Top 400: Towards a unified code of conduct
A universal code of conduct for asset managers will raise confidence among investors, argues Nitin Mehta
In the aftermath of the global financial crisis, the markets remain inhospitable to many investors for new allocations of capital, as new dimensions of risk seem to change and grow almost daily. Yet those who serve investors remain oddly passive in offering reasons for renewed faith and trust in markets and investing. Without proactive, substantive commitment from the professionals who navigate markets on clients' behalf, recovery of confidence in the integrity of markets is uncertain at best, and doomed to a plodding pace.
Even professional investors confess to considerable obstacles remaining in restoring investor confidence in the world's capital markets. Earlier this year, CFA Institute surveyed its membership of investment professionals globally, including 1,200 respondents in the EMEA region, who had a more pessimistic view of the prospects for improved integrity in capital markets relative to the global sample. The majority of those surveyed believed that the crisis would have an impact on market trust and confidence for at least three years.
Lack of confidence in the markets is especially troubling in difficult economic times. When things work as they should, capital markets align risks and returns and channel capital to the most promising ventures, and similarly serve a constructive purpose of diverting capital away from those companies with the most difficult prospects. When the capital markets suffer disfunction, as when investors lack confidence in market institutions and investor protections, this efficient capital allocation process suffers as well. The engines of restored economic vitality are thus potentially starved of the capital they need to grow, prosper, and contribute to economic vitality.
None of this is especially novel. Given the widespread economic pain suffered throughout the crisis, political responses have been both expected and welcomed. The European Commission's focus is on a number of directives addressing transparency and accountability issues. Despite these noble intentions, Europe's competitive posture in the capital markets, when coupled with the watering down of reform, still leaves issues to be addressed. The stakes are huge, and so despite occasional unease with the pace of reform (especially with regard to improving capabilities to detect and mitigate systemic risks), the very fact of any progress bolsters investors' willingness to take an optimistic view of a revamped financial system.
Already, UCITS IV, the revised Capital Requirements Directive (CRD), and the European Commission's green paper on corporate governance in financial institutions have addressed important issues underpinning fairness, transparency and prudent practices. Still ahead are a review of, and development of, implementing measures (so called level two measures) for the AIFM Directive, legislative proposals for packaged retail investment products (PRIPS), and another green paper on the corporate governance framework in the EU, as representative of the broad scope of inquiry and review.
There is no doubt, however, that the legislative and regulatory apparatus are key to effective reform, and the EU agenda clearly recognises the priority of improved financial architecture. Edelman, a global public relations firm, creates an annual ‘trust barometer' that assesses the degree of trust enjoyed by various institutions in society across the world. The good news is that governments in several European countries have seen an increase in survey respondents who say government "can be trusted to do what is right". The bad news is that even with improvement in 2011 relative to 2010, those who voice their belief in governments' good intentions are firmly in the minority.
So given a measured pace of government reform efforts and an apparent inclination among the public to be suspicious of governments' ability to do right, more is required to restore investor confidence. What better opportunity for those with responsibility for managing investors' capital to demonstrate that they understand that business as usual can't be accepted going forward, and to affirm that clients' interests are fundamental to their own business models and strategies. How can this be conveyed to investors credibly, going beyond marketing slogans to reflect real commitments to how business is done?
Over the years, many CFA Institute members urged us to consider ways to extend the commitments embodied in our code of ethics and standards of professional conduct beyond individual practitioners to include entire firms. The Asset Manager Code of Professional Conduct was developed with this in mind, reflecting ethical principles that could be applied by firms in ways that were appropriate to their circumstances while upholding commitment ethical conduct. A second edition of the asset manager code was published in 2010, and over 450 firms globally now claim compliance.
Several industry associations have also attempted to codify the behaviour of asset management firms for their members, and local regulators have also created similar standards. While well intentioned from the standpoint of fixing accountability for ethical conduct, the resulting patchwork of codes can be confusing to investors as they try to evaluate the substance behind the claim of compliance. Compliance with myriad codes can also impose unusual expense on investment managers, which may be reflected in end-investor costs.
The investment management industry is highly diverse, and as a result it is impossible to impose rules of conduct that adequately account for legitimate differences between firms. Depending on the asset class of specialty, size of the firm, legal organisation of the firm's products, target markets served, and markets invested in, different firms will have different yet equally acceptable procedures for assuring ethical conduct. With this in mind, we believe firmly that a successful code of conduct will specify universal principles that affirm clients' interests, and allow bespoke implementation of processes and procedures at each complying firm that are true to those principles.
A uniform standard by which investors may quickly discern a base level of commitment to ethical conduct, perhaps as an initial screening mechanism, would be a better approach. This would require ‘all or nothing' compliance with ethical principles, allowing for differences in implementation that reflect unique firm characteristics, and it would not preclude further investigation by investors as to how the principles are implemented. Indeed, we expect that a cottage industry of independent verification firms might arise to help investors, as has occurred in connection with verification of compliance with the global investment performance standards (GIPS).
The times call for codes of conduct to graduate beyond their traditional status as a necessary compliance evil. A ‘tick the box' mentality must give way to embedding commitment to ethical conduct as fundamental to firms' business strategy. Research commissioned by CFA Institute suggests that a firm majority of plan sponsors would be more likely to retain or hire firms that comply with a universal market standard that embrace high levels of professional and ethical conduct. Although we see advantages to the global recognition of the principles-based Asset Manager Code of Professional Conduct, it is most important that investment managers come together to agree on a universal code of conduct that raises the bar for professional conduct. Nothing less will convince investors of our determination to defend the integrity of capital markets.
Nitin Mehta is managing director, CFA Institute, Europe, Middle East and Africa.