Traditional forms of company-specific engagement will not happen unless institutional investors face “mandatory legal or regulatory” demands, according to a new paper on the UK stewardship code from a leading legal scholar.
In an article for the Oxford University business law blog Bobby Reddy, a former partner at law firm Latham and Watkins, argues that the UK stewardship code risks losing the battle to remain relevant unless it can increase levels of engagement from investment managers that is aimed at individual companies rather than taking a holistic view of markets.
Reddy suggests that the code is like the “emperor’s new clothes” in that many observers have concluded that it’s “soft law” approach to engagement is not working. He claims that the only “issuer-specific” engagement likely to happen under the code is from hedge funds, or activist investors. Other investors are unlikely to do so at a scale that would make a difference.
Criticism of the revised code
The code came about following the Walker Review of 2009, in the wake of the financial crisis, and was heavily criticised by the Kingman Review in 2018 which concluded it was “not effective” and should be abolished unless it shifted its emphasis from “boilerplate reporting”.
A revised code was published last year by the Financial Reporting Council with a new emphasis on investment managers reporting the outcome of their stewardship activities rather than on their policies.
Reddy argues this has not changed the nature of engagement and that the code remains a failing document.
“The traditional forms of engagement coveted by the Walker and Kingman reviews will only proliferate if institutional investors are placed under mandatory legal or regulatory impositions (rather than the voluntary soft-law encouragement of the 2020 code) such that all institutional investors are required to engage,” Reddy writes, though he concedes it is “difficult to envisage” how this might operate or be enforced.
Since activist investors are the only investment managers likely to engage directly with a company over governance issues, other institutional investors should report on the circumstances in which they would support activists. Reddy also proposes institutional investors disclose the way “systemic and market-wide risks” appear in their “real-world engagement”.
Investors and governance standards
Reddy’s article comes as another entry in a debate about the role investors should play in maintaining standards of corporate governance among companies. The issue was a significant discussion in the wake of 2008 financial crisis but has gained traction again as companies and investment funds grapple with the problems underlying the climate crisis.
Last week, the current UK stewardship code received a qualified vote of confidence from the government in its consultation paper proposing reforms to audit firms and the audit market. According to the white paper the revised code “represents a significant shift that sets higher standards”.
However, the government promised to consider new powers to “promote” compliance with the code once its impact has been reviewed in 2023. That appears to chime with Reddy’s view.
Reddy is concerned about the kind of contact investors have with companies. Is it direct and specific, or at arms length and generic? His views suggest greater pressure is needed on investment institutions to come to terms with a deeper engagement role. One thing is for sure: with a review of the UK stewardship code on the horizon, it remains an unresolved issue.