trustees, and to extend similar member representation to contract-based forms of pension provision.[257]

Lord Myners added to this list, telling us that the "Government should force the creation of this investor forum, and it should say that the financial means will be placed there for it".[258]

142. The Government was clear in its support of Professor Kay's 'voluntary first—legislate later' approach. When we spoke to the Secretary of State, however, he told us that there was a balance to be found and that regulation could be introduced alongside cultural changes. He clarified the areas that he was prepared to legislate in and those he would leave to the industry:

    There is a two-track approach to most of these questions. In the mandatory area, of course, we have the legislation on executive pay, and narrative reporting is coming into effect as well.[259]

He went on to tell us that:

    There are key areas of corporate behaviour that have to be regulated, and are regulated, but for other areas, where subtle changes are involved, the voluntary approach works well, as it is the best solution and it works.[260]

The Secretary of State was slightly more firm however, on the consequences for the industry if it did not change:

    I do not have any problem with adopting tough regulatory solutions when voluntary methods have failed and we have demonstrated that in one or two areas, with executive pay being the most obvious one. [...] My approach to all these things [...] is to try the voluntary approach and try to build up trust with the practitioners. If it fails, we can adopt more aggressive solutions, but let us try the voluntary approach first.[261]

143. In considering the merits of a voluntary approach versus a statutory one, it is worth returning to the Myners Review of 2001:

    The review therefore believes it is important at least to attempt to seek an effective approach which does not rely on direct Government intervention in banning or directly determining behaviour.[262]

In 2012, Professor Kay wrote:

    The Review believes that it is generally more effective, and in the long-term less intrusive, to give incentives to do the right thing than to attempt to prevent people who are subject to inappropriate incentives from doing the wrong thing.[263]

144. We sympathise with Professor Kay and the Secretary of State's concerns that over prescription and formal legislation risk alienating the UK equity market in a global environment, providing false security through 'tick-boxing' and distorting the effective operation of the market. However, we have yet to be convinced that all of the major players in the institutional investment sector are committed to significant voluntary reform.

145. We agree that the industry should be given a chance to change of its own volition but the experience of the Myners Review does not fill us with confidence. A cultural change will not happen without a catalyst. Ministers must be willing, and seen to be willing, to pick up a 'regulatory stick' should progress stall. We reiterate our recommendations that the Government has to set out a timetable for reform which includes the following for every one of Professor Kay's recommendations:

·  a clear measure of success for the recommendation (the target);

·  who is responsible for achieving the target;

·  a clear deadline by which the target needs to be achieved; and

·  the action that the Government will take if the target is not achieved.

232   Ev 86 Back

233   Q 84 Back

234   Q 129 Back

235   Q 129 Back

236   Q 174 Back

237   Ev 122 Back

238   Ev 134 Back

239   Ev 134 Back

240   Ev 115 Back

241   Q 319 Back

242   Q 318 Back

243   Q 377 Back

244   Professor Kay, The Kay Review of UK equity markets and long-term decision making, July 2012, para 13.16 Back

245   Professor Kay, The Kay Review of UK equity markets and long-term decision making, July 2012, para 5.36 Back

246   Q 17 Back

247   Professor Kay, The Kay Review of UK equity markets and long-term decision making, July 2012, para 12.4 Back

248   Q 21 Back

249   Ev 85 Back

250   Q 253 Back

251   Q 253 Back

252   Ev 137 Back

253   Q 310 Back

254   Ev 91 Back

255   Q 310 Back

256   Ev 135 Back

257   Ev 114 Back

258   Q 92 Back

259   Q 349 Back

260   Q 349 Back

261   Q 383 Back

262   Lord Myners, Myners Review of institutional investment: Final Report, March 2001, page 2 Back

263   Professor Kay, The Kay Review of UK equity markets and long-term decision making, July 2012, para 6.17 Back

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© Parliamentary copyright 2013
Prepared 25 July 2013