Business, Innovation and Skills CommitteeWritten evidence submitted by the Government

1. In June 2011, the Secretary of State for Business commissioned Professor John Kay to undertake an independent review to examine investment in UK equity markets and its impact on the long-term performance and governance of UK quoted companies. This followed the Department’s earlier call for evidence “A Long-Term Focus for Corporate Britain”, launched in October 2010, which explored issues of economic short-termism in the UK. The responses to that call for evidence found that there was evidence of short-termism in UK equity markets and of some agency problems in the investment chain.

2. The Kay Review’s principal focus was to ask how well equity markets are achieving their core purposes: to enhance the performance of UK companies (by facilitating investment and enabling effective governance and decision making in support of long-term profitability and growth); and to enable investors to benefit from this corporate activity in the form of returns from equity investment.

3. The Kay Report seeks to shift the culture of UK equity markets to ensure they support long-term investment, constructive relationships between companies and their investors, and sustainable value creation by British companies. It has been widely welcomed by business and the investment industry.

4. The Government published its response to the Kay Report in November 2012, welcoming the report, accepting its conclusions and setting out next steps for Government and regulators, and expectations of market participants. The response:

endorsed 10 principles for equity markets to which market practitioners, Government and regulatory authorities should have regard, and the report’s directions for market participants which follow from these principles;

committed to working with the relevant regulatory authorities to explore further the Kay Report’s directions for regulatory policy—to identify to what extent these directions are practical, what changes in the law or in regulation might be therefore be appropriate, and how these can best be delivered; and

set out a number of steps the Government is already taking to deliver on the Kay Report’s detailed recommendations, including:

completing reform of corporate narrative reporting to be higher quality, simpler, more relevant to users and more focussed on forward looking strategy;

pursuing reforms to the EU Transparency Directive which will remove mandatory quarterly reporting; and

promoting the revised edition of the Stewardship code (published in September 2012) which emphasises that stewardship should encompass engagement by investors on company strategy.

5. Many of the report’s recommendations are for market participants, in particular companies and institutional investors. 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.

6. The Kay Report’s recommendations, and the Good Practice Statements, aim to deliver, among other things:

more collective action by institutional shareholders, including via the establishment of an investors’ forum,

better disclosure of costs in the investment chain, transparency and fairness around the lending of securities,

better alignment between pay and long-term performance for company directors and asset managers, and

a greater focus on stewardship and engagement to create sustainable economic value in public companies—supported by trust-based relationships and alignment of interests through the investment chain.

7. The Government is now driving forward these recommendations, in particular by:

challenging business and the investment industry bodies to respond to Professor Kay’s Good Practice Statements for company directors, asset managers and asset holders, and give clear direction to their members that will promote the behaviour needed to restore trust and confidence in the investment chain;

emphasising the principle that all investment intermediaries should act in good faith; in the best long-term interest of their clients or beneficiaries and in line with generally prevailing standards of decent behaviour, and that these obligations should not be contractually overridden;

asking the FSA to ensure that their regulatory framework supports this principle and pursuing changes to regulation at EU level if this is required; and

asking the Law Commission to review the legal obligations on investment intermediaries so that investors are clear that they cannot simply assume maximising short-term returns will meet their obligations to their clients.

8. The Government’s commitment to take forward the recommendations of the Kay Report is part of a wider commitment to achieving sustainable, long-term economic growth. In particular:

The Government’s Industrial Strategy, launched in September 2012, set out a clear and ambitious vision for a long-term, strategic partnership between Government and industry, focusing on issues like access to finance, skills, innovation and government procurement, in specific sectors in which the UK has a competitive advantage, to ensure businesses have confidence to take long-term decisions.

The Government has also taken steps to ensure that the new Competition and Markets Authority (CMA) takes an appropriately long-term view. It will have a duty to promote competition for the benefit of consumers—with the objective of supporting long-term growth built into its performance framework.

9. 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.

10. The Kay Report does not provide an exhaustive list of detailed reforms but rather provides a framework for further work to ensure investment in equity markets supports UK companies to deliver sustainable long-term economic growth. This will require a sustained commitment to reform from government, regulators and market participants. The Government therefore welcomes the Committee’s inquiry as an important contribution to the debate about how to take forward Professor Kay’s directions for market practice and regulatory policy, and how to develop and embed good practice throughout the investment chain.

24 January 2013

Prepared 24th July 2013