F EAT U RE

The number of new stewardship codes around the world indicates significant take-up, but there are questions on application

Good stewards? corporates are robust and run effectively and make a positive contribution to the wider economy.” A key by-product of the financial crisis has been the spotlight it shone on how pension funds invest their assets and scrutinise companies they invest in. Anne Sheehan, director of corporate governance at CalSTRS, the second largest pension fund in the US with assets of $193.2bn (as of 30 September 2016), says the market crisis drove home the need for investors to be more active and engaged: “It heightened the focus of pension funds’ fiduciary responsibility and accountability to their beneficiaries.” She adds: “The crisis put the spotlight on questions like who is sitting in the boardroom on the shareholders’ behalf, and what is driving corporate decisions. We are obligated to know what’s happening to our investment dollars as we are the stewards of those dollars for our members.”

raji menon The focus on long-term stewardship, with the upcoming launches of a slew of new codes globally, is driven by regulators and an institutional investment community keen to address issues thrown up as a result of a series of financial scandals and market crashes, according to leading industry experts. Various markets, including Singapore, Brazil and South Korea, are gearing up to launch their own stewardship codes. The UK’s Financial Reporting Council, which oversees the first specifically titled Stewardship Code, recently published an assessment and rating of fund managers based (see box below). Luke Hildyard, policy lead for stewardship and corporate governance at the Pensions & Lifetime Savings Association (PLSA), the umbrella body for UK pension funds, representing about £1trn in assets, says various factors are driving political interest in longterm stewardship in the UK: “The financial crisis of 2008 is a big factor, but there have been other challenges, including environmental incidents in the extractive industries, market manipulation and mis-selling of banking products and added to all this is the widening inequality gap.” He adds: “So all these factors are resulting in companies and investors being subject to wider scrutiny as policy makers and regulators recognise they have a key role to play in ensuring that financial institutions and

Anne Sheehan: “We are obligated to know what’s happening to our investment dollars as we are the stewards of those dollars for our members”

The first stewardship code takes stock In November, The FRC published a detailed assessment and rating of fund managers based on compliance with the Stewardship Code, showing what it said was a “significant” improvement in the quality of statements with 120 out of 300 signatories reaching the highest Tier 1, compared to just 40 when it was launched. David Styles, head of FRC’s corporate governance, said: “We are very pleased with the response. We now have substantially more managers in Tier I.” The FRC introduced a new tier between its top and bottom tiers to distinguish between asset managers that made a significant improvement in the quality of reporting, but not made the first tier, and those that have continued to report in a minimal way. The regulator postponed the initial deadline of 22 July to 23 September to allow asset managers more time to provide information. Styles said the process was a success, with the FRC holding over 200 meetings and calls with signatories wanting to improve the quality of reporting. The FRC asked its 300 signatories, which include fund managers and pension funds, to provide “distinctive” statements for each of the seven principles of the Stewardship Code to boost the quality of reporting and bring more transparency to the market. This information formed the basis for dividing fund managers into the three tiers.

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In response to criticism about the role played by institutional investors in the run-up to and during the 2008 financial crisis, the first Stewardship Code was published in 2010 by the UK’s Financial Reporting Council (FRC). The code, which has 300 signatories – 200 asset managers, around 70 asset owners, and the balance made up of service providers – has been widely hailed as a success. Its aim was to improve the quality of engagement between asset managers and companies. Following the publication of the UK Stewardship Code, other countries followed suit, including the Netherlands, South Africa, Switzerland, Canada, Japan, Kenya and Italy (see table). In 2011, the European Fund and Asset Management Association (EFAMA) provided a framework of six high-level principles and best practice recommendations for asset managers to follow when engaging with investee ­companies. Global governance body ICGN published its Global Stewardship Principles earlier this year, setting out its view of best practices in relation to investor stewardship obligations, policies and processes. “I see stewardship as the yin to the yang of the corporate governance code,” says Kerrie Waring, executive director at ICGN. “If a company doesn’t meet the comply or explain criteria in the corporate governance code, the onus is on the investor to see where the company deviated from compliance.” Waring says the expansion of steward-

Japan counts the numbers Stewardship-related codes around the world Country Code South Africa Code for Responsible Investing, IoDSA Netherlands Best Practices for Engaged Share-Ownership, EUMEDION Corporate Governance Forum EU Code for External Governance, EFAMA South Africa Code for Responsible Investing, IoDSA UK Stewardship Code, Financial Reporting Council Canada Principles for Governance Monitoring, Voting and Shareholder Engagement, Canadian Coalition for Good Governance Switzerland Guidelines for institutional investors, governing the exercising of participation rights in public limited companies, Ethos Foundation Japan Principles for Responsible Institutional Investors, Financial Services Agency Malaysia Code for Institutional Investors Kenya Draft Stewardship Code for Institutional Investors For Public Exposure, CMA Taiwan Stewardship Consultation, Taiwan Stock Exchange Hong Kong Principles of Responsible Ownership, Securities and Futures Commission ICGN Global Stewardship Principles Italy Stewardship Principles for the Exercise of Administrative and Voting Rights in Listed Companies, Assogestioni

Date introduced or updated February 2011 June 2011 April 2011 February 2011 September 2012 December 2012 January 2013

February 2014 June 2014 August 2015 December 2015 March 2016 2016 September 2016

Source ICGN

ship codes in various markets is similar to the trend seen with corporate governance codes a decade ago. She expects most major capital markets to adopt a stewardship code or a similar instrument by 2020. While the rise of stewardship codes is seen as a welcome development, some market participants believe the concept of long-term stewardship is often misinterpreted. “Stewardship is misunderstood by a lot of participants in the investment chain who think it is just about voting or engagement,” says Daniel Summerfield, co-head of responsible investment at the Universities Superannuation Scheme, one of the UK’s largest pension schemes. “This is a one-dimensional way of looking at it. As long-term stewards we need to ensure that assets entrusted to us are safeguarded and returned in a better condition than when we received them,” he adds. Summerfield describes stewardship as a continuous process, which starts at the beginning of the investment process and has to apply across all investment classes. “Stewardship is a continuum, not a one-step process.” He says that when the pension fund makes asset manager hires, the role of ESG in the investment process is crucial: “ESG, when financially material, needs to be embedded in the investment process and across all asset

classes. So when you are hiring asset managers, you really need to look under the bonnet and do the due diligence to ensure that relevant ESG issues are integrated,” he says. CalSTRS’s Sheehan believes that ESG issues have now become more mainstream, with the process starting with governance and moving to broader issues like proxy voting access in the US. “When we hire managers, we do ask them about ESG. There is an expectation that managers will now look at these issues when they are managing our money,” she adds. New proxy access rules in the US have also given investors greater powers to remove directors and influence corporate strategy by nominating board candidates. While Japan is the only other market besides the UK to have launched a stewardship code drafted by a regulator, Sheehan believes that if the US goes down the road of launching its own code, it would have to come from the industry. “Although in the US we have no formal code, we do have an unwritten code which forms the basis of our governance practices. It’s better if it comes from that way,” she says. Sheehan believes recent reforms in the US, such as say-on-pay, have opened the door to wider stewardship/governance issues like

Japan’s Stewardship Code — launched in early 2014 as a critical weapon in the ‘Abenomics’ push to improve corporate governance and contribute to economic rejuvenation — has been adopted by just one nonfinancial corporate pension fund, causing some concern in the country.  By September this year, the total number of signatories to the code had risen to 213, notably comprising many asset managers. But, with the exception of the pension fund of Secom, a Tokyobased security company, there are no other corporate pension funds of non-financial actors, despite the potential for many corporate pension funds of Japanese companies to sign.  Significantly, but perhaps unsurprisingly, Japan’s giant ¥135trn (€1trn) Government Pension Investment Fund (GPIF) is a signatory and has set up a new division in the fund called Stewardship & ESG, which formally started work on 1 October. Senior figures at the Financial Services Agency (FSA), which oversees the code, are trying to push more corporate pension funds to sign up, but the agency has no fixed targets for how many it would like to see adopting the code.

board composition, allocation of capital and long-term strategic decisions. She says the pension fund is also now taking calls directly from company directors. CalSTRS portfolio manager Aeisha Mastagni says: “The involvement of the board of directors in communicating with us is a recent development – maybe two to three years old. And it’s not us requesting these talks, but the board wanting to hear directly from investors.” Sheehan expects a lot more public recognition of the role of governance since the launch this summer of the Commonsense Corporate Governance Principles, backed by a coalition of CEOs of the world’s largest companies and investment managers, led by Warren Buffett, Larry Fink and Jamie Dimon. The group of 13 high-profile investors and corporate executives outlined its view on the roles and responsibilities of boards and investors. “This news and these principles are a significant move and an acknowledgment of the public recognition of governance. Going forward, we hope to see more of that,” Sheehan says. 25