Conclusions and recommendations
In the report conclusions are shown in bold,
recommendations are shown in bold italics. In this
list, recommendations are shown in italics.
Previous review of the market
1. In the 12 years
since the Myners Review, little has changed in the role and actions
of institutional shareholders. The recommendations and findings
of the Kay Review cannot be ignored or diluted as we have heard
the Myners Review was. The similarities between the remit of the
Kay review and that of the Myners Review demonstrate that little
progress has been made to reform the sector. It is therefore critical
that they do not share a similar fate. The Government must play
an active role to drive reform on implementation of Professor
Kay's recommendations. Our Report, therefore, concentrates on
where that activity must take place. (Paragraph 14)
Investors Forum
2. We agree with
Professor Kay and the Government that collective engagement is
to the benefit of the equity market and UK businesses. However,
we are concerned that the hands-off approach taken by the Government
runs the risk that progress will stall. The Government has provided
no remit, deadline or resource for the Investor's Forum and the
'working group' to investigate the concept of the Investor's Forum
will not report until later in 2013. The Government has told us
that it will publish an update on progress in the summer of 2014.
We recommend that the Government outlines a clear timetable for
setting up the Forum before that point, engaging with different
types of investors, along with milestones and assigned responsibilities
for achieving this. (Paragraph 27)
Fiduciary duty
3. The Law Commission
is currently consulting on the legal definition of fiduciary duty
and will not report back until June 2014. We believe that this
is too slow. We recommend that the Government liaises with the
Law Commission to bring forward the timing of this project. The
Government is paying up to £140,000 for this project and
we expect it to push for the highest value for the taxpayer's
money. The Law Commission will launch a three month consultation
in October 2013. We suggest that it gives this issue the appropriate
priority and publishes its final definition in the first quarter
of 2014. (Paragraph 36)
Appointment of executives
4. Professor Kay
has provided a clear recommendation, proposing that companies
consult with major investors over all board appointments and the
Government has agreed to implement this. We therefore recommend
that the Government publishes a timetable for the implementation
of this policy, clarifies which investors companies are to consult
with and outlines how it intends to combat the issues surrounding
insider trading and confidentiality which inevitably accompany
such board appointments. Alongside this, the Government should
undertake an impact assessment, particularly looking at the possible
increase of bureaucratic burdens on small businesses and, if necessary,
introduce an opt-out clause for them.
(Paragraph 43)
Remuneration of executives
5. The Government
has accepted the principles underlying Professor Kay's recommendation
on the remuneration of executives. We are therefore disappointed
that it has failed to take the action to see it put into practice
or responsibility for its implementation. We are not persuaded
by the Government's view that businesses will see the benefit
of this recommendation and will adopt this measure voluntarily.
(Paragraph 52)
6. We support the
recommendation that company directors should be tied into the
long-term performance of their companies through time-appropriate
shares. Since the Government has accepted Professor Kay's analysis
and agreed with his findings, it should reconsider its response
and take an active approach to its implementation. In particular,
we recommend that the Government outlines how it intends to combat
the issue of directors using options and derivatives to avoid
these rules. Alongside this the Government should outline how
it will ensure that departing directors will not be perversely
incentivised to artificially inflate the share price immediately
prior to their retirement or retire early to realise the locked-in
value of their shares. (Paragraph 53)
Incentivising fund managers
7. The incentives
driving the actions of fund managers are one of the most important
factors within the investment chain. Professor Kay made a specific
recommendation on this but the Government has shied away from
accepting it, citing an unwillingness to prescribe pay structures.
While this may be understandable, it is clear that the Government
must be involved; at the very least encouraging a cultural shift
away from short-term to long-term performance-based pay. (Paragraph
62)
8. We recommend
that the Government takes a harder line when framing the culture
in which fund managers work by highlighting best practice where
it sees it. We further recommend that it should work towards the
goal that fund manager performance be reviewed over longer time
horizons than the typical quarterly cycle.
(Paragraph 63)
9. One way that
the Government can help effect a culture change in the incentives
driving fund-manager behaviour is to develop and publish a set
of long-term measures of success alongside options for sanctions
for demonstrable failure. We recommend that it does so, and then
annually publishes a list of those firms that have fully adopted
such measures. This would provide a different measure of success
to the very short-term ones which are currently available.
(Paragraph 64)
Quarterly reporting
10. We support
Professor Kay's recommendation that the requirement for quarterly
reporting should be removed and recommend that the Government
now outlines a clear timetable to implement this recommendation
including what alternative strategies would be followed in the
absence of any change in EU law. (Paragraph
70)
11. We recommend
that the Government sets out details of progress in negotiations
with other international accounting standard bodies (such as the
U.S. Securities and Exchange Commission) on the requirement for
quarterly reporting to ensure that any changes made to the domestic
or EU-wide accounting practices are accepted on a global level.
(Paragraph 71)
Narrative Reporting
12. We recommend
that the Government sets out how it will ensure that enhanced
narrative reporting will remain consistent with, and accepted
by, overseas regulators, for example the US Securities and Exchange
Commission. (Paragraph 78)
13. When the proposed
changes are made to the structure and format of reporting, the
Government (through the Financial Reporting Council) will need
to ensure that any accompanying guidance on the new provisions
included clear minimum standards to ensure comparability. The
Government must not shy away from strict enforcement of these
standards. The scrutiny and consistency of narrative reports may
be harder than that of reports containing only information about
pounds and pence, but the Government must ensure high standards
are maintained. We therefore recommend that the Government outlines
how it proposes to implement auditing and monitoring of narrative
reports. Ongoing shareholder scrutiny and transparency must be
at the heart of this. These processes must be in place before
the proposed changes come into effect.
(Paragraph 79)
The Stewardship Code: Content
14. In its current
form, the Stewardship Code contains seven voluntary principles
which represent the minimum benchmark for the relationship between
owners and investment managers. Professor Kay recommended that
the Code should be developed to take account of strategic issues
as well as those around corporate governance. We recommend that
this be implemented through a formal consultation by the Financial
Reporting Council. It is essential that the Code is accepted by
all players of the equity market, therefore all such participants
must have a say in its development. Having considered the evidence
and suggestions from many players in the market, we specifically
recommend that the Code be enhanced:
· To allow investment managers to focus
on strategic issues facing companies within their policies on
how they discharge their stewardship responsibilities (rather
than the current focus on profit, which is inherently short-term).
· To include the principle that engagement
and corporate governance should extend beyond financial affairs
and encompass more long-term value adding activities such as environmental,
social and governance factors.
· To include the provision that institutional
investors and significant owners should be members of at least
one Investor's Forum.
· Related to the previous point, to include
the role of institutional investors to engage in potential systemic
risks to the UK equity market rather than only engaging with risks
to individual companies in their portfolio.
· To redefine a clearer explanation of
conflicts of interest and in particular for asset management firms
to publish how key conflicts of interest are managed in practice.
· To provide one clear and authoritative
definition of the term 'stewardship'. (Paragraph 85)
The Stewardship Code: Sign-up
15. Progress has
been made in terms of the number of asset managers signing up
to the Stewardship Code. However, sign-up among owners remains
low. We recommend that the Government:
· Outlines what it considers a minimum
acceptable level of sign up to the Stewardship Code (making provision
for the distinction between manager and owner).
· Makes clear that it is government policy
to encourage sign-up to the Code and publishes a clear target
(and timescale) of success. This timescale should be no longer
than two years.
· Outlines clearly what action it will
take if this target is not met by the market on a voluntary basis.
(Paragraph 89)
16. Finally, some
witnesses pointed out that, at the time of our inquiry, the Parliamentary
Contributory Pension Fund (PCPF) was not signed up to the Stewardship
Code. Penny Shepherd, Chief Executive of UKSIF, told us that "one
area in which this House can act to raise awareness is by acting
as an exemplar of good practice". We are pleased to take
this opportunity to formally welcome the fact that the trustees
of this fund have made the decision to sign up to the Stewardship
Code in the near future. We will continue to monitor this. (Paragraph
90)
The Stewardship Code and Professor Kay's good
practice statements
17. We support Professor
Kay's Good Practice Statements and agree that the industry, asset
holders and company directors should be given the opportunity
to formally embrace the principles that are contained within them.
However, we are conscious that many individuals and firms are
already signed up to the Stewardship Code and we are concerned
that yet another voluntary compliance statement will be submerged
by a rising tide of self-regulation and codes of best practice.
The market requires clarity and certainty and we are concerned
about over-burdening it with regulation and codes. (Paragraph
97)
18. Professor Kay's
Good Practice Statements should be the standard level of behaviour
for the industry and all players in the UK equity market. We expect
the Government, in its response to this Report, to outline its
timetable for all companies to sign up to Professor Kay's Good
Practice Statements. If this target is not met, the Government
should be prepared to incorporate Professor Kay's Good Practice
Statements into the already established Stewardship Code.
(Paragraph 98)
Resourcing stewardship
19. The attitude
of 'do the minimum possible' found in many of our institutional
investment firms has hindered the development of good stewardship.
Asset managers are currently allowed to use commissions to pay
for long-term research, including long-term stewardship, but it
appears that few are aware of this. We therefore recommend that
the Financial Conduct Authority contacts all major institutional
investors highlighting that long-term investment research that
is orientated towards good stewardship could (and should) be paid
for using a proportion of equity commissions reserved for research.
Furthermore, we recommend that the FCA sets and publishes an appropriate
minimum proportion of a firm's commission allocated to research
that should be used towards such activities and an annual list
of those firms which do not achieve that level. Those firms will
be expected to comply or explain why they have not dedicated the
recommended proportion of resources on good long-term stewardship.
(Paragraph 104)
The Financial Transaction Tax
20. There was some
support for the concept of a Financial Transaction Tax on trading
practices such as High Frequency Trading. However, concerns were
raised about the practicality of implementing such a tax unilaterally.
We recommend that the Government considers the viability, benefits
and risks of a Financial Transaction Tax and commissions research
in the following areas:
· An impact assessment of the introduction
of a Financial Transaction Tax on equities at a level which is
the average profit made on a High Frequency Trade in the UK.
· A impact and feasibility study of the
proposal to ban any of those banks which establish branches or
subsidiaries in an offshore centre that does not adhere to the
OECD's white list of financially compliant economies from trading
in the UK. This should include an assessment of whether doing
so would counter the arguments against a domestic FTT being ineffective
in the global market. (Paragraph 113)
Mergers and acquisitions
21. Professor Kay
recommended that the Government should take a more 'sceptical'
view of the benefits of large takeovers and should be much more
proactive in its monitoring of such activity. He drew particular
attention to the relative vulnerability of UK companies to takeovers
by foreign actors. We recommend that the Government conducts and
publishes an assessment of the take-over regimes of other similar
economies with a view to learning about the impact that takeovers
have had on their companies and economies. Furthermore it should
summarise which positive elements may be incorporated into our
domestic system to strengthen our economy and ensure that takeovers
benefit, rather than damage our economy.
(Paragraph 119)
22. The Government
has accepted Professor Kay's recommendation on mergers and acquisitions
but it is unclear what specific action it will take. We recommend
that the Government clarifies what actions it will take over the
next six months to be in a position to effectively monitor all
merger activity in the UK. In its response to us, the Government
should outline what action it will take to engage with companies
and their investors to ensure that any investment merger activity
is to the long-term benefit of the UK economy.
(Paragraph 120)
23. We have heard
evidence that the 'one-share one-vote' is fairest. Some witnesses
pointed out to us that the long-term shareholders must choose
to sell to short-term traders and argued that the 'market' ruled.
However we cannot help but think back to the evidence that we
have heard that, overall, takeovers detract value from companies.
The Secretary of State told us that his instinct was to go back
and consider introducing differential votes (i.e. encouraging
the principle that short-term traders should have no influence
over the takeover vote). (Paragraph 125)
24. We recommend
that the Department produces a feasibility study which clearly
outlines the risks and benefits of introducing a policy that differentiates
between shareholders and voting rights based on the length of
time a share has been held. (Paragraph
126)
25. We further
recommend that the Government commissions a study to set out the
impact on the UK of foreign takeovers of British companies over
the past 25 years. (Paragraph 127)
Measuring success
26. 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. (Paragraph 134)
27. 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.
(Paragraph 135)
Regulatory or voluntary approach
28. 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. (Paragraph 144)
29. 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. (Paragraph 145)
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