Corporate governance processes of institutional investors have come under the spotlight with the publication of two UK reviews. The Walker Review and the Financial Reporting Council's (FRC) review of the UK Combined Code encourage greater shareholder engagement through a proposed Stewardship Code. But what impact will they have on pension funds?
The Stewardship Code, based on principles developed by the Institutional Shareholder Committee (ISC), will address issues such as monitoring investee companies and voting policies. It is envisaged the FRC will oversee the implementation of the code, on a ‘comply or explain' basis.
Jane Goodland, senior investment consultant at Watson Wyatt, said: "What is clear is that the regulators would like more shareholder engagement, but they can't mandate institutional investors to be more engaged. It is probably quite difficult to be prescriptive, as the style of some asset managers means they can't take that approach. But it is clear there is a drive and an ambition for investors to be more engaged."
She says a greater focus on ‘comply or explain' suggests pension funds are expected to make a clearer statement on how they apply the code: "It is about more transparency and disclosure. That is likely to stimulate pension funds to reflect on existing processes and how they monitor and operate now".
Simon Wong, managing director at Governance for Owners, added that greater transparency of fund managers means the asset owner has a greater responsibility to monitor this. Two questions raised by the reviews are how to achieve this and how asset owners can encourage managers to think longer term.
Wong argued that while some pension funds are "quite thorough" in their monitoring of asset managers, others adopt a more perfunctory approach, simply asking about compliance with the existing ISC principles and not going into further detail.
"Monitoring is an important task, so that means the schemes themselves have to either bolster their capabilities or build economies of scale. It is a question whether industry bodies can fill some of that role or whether they will need third party advisers. Collective-type activities make sense, but there doesn't seem to be an existing solution or anyone to service it," said Wong.
But while Goodland suggested that there might be a trend in the future towards outsourcing to one provider for a "coherent approach to shareholder engagement", Wong suggested that pension funds do not necessarily need to move away from fund managers in terms of voting, "but they need more scrutiny".
He said: "Particularly for smaller schemes, it is not necessarily economical to undertake voting and engagement in-house. Fund managers can provide scale, but you need a disciplinary force to ensure they allocate the right level of resources to this task."
Part of this disciplinary force could include focusing on the investment mandate and incentives offered to managers to encourage them to develop a long-term approach rather than focusing on quarterly performance. Wong pointed out that if managers are incentivised for the short-term - through fee structures or turnover in a portfolio - then "there is a mis-match with the long-term aim of the pension fund".
Daniel Summerfield, co-head of responsible investment at Universities Superannuation Scheme (USS), agreed the fund management industry needs to "up its game", and suggested Walker's recommendations "strike a delicate balance, between being overly prescriptive and allowing for appropriate flexibility".
However, he highlighted, the key issue will be the degree of information investors such as pension funds and fund managers will have to provide to the FRC, and how the Council will assess it against the principles.
"We want to see an integrated approach towards engagement encouraged where corporate governance is integrated more effectively into the investment management process, and for investors to report on how this is implemented in practice."
Because the industry wants to avoid prescriptive regulations that could encourage "boilerplate statements and box ticking", Summerfield warned that it will be up to shareholders and boards to respond "positively and constructively" to the proposals and for investors to demonstrate they can be effective in engagement without regulators needing to "interfere in this area".
For example, this could include more detailed information on director candidates' skills and competencies, and for investors to prioritise engagements on important and substantive issues. "We would suggest the quality rather than quantity of engagements should be the key focus for shareholders," added Summerfield.