The Code’s purpose is not to tell signatories what to do. Stewardship varies considerably depending on the investment strategy and beliefs of the steward, their time horizons, their role in the investment chain, and the type of asset they invest in. No one size fits all.
Rather, the Code provides a framework for the disclosure of stewardship policies, activities and outcomes. The underlying premise is that transparency drives good stewardship practices and underscores accountability. If the framework is too prescriptive, too burdensome or if it emphasises the wrong features (e.g. escalation over other forms of engagement), then it may undermine its own objectives.
The consultation
Emphasising autonomy and flexibility
The Code has been reformulated and restructured to greater emphasise that it is a principles-based, flexible framework designed to give Code signatories significant autonomy and discretion in how best to apply the Code. Reporting under the Code is not a “tick-box” exercise.
We see clear parallels here with how the FRC expects the Corporate Governance Code to be applied and we see similar approaches by other UK regulators in line with the Government’s shift to smarter regulation.
Clarifying what stewardship and its purpose is
In our discussions with clients and other industry participants, it was evident that there are different views as to what stewardship is and what it is intended to achieve. This often stems from an incomplete picture of the stewardship landscape (the “stewardship ecosystem”) and the commercial incentives driving the behaviour of / engagement by individual stewards.
The consultation addresses this:
- Firstly, the consultation acknowledges that stewardship takes many forms, depending on the investment strategy and beliefs of the steward, their time horizons, their role in the investment chain, and the type of asset they invest in. It also acknowledges that different stewards and those that service them (e.g. proxy advisers) come together to comprise a system that interacts with itself and continues to evolve. The Code provide scope for signatories to explain what it is they do (including their role in the ecosystem) and how that influences the activities they undertake (including the nature of the engagement they undertake). Engagement may be at company level, portfolio level, system level or policy level, or a combination thereof.
- Secondly, the consultation clarifies that the primary focus of stewardship is the creation of long-term sustainable value for clients and beneficiaries (savers and pensioners). This may include a focus on broader considerations, such as the economy, the environment and society, but viewed through the lens of what is value accretive to the client and the ultimate beneficiaries. Here, we draw parallels with similar discussions in the areas of director duties and the duties of pension trustees, and to what extent directors and trustees should have regard to broader economic and societal considerations. There are some who will be disappointed by what may appear to be a downgrading of the importance of sustainability factors. We don’t think that is necessarily the case, but this is an important point that will undoubtedly be debated during the consultation.
Streamlining and improving disclosure
The consultation proposes changes in the manner in which and what signatories report. We believe that the proposed changes, when combined, have the potential to cause a behavioural shift in how one approaches the reporting and, therefore, exercise of stewardship:
How signatories report
The consultation redesigns the Principles to encourage the disclosure of stewardship approaches that are individual to the signatory, and not formulaic. This is achieved through the use of supporting brief “prompts” on how to report and accompanying “guidance”.
- The prompts are just that. They prompt the signatories to explain how they have applied the Principles. They provide significant scope and discretion in the information that can be disclosed.
- The guidance provides more narrative and some examples for signatories to drawn on to help them articulate how they exercise stewardship in a way tailored to their organisations. Guidance touches on the range of information they may use.
In short, the Code prompts signatories as to what they ought to consider reporting and gives them assistance in thinking though how they may go about reporting.
Adjustments to the Code to counter concern that current wording in the Code has resulted in certain counterproductive practices. These adjustments, we assume, are intended to positively influence the engagement between investors and companies.
- The separate sub-headings of “Context”, “Activity” and “Outcomes” are removed.
- Escalation activities are consumed within the broader bucket of engagement activities
These changes reduce perceived (by some) bias towards reporting on specific outcomes and escalation activities, which, in turn, may have caused investors to engage in particular types of behaviour for the sake of being seen to be doing something. Escalation, for example, is an important form of engagement but it should be considered as one amongst a number of engagement techniques and its use, or decision not to use, will depend on the circumstances.
The removal of outcomes also recognises that outcomes may occur over longer periods and may be more subtle. Guidance will also ensure that reporting on outcomes is not too narrowly understood and does not drive short term activities to meet a reporting requirement.
What signatories report
Reporting is to be separated into (i) a Policy and Context Disclosure and (ii) an Activities and Outcomes Report.
- The Policy and Context Disclosure requires disclosure on a signatory’s organisation, its governance and resourcing, linking to relevant policies. Consequentially, whilst it needs to be published annually, it need only be updated when necessary and it need be reviewed less frequently by the FRC (once every three years).
- The Activities and Outcome Report will provide information on how a signatory has exercised stewardship in the preceding year. This would include how the signatory has sought to apply the Principles through the activities it has undertaken and the resulting outcomes. This is an annual disclosure and is to be reviewed annually by the FRC.
Distinguishing between disclosures that are not expected to change annually from the disclosure of annual activities will reduce the reporting burden on signatories.
The FRC analysed reporting against the prior Code to determine which Principles generated the most valuable, and which did not. They used this insight to reduce the number of Principles to ensure that useful information is being reported, and information that is less useful is not.
Positioning
The FRC recognises that some signatories may follow other reporting frameworks or requirements that align with content of the Code. The FRC will allow signatories to refer to information disclosed outside of their stewardship report as part of their assessment with the aim of avoiding duplication and reducing burden. The FRC states that any use of cross-referencing would be supported by a clear policy on its appropriate use to ensure that signatories are able to demonstrate their application of the Principles, without compromising the quality of reporting.
Next steps
The consultation ends on February 19, 2025. The FRC anticipates that the updated Code will be published in the first half of 2025, with an effective date of January 1, 2026. The FRC will provide information to signatories upon launch of the updated Code to ensure a smooth transition ahead of reporting in 2026.
