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The Engaged Investor: UK code, global practice

The UK Stewardship Code has inspired much discussion and activity overseas. However, Nina Röhrbein discovers significant obstacles to implementing something similar in other countries

When the UK Stewardship Code arrived on the investment scene in 2010, the rest of the world took note. The UK already had a Corporate Governance Code in place - formerly known as the Combined Code - but the new code was specifically aimed at institutional investors. Well received overseas, the question now is whether the UK's code will continue its triumph by conquering other countries and helping them to establish their own code - or perhaps even spur the development of an international governance code.

"A stewardship or corporate governance code is being actively discussed in a number of jurisdictions," says George Dallas, director, corporate governance at F&C Investments. "What has been done in the UK is being looked at for potential applicability into other jurisdictions."

The European Commission (EC) is already reviewing responses to its own green paper on corporate governance in financial institutions, and is expected to issue another green paper on corporate governance in other sectors in the first quarter of 2011. "One of the things that will probably be asked in this green paper is whether there is a case for a pan-European code or whether it should remain at member state or market level," says Frank Curtiss, head of corporate governance at Railpen Investments.

In today's market, there is a greater preference for global or regional as opposed to national equity products. As such, an international code to tackle active ownership as opposed to a series of national codes would probably be preferable. However, in practice there are too many barriers for one single code, such as different national cultures and social norms, board structures and pools of directors. Corporate governance codes are more likely to remain country-specific over the next five to seven years, says Emma Hunt, senior investment consultant at Towers Watson.

The UK Stewardship Code works on a comply-or-explain basis; institutional investors can either adhere to the code or explain their non-compliance. This approach is not a natural one in other jurisdictions, meaning there would have to be a big cultural shift to adopt it.

"Comply-or-explain is a very British approach and may work well in countries with a similar legal tradition to that of the UK, such as Australia. But it does not work in every jurisdiction, particularly in rules-based ones like the US and like-minded European countries," explains Curtiss.

"The UK is very keen on principles and the underlying spirit - that is why we have a tradition of soft law and voluntary codes. In recent years, Europe has tended to embrace this type of approach but there are voices in the EC that are not entirely satisfied that this is an adequate defender of the public interest. Their answer is to have more prescriptive rules. So what may emerge in Europe is, in part, a result of these forces. The challenge is to show that stewardship codes with the right mix of outright regulation and voluntary compliance can work, while taking into account different approaches. That is why I favour a market-by-market approach rather than a one-size-fits-all global code. Especially for cross-border investors like us, a good system would imply mutual recognition and harmonisation between codes."

The factor underpinning the UK Stewardship Code is that domestic institutional shareholders are dominant in its market, even though their significance is fading in favour of foreign shareholders, says to Simon Wong, partner at Governance for Owners. "This is not the case in Europe. Any development in this area needs to recognise differences in shareholding," he says. "Those make it difficult to have a one-size-fits-all pan-European code, at least in the short term, as domestic institutional shareholders may have a lesser impact in the respective markets."

On the continent, ownership tends to be relatively more concentrated than in the US or the UK. Therefore the idea of stewardship needs to take on board not only the issue of engagement with companies in relevant areas but also be conscious of the fact that there might be a significant controlling shareholder.

"If there is concentrated ownership, which often is the case in, for example in Italy, it can be more challenging for minority shareholders to make themselves heard," says Dallas. "A continental European version of the UK Stewardship Code would have to take that into consideration."

But others, like Colin Melvin, CEO at Hermes Equity Ownership Services (EOS), believe there are significant benefits in extending to other countries the UK Stewardship Code. "It will be of most relevance in markets with a strong financial services or pension fund industry, such as the Netherlands and the Nordics, but also in markets where large insurance companies provide pensions or pension-like products," he says.

"It may require some adaptation to local conditions but an approach like this is suitable and indeed essential in all markets. It is not about the precise wording of a code - it is about improving investors' corporate behaviour. A stewardship code promotes responsible investment, more accountable public companies and strong capital markets, while reducing the need for costly regulation."

One of the dangers of an international code is that it could go down to the lowest common denominator because different jurisdictions would not be able to agree on what it should or should not include. Another danger is that a code could easily turn corporate governance into a box-ticking exercise. The UK Stewardship Code has tried to avoid that by focusing on engagement instead of just voting.

"The Stewardship Code is a good idea, but we need to avoid certain unintended consequences of its introduction," says Melvin. "For example, several years ago the US introduced a law that requires funds to vote their shares. This led to unthinking voting in favour of management in all cases, as the fund managers to whom this was delegated decided it would be sufficient just to take a box-ticking-type compliance approach, employ a low-level voting service and not attend properly to the voting. The ones that were thinking about the votes and engagement with companies found their influence diluted by the unthinking voting - so the unintended consequence was actually poorer rather than better stewardship. To address this problem long-term investors need to be willing to act collectively. If they share resources they will have a sufficient number of high-quality conversations or engagements, which is good stewardship."

Anita Skipper, corporate governance director at Aviva Investors, agrees. "It takes time to vote and engage on every single stock investors hold," she says. "Therefore institutions will most certainly establish a priority system within their own organisation on engaging, for example, with the five companies that are most likely to gain the best returns from stewardship. That means, though, the other companies will not get the same level of attention."

Another challenge to governance codes is the disappearance of buy-to-hold. The insurance companies and pension funds that until recently held almost half of all UK market capitalisation now hold 13% each, Skipper observes.

"Not only do we have more short-term investors now, we also have exchange-traded funds and other derivative-type holdings, which takes the economic interest away from the traditional long-term shareholders," she says. "That is why the UK Stewardship Code tries to encourage foreign shareholders who represent a huge percentage of shareholders in UK companies to commit themselves to being good stewards as well."
 

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