On 24 October the FRC published the 2020 Stewardship Code (the "2020 Code"), that takes effect from 1 January 2020. The 2020 Code comprises a set of "apply and explain" Principles, as follows:
- 12 Principles aimed at: (i) asset managers (i.e. those who have day-to-day responsibility for managing assets e.g., BlackRock); and (ii) asset owners (i.e. institutional investors responsible for protecting and enhancing assets on behalf of beneficiaries e.g, occupational pension schemes); and
- 6 Principles aimed at service providers (i.e. organisations that do not manage investments directly but play a key role in providing services that enable clients to deliver quality stewardship, including, but not limited to, investment consultants, proxy advisors and data and research providers).
Each of the Principles is supported by reporting expectations that indicate the information that the FRC expects should be publicly reported in order for a relevant organisation to become a signatory. Organisations must submit their first Stewardship Reports based on the 2020 Code by 31 March 2021, following which the FRC will publish a list of the first 2020 Code signatories in the third quarter of 2021.
While the 2020 Code is not directly aimed at listed companies, it may, nevertheless, prove to be a significant development for them. Key changes to be aware of include:
- the Code now requires asset managers and asset owners to report on their specific stewardship activities and outcomes over a period of 12 months, rather than just focussing on reporting on stewardship policies;1
- for listed equity assets, the Code requires signatories to provide much more granular information about their voting decision-making process and history, including disclosing: (i) their voting policy, including any house policies and the extent to which funds set their own policies; (ii) the extent to which they use default recommendations of proxy advisors; (iii) the extent to which clients may override a house policy; (iv) their policy on allowing clients to direct voting in segregated and pooled accounts; and (v) the approach they take to stock lending, recalling lent stock for voting and how they seek to mitigate "empty voting", and providing a link to their voting records (including votes withheld) and stating their rationale for voting decisions;2
- it coincides with the new requirement for proxy advisors to publicly disclose a code of conduct they adhere to and explain how they have followed it (and many may choose the 2020 Stewardship Code), or explain why they are not following a code of conduct;3 and
- in parallel with the current focus on listed companies providing further information on material environmental, social and governance (ESG) issues that impact their business, it requires signatories to take account of material ESG factors, including climate change, when fulfilling their stewardship responsibilities.4
The introduction of the 2020 Code is therefore an opportunity for listed companies to:
- revisit established engagement methods with institutional investors, and seek further / different engagement with such investors, where this is deemed desirable, even where previous attempts to engage have been unsuccessful, or only partially successful;
- consider the disclosure requirements under Principles 9 to 12 of the 2020 Code ahead of engaging with institutional investors. Consider how such investors might report on the engagement in accordance with the 2020 Code. Is there anything that the company would be willing to do that might help the institutional investor in drafting compelling disclosure?
- revisit engagement procedures with relevant proxy advisors, particularly in the lead up to the 2020 AGM as they may be more willing to engage than they have been in the past; and
- review and, if necessary, improve ESG disclosures in order make it easier for investors to understand the material ESG issues relevant to the company. If not already doing so, consider whether to start reporting in compliance with the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD) Recommendations and take a look at the Financial Reporting Lab's Report on Climate-related Corporate Reporting (published in October 2019).
The Stewardship Code - a quick recap of how we got here
Following the 2009 Walker Review recommendations, the FRC took responsibility for a statement of best practice in stewardship for institutional investors and fund managers, alongside its responsibilities for the UK Corporate Governance Code. Inspired by the Institutional Shareholders Committee's Code that dated back to 2002, the FRC published its first Stewardship Code in 2010. The aim was for its status to be akin to the Corporate Governance Code, with institutional investors and fund managers adhering to it on a "comply or explain" basis. The Kay Review made certain recommendations for changes to the Code in 2012, following which the 2012 Stewardship Code was published. The Stewardship Code and its effectiveness came into the spotlight again when the FRC was consulting on amendments to the Corporate Governance Code between 2017 and 2018. The Kingman Review, published in December 2018, described the 2012 Code as "a major and well-intentioned intervention" but "not effective in practice". It called for a fundamental shift in approach so that the Code focused on outcomes and effectiveness, not on policy statements, and if that could not be achieved, serious consideration should be given to its abolition. Following on from that, in January 2019, the FRC launched a consultation on proposed amendments to the 2012 Code and the FRC and FCA published a joint discussion paper ("Building a Regulatory Framework for Stewardship" (DP19/1)), that called for input on how best to encourage the institutional investment community to engage more actively in stewardship of the assets in which they invest.
Who does the Stewardship Code apply to?
The Stewardship Code is voluntary, save that, since December 2010, FCA authorised asset managers have been required (under the FCA’s Conduct of Business Rules) to disclose whether, and if so how, they comply with it.5 Many asset owners and service providers have, nevertheless, voluntarily become signatories to the Stewardship Code. In part, this is because voluntary compliance is encouraged by third parties. For example, the Pensions Regulator encourages adherence to the Stewardship Code in its guidance for trustees of pension schemes. By January 2019, there were 280 signatories to the 2012 Code, of which 12 were service providers and the remaining 268 were asset managers or asset owners.
There have previously been more signatories to the Code (with 305 signatories to the Code in June 2016), but at the time there was a concern about the quality of reporting against the Code and that this was impacting its credibility. As a result, the FRC assessed signatories based on the quality of their Code statements and put them into one of three categories, Tier 1, Tier 2 and Tier 3. Any signatories that did not meet at least Tier 2 expectations for reporting were removed from the list of signatories and the Tier 3 category was removed.
What are the main differences between the 2012 Code and the 2020 Code?
The 2020 Code represents a significant departure from the 2012 Stewardship Code ("2012 Code"), both in content and in terms of how relevant organisations become "signatories" to the Code. The 2020 Code is 32 pages long, and comprises a set of "apply and explain"6 Principles, as follows:
- 12 Principles (addressing "Purpose and Governance", "Investment Approach", "Engagement" and "Exercising Rights and Responsibilities") aimed at: (i) asset managers; and (ii) asset owners; and
- 6 Principles (addressing "Purpose, Strategy and Culture" and "Conflicts of Interest", among others) aimed at service providers.
By contrast, the 2012 Code is significantly shorter (at 10 pages long), with only 7 Principles in total aimed at all three categories of organisation (asset managers, asset owners and service providers), and applies on a "comply or explain" basis.
There are six further key changes in the 2020 Code, as follows:
- it introduces a new definition 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."
This new definition identifies the primary purpose of stewardship as looking after the assets of beneficiaries that have been entrusted to the care of others. At the same time, it broadens the scope of the Code to include investment decision-making and investment in assets other than listed equity;
- it has an extended focus that includes asset owners and service providers, as well as asset managers;
- it requires asset managers and asset owners to report on their specific stewardship activities and outcomes over a period of 12 months, rather than just focussing on reporting on stewardship policies;
- for listed equity assets, it requires signatories to provide much more granular information about their voting decision-making process and history, including disclosing: (i) their voting policy, including any house policies and the extent to which funds set their own policies; (ii) the extent to which they use default recommendations of proxy advisors; (iii) the extent to which clients may override a house policy; (iv) their policy on allowing clients to direct voting in segregated and pooled accounts; and (v) the approach they take to stock lending, recalling lent stock for voting and how they seek to mitigate "empty voting", and providing a link to their voting records (including votes withheld) and stating their rationale for voting decisions;
- it requires signatories to take material ESG factors, including climate change, into account and to ensure that their investment decisions are aligned with the needs of their clients; and
- mirroring some of the new requirements of the 2018 Corporate Governance Code, it requires signatories to explain their organisation's purpose, investment beliefs, strategy and culture, and how they are demonstrating this through appropriate governance, resourcing and staff incentives.
How will an organisation become a signatory to the 2020 Stewardship Code?
Organisations that want to become signatories to the 2020 Code will be required to produce an annual Stewardship Report that explains how they have applied the Code in the last 12 months. The FRC will assess each year whether the Report meets its expectations for the organisation to be included in the list of signatories to the Code. The first Stewardship Reports based on the 2020 Code must be submitted by 31 March 2021, following which the FRC will assess them and publish a list of the first 2020 Code signatories in the third quarter of 2021 (organisations will not be ranked or tiered as they are currently). Organisations that are currently signatories to the 2012 Code will remain as such until the first list of 2020 Code signatories is published in 2021.
How will the 2020 Stewardship Code be "enforced"?
Although adherence to the Stewardship Code is voluntary, there is a consensus that the FRC should consider the extent to which a firm that is claiming to engage in stewardship activity is doing so appropriately, and action should be taken where it is not. As discussed above, the main way that the FRC will do this is by making an annual assessment as to whether an existing signatory to the Code can continue to be a signatory. However, the consultation also explored whether there should be a mechanism for investors to escalate concerns about an investee company in confidence with the FRC. The FRC will not take any action in this area now, but has shared the findings from the consultation with BEIS for its consideration. The FRC also commented that it will expand its stewardship team and work with BEIS to keep its enforcement and regulatory powers under review as it transitions to a new entity, the Audit, Reporting and Governance Authority (or ARGA).
Why should listed companies be aware of the 2020 Stewardship Code?
Those asset managers and asset owners that wish to be signatories to the 2020 Code will need to report on their methods of engagement with listed companies, the extent to which they have been used, any actions or changes made by the listed company as a result of engagement, as well as much more granular information about their voting decision-making process and history. 2020 may, therefore, be an opportune time for listed companies that have historically struggled to get direct engagement with their largest institutional investors to explore whether those institutional investors now have more appetite for such engagement, or different types of engagement. Additionally, once the Reports of signatories to the 2020 Code are published, listed companies may find that there is more detailed and useful information about a relevant investor's voting decision-making process publicly available, which may reduce their use of service providers to find this information out.
In addition, a combination of the introduction of a new requirement7 for proxy advisors to publicly disclose a code of conduct and explain how they have followed it (or explain why they are not following a code of conduct), and the update of the Stewardship Code (which they may wish to use as their code of conduct), may mean that proxy advisors will be more willing to engage with listed companies on a timely basis in 2020, particularly in the critical period in the lead up to the relevant company's 2020 AGM.
Finally, as the FCA has recently announced8 that it intends to consult in early 2020 on new "comply or explain" rules requiring "certain listed issuers" to report in compliance with the TCFD Recommendations, and BEIS announced in July that it would expect all listed companies and large asset owners to report in compliance with the TCFD Recommendations by 2022,9 those companies not yet reporting in compliance with the TCFD Recommendations should be considering what this would entail, and whether to start reporting against the TCFD Recommendations on a voluntary basis. The new requirement for Stewardship Code signatories to take material ESG factors, including climate change, into account and to ensure that their investment decisions are aligned with the needs of their clients is yet another reason for listed companies to take a fresh look at their approach to ESG reporting to ensure that it is fit for purpose and provides a clear picture to investors. There will now be clear benefits in doing so as it will help relevant investors and asset managers satisfy themselves that they are fulfilling their own stewardship responsibilities, and make it easier for them to report on. Listed companies should take a look at the Financial Reporting Lab's Report on Climate-related Corporate Reporting (published in October 2019), which includes lots of early reporting examples.
1 See Principles 9 to 11 of the 2020 Code (for asset managers and asset owners), in particular.
2 See Principle 12 (for asset managers and asset owners).
3 Under the Proxy Advisors (Shareholders' Rights) Regulations 2019.
4 See Principle 7 (for asset managers and asset owners).
5 COBS Rule 2.2.3.
6 This means that signatories are required to make a clear statement to explain how they have applied each of the Principles in a manner that will enable their stakeholders to evaluate how the Principles have been applied.
7 Under the Proxy Advisors (Shareholders' Rights) Regulations 2019.
8 See page 6 of the FCA's Feedback Statement FS19/6) (October 2019).
9 See page 8 of the Green Finance Strategy Paper (July 2019).