In the last 12 months it has become de rigueur for asset managers to boast of their stewardship credentials, sometimes rewriting their histories to bolster their case. But the crunch time is coming for UK market participants, as on 31 March the first cohort of would-be signatories to the UK’s revised Stewardship Code must submit their applications for assessment.
The original Stewardship Code was criticised by Sir John Kingman in his December 2018 review of the Financial Reporting Council (FRC) as well-intentioned but “not effective in practice”. “If the Code remains simply a driver of boilerplate reporting, serious consideration should be given to its abolition,” he said.
Following a public consultation, to which we contributed, the FRC revised the Code, and from April it will begin assessing the submissions it receives, to determine who has made the grade. The aim is to more clearly differentiate between those who demonstrate excellence in stewardship and those that do not, by setting a more testing standard.
The revamped Code adopts a much wider and more ambitious definition of 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”. We were very supportive of such a definition in our contribution to the FRC’s revision of the Code.
There are 12 principles for asset managers and owners instead of the previous seven, with a much stronger focus on stewardship activities and their outcomes, not just policy statements. There are also new disclosure expectations regarding investment and stewardship integration, including material environmental, social and governance (ESG) issues. The new Code represents an opportunity for those firms that have embedded stewardship into their activities to demonstrate how their approach works in practice and the tangible outcomes they have achieved.
Sea change in reporting
The FRC’s feedback to the preliminary reporting submissions illustrated the challenge involved in satisfying all the requirements of the revised Code, as even some market participants with strong ESG credentials found this difficult. The Code expands stewardship across all asset classes and to investments outside the UK, with a change in approach from ‘comply or explain’ to ‘apply and explain’. This is a real sea change, requiring a completely different level of reporting to the old boilerplate responses of the past.
Finally, there are new principles for service providers, setting out expectations on the role they play in supporting their clients in meeting their own stewardship responsibilities. Given this, EOS at Federated Hermes has made its own application for the first time.
Stewardship has been central to what we do for many years, and we have well-documented processes, policies, and outcomes. In our engagements, we set objectives for companies related to the ESG concerns that we identify and track their progress through our proprietary milestone system. When companies implement a strategy or measures to address the concerns we raise, we document the outcomes through public case studies, articles, and other reporting. Independent academic research has shown that our engagement on ESG issues can benefit shareholders by reducing downside risk.
We hope that the revised Code’s challenging reporting requirements will now trigger a more fundamental change across the asset management industry. Given the significantly increased expectations in the Code for all participants in the investment chain, including asset owners, asset managers and service providers, we could see a more widespread embedding of stewardship across the industry.
As we argued in Stewardship: the 2020 vision, active stewardship is the investment management industry’s social licence to operate. However, a greater focus on the purpose of different entities in the investment chain, and their fiduciary role, is important. This should manifest in the contractual relationships between asset owners and asset managers, which should comprise expectations regarding stewardship activities. At the very least, the revised Code will lead to the more rigorous stewardship reporting that Sir John envisaged.
As we continue on this journey, we hope that would-be signatories will engage wholeheartedly with the spirit of the Code, helping to raise the bar for stewardship across the investment industry and acting as a beacon for other markets.