This note has been updated to reflect the new UK regulatory structure, with effect from 1 April 2013 and amendments to the Financial Services and Markets Act 2000 (FSMA) made by the Financial Services Act 2012.
The UK Stewardship Code sets out good practice for institutional shareholders when engaging with listed companies. Major investment committees have also published guidelines and policy statements on the responsibilities and duties of institutional shareholders.
There are two versions of the UK Corporate Governance Code, the applicability of which depends on the relevant reporting period:
June 2010 Code (www.practicallaw.com/5-502-4036). This applies to reporting periods beginning on or after 29 June 2010 and before 1 October 2012.
September 2012 Code (www.practicallaw.com/9-521-6175). This applies to reporting periods beginning on or after 1 October 2012, although the Financial Reporting Council (FRC) (www.practicallaw.com/7-107-5755) encourages companies to consider whether it would be beneficial to adopt some or all of the new provisions in the September 2012 Code earlier than formally expected.
For details of the changes introduced in the September 2012 Code, see Practice note, UK Corporate Governance Code: overview: Key features of the 2012 Code (www.practicallaw.com/9-502-0734).
The UK Corporate Governance Code contain Main Principles, Supporting Principles and Code Provisions. Under the Listing Rules , the "comply or explain" approach remains (LR 9.8.6R). Companies (incorporated in the UK) with a premium listing of equity shares are required to produce a statement in their annual reports stating how they have applied the Main Principles of the UK Corporate Governance Code (see Practice note, UK Corporate Governance Code: disclosure statement in annual reports (www.practicallaw.com/6-502-5356)).
For details of the UK Corporate Governance Code and annotations including guidance from institutional shareholder bodies, see Practice note, Annotated UK Corporate Governance Code: Index (www.practicallaw.com/6-508-2403) and Practice note, UK Corporate Governance Code: overview (www.practicallaw.com/9-502-0734).
The UK Stewardship Code sets out good practice on institutional investors' engagement with investee companies. For further details, see Practice note, UK Stewardship Code (www.practicallaw.com/6-502-2065).
The Companies Act 2006 (CA 2006) contains provisions giving the Secretary of State or the Treasury power to make regulations requiring institutional investors to disclose how they have voted publicly traded shares which they own or in which they have an indirect interest (sections 1277 to 1280) (see Practice note, Institutional investors: information as to exercise of voting rights: Companies Act 2006 (www.practicallaw.com/1-204-0621)). The Institutional Shareholders' Committee (ISC) developed a framework on voting disclosure (June 2007) and published the ISC Code on the Responsibilities of Institutional Investors (www.practicallaw.com/1-500-7680) (November 2009)
The framework covers, in particular, the following:
Method of disclosure. The most cost-effective method will normally be to publish voting information on a publicly accessible website, although each institution has significant flexibility to determine how to approach the matter and they should choose the precise method which suits them (for example, disclosure relating to each and every vote, or only on individual votes where they depart from their published policy). Disclosure will usually relate to voting instructions given rather than votes cast, due to voting chain complexity.
Timing of disclosure. Disclosure should take place only after the relevant general meeting.
What is disclosed. Information only needs to be disclosed once in situations where voting is delegated: beneficial owners’ representatives are not required to repeat disclosures made by the fund manager. Fund managers offering different products may aggregate their disclosure of voting instructions given according to the issuer, without specifying the clients whose shares they have voted or other client information.
Review of disclosure policy. Policies on voting disclosure should be reviewed regularly, perhaps as part of the wider review of policy on engagement generally.
The framework sets out a "comply or explain" approach, supporting a non-prescriptive and flexible approach, reflecting that voluntary public disclosure is generally desirable, although may not be appropriate in all cases.
A successful voluntary code of voting disclosure should help avoid the need for regulations under sections 1277 to 1280 of the CA 2006.
Institutional investors are represented by investment committees. The main investment committees are those of the Association of British Insurers (www.practicallaw.com/A35866) (ABI), the National Association of Pension Funds (www.practicallaw.com/A35517) (NAPF) and Pensions Investments Research Consultants (www.practicallaw.com/A36640) (PIRC). Some investment committees have published policy positions and guidance on the corporate governance responsibilities of institutional investors.
The ISC first published its Statement of Principles in October 2002.
The latest version is now known as the ISC Code on the Responsibilities of Institutional Investors (www.practicallaw.com/1-500-7680) (November 2009) (see Institutional shareholders: ISC Code on the responsibilities of institutional investors (www.practicallaw.com/8-500-1401)). The Code sets out best practice for institutional investors that choose to engage with the companies in which they invest. It highlights the duties imposed on institutional investors to:
Publicly disclose their policy. Institutional investors are to set out their policy on how they discharge their stewardship responsibilities, including how investee companies will be monitored, stating strategy on intervention and on voting.
Manage conflicts of interest.
Monitor investee companies' performance. Institutional investors will identify problems at an early stage and make the investee company's board aware of any concerns.
Establish guidelines on escalating activities/intervention. Institutional investors may want to intervene when necessary when they have concerns about, for example, the investee company's strategy or performance, its governance or approach to risk on social and environmental matters. If boards do not respond constructively to intervention, they should consider escalating their action, for example by holding additional meetings with management, the chairman or the company's advisers, intervening jointly with other institutions, making public statements or submitting resolutions to or requisitioning a shareholders' meeting.
Act collectively with other investors as appropriate. Institutional investors should disclose their policy on collective engagement.
Have a clear policy on voting and disclosure of voting activity.The guidelines suggest that they should vote all shares and register an abstention or vote against a resolution. Institutional investors should disclose publicly voting records and if they do not explain why.
Report periodically on their stewardship and voting activities. Institutional shareholders that act as agents should regularly report how they have discharged their responsibilities to their clients.
On 5 June 2009, the ISC published the paper " Institutional Improving Investors' Role in Governance (www.practicallaw.com/5-386-2588)". The proposals made in the paper were intended to contribute to both the Walker Review (see below) and are aimed at improving the quality of dialogue between institutional investors and listed companies. For further details, see Legal update, ISC publishes paper on improving the role of institutional investors in corporate governance (www.practicallaw.com/5-386-2606).
In August 2009, the FSA sent a letter to the ISC in which it clarifies how FSA rules apply to activist shareholders who wish to work together to promote effective corporate governance in companies in which they have invested (see Legal update, FSA clarifies how its rules apply to activist shareholders (www.practicallaw.com/9-422-3907)). On 9 September 2009, the Takeover Panel Executive also published Practice Statement No. 26, setting out how it interprets and applies certain provisions of the Takeover Code to collective shareholder action (see Takeovers: Panel statement on shareholder activism (www.practicallaw.com/7-500-1604)).
NAPF publishes its Corporate Governance Policy and Voting Guidelines (December 2012) (www.practicallaw.com/7-522-8495) which include UK corporate governance principles and UK voting guidelines. Appendix 1 to the guidelines sets out detailed voting guidelines. For details of the content of the guidelines, see Legal update, Corporate governance: revised NAPF corporate governance policy and voting guidelines 2012 (www.practicallaw.com/6-522-8542) and the documents linked to in Practice note, Annotated UK Corporate Governance Code: Index (www.practicallaw.com/6-508-2403).
NAPF has also published:
NAPF: Corporate Governance Policy and Voting Guidelines for Investment Companies (December 2012) (www.practicallaw.com/0-522-8489). For further details, see Legal update, Corporate governance: revised NAPF corporate governance policy and voting guidelines for investment companies 2012 (www.practicallaw.com/5-522-8514).
NAPF: Corporate Governance Policy and Voting Guidelines for Smaller Companies (www.practicallaw.com/4-522-8492). For further details, see Legal update, Corporate governance: revised NAPF corporate governance policy and voting guidelines for smaller companies 2012 (www.practicallaw.com/6-522-8504).
Since 1993, PIRC has published its UK Shareholder Voting Guidelines. The 17th edition was published in February 2013 and can be ordered from the PIRC website (www.practicallaw.com/T323). For details of these guidelines, see Legal update, Corporate governance: PIRC UK shareholder voting guidelines 2013 (www.practicallaw.com/9-524-3169) and the documents linked to in Practice note, Annotated UK Corporate Governance Code: Index (www.practicallaw.com/6-508-2403).
On 2 February 2010, PIRC published some principles of best practice (www.practicallaw.com/9-501-3880) for proxy voting and corporate governance advisers. PIRC believes that voting advisory organisations, which generally provide research, analysis and voting recommendations to institutional shareholders, should display the same standards of accountability and openness which companies and institutional investors are expected to demonstrate. For further details, see Legal update, PIRC: Proxy voting and corporate governance advisers: principles of best practice (www.practicallaw.com/0-501-3851).
The Hermes Principles (www.practicallaw.com/T3604)" What shareholders expect of public companies — and what companies should expect of their investors" was first published in October 2002. Under the principles, Hermes expects companies to:
Test all investment plans for their ability to deliver long-term shareholder value.
Have systems to analyse which activities maximise shareholder value.
Minimise the long-term cost of capital.
Allocate capital in core businesses rather than unrelated diversification.
In January 2005, Hermes published “Corporate Governance and Performance (www.practicallaw.com/7-200-2777), a brief updated review and assessment of the evidence for a link between corporate governance and performance. This concludes that there is an increasing body of evidence showing that active promotion of good corporate governance in investee companies increases shareholder value in the long term.
On 31 January 2005, Hermes announced (www.practicallaw.com/1-200-2761) that it was replacing its own corporate governance guidelines with the then Combined Code. It further noted that it recognises that many companies will have a valid explanation for non-application of provisions of the Combined Code and it will consider carefully any explanation given for non-applicability. The Hermes Principles are not affected by this change.
In March 2006, Hermes published its Corporate Governance Principles (www.practicallaw.com/2-202-0811).
The International Corporate Governance Network (ICGN) first published its Statement on Institutional Shareholder Responsibilities (www.practicallaw.com/T3613) in December 2003. The ICGN (www.practicallaw.com/T3614) was set up in 1995 to further the corporate governance endeavours of investment committees and other bodies. Its Statement sets out a framework of best practices on the implementation of fiduciary responsibilities in relation to equity shareholdings.
On 15 August 2007, the ICGN published a revised Statement of Principles on Institutional Shareholder Responsibilities (www.practicallaw.com/0-375-9348). The revised statement includes much of the wording from the previous statement, although some further changes have been made. The revised statement also includes an annex that is intended to give practical help to those interested in following the principles set out in the statement. For further information, see Legal update, ICGN: Revised Statement of Principles on Institutional Shareholder Responsibilities (www.practicallaw.com/9-375-9363).
The review of corporate governance in UK banks and other financial institutions (BOFI) conducted by Sir David Walker (Walker Review) was launched in February 2009 (see Practice note, Walker Review: all listed companies (www.practicallaw.com/6-502-0735)).
On 26 November 2009, the final recommendations (www.practicallaw.com/9-500-8690) of the Walker Review were published. One key recommendation was that the ISC Code be ratified by the FRC and become the UK Stewardship Code (see Practice note, UK Stewardship Code (www.practicallaw.com/6-502-2065)).
The Walker Review includes the following recommendations on the role of institutional shareholders in relation to communication and engagement:
Boards should ensure that they are made aware of any material cumulative changes in the share register as soon as possible, understand as far as possible the reasons for changes to the register and satisfy themselves that they have taken steps, if any are required, to respond. Where material cumulative changes take place over a short period, the Financial Conduct Authority should be promptly informed.
The FRC remit should be explicitly extended to cover the development and encouragement of adherence to principles of best practice in stewardship by institutional investors and fund managers. This new role should be clarified by separating the content of the then Combined Code, which might be described as the Corporate Governance Code, from what might most appropriately be described as the Stewardship Code.
The ISC's Code on the Responsibilities of Institutional Investors should be ratified by the FRC and become the Stewardship Code. By virtue of the independence and authority of the FRC, this transition to sponsorship by the FRC should give materially greater weight to the Stewardship Code. Its status should be akin to that of the Combined Code as a statement of best practice, with observance on a similar "comply or explain" basis.
The FRC should oversee a review of the Stewardship Code on a regular basis, in close consultation with institutional shareholders, fund managers and other interested parties, to ensure its continuing fitness for purpose in the light of experience and make proposals for any appropriate adaptation.
All fund managers that indicate commitment to engagement should participate in a survey to monitor adherence to the Stewardship Code. Arrangements should be put in place under the guidance of the FRC for appropriately independent oversight of this monitoring process which should publish an engagement survey on an annual basis.
Fund managers and other institutions authorised by the FCA to undertake investment business should signify on their websites or in another accessible form whether they commit to the Stewardship Code. Such disclosure should be accompanied by an indication that their mandates from life assurance, pension fund and other major clients normally include provisions in support of engagement activity and of their engagement policies on discharge of the responsibilities in the Stewardship Code. Where a fund manager or institutional investor is not ready to commit and to report in this sense, it should provide, similarly on the website, a clear explanation of its alternative business model and the reasons for the position it is taking.
The FCA should require institutions that are authorised to manage assets for others to disclose clearly on their websites or in other accessible form the nature of their commitment to the Stewardship Code or their alternative business model.
In view of the importance of facilitating enhanced engagement between shareholders and investee companies, the FCA, in consultation with the FRC and Takeover Panel, should keep under review the adequacy of the what is in effect "safe harbour" interpretation and guidance that has been provided as a means of minimising regulatory impediments to such engagement.
Institutional investors and fund managers should actively seek opportunities for collective engagement where this has the potential to enhance their ownership influence in promoting sustainable improvement in the performance of their investee companies. Initiative should be taken by the FRC and major UK fund managers and institutional investors to invite potentially interested major foreign institutional investors, such as sovereign wealth funds, public sector pension funds and endowments, to commit to the Stewardship Code and its provisions on collective engagement.
Voting powers should be exercised, fund managers and other institutional investors should disclose their voting record, and their policies in respect of voting should be described in statements on their websites or in other publicly accessible form.