Missing in action

The Stewardship Code, while not expanding significantly on the existing
Institutional Shareholders Committee guidelines, is heralded as being a real
step towards promoting active engagement between institutional investors and the
companies in which they invest – improving corporate governance.

There is a strong expectation that institutional investors will voluntarily
comply with the code. It will acquire more teeth if authorised asset mangers are
required to report on compliance (or explain why not), which is a move that
seems likely to happen regardless of the government’s plans to reorganise the

If institutional investors choose to comply, they will need to disclose how
they will discharge their stewardship responsibilities. But is it always
appropriate for investors to tackle under-performance in a company? Some
investors may only buy a stock to re-balance their portfolio. What about tracker
funds that are required to hold stock in whatever index they are tracking? In
theory, they should have more incentive to take an active stance because they
must hold the stock. But this may not fit with their business model, which is
often built around a low cost tracker service, not a higher cost interventionist

In practice, this will depend largely on what investors are seeking to
achieve. Ultimately, all institutional investors seek to ensure an attractive
return to their clients, who may be better served by selling an underperforming
stock and moving on, rather than tying up time and resources by engaging closely
with a board on the future direction of a company. Those investors who do choose
to comply will still need to monitor the costs of doing so to ensure that
increased activism does in fact pay.

Before taking action, they will also need to assess whether they are prepared
to become insiders and potentially lose the ability to trade out of a stock for
a period of time. This risk arises in any discussions with a board about a
company’s strategy and is one that the code recognises, but offers little
guidance on how to manage. Questions remain about whether investors will cross
the line to become insiders in the name of responsible stewardship.

Even compulsory reporting will not necessarily provide the level of
engagement the code seeks to encourage. It is the openness and liquidity of the
UK’s capital market which makes it increasingly attractive to foreign investors,
who may not be within the UK regulator’s remit. There is nevertheless an
expectation that companies will have increasing numbers of investors with more
transparent stewardship policies. The best encouragement for other investors to
apply the code’s principles is if this does indeed influence a company’s share
price over time and improve long-term returns to investors.

If so, the problems identified are likely to be overcome, with the code
developing into a significant piece of the UK regulatory regime, in much the
same way as the original Combined Code has developed over nearly 20 years into
the Corporate Governance Code of today.

Rani Mina and James Trentham are senior associates at Mayer Brown
International LLP.

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