Investor engagement with boards and companies is set to come under much closer scrutiny following the release of a new stewardship code by the UK’s watchdog for corporate reporting and governance.
The Financial Reporting Council (FRC) published the new code this week confirming, as expected, that it would place a much heavier emphasis on outputs rather than inputs: signatories to the code must report on their actual stewardship activities and their outcomes, rather than just their policies.
Recommendations to shift the emphasis of the code, or abolish it, were made a report last year by Sir John Kingman after he had reviewed the work of the FRC.
A statement from the FRC said the new code includes a requirement for investors to detail their activities and its outcomes “including their engagement”.
Perhaps more significantly, those following the code must also “take environment, social and governance factors, including climate change, into account”. The order is likely to trigger a fresh round of investigation as investors ensure they have measures in place to monitor these areas. Numerous indexes interrogate sustainability activity but the “social” in ESG has proved difficult to measure so far.
Sir Jon Thompson, chief executive of the FRC, called on investors to sign up to the newly revised code and warned investors they would be “held to account” on the quality of their reporting through “regular review”.
“Asset owners and beneficiaries will then be able to see if those investing on their behalf are doing so in accordance with their needs and views,” Sir Jon said.
“They will also be able to see the impact of their manager’s decisions, particularly in relation to environmental, social and governance issues, including climate change.”
The FRC’s chair, Simon Dingemans, called the revision “ambitious”. However, he emphasised that the code is still voluntary.
“We are looking for widespread adoption by the investment community, reinforcing the attractiveness of the UK as a place to do business and delivering real benefits to the economy, the environment and society.”
The code’s Principle 7 captures the need for integrating ESG issues into investment decisions. It says: “Signatories systematically integrate stewardship and investment, including material environment, social and governance issues, and climate change, to fulfil their responsibilities.”
Principle 9 in the code covers the document’s significant new emphasis on the consequences of policy and contact with investee companies.
It says: “Signatories should describe the outcomes of engagement that is ongoing or had concluded in the preceding 12 months, undertaken directly or by others on their behalf.”
This might include how outcomes of engagement have affected investment decisions and the action taken by companies as a result of engagement.
The code has also been extended to cover asset owners, such as pension funds and insurance companies.
Those signed up to the code are also required to “explain their organisation’s purpose, investment beliefs, strategy and culture”. They must also demonstrate their purpose and beliefs through “appropriate governance, resourcing and staff incentives”.
The code is not only intended to address the behaviour of asset owners and managers but also responds to criticism of the FRC in a review of the regulator by Sir John Kingman, which also looked at its handling of stewardship. In his final report last year Sir John wrote: “The Stewardship Code, whilst a major and well-intentioned intervention, is not effective in practice.”
It was Sir John who recommended the code “focus on outcomes and effectiveness and not on policy statements”. He added the code should be abolished if it could not be reformed because it was acting as a “driver of boilerplate reporting”.
Sir John also proposed that government should consider whether more powers were need to “assess and promote compliance” with the code.
He asked that the FRC “engage at a more senior level in much wider an deeper dialogue with UK investors”. Sir John also recommended the abolition of the FRC and replacement with a new body, with new powers and funding arrangements to be called the Audit, Reporting and Governance Authority.