EUROPE - Asset managers must be compensated for the cost of engagement, or they must be compelled to engage with companies through the Stewardship Code or the demands of their beneficiaries and trustees, according to John Kay, chairman of the UK's Kay Review.

Speaking at the UK Sustainable and Finance Association's Kay Review Interim Report presentation hosted by FTSE last week, Kay said: "The truth is that things people are obliged to engage in are rarely things to which they can devote a great deal of resource, and they are rarely things that are done particularly effectively or particularly well.

"We can only fully answer this problem when we move to a world in which engagement with companies is not something that is a cost […] but a benefit to asset managers."

This, according to Kay, would require a world with more long-term holdings and more concentrated portfolios holding fewer stocks.

In turn, it also requires an equity market that puts more emphasis on investors - whose primary concerns are underlying dividend earnings and the cash flows of the companies they invest in - and less emphasis on traders, whose primary concerns are price movements, price restraint, arbitrage and momentum.

"Now there is a role for both traders and investors in equity markets," Kay said. "We need to have traders in order to provide a degree of liquidity. [But] perhaps today we live in a world where there is rather too much trading and not enough investing in the way in which the asset manager activity is conducted."

Speaking at the same event, Mark Makepeace, chief executive at FTSE Group, said that while the UK's 'comply or explain' regime generally found a lot of support among investors, it required institutional investors as shareholders to influence and promote good stewardship.

He also said that, at times, it felt that institutional investors were expected to do far more than could be reasonably expected of them.

"Where we struggle with the comply-or-explain approach is where we find controlling shareholders or a large controlling shareholder," he added.

This is a particular issue in companies that are included in indices.

To ensure a minimum corporate governance standard and the ability of shareholders to influence companies in its UK indices, FTSE requires a minimum 50% freefloat of the companies, higher than the 25% required by the regulator.

"So while we strongly support the comply-or-explain regime," Makepeace said, "we would certainly like to see regulators and government agencies setting standards and policing the market where there are controlling shareholders.

"We would [also] like to see further commitment [from passive investors] to engage with companies to improve corporate governance because, after all, those passive holders are large holders across the UK market, and active engagement with companies would raise the standards for the whole of the market for the benefit of all investors.

"Active investors who are making short-term investments also have a role in the market and can improve inefficiencies that exist. We should be careful not to over-criticise some of these players, as they have a role to play within the whole system."

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