The UK’s Journey From Regulation to Responsibility Essay

Introduction

Stewardship is the proper deployment, control, and management of investment to generate long-term profit for customers and beneficiaries, resulting in enduring advantages for society, the environment, and the economy. In response to a Walker Review suggestion, the United Kingdom created a Stewardship Code (SC) during the 2007-2009 global recession¹. The initial edition of the Code, published in 2010, was hurriedly drafted by the Financial Reporting Council (FRC), the quasi-governmental organization that Walker said ought to be in control of developing and implementing the SC.

In comparison to the UK, Japan has also begun to develop its stewardship laws. The Japanese regulator, which was established in 2014 and had 214 signatories at the end of 2016, recently reinforced the standards of its Principles for Responsible Institutional Investors. Japan seems to be headed in the right direction, even though significant cross-shareholdings of corporations continue to be a barrier to efficient stewardship operations.

It was primarily centered on the principle that the representing group of institutional shareholders had drafted over two decades ago and changed since then. The UK Stewardship Code 2020 (the Code) establishes stringent stewardship requirements for asset owners, asset managers, and service suppliers that assist them². The Code includes a set of guidelines for asset managers and asset owners as well as a distinct moral framework for service operators. A single technique in the Code does not prescribe sustainable stewardship.

Alternatively, it enables organizations to satisfy the requirements consistent with their strategy and company structure. Since the release of the inaugural UK Stewardship Code, the financial sector has altered substantially. There has been a substantial increase in investments in non-equity assets, such as fixed-income bonds, real estate, and infrastructure³. These investments have varying conditions, durations, entitlements, and obligations, and participants will need to determine how to execute stewardship successfully under these conditions. Therefore, the Steward Code has been an instrumental transformation in UK corporate governance; its absence would have led to most organizations’ failure.

The Goals of Stewardship in the Two Versions

The first version of the Steward Code is argued to be the best corporate governance code ever for the United Kingdom Corporate Governance. Before the introduction of the 2012 code, the most used corporate governance method was the aspect of the monitoring board⁴. This can be seen as why the 2012 code was more stringent on the aspect of directors being not cooperative in corporate governance. The prior governance was to ensure that the directors of the companies and the shareholder directors had the upper hand in the management of the companies. It was evident in how the directors carried out their business and how the treatment was made towards the shareholders. However, some scholars argued that the framework had failed. Walker Review disbelieved the aspect in 2009 and made it doubtful whether the same was sustainable.

As a result, it was emphasized that the directors’ performance was seriously inadequate as the same was based on their sole decision and understanding of corporate governance. The proposal was made for the directors and the shareholders to be seriously engaged in the decisions of the management of the companies⁵. The shareholders were to ensure that a person appointed as a director had some qualifications and understanding of the governance in the role they were taking up.

In this regard, the concept of engagement was devolved, and reviews were done for its purpose. First, there was a need for monitoring investee companies. The second review was for a meeting, as was suggested to be called by the company chair. The aspect of voting was also introduced to enable proper decision-making in the company. This made the corporate decision based on voting decisions, unlike before when the directors did it.

Moreover, the aspect of share transfer was equally addressed by the Code. Unlike previously, when share transfer was an absolute issue to be determined by a company, the Code introduced the aspect of the decision to be made by the shareholder in making the decision⁶. That was how the first version was portrayed. The second version of the Steward’s Code aimed to transfer the responsibility to an exclusive organ in the governance; this second version had various sections.

The first section was labeled engagement. This aspect relates to the first instance and view of the person’s engagement with the company; the members and the director were proposed to be the head of the company and should therefore engage in running the company. The second section was labeled purpose and focused on the company’s running to ensure that the same was achieved without any governance issues⁷. The directors were to be governed by the company principles and purposes, bringing about ultra vires practices. The directors had to make a decision based on the company’s objectives. The third section was the section on governance. This section dealt with how the company should be operated without the hindrance of corporate governance.

The fourth section was the investment approach, which was the framework on which the members of the company, especially the directors, were to organize themselves before taking up an investment opportunity in the company. The investment decision had to be based on the company’s objectives, and there had to be value⁸. One could not bring about the investment decision before the board could sit and resolve the same. This section also brought about the aspect of the rights and responsibilities of the company’s members. The members of the company, according to this rule, were to have a say in the way the directors ran the company. Some rights passed included the right to audit the books of accounts, among others. This was seen as a positive step in strengthening the concept of engagement in business management. Further, the scope of stewardship was determined and expanded.

In the Code, Stewardship activities were expanded to include investment decision-making. The second expansion was in line with the monitoring assets and service providers. The assets were viewed to belong to the company, and anyone could question their existence⁹. The third expansion aligned with engaging with issuers and holding them to material issues. This was seen as the aspect that could enable individuals to analyze their asset tracks. Equality in rights was also under review, so monitoring may be done as much for this purpose as for engagement.

How the Investment Market Has Changed Since the Introduction of the Code

The stewardship code of application was to start from 1^ST November 2012, as the new way of corporate governance brought some transformations. The main changes to the UK Corporate Governance Code included that boards should confirm that the annual report and accounts taken as a whole are fair, balanced, and understandable¹⁰. This stringent measure was introduced to ensure that there was accountability in the way through which the company was managed. The second recommendation was that audit committees report more fully on their activities. As they were classified as independent contractors, the audit committee had no duty to report their work. However, the Code made it mandatory for them to disclose the same.

Thirdly, there was a recommendation company should put the external audit contract out to tender at least every ten years. The fourth criterion, requiring businesses to report on their boardroom diversity strategies, was first announced in 2011 and went into force in 2012¹¹. As with all existing provisions of the Code, these additions are subject to compliance or explanation. The introductory section of the new Code identifies what the FRC believes should be disclosed when companies choose to explain to help investors assess the appropriateness of the company’s governance arrangements.

Further, there was an aspect of consultation on remuneration issues which was not to occur until after the government’s revised legislation on reporting and voting on remuneration had been finalized. This was seen as an upper hand in managing the company shares and the openness in running the company affairs. The same was to be used to ensure that the company was always kept on its toes. Implementing the Steward Code was considered a stringent corporate market and governance measure. As a new idea, it was challenging to comprehend what the market’s reaction would be like and the reaction it would attract from the existing corporate laws¹². As a general rule, new changes would always face strict opposition. Various changes were proposed before the implementation of the report in 2012. The changes were done in the 2011 report, which was the first intended change in the market.

Some of the changes introduced in the 2011 code included clarifying the respective responsibilities of asset managers and asset owners for stewardship. This measure was considered to highlight the company assets and enable a direct link for accountability with the asset owners. The second change was for stewardship activities that they have chosen to outsource. Outsourcing is a great business deal that enables a company to get human resource expertise that they may not have in the company from an external source. The third proposal was the requirement of more transparent reporting requirements, including the policy on stock lending. Asset managers are also encouraged to have the processes that support their stewardship activities verified to provide greater assurance to their clients.

The Changes in the 2020 Governance

The Financial Reporting Council of the United Kingdom published the 2020 UK Stewardship Code in October 2019, and the rules were to take effect in January 2020. The 2020 Code of Governance was considered a game-changer for corporate governance and management in the United Kingdom. The principle sets forward the principle of explanation in the corporate market. Thus, this value requires the disclosure of all the material facts in the company. This further required that the directors had to avail the books of accounts of the company to the shareholders and the creditors at their demand.

This approach allowed the business to carry out its operation in a manner that would make it realize its obligations according to its objectives. The changes in the stewards market have been seen to enable the proper carrying out of business in the United Kingdom¹³. The results are seen in the increased number of companies owning assets and having regard to their capital investment and many more procedures in the market structure. Furthermore, it has some approaches, among them on investment periods. The company had to invest in the trade within a certain period, and the investment had to be realized within that timeline. The other strategy was on rights and responsibilities. The company had to determine the members’ rights and responsibilities and the extent of their involvement in the company.

Further, there was an aspect of signatories derived from diverse grounds, enabling accountability in corporate governance. In addition, other issues underscored were the unprecedented environmental changes that affect corporations¹⁴. On the same note, social factors, seen as the world movers in terms of needs now, were another critical issue in the Code. Therefore, before making an investment decision, the company must consider all the elements and ensure that the people are not disadvantaged socially and through the adverse climate change aspects witnessed in the world.

Additionally, the Code aimed mainly at ensuring corporate managers were responsible for seamless governance in the United Kingdom. As such, they were brought to account to ensure that they are up to the task of raising the bar for other investors in the country in the aspect of accountable allocation management and oversight capital was the main motivators behind the review in 2020¹⁵. Further, there was an obligation imposed through the Code to implore investors and directors to explain how they have exercised stewardship concerning a broad range of asset classes owned by the company in the trust of the members.

The range of assets was not only listed equities, which was the previous focus. The scope was extended to include the fixed income of the company. The private markets were also brought to the category of assets. Other share classes were expanded to infrastructure investments, plus investments in assets listed or located outside the United Kingdom¹⁶. One appreciation of the Code is the ability to cater to assets commonly owned by the companies. The Code also covered the investment in different horizons within a trading agreement with the United Kingdom¹⁷. Further, the rights and responsibilities of each of these asset classes were determined in the Code.

Notably, the 2020 Code contains principles for directors and asset managers. The Principles are divided among that signatories must be charged with three primary duties. The duties include the need for the signatories to explain the transaction’s context. That means the signatories must explain why the transaction is being carried out and for what intention¹⁸. The signatories also have to explain the activities, such as the project undertaken by the organization. The question mainly concerned was operations and outcomes of such activities. Therefore, the result will determine the company’s liabilities to engage in the business; hence the principles included.

The 2020 Code for Improving Performance

The second version tackles the criticism of Kingman’s inefficacy by increasing the reporting obligations for SC participants’ lack an effort to improve performance. Consequently, the goal of the new Code is crystal clear; its concept of stewardship has been forcefully revised as the delivery of long-term benefits for the business, the environment, and broader society. Moreover, the scope of concepts for asset managers and asset owners has expanded from seven to twelve in 2020, and for the inaugural time, environment, social, and corporate governance (ESG) is expressly incorporated as a rule in coverage¹⁹. Service suppliers, such as proxy advisers and research organizations, must comply with the Code and report against seven basic criteria.

In this sense, it provided some ways to improve the performance they entail.

First, the tendency toward more comprehensive stewardship action declarations and policies entailed few insurers free themselves entirely of stewardship obligations, and several are detailing long-term plans to provide more successful stewardship. Nonetheless, there is a significant reporting gap between asset managers and insurers. To achieve the heightened requirements of the 2020 Code, insurers must make substantial improvements. These may not always correspond to the requisite proof of actions and consequences

Second, EY’s investigation showed less evidence of insurers’ active engagement with asset managers about stewardship goals. Even when stewardship rules are in place, what actions are conducted in response to them is not often apparent. Where results are provided, they are often qualitative, hindering attempts to quantify their economic, environmental, and social benefits²⁰. Finally, numerous insurers subcontract their stewardship duties. In some situations, insurers admit to outsourcing stewardship duties to asset managers. Though few, if any, describe how they engage with their asset managers’ stewardship initiatives and maintain responsibility for them. Several insurers’ in-house asset managers have signed the UK Stewardship Code 2012 even though their respective asset owners have not. This creates the possibility for conflict and misplaced stewardship expectations.

Implications of the 2020 Stewardship Code

Philosophical

The dominant philosophical perspective is one of realism, recognizing that market-level truths may be seen. Therefore, shareholder involvement is a crucial mechanism, aiding in the reduction of agency difficulties, information asymmetry, and the improvement of systems of investee corporations²¹. In addition, shareholders may have a beneficial influence on both investee corporations and themselves by engaging in successful engagement initiatives. Therefore, implementing the Stewardship Code might be advantageous to shareholders by boosting the quality of their involvement²². This essential philosophical stance serves as the foundation for the present research issues.

Political

Uncertainty surrounds the political implications of the Stewardship Code for its signatories concerning ongoing FRC reviews. It is unclear how the effectiveness of their stewardship actions may be measured using the Stewardship Code. Accordingly, it may be claimed that if the FRC develops criteria to assess stewardship actions, institutional investors could experience the benefits of implementing the Stewardship Code in their organization. Consequently, the FRC must alter its existing methodology to evaluate the execution of the Stewardship Code. The FRC may, for instance, have monthly meetings with signatories of the Stewardship Code to solicit their feedback on the guideline’s merits and faults. In addition, the FRC should watch and quantify the interaction between investors and firms to compare stewardship efforts and investor stewardship reports.

Technological

The Financial Conduct Authority (FCA) mandates that asset managers declare dedication to the Stewardship Code’s technology directions or explain why it does not apply to their business model. In addition, technological implication disclosure aims to improve readers’ comprehension of the stewardship strategy taken by institutional investors. Since asset managers are the main market for the Stewardship Code, the FRC underlined that surveillance is not only the duty of asset managers, given asset owners may oversee the firm directly or indirectly via fund manager instructions²³. The Stewardship Code’s technical foundation is described in further depth in the next part.

Economic

The Stewardship code suggested an economic perspective. For instance, it aimed to enhance social utility in at least some situations autonomously of the benefit of those who offer the capital for expansion, with the implication that, in some cases, the societal benefit could come at the cost of financial returns for beneficiaries²⁴. Consequently, the draft emphasized that Stewardship is the appropriate deployment and administration of capital throughout the organizational investment community to generate value propositions for recipients, the economy, and communities.

Legal

From the perspective of legal analysis, The Financial Reporting Council’s pioneering Stewardship Code aims to improve communication between corporate boards and shareholders. The code’s tenets will be essential for good stewardship practices to spread around the world, given the UK market’s status as a governance role model. However, this new Code creates questions, such as how to handle non-UK investors who jointly control more than 40% of the country’s share market.²⁵

The Comparative Analysis of the UK Code with Other Codes

Since the adoption of the stewardship Code by the United Kingdom in July 2010, several countries, for example, Japan, have also adopted the policy to an extent. The codes are not identical to those of England, but they have non-compulsory “comply or explain” rules.²⁶ The rule was adopted to help investors not from Japan have leeway in carrying out business in Japan. The Japanese success of the Stewardship Code depends on how well domestic institutional investors are incentivized to act in the interest of their ultimate beneficiaries and to monitor entrenched management. This goal of the Japanese Code is more compatible with the logic of stewardship than the UK Code, which is premised on the management mode.²⁷ The Canadian Comparison of Good Governance also developed codes to control the corporate world. The stewardship principles motivated institutional investors to take on climate change risk, which the federal government understands to pose systemic risks to the Canadian economy.

Changes in the FCA Requirements

The Code applies to all firms in that it is prudent for a company to have its operations regulated by the laws of the country of operation. However, it is not applicable when a company that does not offer professional services is under no strict obligation to comply with those regulations. Professional service provider firms like banks are seen to have complete trust in the public sector and, therefore, should be regulated. The aspect of quality is a widely analyzed concept that cannot be assumed in the internal analysis of corporate governance.

Conclusion

The Stewardship Code had a spectacular escape from the Kingman Review’s conclusion that it was ineffectual. In the second (2020) edition of the Code, none of the probable explanations for the unwillingness of asset owners and asset managers to interact with investee enterprises under the first version of the Code have been handled. The legal analysis of stewardship shows that this code’s tenets will be essential for good stewardship practices to spread around the world.

Bibliography

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‘The UK Stewardship Code and Investee Earnings Quality. Emerald Insight‘ (2018) 31. Web.

Cash D and Goddard R, ‘The Stewardship Code 2020‘ [2021] Investor Stewardship and the UK Stewardship Code 37. Web.

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Shah, Neeta, Christopher J. Napier, and R. Holloway. “The Cadbury Report 1992: Shared Vision and Beyond.” United Kingdom, Web.

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Yang L, ‘Promoting the Institutional Investors’ Engagement of Corporate Governance in Emerging Countries—from the Perspective of the Revision of the UK’s Stewardship Code (2022) 5 Financial Engineering and Risk Management 90. Web.

Footnotes

1. Shah, Neeta, Christopher J. Napier, and R. Holloway. “The Cadbury Report 1992: Shared Vision and Beyond.” United Kingdom.
2. Klettner A, ‘Stewardship Codes and the Role of Institutional Investors in Corporate Governance: An International Comparison and Typology’ (2021)
3. Ibid
4. Davies P, ‘THE UK STEWARDSHIP CODE 2010-2020 from Saving the Company to Saving the Planet?’ [2020]
5. Ibid
6. Cash D and Goddard R, ‘The Stewardship Code 2020’ [2021] Investor Stewardship and the UK Stewardship Code 37
7. Davies P, ‘THE UK STEWARDSHIP CODE 2010-2020 from Saving the Company to Saving the Planet?’ [2020]
8. Ibid
9. Ibid
10. Chiu IH-Y, ‘Governing the Purpose of Investment Management: How the “Stewardship” Norm Is Being (Re)Developed in the UK and EU’ [2021]
11. Ibid
12. Davies P, ‘THE UK STEWARDSHIP CODE 2010-2020 from Saving the Company to Saving the Planet?’ [2020]
13. Davies P, ‘THE UK STEWARDSHIP CODE 2010-2020 from Saving the Company to Saving the Planet?’ [2020]
14. Cash D and Goddard R, ‘The Stewardship Code 2020’ [2021] Investor Stewardship and the UK Stewardship Code 37
15. Cash D and Goddard R, ‘The Stewardship Code 2020’ [2021] Investor Stewardship and the UK Stewardship Code 37
16. Routledge, James.” ‘Institutional Investors, Stewardship Code Disclosures and Audit Fees | Emerald Insight’ (2020)
17. Council, Financial Reporting. “Proposed Revision to the UK Stewardship Code.” (2019) Consultation Paper, Financial Reporting Council 30.
18. Reddy, Bobby V. “The Emperor’s New Code? Time to Re‐Evaluate the Nature of Stewardship Engagement Under the UK’s Stewardship Code.” (2021): 842-873.
19. Yang L, ‘Promoting the Institutional Investors’ Engagement of Corporate Governance in Emerging Countries—from the Perspective of the Revision of the UK’s Stewardship Code’ (2022)
20. Ibid
21. Elmi, Samaneh. “An Analysis of the Impact of UK Stewardship Code on UK Asset Managers: Financial Performance and Quality of Engagement.” PhD diss., Oxford Brookes University 2019.
22. Ibid
23. Shiraishi Y and others, ‘Stewardship Code, Institutional Investors, and Firm Value: International Evidence’ [2019].
24. Ibid
25. ‘The UK Stewardship Code and Investee Earnings Quality. Emerald Insight’, 2018, Accounting Research Journal 388.
26. Ibid
27. Goto G. The logic and limits of stewardship codes: The case of Japan. Berkeley Business Law Journal, Forthcoming, the University of Tokyo Business Law Working Paper Series. 2018 Oct 19(2018-E):01.