Key takeouts

• Following consultation, the UK Financial Reporting Council (FRC) published a revised stewardship code: UK Stewardship Code 2020 (Code) and feedback statement. The Code was last revised in 2012.
• Changes? The FRC says that the '2020 Code sets a much higher standard and marks a substantial shift away from boilerplate policy statements, towards a focus on activities (what investors did) and outcomes (what was the result)'. In addition, the new Code has a strong focus on delivery, by signatories, of sustainable long term investment.  

Some key changes to note:

1. Redefinition of stewardship: 'Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society'.
2. Signatories are required to explain their organisation's purpose, investment beliefs, strategy and culture and how these enable them to practice stewardship. They are also expected to show how they are demonstrating this commitment through appropriate governance, resourcing and staff incentives  
3. New outcomes focus: signatories are required to report annually on what they have done and what the outcome was, rather than on the generally policy.
4. Expectation that signatories consider environmental, social and governance (ESG) issues (including climate change) in their investment, monitoring, engagement and voting.
5. Signatories are now expected to explain how they have exercised stewardship across asset classes other than listed equity, such as fixed income, private equity and infrastructure, and in investments outside the UK.
6. Extension to asset owners and service providers (eg pension funds and insurance companies, and service providers)

Support for the changes? The FRC says that there was 'strong support' for the key proposals including: a) a focus on reporting activities and outcomes; b) the inclusion of how signatories' purpose and culture support stewardship; c) the extension of scope to asset classes beyond UK listed equity; d) a code that sets expectations for different entities in the investment chain; and e) integration of ESG issues.

The Code remains voluntary but the WSJ suggests that the requirement for asset managers to provide additional explanations if they don't follow the Code is likely to operate as an incentive to do so.

Timing? The new Code takes effect on 1 January 2020.  Signatories are required to report annually on their stewardship activity.  To be included in the first list of signatories, organisations must submit a final report, in line with the FRC's reporting expectations, to the FRC by 31 March 2021.

Revised Stewardship Code released

Following consultation, the UK Financial Reporting Council (FRC) has released a revised Stewardship Code (Code). 

Announcing the release of the Code, the FRC said that it 'builds on the success of the previous Code, but sets a substantially higher standard, reflecting the changing expectations of investors and the significant developments in sustainable and responsible investment and stewardship since the Code was last revised in 2012'. The FRC's Chair, Simon Dingemans said the new Code 'marks a step-change in the expectations for investors, their advisors, and how they manage investments for their savers and pensioners'. 

Some Key changes

Expanded focus/application

The 2012 was primarily directed to institutional investors (asset owners and asset managers) with equity holdings in UK listed companies. The revised 2020 Code is explicitly directed at asset owners and managers and at service providers with separate principles for each group.

Signatories are also now expected to explain how they have exercised stewardship across asset classes beyond listed equity, such as fixed income, private equity and infrastructure, and in investments outside the UK.

Reporting: Shift away from 'boilerplate' reporting — 'show me' don't tell me

Signatories to the 2012 Code were required to publish a statement (policy statement) describing how they applied each of the seven principles and where one or more principles were not applied, an explanation as to why. The 2012 Code provided that signatories were 'encouraged' to review policy statements annually and to update them where necessary to reflect changes in actual practice.

One of the recommendations made by the Kingman Review (Recommendation 42) was that a revised code 'should focus on outcomes and effectiveness, not on policy statements…If the Code remains simply a driver of boilerplate reporting, serious consideration should be given to its abolition.'

The 2020 Code requires signatories to report annually on stewardship activities and its outcomes (every principle has reporting requirements under the headings activity and outcome). The FRC explains that under the 2020 Code 'signatories reports are required to "show" what has actually been done in the previous year, and what the outcome was, including their engagement with the assets they invest in, their voting records and how they have protected and enhanced the value of their investments' rather than just their general policy'.

As such, The FRC said that the changes directly addresses the issues raised by the Kingman review.

Focus on supporting long-term, sustainable value and a new requirement to factor ESG issues into investment decisions

The 2020 Code has a strong focus on establishing 'a clear benchmark for stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society'.

In addition, signatories are expected to take environmental, social and governance factors, including climate change, into account and to ensure their investment decisions are aligned with the needs of their clients.

Further detail: An overall shift in scope

The 2012 Code included seven principles. Namely:

1. Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities
2. Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship which should be publicly disclosed.
3. Institutional investors should monitor their investee companies
4. Institutional investors should establish clear guidelines on when and how they will escalate their stewardship activities.
5. Institutional investors should be willing to act collectively with other investors where appropriate.
6. Institutional investors should have a clear policy on voting and disclosure of voting activity

Institutional investors should report periodically on their stewardship and voting activities.

The 2020 Code includes two sets of principles, one set for asset owners/asset managers (12 Principles) and a separate set (6 Principles) for service providers (eg investment consultants, proxy advisors, and data and research providers).  The principles themselves have been substantially changed.

Overview of new requirements: 12 principles/reporting requirements for asset owners

Principle 1 Signatories' purpose, investment beliefs, strategy, and culture enable stewardship that creates longterm value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society: Signatories are required to explain both the purpose of the organisation and to give an outline of its culture, values, business model and strategy as well as their investment beliefs, ie what factors they consider important for desired investment outcomes and why.  In addition, the Code requires signatories to explain the actions they have taken to ensure their investment beliefs, strategy and culture enable effective stewardship.   Ultimately, signatories' disclosure should make clear how their purpose and investment beliefs have guided their stewardship, investment strategy and decision-making and include an assessment of how effective they have been in serving the best interests of clients and beneficiaries.

Principle 2 Signatories' governance, resources and incentives support stewardship: Signatories should explain how: 1) their governance structures and processes have enabled oversight and accountability for effective stewardship within their organisation and the rationale for their chosen approach; and 2) they have appropriately resourced stewardship activities including a) their chosen organisational and workforce structures; b) their seniority, experience, qualifications, training and diversity; c) their investment in systems, processes, research and analysis; d) the extent to which service providers were used and the services they provided; and e) performance management or reward programs have incentivised the workforce to integrate stewardship and investment decision making.  Signatories should disclose both how effective their chosen governance structures and processes have been in supporting stewardship and how they may be improved.

Principle 3 Signatories manage conflicts of interest to put the best interests of clients and beneficiaries first: Signatories should both: a) disclose their conflicts policy and how this has been applied to stewardship; and b) explain how they have identified and managed any instances of actual or potential conflicts related to stewardship.  Disclosure should include examples of how they have addressed actual or potential conflicts.

Principle 4 Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system: Signatories should explain: a) how they have identified and responded to market-wide and systemic risk(s), as appropriate; b) how they have worked with other stakeholders to promote continued improvement of the functioning of financial markets; c) the role they played in any relevant industry initiatives in which they have participated, the extent of their contribution and an assessment of their effectiveness, with examples; and d) how they have aligned their investments accordingly.   Disclosure should include an assessment of their effectiveness in identifying and responding to market-wide and systemic risks and promoting well-functioning financial markets.

Principle 5 Signatories review their policies, assure their processes and assess the effectiveness of their activities: Signatories should explain: a) how they have reviewed their policies to ensure they enable effective stewardship; b) what internal or external assurance they have received in relation to stewardship (undertaken directly or on their behalf) and the rationale for their chosen approach; and c) how they have ensured their stewardship reporting is fair, balanced and understandable.  In addition, the Code requires signatories to explain how their review and assurance has led to the continuous improvement of stewardship policies and processes.  The Code says that internal assurance may be by given by senior staff, a designated body, board, committee, or internal audit and external assurance by an independent third party.

Principle 6 Signatories take account of client and beneficiary needs and communicate the activities and outcomes of their stewardship and investment to them: Signatories should explain either:

• how they have evaluated the effectiveness of their chosen methods to understand the needs of clients and/or beneficiaries; and how they have taken account of the views of beneficiaries where sought, and what actions they have taken as a result; OR
• how they have taken account of the views of clients and what actions they have taken as a result; and where their managers have not followed their stewardship and investment policies, and the reason for this; OR
• where they have not managed assets in alignment with their clients' stewardship and investment policies, and the reason for this

Principle 7 Signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities: The revised Code requires that signatories explain how information gathered through stewardship has informed acquisition, monitoring and exit decisions, either directly or on their behalf, and with reference to how they have best served clients and/or beneficiaries.

Principle 8 Signatories monitor and hold to account managers and/or service providers: Signatories should explain: a) how the services have been delivered to meet their needs; OR  the action they have taken where signatories' expectations of their managers and/or service providers have not been met.  The revised Code gives as an example (among others) that asset managers monitoring data and research providers should ensure the quality and accuracy of their products and services.

Principle 9 Signatories engage with issuers to maintain or enhance the value of assets: Signatories should describe the outcomes of engagement that is ongoing or has concluded in the preceding 12 months, undertaken directly or by others on their behalf.  The Code includes a number of examples including (among others): how outcomes of engagement have informed investment decisions (buy, sell, hold); and how outcomes of engagement have informed escalation.

Principle 10 Signatories, where necessary, participate in collaborative engagement to influence issuers directly or by others on their behalf: Signatories should describe the outcomes of collaborative engagement.  For example: a) any action or change(s) made by the issuer(s); b) how outcomes of engagement have informed investment decisions (buy, sell, hold); and c) whether their stated objectives have been met.

Principle 11 Signatories, where necessary, escalate stewardship activities to influence issuers: Signatories should describe the outcomes of escalation either undertaken directly or by others on their behalf.  Including (for example): any action or change(s) made by the issuer(s); any action or change(s) made by the issuer(s); any action or change(s) made by the issuer(s); and any changes in engagement approach.

Principle 12 Signatories actively exercise their rights and responsibilities: For listed equity assets, signatories should provide examples of the outcomes of resolutions they have voted on over the past 12 months.

Overview: Six principles/reporting requirements for service providers

The six principles (and accompanying reporting requirements) for service providers are as follows:

Principle 1 Signatories' purpose, strategy and culture enable them to promote effective stewardship: The Code requires signatories to disclose an assessment of how effective they have been in serving the best interests of clients.

Principle 2 Signatories' governance, workforce, resources and incentives enable them to promote effective stewardship: Signatories should disclose both: a) how effective their chosen governance structures and processes have been in supporting their clients stewardship; and b) how they may be improved.

Principle 3 Signatories identify and manage conflicts of interest and put the best interests of clients first: The Code requires that signatories disclose examples of how they have addressed actual or potential conflicts.  The Code states that conflicts may arise from (but are not limited to): ownership structure, business relationships, cross directorships and client interests diverging from each other.

Principle 4 Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system: The Code requires signatories to disclose the extent of their contribution and an assessment of their effectiveness in identifying and responding to systemic risks and promoting well-functioning financial markets.  

Principle 5 Signatories support clients' integration of stewardship and investment, taking into account, material environmental, social and governance issues, and communicating what activities they have undertaken: The Code requires signatories to explain: a)  how they have taken account of clients' views and feedback in the provision of their services; and b) the effectiveness of their chosen methods for communicating with clients and understanding their needs, and how they evaluated their effectiveness.

Principle 6 Signatories review their policies and assure their processes: The Code requires that signatories explain how the feedback from their review and assurance has led to continuous improvement of stewardship practices.

Broad support for the changes?

The feedback statement released with the 2020 Code, states that there was overall 'strong support' for the key proposals including: a) a focus on reporting activities and outcomes; b) the inclusion of how signatories' purpose and culture support stewardship; c) the extension of scope to asset classes beyond UK listed equity; d) a code that sets expectations for different entities in the investment chain; and e) integration of ESG issues. 

Why sign up?

The Code remains voluntary.  The FRC's CEO, Sir Jon Thompson encouraged 'institutional investors, asset managers and their service providers to sign up to the new Code and demonstrate that they are operating across their businesses to these high standards of Stewardship.'  

He added that the FRC 'will be holding signatories to account by regular review of adoption of the new Code and the quality of the reporting against its principles. Asset owners and beneficiaries will then be able to see if those investing on their behalf are doing so in accordance with their needs and views. They will also be able to see the impact of their managers decisions, particularly in relation to environmental, social and governance issues, including climate change.'

May meet other requirements? The FRC notes that 'signatories may choose to use their Report to meet the requirements of the Code and disclose information to meet other stewardship-related UK regulatory requirements or stewardship Codes.'  The WSJ suggests that this may act as an incentive to reporting against the Code.

[Note: Pages 30-32 of the Code outlines the regulations/rules that signatories may satisfy by reporting against the Code.] 

Transition arrangements

The FRC says that it will accept applications to the UK Stewardship Code 2012 until 31 December 2019. Organisations will remain signatories to the UK Stewardship Code until the first list of signatories to the 2020 Code is published. 

To be included in the first list of signatories, organisations must submit a final report to the FRC, meeting the FRC's reporting expectations,  by 31 March 2021

[Note: As part of its broader response to the Financial Services Royal Commission, The Australian Council of Superannuation Investors (ACSI) released a policy paper outlining two proposals to strengthen investment stewardship in line with global best practice and in line with growing ESG expectations.  ACSI called for two changes: 1) explicit regulatory recognition (by APRA) of the importance of ESG issues in the formulation of investment strategies; and 2) a review of the regulatory framework for stewardship (including consideration of: the appropriate minimum standards and reporting, the regulatory framework and a stewardship code for institutional investors).  A summary of ACSI's proposals

[Note: The Australian Council of Superannuation Investors (ACSI) has released The Australian Asset Owner Stewardship Code (the Code) on 17 May 2018.  The voluntary Code is open to all asset owners (including super funds, endowments and sovereign wealth funds), not just ACSI members.