Armstrong Bonham Carter Armstrong Bonham Carter, 1 Angel Court, EC2R 7HJ, England

Armstrong Bonham Carter's response to the Financial Reporting Council's consultation on the Stewardship Code for Institutional Investors April 2010
Article by Tom Bonham Carter 16 Apr 2010

Armstrong Bonham Carter (ABC) is delighted to provide some views on the proposed Stewardship Code (SC) for Institutional Investors and has commented as per Appendix A of that consultation document.

Overall:

ABC notes that the real crux of the Stewardship Code lies in Principle 3 of the Institutional Shareholders Committee Code (ISC Code). This principle states that institutional investors should monitor their investee companies. The guidance provided is correct in that institutional investors should check whether the investee company board and sub-committee structures are effective. But there is no further guidance as to what is an effective board or sub-committee. The current Combined Code of Corporate Governance and the proposed new UK Corporate Governance Code also does not provide any definition of an effective board.

So there is a real risk that a myriad of different definitions will continue to be used by institutional investors in their monitoring processes and boards will continue to be confused by the messages from the engagement with their shareholders. Hence despite all this effort by the Institutional Shareholders Committee, Sir David Walker and the FRC and the consequential raised expectations that relations between boards and their shareholders could radically improve, nothing is likely to change.

Section 1: Introduction

The FRC would welcome views on the policy objectives against which the
FRC should judge its approach to a Stewardship Code (paragraph 1.14), the
proposed objectives being to:

• Set standards of stewardship to which mainstream institutional
investors should aspire, and maintain the credibility and quality of
these standards through independent input on the content and
monitoring of the Code;

• Promote a sense of ownership of the Code amongst institutional
investors in order to encourage UK and foreign shareholders to
apply and report against it;

• Ensure that engagement is closely linked to the investment process
within the investment firm;

• Contribute towards improved communication between
shareholders and the boards of the companies in which they invest;
and

• Secure sufficient disclosure to enable institutional shareholders’
prospective clients to assess how those managers are acting in
relation to the Code so that this can be taken into account when
awarding and monitoring fund management mandates.

The FRC is seeking views on whether it should accept oversight of the Code
in its current form, or whether amendments should be made before the FRC
does so (paragraph 1.16).

Views are also sought on which institutional investors and agents should be
encouraged to apply the code on a “comply or explain” basis, what they
should be asked to disclose and to whom, and the monitoring arrangements
that should be put in place (paragraph 1.17).

The proposed objectives are reasonable subject to the following caveats.

• Institutional investors should always aspire to meet the needs of their clients and thus it is they, the beneficial owners, who should set the requirements of their appointed managers. So whilst the FRC is in a position to set the standards of stewardship, it is an imperative that the beneficial owners agree to these standards. Without this endorsement, the credibility of these standards will be undermined. Assuming that beneficial owners do believe adherence to these standards is in their best interests, then the credibility and quality of these standards will be enhanced by independent and appropriate input on the content and monitoring of the SC.
• A real sense of ownership of the SC amongst institutional investors will depend on the beneficial owners requiring that their agents do comply with the SC.
• If the institutional investors do feel they are required by their beneficial owners to comply with the SC then it is an imperative that engagement is not just linked to, but integrated into the investment process.
• Adherence to the SC should not just improve communication but also allow boards to be aware of whether they have the support of their shareholders in achieving any declared aim via the implementation of the announced strategy and component plans.
• If beneficial owners believe it is in their best interests to ensure their appointed institutional investment manager should engage effectively, then these managers should ensure sufficient information is available both prior to, and during appointment, in order to assess the effectiveness of their engagement. The FRC‘s efforts to provide suitable standards of disclosure will be of value to these owners.
• It is ABC’s view that the FRC should accept oversight of the Code, both in current and future form as it is a suitable, independent and authoritative body capable of administering the task. Ideally, if a sole body or organisation existed to represent all beneficial owners of all equity investment products and services covering pension funds, insurance products investment trust, unit trust etc., this could prove to be a more effective owner of the SC. But at present ABC is not aware of any such body.
• Whilst some beneficial owners may not require their institutional investors to comply with the SC or explain their reasons for not doing so; a comply or explain basis is an optimum solution.

Section 2: Background and Recent Developments

The FRC would welcome any insights on lessons which may be learned from
experience outside the UK (paragraph 2.18).

• No comment.

Section 3: The Coverage of the Code

The FRC would encourage all UK institutional investors to apply and report
on the Code regardless of whether or not they are subject to mandatory
requirements, and would welcome views on whether there are any barriers or
other reasons that would prevent or discourage them from doing so
(paragraph 3.6).

Views are invited on whether agents such as voting services agencies and
investment consultants should be encouraged to commit to the spirit of the
Code, and if so how this could be done (paragraph 3.8).

The FRC is keen to hear from foreign investors in response to this
consultation, and would in particular welcome comments on:

• Whether foreign investors would be willing voluntarily to commit to a
Code sponsored by a UK regulator such as the FRC or a UK industry body
like the ISC in respect of their holdings in UK companies;
• Their current practice on disclosing information on their engagement
policy, including any national or international standards they follow; and
• Any barriers or other potential difficulties for foreign shareholders seeking
to engage with UK companies (paragraph 3.13).

The FRC would also be interested to hear from investors who operate on a
cross-border basis about any potential conflicts which might arise between
requirements or codes in place in other countries and the proposed Stewardship Code (paragraph 3.14).

• ABC believes it is the prime responsibility of institutional investors to act in accordance of the mandates awarded to them by their clients or beneficial owners. If these owners do not believe it is in their interests to engage, then their agents should explain that they cannot adhere to the SC. ABC also recognises that some institutional investors may not be convinced that more active engagement will necessarily lead to improved investment returns, after the costs of that engagement activity and may persuade their clients or prospective clients of the merits of that argument.
• If there are other bodies such as voting agencies or investment consultants that are either opining on corporate governance standards and practices of boards or evaluating the engagement policies and practices of institutional investors, then they should be encouraged to commit to the spirit of the SC and describe how their business model and practices do so in their company brochures and on their websites.

Section 4: The Content of the Code

Respondents are welcome to comment on any aspect of the ISC Code, but in
particular views are invited on these questions:

• What are the responsibilities for engagement of institutional investors to
the beneficial owners whose interests they represent? Does the ISC Code
cover all the relevant responsibilities?
• What are the responsibilities for engagement of institutional shareholders
to the UK listed companies in which they invest? Does the ISC Code cover
all the relevant responsibilities?
• Are the respective responsibilities of the different parts of the investment
chain sufficiently clear and appropriate?
• Does the Code strike the right balance between the need to avoid over specification
that might discourage the application of the Code and the
need for it to be effective with an appropriate degree of transparency?
• Are there any parts of the ISC Code where further guidance is needed, or
where the existing guidance should be amended? (paragraph 4.2)

Views are invited on whether the ISC Code adequately covers the content of
Section E of the Combined Code (paragraph 4.4)

• The responsibilities for engagement of institutional investors to the beneficial owners (whose interests they represent) should be laid out in the mandate that the latter have given to the former. If beneficial owners determine that they require engagement as part of the mandate awarded, then they should stipulate what is required. Hence the FRC’s provision of the SC will provide some guidance for the beneficial owners. This will need to be supported by the investment consultants.
• Overall, the ISC Code does cover all the relevant responsibilities within the seven principles.
• If UK listed company boards were true to the principles of accountability and transparency, institutional investors would be more easily persuaded to be clearer over their support for these boards. But whilst this is not consistently provided by UK listed companies (where many boards tend to operate with a high degree of opacity), there are no responsibities for engagement of institutional investors to the UK listed companies in which they invest and thus the ISC Code does not have to cover this.
• The only responsibilities are those of the institutional investors and their agents towards their clients which are sufficiently clear.
• The risk of the use of principles is that in under-specifying engagement the mean standard of engagement does not achieve the desired expectations and thus complying with the ISC Code does not lead to improved standards of engagement. Boards of UK listed companies and institutional investors will remain at odds with one another over the quantity and quality of their engagement. This is the current and real risk, not simply one of over-specifying.
• The real crux of the ISC Code is in principle 3: Institutional investors should monitor their investee companies. The guidance is correct in that institutional investors should check whether the investee company board and sub-committee structures are effective, but there is no further guidance as to what is an effective board or sub-committee. In addition, the current Combined Code of Corporate Governance and the proposed new UK Corporate Governance Code also does not provide any definition of an effective board. At the very least, this risks a myriad of different definitions being used by institutional investors in their monitoring processes and confusing the boards of their investee companies, having engaged with their shareholders. For example, one investor may feel a board is ineffective because there is an executive chairman, whereas another may not view this as an issue. Also there are unresolved areas of confusion over such things as: do you need to monitor all equity holdings irrespective of size, when should you meet companies and with whom, what should be discussed at that meeting, when does an institutional investor intervene and how, when should that investor escalate by sharing its concerns with the company, the broker or with other shareholders, when should an investor use its voting powers and when would it be appropriate to sell?
• As a consequence of the lack of clarity on how to monitor, it is not evident how institutional investors would be able to assess the effectiveness of their engagement process.
• ABC believes the ISC Code more than covers the content of Section E of the Combined Code.

Section 5: Reporting, Monitoring and Review

The FRC would welcome views on:

• The information that institutional shareholders should disclose publicly
and that they should report to clients;

• The arrangements that should be put in place to monitor how institutional
shareholders apply and report against the Code; and

• The arrangements for reviewing the operation and content of the Code
(paragraph 5.2).

The FRC would welcome views on the specific information that should be
disclosed by institutional shareholders and their agents, and at what level of
detail the “comply or explain” principle should apply (paragraph 5.3).

Views are invited on whether public disclosure of the information
summarised is appropriate and useful, and whether other information might
also usefully be disclosed (paragraph 5.6).

Views are invited on the structure of the ISC Code and on the best way to
encourage reporting against it on a “comply or explain” basis (paragraph
5.10).

Views are invited on the proposals in ISC Code for reporting to clients and
the merits of independent opinions from auditors or other professional
accountants. It would be helpful to have estimates of the costs incurred by
asset managers in commissioning these opinions and of the benefits to asset
owners (paragraph 5.14).

Views are invited on the merits of the current IMA survey and other possible
approaches to monitoring the overall application of the Code (paragraph
5.21).

Views are invited on the proposed approach to reviewing the Code (paragraph 5.22).

• Institutional investors who wish comply with the ISC Code disclosing their engagement policy and how this was fulfilled over the last year. This should be updated, at the very least, after each AGM season.
• The implication of a comply or explain basis would suggest a self-reporting mechanism, such as a survey, would be the most appropriate.
• As above, periodic surveys requesting comments on the operation and the content of the Code from institutional investors, agents, beneficial owners and boards of listed companies would be the most appropriate.
• The disclosure of specific information should consist of the policy and the actions taken in implementing that policy. This should all be subject to public disclosure, unless there is a particular engagement issue still ongoing which may influence the share price.
• ABC views the structure of the ISC Code as suitable enough to allow reporting against it on a comply or explain basis, subject to ABC’s previous comments on the lack of clarity of the monitoring process.
• ABC does not believe that auditors or other professional accountants have suitable skills to evaluate the effectiveness of engagement policies and practices. But an independent evaluation of these policies and their actual practices would be useful to ensure that compliance with the ISC Code is maintained, best practices can emerge and then be shared, which over time can improve the ISC Code.
• IMA Code is a suitable survey, but as with many surveys, it is not subject to verification of the data submitted.
• ABC agrees that the ISC Code should be subject to periodic review for its effectiveness.






The Combined Code quotes Sir Derek Higgs The use of an external third party to conduct the evaluation will bring objectivity to the process.		Armstrong Bonham Carter's response to the Financial Reporting Council's consultation on the Stewardship Code for Institutional Investors April 2010 Article by Tom Bonham Carter 16 Apr 2010 Armstrong Bonham Carter (ABC) is delighted to provide some views on the proposed Stewardship Code (SC) for Institutional Investors and has commented as per Appendix A of that consultation document. Overall: ABC notes that the real crux of the Stewardship Code lies in Principle 3 of the Institutional Shareholders Committee Code (ISC Code). This principle states that institutional investors should monitor their investee companies. The guidance provided is correct in that institutional investors should check whether the investee company board and sub-committee structures are effective. But there is no further guidance as to what is an effective board or sub-committee. The current Combined Code of Corporate Governance and the proposed new UK Corporate Governance Code also does not provide any definition of an effective board. So there is a real risk that a myriad of different definitions will continue to be used by institutional investors in their monitoring processes and boards will continue to be confused by the messages from the engagement with their shareholders. Hence despite all this effort by the Institutional Shareholders Committee, Sir David Walker and the FRC and the consequential raised expectations that relations between boards and their shareholders could radically improve, nothing is likely to change. Section 1: Introduction The FRC would welcome views on the policy objectives against which the FRC should judge its approach to a Stewardship Code (paragraph 1.14), the proposed objectives being to: • Set standards of stewardship to which mainstream institutional investors should aspire, and maintain the credibility and quality of these standards through independent input on the content and monitoring of the Code; • Promote a sense of ownership of the Code amongst institutional investors in order to encourage UK and foreign shareholders to apply and report against it; • Ensure that engagement is closely linked to the investment process within the investment firm; • Contribute towards improved communication between shareholders and the boards of the companies in which they invest; and • Secure sufficient disclosure to enable institutional shareholders’ prospective clients to assess how those managers are acting in relation to the Code so that this can be taken into account when awarding and monitoring fund management mandates. The FRC is seeking views on whether it should accept oversight of the Code in its current form, or whether amendments should be made before the FRC does so (paragraph 1.16). Views are also sought on which institutional investors and agents should be encouraged to apply the code on a “comply or explain” basis, what they should be asked to disclose and to whom, and the monitoring arrangements that should be put in place (paragraph 1.17). The proposed objectives are reasonable subject to the following caveats. • Institutional investors should always aspire to meet the needs of their clients and thus it is they, the beneficial owners, who should set the requirements of their appointed managers. So whilst the FRC is in a position to set the standards of stewardship, it is an imperative that the beneficial owners agree to these standards. Without this endorsement, the credibility of these standards will be undermined. Assuming that beneficial owners do believe adherence to these standards is in their best interests, then the credibility and quality of these standards will be enhanced by independent and appropriate input on the content and monitoring of the SC. • A real sense of ownership of the SC amongst institutional investors will depend on the beneficial owners requiring that their agents do comply with the SC. • If the institutional investors do feel they are required by their beneficial owners to comply with the SC then it is an imperative that engagement is not just linked to, but integrated into the investment process. • Adherence to the SC should not just improve communication but also allow boards to be aware of whether they have the support of their shareholders in achieving any declared aim via the implementation of the announced strategy and component plans. • If beneficial owners believe it is in their best interests to ensure their appointed institutional investment manager should engage effectively, then these managers should ensure sufficient information is available both prior to, and during appointment, in order to assess the effectiveness of their engagement. The FRC‘s efforts to provide suitable standards of disclosure will be of value to these owners. • It is ABC’s view that the FRC should accept oversight of the Code, both in current and future form as it is a suitable, independent and authoritative body capable of administering the task. Ideally, if a sole body or organisation existed to represent all beneficial owners of all equity investment products and services covering pension funds, insurance products investment trust, unit trust etc., this could prove to be a more effective owner of the SC. But at present ABC is not aware of any such body. • Whilst some beneficial owners may not require their institutional investors to comply with the SC or explain their reasons for not doing so; a comply or explain basis is an optimum solution. Section 2: Background and Recent Developments The FRC would welcome any insights on lessons which may be learned from experience outside the UK (paragraph 2.18). • No comment. Section 3: The Coverage of the Code The FRC would encourage all UK institutional investors to apply and report on the Code regardless of whether or not they are subject to mandatory requirements, and would welcome views on whether there are any barriers or other reasons that would prevent or discourage them from doing so (paragraph 3.6). Views are invited on whether agents such as voting services agencies and investment consultants should be encouraged to commit to the spirit of the Code, and if so how this could be done (paragraph 3.8). The FRC is keen to hear from foreign investors in response to this consultation, and would in particular welcome comments on: • Whether foreign investors would be willing voluntarily to commit to a Code sponsored by a UK regulator such as the FRC or a UK industry body like the ISC in respect of their holdings in UK companies; • Their current practice on disclosing information on their engagement policy, including any national or international standards they follow; and • Any barriers or other potential difficulties for foreign shareholders seeking to engage with UK companies (paragraph 3.13). The FRC would also be interested to hear from investors who operate on a cross-border basis about any potential conflicts which might arise between requirements or codes in place in other countries and the proposed Stewardship Code (paragraph 3.14). • ABC believes it is the prime responsibility of institutional investors to act in accordance of the mandates awarded to them by their clients or beneficial owners. If these owners do not believe it is in their interests to engage, then their agents should explain that they cannot adhere to the SC. ABC also recognises that some institutional investors may not be convinced that more active engagement will necessarily lead to improved investment returns, after the costs of that engagement activity and may persuade their clients or prospective clients of the merits of that argument. • If there are other bodies such as voting agencies or investment consultants that are either opining on corporate governance standards and practices of boards or evaluating the engagement policies and practices of institutional investors, then they should be encouraged to commit to the spirit of the SC and describe how their business model and practices do so in their company brochures and on their websites. Section 4: The Content of the Code Respondents are welcome to comment on any aspect of the ISC Code, but in particular views are invited on these questions: • What are the responsibilities for engagement of institutional investors to the beneficial owners whose interests they represent? Does the ISC Code cover all the relevant responsibilities? • What are the responsibilities for engagement of institutional shareholders to the UK listed companies in which they invest? Does the ISC Code cover all the relevant responsibilities? • Are the respective responsibilities of the different parts of the investment chain sufficiently clear and appropriate? • Does the Code strike the right balance between the need to avoid over specification that might discourage the application of the Code and the need for it to be effective with an appropriate degree of transparency? • Are there any parts of the ISC Code where further guidance is needed, or where the existing guidance should be amended? (paragraph 4.2) Views are invited on whether the ISC Code adequately covers the content of Section E of the Combined Code (paragraph 4.4) • The responsibilities for engagement of institutional investors to the beneficial owners (whose interests they represent) should be laid out in the mandate that the latter have given to the former. If beneficial owners determine that they require engagement as part of the mandate awarded, then they should stipulate what is required. Hence the FRC’s provision of the SC will provide some guidance for the beneficial owners. This will need to be supported by the investment consultants. • Overall, the ISC Code does cover all the relevant responsibilities within the seven principles. • If UK listed company boards were true to the principles of accountability and transparency, institutional investors would be more easily persuaded to be clearer over their support for these boards. But whilst this is not consistently provided by UK listed companies (where many boards tend to operate with a high degree of opacity), there are no responsibities for engagement of institutional investors to the UK listed companies in which they invest and thus the ISC Code does not have to cover this. • The only responsibilities are those of the institutional investors and their agents towards their clients which are sufficiently clear. • The risk of the use of principles is that in under-specifying engagement the mean standard of engagement does not achieve the desired expectations and thus complying with the ISC Code does not lead to improved standards of engagement. Boards of UK listed companies and institutional investors will remain at odds with one another over the quantity and quality of their engagement. This is the current and real risk, not simply one of over-specifying. • The real crux of the ISC Code is in principle 3: Institutional investors should monitor their investee companies. The guidance is correct in that institutional investors should check whether the investee company board and sub-committee structures are effective, but there is no further guidance as to what is an effective board or sub-committee. In addition, the current Combined Code of Corporate Governance and the proposed new UK Corporate Governance Code also does not provide any definition of an effective board. At the very least, this risks a myriad of different definitions being used by institutional investors in their monitoring processes and confusing the boards of their investee companies, having engaged with their shareholders. For example, one investor may feel a board is ineffective because there is an executive chairman, whereas another may not view this as an issue. Also there are unresolved areas of confusion over such things as: do you need to monitor all equity holdings irrespective of size, when should you meet companies and with whom, what should be discussed at that meeting, when does an institutional investor intervene and how, when should that investor escalate by sharing its concerns with the company, the broker or with other shareholders, when should an investor use its voting powers and when would it be appropriate to sell? • As a consequence of the lack of clarity on how to monitor, it is not evident how institutional investors would be able to assess the effectiveness of their engagement process. • ABC believes the ISC Code more than covers the content of Section E of the Combined Code. Section 5: Reporting, Monitoring and Review The FRC would welcome views on: • The information that institutional shareholders should disclose publicly and that they should report to clients; • The arrangements that should be put in place to monitor how institutional shareholders apply and report against the Code; and • The arrangements for reviewing the operation and content of the Code (paragraph 5.2). The FRC would welcome views on the specific information that should be disclosed by institutional shareholders and their agents, and at what level of detail the “comply or explain” principle should apply (paragraph 5.3). Views are invited on whether public disclosure of the information summarised is appropriate and useful, and whether other information might also usefully be disclosed (paragraph 5.6). Views are invited on the structure of the ISC Code and on the best way to encourage reporting against it on a “comply or explain” basis (paragraph 5.10). Views are invited on the proposals in ISC Code for reporting to clients and the merits of independent opinions from auditors or other professional accountants. It would be helpful to have estimates of the costs incurred by asset managers in commissioning these opinions and of the benefits to asset owners (paragraph 5.14). Views are invited on the merits of the current IMA survey and other possible approaches to monitoring the overall application of the Code (paragraph 5.21). Views are invited on the proposed approach to reviewing the Code (paragraph 5.22). • Institutional investors who wish comply with the ISC Code disclosing their engagement policy and how this was fulfilled over the last year. This should be updated, at the very least, after each AGM season. • The implication of a comply or explain basis would suggest a self-reporting mechanism, such as a survey, would be the most appropriate. • As above, periodic surveys requesting comments on the operation and the content of the Code from institutional investors, agents, beneficial owners and boards of listed companies would be the most appropriate. • The disclosure of specific information should consist of the policy and the actions taken in implementing that policy. This should all be subject to public disclosure, unless there is a particular engagement issue still ongoing which may influence the share price. • ABC views the structure of the ISC Code as suitable enough to allow reporting against it on a comply or explain basis, subject to ABC’s previous comments on the lack of clarity of the monitoring process. • ABC does not believe that auditors or other professional accountants have suitable skills to evaluate the effectiveness of engagement policies and practices. But an independent evaluation of these policies and their actual practices would be useful to ensure that compliance with the ISC Code is maintained, best practices can emerge and then be shared, which over time can improve the ISC Code. • IMA Code is a suitable survey, but as with many surveys, it is not subject to verification of the data submitted. • ABC agrees that the ISC Code should be subject to periodic review for its effectiveness.
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