Stewardship revisited

19 Feb

19 fEB 2025

The Financial Reporting Council has got it about right with its revised UK Stewardship Code

The UK Financial Reporting Council has been reviewing the UK Stewardship Code. The consultation closes today. There were various things I wanted from the review:

Maintaining the clear apply and explain principles of the Code and encouragement towards good stewardship
Reducing unnecessary reporting requirements
Rationalising the principles where these had become overly segmented
A clear focus on the primary duty of investors to create value for clients
Avoiding too much of a one-size-fits all approach to stewardship

The draft has caused some controversy, particularly in the light of a perceived “watering down” of the code in relation to sustainability. But overall I think it’s struck about the right balance between these objectives. Here are my main observations.

The definition

The main controversy has related to the revised definition of stewardship which now reads:

Stewardship is the responsible allocation, management and oversight of capital to create long-term sustainable value for clients and beneficiaries.

Gone is the last part of the definition which previously added: leading to sustainable benefits for the economy, the environment and society. Instead, the word “sustainable” has now been included after “long-term”. Arguments are raging about whether this is a watering down or not. In my mind it definitely signals a change, but a needed one.

The time the Code was last reviewed was close to the peak of the idea that investors should be pursuing environmental and societal goals as at least a necessary precondition of long-term value creation and possibly even in parallel to long-term value creation. This was reflected in a code that gave these factors a particular significance. However, together with a number of other governance and attitudinal developments in the UK, it also gave rise to the impression that companies listing on the UK market have many obligations and stakeholders that need to be considered alongside the needs of shareholder and financial value creation. In my view, this harmed the view of UK markets amongst those inclined to invest here without necessarily producing commensurate societal benefits. So it seems to me to be useful that the revised definition reminds everyone that to be successful in a capitalist system, a stock market needs, first and foremost, to be about creating value financial in the companies that list on it, for the investors in those companies.

Having said that, the Stewardship Code is intentionally designed to signal and encourage a form of ownership that achieves the goal of financial returns for clients and beneficiaries through the route of fundamental long-term value creation within portfolio companies. This is not the only valid approach to equity market investment, but it is the one the Code is designed to support. This is why the qualifier “long-term sustainable” is so important. Of course, people may ask “what is long-term” or “what is sustainable”. But, in the same way a soap bubble always bursts when you catch it, some things are best left unexplained as in the attempt to define too closely or precisely, the essence can be lost.

The explanatory text following the definition also helpful adds context, although here there was one mis-step. The sentence: “Stewardship the supports sustainable, long-term returns may lead to wider benefits for the economy, the environment and society” is weak, and changes the references to societal and environmental benefits from being integral parts of the stewardship definition to, at best, a happy by-product. Perhaps more than anything this sentence contributed to the perception of weakening.

So while I think the new definition works and creates a healthy focus on the core objective of stewardship, I think the offending sentence referred to in the previous paragraph should be replaced with: “Stewardship that supports sustainable, long-term value will have regard to material dependencies and impacts of companies on the economy, the environment and society.” This wording shamelessly borrows from the stewardship definition proposed by UK SIF, and emphasises an approach to stewardship, which the Code exists to encourage, that is based upon long-term value creation within companies. Consideration of the risks and opportunities that arise from these dependencies and impacts is generally needed for such an approach. But whether investors seek to address these dependancies and impacts is a different matter that needs to be considered case by case with long-term value in mind. I think this wording should be in the explanatory text rather than in the definition. This keeps the clarity about the core stewardship purpose, and avoids debates about the presence or absence of commas which arise when too many concepts are combined in one sentence.

Stewardship policy

In an attempt to avoid repetitive disclosures, the proposed Code splits into two: Policy and Context Disclosure and Activities and Outcomes Report. The idea is a good one, and should avoid unnecessary duplication of disclosures. However, in my view it has gone a bit far. There are dimensions of stewardship policy that are important for clients to understand. These include:

How the asset manager / owner views the role of stewardship in creating long-term value.
The tools that they believe are most effective, in terms of capital allocation, monitoring, engagement, voting.
How they view the role of engagement, including collective engagement, and of voting.
The approach to escalation.
How they view their role in relation to system-wide risks: is the role purely one of managing and responding to those risks or do they also see a role for themselves in addressing those risks, and if so how?

The Activities and Outcomes report only requires disclosure of the extent to which activities have been undertaken, not the underlying philosophy and principles. In a year when a particular activity had not been undertaken the absence would be noted but not necessarily its connection to the underlying approach. These dimensions of stewardship approach should be covered in the Policy and Context Disclosure, but currently only one of the reporting points covers the whole lot of them: “ Your investment beliefs and stewardship strategy”. This should be expanded to ensure that clients have the information they need.

A market for stewardship

There is one change that the FRC has not made, which I would like to see, which is to end the FRC’s review of stewardship reports to determine signatory status. This would be a bold move, which would arguably free up FRC resource for more useful purposes.

The idea behind the Stewardship Code was to facilitate a market for stewardship. Clients want good stewardship, the argument goes, but don’t always have the information needed to assess their managers’ stewardship approach. At the same time there was a perceived societal benefit to encouraging an approach to investor stewardship that looked at the relationship between the investor and the company and which was predicated on the idea that investors should be helping to build long-term value in the companies they own. This provided further impetus for a code-based approach to encouraging information disclosure that the market was not automatically providing.

Market purists might argue that if there really was a market for stewardship then the market would provide the necessary information and so the Code is unnecessary, especially now when so many clients would demand that their asset managers produce such reports anyway. Indeed some asset managers complain that they now have to at least two stewardship reports: one for the FRC and one for their clients! (With potentially many variants of the latter.) There probably does remain a case for an overarching code that encourages the spread of market best practices, not least around the time of the periodic reviews of the code. But the role of the FRC’s review is less clear. They emphasize that they are not measuring the quality of stewardship, indeed they clearly have no capability to do so, without much more invasive supervision. Instead, they are just reviewing how it is reported. How useful this is is questionable. If a stewardship report is bad or misses key elements then asset owners, aided by their investment consultants, should be able to figure that out. The problem is that, with signatory status now being a baseline requirement for inclusion in many tenders, the FRC’s sign-off is in effect being used by the market as an imprimatur of stewardship quality.

The brave decision would be for the FRC to step back from their role in determining signatory status and to instead devote the resources to thematic reviews of particular stewardship issues (or they could even save the money altogether!). The Code provides a framework that signatories commit to disclose against. If there really is a market for stewardship, then it should be the market, not the FRC, that decides whether the reports are up to snuff.

The Stewardship Code review didn’t give me everything that I wanted, but overall I think it’s a good job.