It has been 10 years since the United Kingdom introduced a Stewardship Code, drawn up by its Financial Reporting Council (FRC), a quasi-governmental agency. The code was meant to remedy some of the inadequacies in the system of corporate governance that, it was thought, the crises of 2007-2008 had revealed. Institutional investors were to step up to guard the guardians, becoming much more active in their relationship with the boards of public corporations.
The code was amended slightly in 2012, but then branded as ineffective after a government-ordered review, the Kingsman Review, in 2018.
Since then, the FRC has chosen to amend the Stewardship Code again, expanding the underlying concept of stewardship in order to embrace broader ESG issues, with special emphasis on climate change. This new 2020 Code also has a separate, though shorter, set of principles for service providers, and it extends its coverage beyond investment in corporations to investment in “fixed income, bonds, real estate and infrastructure.”
The Failure of the First Code
A new critique by Paul Davies of Oxford University, Harris Manchester College, looks at the likelihood that this version will be more successful than the earlier one. He doesn’t regard the 2012 amendments as making a sufficiently sharp break to speak of it as a separate “version,” rather he writes of the “first version” of the Code as one implemented by the 2010 and 2012 actions together, and he writes of the 2020 edition as the “second version.”
Why might the first version be seen as a failure? As Davies says, the Kingman Review did not entail any “empirical studies which might have tested the truth” of that proposition. The review put the evidentiary burden on the FRC and found that it had failed to show any evidence that the level of engagement on the part of institutional investors had changed at all since 2010. If the absence of such engagement was the problem, as the first version presumed, then the effectiveness of a solution would entail greater engagement, which ought to be subject to documentation.
Also, the Kingman Review found that the signatories required annual reports on their own engagement and the consequences thereof were mere “boilerplate;” that is, full of unhelpful generalities, that required little change from one year’s filing to the next.
Davies agrees with the Kingman reviewers that the first version was a failure. He thinks it is probably correct to say that the level of institutional engagement did not increase. What is more decisive for him, though, is the sense that the institutional investors involved with publicly owned UK corporations had neither the capacity nor the incentives to serve as the guardian-of-the-guardians that the drafters of the first SC seem to have expected them to become.
Prospects for the Second Code
Unfortunately, Davies continues, none of the plausible reasons to explain the failure of the first version of the Code have been squarely addressed in the second version. So, why would the second version be more successful? It would only work if there were a new and more forceful set of incentives that outside of these documents are pushing institutions toward stewardship, and the change to the second version may be seen as a useful codification of those broader changes.
Davies deems that the second version might prove successful but says this is only a very conditional optimism. It will be successful in producing valuable changes in the ways corporations do business, if and only if governmental policies and social changes continue to support it.
One key fact about the second version, in Davies view, is that it expands beyond the investor-board relationship to take in the investor-market relationship. The signatories to the code acknowledge that their stewardship entails promoting a well-functioning financial system, not merely a well-functioning issuer.
Ambition has certainly expanded. In 2010, the essence of the code was that institutional investors were being called upon to “save the company.” Now they are being called upon, as Davies puts it, to “save the planet.”
The institutions might indeed help serve that end. Asset owners and managers “will want to keep regulation at bay in order to protect their business models and that will require doing enough in relation to ESG considerations to keep the government happy.” The codification may serve as soft law operating within the shadow of not-so-soft regulatory pressures. Within the UK’s political environment, Davies adds, this seems a reasonable prospect, though it is of course not a certainty.