By Guy Jubb, CA, who is an Honorary Professor at the University of Edinburgh, Vice Chair of the European Corporate Governance Institute, and an Independent Non-Executive of Mazars LLP. He was formerly Global Head of Governance & Stewardship at Standard Life Investments.
Charles Darwin wrote,
the species that survives is the one that is able best to adapt and adjust to the changing environment in which it finds itself”.
The Changing Landscape
Despite an emerging anti-ESG lobby, especially in the United States, ESG is here to stay – and rightly so. What was once a cottage industry has now become a global movement that no company can or should ignore. However, the ESG marketplace has become very noisy. It has spawned a spectrum of reporting and engagement initiatives which are sometimes weaving a counterproductive tapestry, both in terms of achieving investor impact and enabling companies to pursue attractive market opportunities.
International Sustainability Reporting Standards (ISRS) will be an important ingredient to help restore order to chaos and reduce duplication when reporting on climate and other environmental issues. Its first two standards are due to be published by the end of June 2023.
Also, from 1990 to 2020 UK pension fund and insurance company ownership fell from 52% to a little over 4%, and international ownership has increased from 12% to 56%. These remarkable changes have had profound and irreversible implications for engagement and voting.
International ownership has increased from
12% to 56%
The Art of Engagement
The cacophony of the ESG choir can sometimes send mixed messages to boards. It has never been easy for boards to reconcile the views of different investors and it certainly isn’t getting any easier.
ESG priorities, net zero transitioning timescales, and the role of ESG targets in remuneration are just the tip of the iceberg when it comes to the issues on which investors engage. Their views on specific subjects will almost certainly not be aligned. This is compounded by many front-line investor engagement executives having entered the investment world through non-traditional channels, which can sometimes limit their ability to engage holistically in discussions about sustainable value creation and preservation.
The engagement landscape will become more confused as moves to give voting empowerment to retail investors in collective investment and similar vehicles gathers momentum. It is an irreversible trend, especially as self-acclaimed voting technology experts, such as Tumelo, roll out innovative products and platforms that give power to the people.
Leading investment managers and their advisors are signing up and showing serious interest. That said, it remains to be seen how many retail investors will take up their voting rights and thereby dilute the voice of institutional investors. It is still early days, but the legal, regulatory, and voting implications are significant for all involved in the stewardship chain.
Diversity and inclusion policies, which are a justifiable priority for many investors, are an important example of how a board can meet investor governance criteria and look great on paper but may fail badly in falling short in appointing the best people to fill the skills requirements.
Chairs are pushing back and becoming more vocal themselves about the challenges they face. In Tulchan’s insightful State of Stewardship Report, published in November 2022, chairs warned that relations with their institutional investors have deteriorated markedly, with “box-ticking” exercises over stewardship now risking company growth. Their concerns should not be brushed under the carpet. Otherwise, they will fester and, with justification, be increasingly cited as a major contributory factor to the decline in the number of UK listed companies.
These concerns were alluded to by the Investor Forum in its 2022 Annual Review. Andy Griffiths, the Forum’s Executive Director, reminded readers that
shareholders and companies can create a powerful reinforcing virtuous circle when they work in tandem to generate outcomes that benefits all stakeholders’.
Perhaps this is not surprising. As of February 2023, there were 254 signatories to the 2020 UK Stewardship Code, which is an increase of 102% over the 125 initial signatories to the Code in September 2021. And individual fund managers are increasing the number of their engagements – for example, in 2022 AXA IM increased its number of global engagements by 111% to 596. With engagement lying at the heart of the UK Stewardship Code’s principles it is small wonder that company chairs are frustrated.
As of February 2023, there were
to the 2020 UK Stewardship Code
In May 2022, the UK Government, in its paper ‘Restoring trust in audit and corporate governance’ confirmed that the FRC, working with the FCA and others, ‘will carry out a review of the regulatory framework for effective stewardship including the operation of the [UK Stewardship] Code’. It was its expectation that this review would be undertaken in 2023. Such a review cannot come soon enough, and it is vital that the quality of investor stewardship - not its quantum - and the effectiveness of stewardship engagement is prioritised within its scope.
Solutions are needed and it behoves the FRC or an organisation of similar standing to convene business and investment leaders to develop authoritative ESG engagement guidelines to help address the current shortcomings and frustrations on both sides. It should be a win-win result, enabling not only more effective, impactful, and constructive engagement but also improved engagement productivity for investors, which may marginally help alleviate the cost pressures many of them are facing.
In any event, engagement is an art not a science, and creative solutions are required to restore and maintain a responsible equilibrium. The status quo is neither sustainable nor desirable.
Are AGMs Fit for Purpose?
AGMs lie at the heart of corporate accountability. They provide a forum for shareholder voting and engagement but little of substance has changed for decades. That said, institutional investors, spurred on by stewardship codes, have steadily raised their game, and most are now voting by proxy at AGMs and other shareholder meetings on a more regular and consistent basis than previously.
However, it remains the case – and always will be – that, voting against the board is a blunt instrument unless it is accompanied by robust and effective engagement, which preferably focuses on solutions to the perceived problems rather than just rendering a binary judgement on the resolution.
Therefore, it is both surprising and concerning how infrequently institutional shareholders find the time and courage to turn up in person to AGMs. They miss out on the opportunity to explain directly to the whole board the reasons for their voting decisions and thereby to not only hold the directors to account but also be seen to be good stewards.
In 2021 ShareAction published a thought leadership paper about AGMs. It set out a bold new vision for the purpose of the AGM of the future. I co-chaired the working group whose deliberations informed the report. The paper highlighted that the AGM has failed to adapt to the changing face of capitalism and shifts in societal values.
ShareAction pinpointed that the AGM of today has lost its sense of purpose. Its proposed new purpose of the AGM of the future is to provide a forum for stakeholders, companies and shareholders to engage in transparent, accountable communication, which crystallises how a company’s board is fulfilling its organisational purpose and its directors in meeting their section 172 responsibilities. After all, that is what they are paid to do, albeit that enforceability of their responsibilities, especially in egregious cases, remains elusive.
Although most boards preach the virtues and benefits of inclusivity and diversity, it is deeply disappointing that very few go out of their way to formally embrace their stakeholders into their AGM processes. Done properly, this would enable shareholders to make much better-informed voting decisions. Also, it would give non-executive directors the opportunity to hear at first hand the views of the company’s stakeholders, whose interests they have a legal obligation to have regard for, rather than just through the rose-tinted prism of the CEO.
ShareAction’s other recommendations included:
a series of meetings with stakeholders throughout the year, an online Q&A provided in advance of the AGM to address clarificatory questions and equip participants for a nuanced discussion at the AGM event itself and, critically, that the annual shareholder vote be separated from the AGM itself and take place only after the minutes of the stakeholder meetings are published;
institutional investors having robust and transparent AGM attendance policies to govern their attendance at and participation in the AGMs of their investee companies. To provide transparency and accountability they would publish the names of the companies whose AGMs they attended, and provide an account of their participation; and
giving all shareholders the opportunity to assess company performance in advance of voting by providing that voting on resolutions happens after the AGM, rather than taking place in the run up to the AGM and on the day. This would give shareholders an improved opportunity to gauge stakeholder views, as well as board responses to them.
The UK continues to be seen as a global leader in corporate governance, but it cannot rest on its laurels. It must adapt to the changing environment in respect of both responsible capitalism and the need for capital markets to be attractive and competitive for both companies and investors. As well as being important to enabling economic growth and the sustainability of London as a major global financial centre, the relative decline in the rankings of the UK capital markets, and in the significance of UK equities, which are arguably no longer an asset class of their own, means that UK corporate governance and stewardship codes are becoming proportionally less relevant for global investors.
In this regard, the codes and the diverse range of ESG initiatives, especially relating to corporate reporting, are a heavy burden to many boards, which is compounded by a shareholder and stakeholder engagement environment that can sometimes be fractious and fickle. An enlightened approach by regulators and leading investors which champions the flexible application of code principles rather than compliance with code provisions would be an important step in the right direction. Bringing sustainable value creation and preservation explicitly into the purpose of such an approach would help to unlock long-term principles-based prosperity.
If and when the procrastination is over, ARGA will be a powerful and potent regulator. The FRC is doing a good job in preparing the way but the inherent uncertainties about how ARGA will operate and what powers it will have is not conducive to attracting and retaining issuers to the London market.
The UK Companies Act needs to be refreshed, not least to embed the changes in social attitudes and the benefits of technological changes over the last twenty years. This will take time and careful consideration by all concerned but this is no excuse. Establishing an independent Corporate Governance and Stewardship Commission deserves consideration to help solve problems without interference from politicians or other interested parties.
If the UK fails to adapt its corporate governance and investor stewardship regimes in a way that enables them to be responsive to the constantly changing ESG and capital market environments, then it risks undermining the spirit of entrepreneurship and losing its corporate governance crown. The public interest and the pursuit of responsible capitalism require the nettle to be grasped with a sense of purposeful urgency.