Political and regulatory news

Issue 2 - 4 May 2010

AIC adds its voice to corporate governance debates

The AIC has called for proportionality in any update of the Corporate Governance standards in the UK and Guernsey and in the creation of a Stewardship Code for institutional investors.

UK Governance

In December 2009, the Financial Reporting Council proposed changing the structure and content of the Combined Code of Corporate Governance.  It also suggested that a new title, ‘UK Corporate Governance Code (UK Code)’, be adopted for these best practice standards - see previous article).  Structural changes to the UK Code will help stakeholders navigate their way around the measures and improve understanding of their objectives.  This exercise is expected to be particularly helpful for overseas companies, which have recently been required to ‘comply or explain’ against the Code under the Listing Rules.

The revised pre-amble to the UK Code will keep existing references to the AIC’s Code of Corporate Governance, which allows investment companies to use it as a means of disclosing against the UK Code.  This will mean boards can continue to choose which governance approach to follow.  However, the FRC’s proposals do raise some issues likely to be of concern to the sector, particularly as they place additional resourcing and financial obligations on boards.  The AIC has been particularly concerned with:

• A requirement for board evaluation to be externally facilitated every three years.  Whilst this may (or may not) be appropriate for bank governance, where the proposals originated, they seem unlikely to generate any significant benefits for shareholders for the mainstream of the investment company sector, where the governance challenge is very different.  The AIC believes the FRC should be more flexible in its approach and encourage companies to simply consider whether external evaluation would be appropriate rather than expect it as a matter of course.
• A proposal that the chairman must agree and regularly review a personalised approach to training and development with each director.  Again, this may have relevance in the context of banks, which often have many-faceted operations, but is likely to impose too onerous an obligation on investment company directors.  The AIC believes the existing requirement for a chairman to ensure that directors continually update their skills as necessary is sufficient.  Although the FRC’s proposal stops short of requiring directors to undertake formal training courses, it is too inflexible and fails to recognise that directors customarily update their skills through the ongoing work of the board, for example as they consider changes to regulatory or governance requirements.
• Seeking to replace the three-year rolling re-election process for directors with either:
- annual re-election of the whole board; or,
- annual re-election of the chairman and any director who is newly appointed or who has served over nine years plus rolling re-election for the remaining board members

The AIC has opposed both these suggestions.  Annual re-election of the entire board creates uncertainty (particularly the threat of an entire board being voted off).  Annual re-election also encourages short-termism and could turn the election process into more of a ‘box-ticking’ exercise with little or no consideration being given to the director’s skills and contribution.  Given that shareholders can already table resolutions to remove directors if there is an issue, maintaining the status quo seems a far better option.  The AIC also remains opposed to singling out long-serving directors for annual election, as there is no justification for this and it could encourage arbitrarily negative perceptions of those who have served over the 9 year threshold.

Some changes are expected to the content of the UK Code, but the AIC hopes that the original proposals will be moderated before they are introduced.

The FRC has also commissioned the Institute of Chartered Secretaries and Administrators to update the ‘Higgs Guidance’ on board effectiveness which supplements the UK Code.  The AIC believes the title of this guidance should also be changed to reflect its purpose rather than its originator (it was originally based on a report by Sir Derek Higgs).  Instead it suggests a functional name such as, ‘Guidance on board effectiveness: implementing the UK Corporate Governance Code’, as this would make the material more accessible.  The AIC also proposes that the guidance should be extended to incorporate best practice guidelines on shareholder engagement, particularly in relation to issues which emerge from the creation of the new Stewardship Code for institutional investors (see previous article).  For example, it could cover the board’s response to concerns raised by shareholders, the disclosure of inside information to shareholders and dealing with governance agencies.

Stewardship

The FRC’s Stewardship Code will have a dual role for the investment company sector.  It will seek to improve engagement between an investment company’s own shareholders and the board.  It will also influence the way that the company’s own managers engage with investee companies.  The AIC suggests that all parties which are active in engagement and signed up to the Code should publish an annual statement describing how they have complied with its recommendations or explaining why they have not complied.  This would mirror corporate governance statements published under the UK Code and should help boards where they are trying to initiate dialogue with their own shareholders. 

The Institutional Shareholders’ Committee’s ‘Statement of Principles’ is expected to  provide the basis for the FRC’s Stewardship Code but this material should be enhanced in two important areas to deal with problems experienced by investment companies.  Firstly, a section of the guidance should be devoted to the responsibilities of governance agencies to encourage them to be more transparent in their activities and more willing to pro-actively engage with the companies whose practices they are assessing.  Secondly, greater emphasis needs to be placed on encouraging institutional investors to carefully consider explanations provided by companies, particularly where they have chosen not to follow the UK Code.  This is a critical element of the engagement process which has not always functioned effectively.  If the Stewardship Code were to address these areas, the AIC hopes it would help boards who are seeking to engage with their shareholders and be an important tool for improving the quality of voting decisions.

Guernsey Code of Corporate Governance

As well as responding to governance developments in the UK, the AIC has also provided feedback to the Guernsey Financial Services Commission which has recently published its own draft Code of Corporate Governance. 

Under current plans, this will apply to Guernsey-domiciled investment companies and the AIC is concerned that these additional obligations are not justified where these companies also have to comply with the UK Code.  It has therefore asked the GFSC to formally recognise the UK Code as an appropriate alternative to its own Code so that boards would only need to consider, and report against, one set of standards.  This approach could be extended to other internationally recognised corporate governance codes if the GFSC deems they meet suitable standards.  Adopting this approach would also allow AIC members to continue to report against the AIC Code (as it provides a recognised means of meeting obligations to report against UK standards).

The GFSC should also shift the emphasis of its proposals away from a regulatory reporting process to one focussed on shareholders.  With this in mind, it should require Guernsey companies to include a corporate governance statement in their annual report and accounts much like those published in relation to the UK Code.

Developments on the corporate governance agenda continue to move quickly both in the UK and overseas.  Changes will not only affect investment companies themselves, but also their managers, particularly given the FSA’s current focus on governance practices within regulated firms, and their shareholders.  Many of the recent proposals emanate from the recommendations of the Walker Review into the banking sector and the debate continues on the extent to which they are suitable for wider adoption.  The right balance needs to be achieved between improving standards and imposing unnecessary obligations.

To view the AIC’s response to the FRC’s consultation on the revised UK Corporate Governance Code, click here.

To view the AIC’s response on the Higgs Guidance, click here.

To view the AIC’s response to the FRC’s consultation on the Stewardship Code, click here.

To view the AIC’s response on the Guernsey Code of Corporate Governance, click here.

This is the last article in this edition.

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