The UK Stewardship Code 2020: What’s changing and why it matters

On 24 October 2019, the UK’s Financial Reporting Council (“FRC”) published an updated version of its Stewardship Code, the UK Stewardship Code 2020 (the “Code”). This represents the first significant revision of the Stewardship Code since its original publication in 2010, and it will take effect from 1 January 2020. The FRC along with the Financial Conduct Authority (“FCA”), at the same time published a joint Feedback Statement (FS19/7) outlining their overall approach to stewardship.

What was the 2010 Stewardship Code?

The origins of the Stewardship Code go back to the last days of the New Labour administration when stakeholder capitalism was a key theme. In particular, the Walker Review 2009 brought the previous Code of Responsibilities of Institutional Investors within the remit of the FRC.

The 2010 Stewardship Code (the “2010 Code”), which was subject to minor revisions in 2012, contained a set of principles and guidance for “institutional investors”. The 2010 Code adopted a “comply or explain” approach meaning that investment managers were encouraged to engage with these broad principles, as opposed to slavishly following a rigid set of rules.

What’s changed in the 2020 version?

In place of the previously worded “should” – guidance on what institutional managers ought to be doing – the new Code is framed as a set of statements focusing on what signatories are doing. Signatories fall into two main categories:

1. Asset owners and asset managers (previously institutional investors); and
2. Service providers.

The Code aims to set high expectations on those responsible for managing the long-term savings of the UK public. In particular, it seeks to position 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 (Introduction to the Code).

The Code also contains new expectations of how investment and stewardship should be integrated, including Environmental, Social and Governance (“ESG”) issues. The Code asks investors to explain how they have exercised stewardship in relation to a broad range of asset classes – not only listed equities, which was the previous focus. This includes fixed income, private markets, infrastructure investments, plus investments in assets listed or located outside the UK. The Code is designed to accommodate the different terms, investment horizons, rights and responsibilities of each of these asset classes.

What are the new Principles?

The new Code contains 12 Principles for asset owners and asset managers, and six separate Principles for service providers that support them. The Principles are divided into four main categories. and for each Principle, signatories are required to provide a summary of:

1. Context (why are we doing this?);
2. Activities (what are we doing?); and
3. Outcomes (what are the desired consequences?). The 12 Principles for asset owners and asset managers are as follows:
    

Purpose and Governance

1. Signatories’ purpose, investment beliefs, strategy, and culture enable stewardship that creates long term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society.
2. Signatories’ governance, resources and incentives support stewardship.
3. Signatories manage conflicts of interest to put the best interests of clients and beneficiaries first.
4. Signatories identify and respond to market-wide and systemic risks to promote a well-functioning financial system.
5. Signatories review their policies, assure their processes and assess the effectiveness of their activities.
    

Investment approach

1. Signatories take account of client and beneficiary needs and communicate the activities and outcomes of their stewardship and investment to them.
2. Signatories systematically integrate stewardship and investment, including material environmental, social and governance issues, and climate change, to fulfil their responsibilities.
3. Signatories monitor and hold to account managers and/or service providers.
    

Engagement

1. Signatories engage with issuers to maintain or enhance the value of assets.
2. Signatories, where necessary, participate in collaborative engagement to influence issuers.
3. Signatories, where necessary, escalate stewardship activities to influence issuers.

 

Exercising rights and responsibilities

1. Signatories actively exercise their rights and responsibilities.
    

Service providers

Service providers play an important role, as they provide services that support clients, such as asset owners and managers, to fulfil their stewardship responsibilities. Service providers applying these principles include, but are not limited to, investment consultants, proxy advisors, and data and research providers.

Service providers are seen as undertaking important services to support their client’s stewardship activities, including, but not limited to voting recommendations and execution, data and research provision, and the provision of reporting frameworks and standards.

 

What are the requirements on managers signing up to the Code?

Signatories to the Code will be required to produce an annual Stewardship Report explaining how they have applied the Code in the previous 12 months. To be included in the first list of signatories, firms must submit a final report to the FRC by 31 March 2021.

Firms considering signing up to the Code will want to conduct a thorough review of their policies and procedures in all areas relevant to the principles. This in turn is likely to require an examination of their overall approach to stewardship in the context of related industry initiatives, such as sustainable finance, responsible investing and ESG.

 

Does anything change in terms of the FCA regulatory obligation?

The FCA’s rule on the disclosure of commitment to the FRC’s Stewardship Code applies to any regulated firm, which is managing investments for professional clients. For the foreseeable future this obligation remains essentially on a “comply or explain” basis – namely to disclose on the firm’s website (or other accessible form) the nature of its commitment to the Financial Reporting Council’s Stewardship Code; or where it does not commit to the Code, its alternative investment strategy. (COBS 2.2.3R).

 

Aside from the Stewardship Code, what other initiatives are the FCA pursuing in this area?

The FCA views the Stewardship Code as one of numerous overlapping (and, in some senses, competing) regulatory initiatives. The FCA’s recent statement clarifies its immediate order of priorities: “We also agree that we should let firms first adapt to our new rules on shareholder engagement (implementing the revised Shareholder Rights Directive (“SRD II”)), which took effect in June 2019, and other related measures”.

One related topic in the FCA’s crosshairs may be seen in their initiative on Climate Change and Green Finance. Although not yet formulated as specific rule proposals, the FCA’s approach in two discussion papers to date is focusing on the following issues:

1. The obligations on issuers to make disclosures on the climate change impact of their activities;
2. Firms’ integration of climate change into their overall risk and governance structures; and
3. Restrictions around the marketing of “green” financial products and services.

 

For more information about this alert, please speak to Martin Lovick, Thanos Delizisis, or your usual ACA consultant on +44 (0)20 7042 0560.