Business, Innovation and Skills CommitteeWritten evidence submitted by Tomorrow’s Company

About Tomorrow’s Company

1.1 Tomorrow’s Company is a London based global think tank delivering value for business leaders and owners by addressing the systemic questions of the business world through the overarching themes of: leadership and talent; sustainability and models of business success and governance and stewardship.

1.2 Our solutions are by business for business, built on deep relationships with business leaders, government, opinion formers and the media.

Our work informs company law, creates international frameworks and shapes today’s business landscape in the UK and globally.

We defined the inclusive duties of directors for The UK’s Company Act 2006.

Our work on capital markets informed the creation of the UN PRI.

Our thought leadership on ownership and asset classes is at the heart of the UK Stewardship Code.

Our work on reporting is at the heart of Europe’s move towards narrative reporting.

King III in South Africa acknowledges our influence.

1.3 Tomorrow’s Company has a long-standing relationship with BIS and has contributed to the reform of company law, the review of the combined code, the development of corporate reporting (including narrative reporting) and the creation of the stewardship code.

1.4 In March 2010, with the encouragement of and participation of BIS, Tomorrow’s Company established the GGF, which brings together a number of key businesses, organisations and individuals to explore what good governance means and to make practical recommendations to company boards and policy makers. The forum is developing a series of guides and toolkits for use by chairs, boards and advisors, to help achieve practical improvement and change.

1.5 A meeting was held on in November 2011 with representatives from BIS, leading to a joint response by Tomorrow’s Company and The Good Governance Forum was submitted to The Kay Review.

1.6 Tomorrow’s Company welcomes this Committee’s inquiry into the Kay Review of UK Equity Markets and Long-Term Decision Making and the Government’s Response to that Review.

2 Our Response

2.1 Tomorrow’s Company welcomes the recommendations set out in the Kay Review and the Government’s plans for the implementation of its recommendations, many of which Tomorrow’s Company has argued for in its work.

2.2 In particular, we have been arguing that the financial crises are a result of a systemic failure—not only a failure of individuals and particular companies and institutions. Issues such as:

investor short-termism;

the stewardship deficit;

the dysfunctional nature of the long investment chain (that links the saver at one end to the investee company at the other, a chain that is presently far too heavily influenced by intermediaries);

the focus on quantity rather than quality of reporting;

the current understanding and application of fiduciary duty;

lack of alignment of incentives across the investment chain to the interests of beneficiaries; and

all play their part.

2.3 It is therefore critical to understand the system as a whole and that any lasting solutions need to move beyond blame and a view that reform can be achieved by a series of piecemeal interventions.

2.4 Structural and process change is necessary but not sufficient to achieve change in the system. Culture and values both drive and inform behaviour across the system. In this respect we would highlight the work of The City Values Forum, supported by the Lord Mayor, aimed at enhancing the City’s reputation for integrity and high ethical standards. As part of this initiative, Tomorrow’ Company, in conjunction with the Good Governance Forum has been asked to undertake work on ‘Governing Values’ focused on the role of the board in overseeing the embedding of corporate values which are aligned to the business’s long-term strategy, and in ensuring that management promotes and embeds such values consistently all the way through the business.

2.5 In support to the proposals of the Review’s proposals, we would suggest the following.

2.6 Stewardship

Stewardship is needed throughout the system—by pension trustees, investment consultants, asset managers, company directors, and regulation is needed to ensure all of the above are governed by consistently framed fiduciary duty.

To assist we have developed four key principles of stewardship:

“Setting the course” deals with purpose, roles, and relationships.

“Driving performance” is about continually stimulating improved performance and capability.

“Sensing and shaping the landscape” is about how the company anticipates and influences change in its surrounding environment.

“Planting for the future” reflects the need for consistency between short-term actions and long term success.

(See: Tomorrow’s Owners: Defining, differentiating and rewarding stewardship. )

These principles underpin the Tomorrow’s Company Stewardship Manifesto which offers an agenda for change, and identifies the part that each participant can play in creating an effective stewardship value chain See: Tomorrow’s Company Stewardship Manifesto

As part of the Investor Stewardship Working Party, we have developed a ‘stewardship framework’ against which institutional investors can categorise themselves to help asset owners compare the stewardship activities of different fund managers and so make informed decisions. (See: 2020 Stewardship: improving the quality of investor stewardship

2.7 Governance

Boards to be more confident in ensuring that they are crystal clear about their own long-term view as the best way of achieving success and managing risk in these conditions of rapid change and growing uncertainty—and then setting out their strategy and communicating this effectively to investors. They should actively seek out the investors that they want. To assist them in doing this, Tomorrow’s Company and the Good Governance Forum argue that boards should create a board mandate. This mandate captures the “essence” of the “character” and distinctiveness of the company, in terms of: its essential purpose; its aspirations; the values by which it intends to operate; its attitude to integrity, risk, safety and the environment; its culture; its value proposition to investors; and plans for development. It is about what the company stands for and how it wishes to be known to all of its stakeholders.

(See: Tomorrow’s Corporate Governance: The case for the “board mandate”

Corporate reporting plays an essential role in the effective functioning of the market economy, enabling shareholders and investors to assess the performance of a business across all aspects of activity, establish its value and exercise effective oversight. Whilst there are many regulatory and market initiatives and consultations in various parts of the world focused on different aspects of reporting and of the reporting system there is a danger of overload. While these consultations are all well-intentioned, the very fact they are addressing separate elements of the model and the system is indicative on a lack of understanding of how the system operates, its interdependencies, and most critically, how proposed actions will impact on behaviours. The proposals for narrative reporting—which we strongly welcome and have long argued for—need to be framed in a context which reinforces this coherence of approach by recognising the systemic nature of the corporate reporting system and the place of the specific reform in that wider context.

(See: Tomorrow’s Corporate Reporting: a critical system at risk )

2.8 Incentives

There is a lack of alignment between incentives, the interests of beneficiaries and business strategy. The criteria on which performance and hence reward is based are still too often founded on financial and market value based measures. In part this is a reflection of the lack of knowledge, understanding, common language and metrics about what drives sustainable performance. Discussions about sustainability often default to ESG, SRI, the “green agenda” or are simplified to discussions about long-term versus the short-term horizons.

For outsiders, it is hard to obtain detailed information on how incentives are structured and designed—there is a lack of transparency. Financial incentives do not operate in isolation—neither are they the only incentives for those in the system. Reputation, personal success and security, organisational values and culture, regulation, fiscal policy and reporting models, all play their part.

In our work on Tomorrow’s Capital Markets, we found that there is a growing appetite for change by many who have deep and long experience of working in the system. We have set out an agenda for change, encompassing a set of principles for the structure of financial remuneration so that capital markets can better support companies to achieve more sustainable outcomes. We are in the course of developing a follow-up phase which will focus on designing new incentive structures as well as looking at what is needed to create the necessary framework conditions for these incentives to operate effectively and also to ensure greater stability of the system as a whole.

(See: Tomorrow’s Capital Markets )

2.9 Regulation

In our current project: “Tomorrow’s Value: Achieving sustainable financial returns” we are exploring how we can redefine value in order to ensure sustainable financial returns and a more balanced approach to investment. This includes understanding the behavioural pressures and fiduciary issues which can lead short-term thinking and investment decisions by pension fund trustees and aims to provide them with fit for purpose evidence and some practical support.

Our research to date endorses the view that fiduciary duty is not well understood by pension fund trustees and needs to be appropriately and more widely interpreted. Trustees can then feel more confident in implanting their wider views of value into their investment mandates, allowing for a more risk adjusted investment portfolio and sustainable financial returns.

As behavioural pressures on the pension fund trustees are numerous, systemic and powerful, a better understanding may not be enough.

Following consultation with a number of key players in the UK pension fund system and across Europe, the case can be made for strengthening the Statement of Investment Principles, through an appropriate intervention to encourage and support pension fund trustees in setting out on a comply or explain basis the criteria that inform the mandate that they set.

To conclude, we welcome the Committee’s inquiry into the Kay Review of UK Equity Markets and Long-Term Decision Making and the Government’s Response to that Review and also welcome many of the proposals outlined. Our major disagreement with the Kay Report lies in its excessive focus of on the role of the asset manager at the expense of the asset owner. The key point is that this complex system can only be reset with asset owners playing the role that they are required to play.

We would be happy to discuss any of the aspects of our response in more detail.

22 January 2013

Prepared 24th July 2013