ISAAC JUMA

The UK market is among the dominant players in continental Europe, rivalled by Germany as an economic powerhouse. The high ranking is dependent on several factors, the most prevalent means of indication worldwide has been in terms of economic standing denoted by the Gross Domestic Product. These economic indicators are key to informing investors on the state of a market for analysis and discovery of opportunities. The UK market, with a GDP of 2.2 trillion British pounds, emerged as the world’s fifth largest economy and  thus a key player too big for investors to ignore. The UK is also the second-largest centre for asset management and pioneers of sustainable and responsible investing.

The Walker Review and Creation of the Financial Reporting Council

Following the recommendations of the Walker Review on the effectiveness of corporate governance in the UK after the global financial crisis of 2008, among them was the formulation of a Stewardship Code aimed at making management more accountable to institutional investors and the formation of the Financial Reporting Council (FRC). Promoting transparency and integrity in business, the FRC’s mandate was to regulate auditors, accountants and actuaries, and set the UK’s Corporate Governance and Stewardship Codes. The FRC is responsible for the oversight, monitoring, and continued development of the Stewardship Code. The 2020 Stewardship Code (henceforth Code), a most recent publication of the Stewardship Code by the FRC, is seminal as it makes explicit reference to the environmental, social and governance factors (ESG). Furthermore, signatories are required to exercise stewardship in the exercise of their duties and report annually on their application of the Code. 

Stewardship and the Code

The aftermath of the publication of the report’s findings and recommendations saw scathing remarks reflective of scepticism from the financial crisis which termed the report to be meagre suggestions or minor tweaks in the already existing sector and a knee-jerk reaction to the economic fallout. Amid this, the FRC took up the recommendations and the outcome was a Stewardship Code embodying the report’s findings. The 2010 Stewardship Code and its successors have set stewardship standards worldwide for those investing money on behalf of the UK populace, the Stewardship Code 2020 went further to include in the scope those that support the organisations investing money for the populace.

The FRC terms the Code as a ‘high standards’ guide for those investing on behalf of the populace and defines stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society. The FRC has been keen to produce reviews on the uptake of the Code’s provision over the two years since its publication. The reviews released have provided guidance on the FRC’s expectations on reporting by the organizations centred on: engagement, and exercising rights and responsibilities; setting expectations monitoring and holding to account third-party managers.

Apply-Explain and Becoming a Signatory

The Walker review had recommended the apply-explain reporting of the Code by signatories which was taken up by the FRC and has been a defining part of the Stewardship Code. The Code is principle-based where the intending signatories explain how they have applied it across any 12-month period prior to reporting. The process involves the signatory submitting a stewardship report to the FRC, subsequently, an assessment is done by the FRC to determine whether the report meets the stipulations of the Code. Once approved the reports are to be made public by the organisations in their own domains easily accessible to the public. However, the FRC has also published these reports in their website to ensure that they are far-reaching to a prospective audience. This ‘application’ process is to be done by the organizations in the consequent years once approved as a signatory in a form of renewing manner. The Stewardship reporting is ideally geared towards ensuring that assets entrusted to investors are managed responsibly and offer a demonstration on how they protect the assets throughout the year.

Since the Code’s first publication in 2020, there has been two reporting periods which has seen a considerable amount of uptake by industry players in the market. First signatories to the Code were published by the FRC in September 2021 where 189 apply-explain compliance reports were assessed with 125 reports being deemed satisfactory. These organizations spread across various asset classes and markets controlled an asset value of about £20 trillion. The year 2022 saw an uptake in the number of signatories and the asset value, the number increased to 235 organisations and doubling of asset value to £40.7 trillion respectively, where there was transparency as to the purpose and approach towards stewardship. The next deadline for an application to be a signatory is in April 2023 with a further date scheduled in October 2023 reserved only for renewal applications.

As per the increase in organisation compliance to the Code, the probability of there being more submissions than previous years is high even though there has been  a period of economic turmoil since. Ideally, this would grant the FRC respite as it embarks on the review process of the Code. Unlike its predecessors, the Code has: seen information reach the wider public; made stewardship expectations clearer; applied to a wide range of asset classes; and places greater focus on stewardship activities and outcomes.

Inclusion of Environmental, Social and Governance Factors  & Outcome Reporting: Setting the Standard?

Having an all-new definition of stewardship and the inclusion of ESG factors, this is a first across the various stewardship Codes proliferating the world since the UK published the 2010 Stewardship Code, which has been regarded as a measure of effectiveness. The Code is voluntary and sets a standard that is higher than the minimum UK regulatory requirements thus organisations and various industry stakeholders holding numerous discussions as to the validity of including ESG factors need to keep in mind that stewardship is key and affects a wider system of market regulation and supervision.

The Code is based on 12 principles for asset owners and asset managers ranging across key components of purpose and governance, investment approach, engagement, and exercising rights and responsibilities with six separate principles for service providers supporting them. These principles are to be applied concurrently with the UK Corporate Governance Code with a view of ensuring high quality reporting and accountability in investment and governance decisions are maintained. The Code makes recognition of the fact that signatories differ by size, type, business model and investment approach. Therefore, the reporting expectations do not require disclosure of stewardship activities on a fund-by-fund basis or for each investment strategy. This should not be construed to be some form of laxity by the code as it explicitly states that the information provided should be clear and offer a detailed outlook of their operations.

Steering from its predecessors where policy disclosures were at the forefront, outcome reporting is core to the Code as each principle is followed by an explicit indication for the need of disclosure of the outcome in its application by the signatories. The Code also not only focuses on listed equity and has encompassed a wider range of asset classes including but not limited to fixed income bonds, real estate and infrastructure. In 2022 the FRC saw an increase in reporting of asset classes outside of listed equity which is a show of organisational purpose and transparency.

Forging Ahead

The Kingman Review recommended the replacement of the FRC with a new independent regulator. Recent developments acted upon from the recommendation has seen the start of a transition process of the FRC to the Audit, Reporting and Governance Authority (ARGA) with the aim of maintaining both the Code and the corporate governance Code core as to how UK entities are run. Perhaps the review will be another publication of the code, as previous reviews have offered valuable insights towards the development of the code. 

Historical trends have provided an outlook where market falls have tended to happen around every five to ten years, although there lacks a definitive manner of predicting when these falls may happen or when they’ll rebound. The UK has recently faced the cost-of-living crisis, tightening of financial conditions as Russia’s invasion on Ukraine had a ripple effect to the global economy and an energy crisis, amid the lingering covid-19 recovery and threat of resurgence, all these coupled  have weighed heavily on its economic outlook. Considering these economic hardships and uncertainty, investor stewardship should be at the forefront towards the creation of a stable functioning market ensuring focus is directed towards the development of long-term sustainable organizational values in line with both economic and social needs. Organisations which embody the principles of the Code with an aim of demonstrating effective stewardship and governance foster trust key to the development of the economy.