RECOMMENDATIONS ON THE MYNERS REPORT - 'INSTITUTIONAL INVESTMENT IN THE UK - A REVIEW'
Consultative documents issued by the Department of Work and
Pensions/ HM Treasury
Comments from the Association of Chartered Certified Accountants
April 2002
Executive Summary
The Association of Chartered Certified Accountants (ACCA) is pleased to have the opportunity to comment on the Department of Work and Pensions/HM Treasury's proposals regarding issues arising from the Myners Report: 'Institutional Investment in the UK: A Review'. We have reviewed the three consultation documents issued in connection with this matter, namely those dealing with i) Encouraging Shareholder Activism, ii) 'Familiarity with the Issues', and iii) Independent Custodians.We consider that the proposal to require fund managers, and even trustees, to intervene in the corporate affairs of investee companies is ill-advised. Like any individual investors, institutional investors have 'rights' in respect of their shareholdings. However, they do not have, and should not have, responsibilities to intervene in management. Fund managers already owe a duty of care to their clients, and, together with any specific instructions which might be given by trustees, this should be sufficient to guide managers in deciding how to react to events within investee companies. We consider that it will be preferable for issues of intervention to continue to be the subject of best practice guidance rather than of legislation.
The Government's proposal to increase the standard of care expected of trustees in investment matters will need to be handled very carefully if it is not to result in future difficulties in recruiting individuals to act as trustees. The proposal will have major training implications, particularly with regard to smaller, predominantly Defined Contribution schemes.
We support the use of custodians by pension schemes and would support the adoption of a legal requirement to this effect if it were considered necessary.
Our comments on the individual consultation documents are set out on the following pages.
1. Encouraging Shareholder Activism
1.1 The Government proposes to impose a statutory duty on all those who are involved in pension fund management to use shareholder powers to intervene in investee companies where this would be in a pension scheme's best interests. The proposal takes forward a conclusion of the Myners review that remedial action needs to be taken to counter what is perceived to be a lack of active intervention in company affairs on the part of institutional investors.1.2 Given that some 80% of the shares in listed companies are held by or on behalf of insurance companies or pension funds, institutional investors are, potentially at least, a powerful influence on company governance in the UK. We acknowledge the conclusion of Myners that this influence is not always, in practice, exerted, and also that the Government is currently looking to increase levels of shareholder participation as a means of controlling excesses in boardroom pay. We query, however, the conclusion that institutional investors' apparent lack of involvement is a matter which needs to be addressed by imposing a legal obligation on them. We believe that the introduction of a statutory duty of this kind would be the wrong way to go about addressing the problem which has been identified, and cite the following reasons for our view.
1.3 First, it is a standard feature of company law that shareholders have rights but no responsibilities in respect of the shares which they hold. (The draft duty set out in paragraph 26 of the document refers to investors' 'powers': for the most part, shareholders only have 'powers' to the extent that they are able to enforce their membership rights.) No shareholders, whatever the size of their shareholdings, are obliged to exercise their rights to participate in company activities; neither are they obliged to enforce their legal rights or to take action, in the name of their companies, should they consider that the companies' affairs are being mismanaged in particular ways. Any shareholder is currently entitled to decide for him or herself what benefit s/he wishes to derive from the investee company. The Government's proposal would, therefore, create a distinction between institutional investors and other investors, with the former being obliged by law to intervene in company management and all others being under no such obligation.
1.4 Secondly, any person who seeks to intervene in the management of a company to the extent of issuing instructions to the company's directors risks becoming classed as a 'shadow director'. Acting as a shadow director carries with it significant responsibilities and liabilities, which are likely to increase materially should the recommendations of the Company Law Review become law in the near future. In particular, it is possible that shadow directors will in future be liable to a company's shareholders for breaches of directors' duties. In this context, we think that it would be unreasonable to expect fund managers to be subject to a duty of care to any entity other than the scheme which has engaged them to manage funds on its behalf.
1.5 Thirdly, Myners reports that there is a lack of 'active intervention' by institutional investors in companies in which they hold shares. It is our understanding that most fund managers actually do engage with their investee companies, either on a regular basis or as and when they consider it appropriate. This engagement is, however, conducted in a discreet, more focused manner than the more public fashion which is now envisaged. (A separate issue is whether more transparency can be injected into these contacts). Responsible fund managers will always be prepared to take some form of interventive action on behalf of their clients, even if this only extends to selling their clients' shares where they feel that the sales would be in the clients' best financial interests. In our view, even this restricted action could be said to be fulfilling the fund manager's duty to the client.
1.6 In the light of the foregoing, we do not believe that it is necessary or desirable to impose a statutory duty on institutional investors along the lines proposed. The Government's own proposal recognises that the trigger to intervention should be a fund manager's consideration of whether shareholder action would be in the best interests of the individual beneficiary. Managers are already subject to a duty of care to their clients and are expected to act in their best interests and to follow any specific instructions which they receive from them. Recent litigation confirms that this is the expectation to which all fund managers are subject. The Government's proposal would extend the current, undisputed duty to the broader company law environment. In our view, this would be beyond the reasonable limit of the fund manager's responsibility to his/her client. Encouragement of a wider engagement in company affairs on the part of institutional investors is, in our view, properly the realm of best practice guidance and not the law.
1.7 Our responses to the specific consultation questions are set out below.
Q1. Should the proposed activism duty be extended to trustees as well as fund managers?
1.8 At present, trustees are required to prepare a statement of investment principles. This statement can be used to set out any guiding policies which the trustee body wishes to apply to the investment of the assets under its stewardship. Over and above the statement of principles, trustees are free to impose on their fund managers whatever investment strategies and selection criteria they wish.
1.9 The fund manager is engaged by the trustees to manage the fund's assets in accordance with this guidance and also with his or her general duty of care. Given this, we believe that, should an activism duty be introduced, it should be imposed only on the fund manager as the person who controls the membership rights attached to the shares. Breach of the duty of care or failure to obey a client's instructions - which could conceivably include a duty to engage in corporate governance-related activities - should continue to be a civil matter between the trustees and the manager.
1.10 Where the trustees act as fund managers themselves, the duty would have to apply to them. Most trustees are, however, not experts in these matters and imposing the proposed duty on them in all circumstances would not be a practical proposition. It would also make it more difficult for schemes to find individuals prepared to act as trustees.
Q2. Which funds should be included in the duty?
1.11 If the Government were to introduce the activism duty, it would be logical for this to apply to all funds held by a fund manager, and not to be restricted to pension funds. Application to all funds would, however, increase complexity and confusion.
Q3. How should compliance with the new law be disclosed?
1.12 Subject to our comments in response to question 1 above, we consider that individual pension funds should be required to disclose, in their annual reports, the identity of the person or persons to whom the duty applies, viz their fund managers or, where they themselves handle the schemes' investments, the funds themselves.
2. Pension Scheme Trustees - 'Familiar with the Issues Concerned'
2.1 The Government proposes that the UK should introduce new legislation which would enhance the standard of care expected of trustees in the making of investment decisions. This addresses the Myners conclusion that many trustees are not expert in investment matters and are only able to bring limited time and expertise to the investment decision-making aspects of their work. It also supplements the Myners proposal to introduce Codes of Investment Principles.2.2 We agree that increasing the level of trustees' understanding of investment matters, as this affects their own funds, is a desirable objective. Beneficiaries are entitled to expect their trustees to have an adequate understanding of the basis on which scheme assets are being invested and of how efficiently they are being invested. The document states that it does not wish to discourage the participation in schemes of member-nominated trustees or to engineer a situation in which professional trustees predominate. We are concerned, however, that, by imposing a higher, statutory standard of care, schemes will find it increasingly difficult to find individuals who are prepared to act as trustees. This risk seems to us particularly acute in the case of smaller schemes. We would have preferred, as an alternative to imposing a new standard of care, to see the Government making it obligatory for all trustees to receive training in their duties under the current law. With the introduction of the new duty, coupled with new uncertainty as to the exact scope of that revised duty, there will in any case be a new imperative for trustee training.
2.3 Our responses to selected consultation questions are as follows:
Q2. Should the new standard of care apply to individual trustees or to the board collectively?
2.4 We consider that it would be appropriate for the proposed new duty to apply to trustees (including independent trustees) on an individual basis.
Q3. Should there be non-statutory guidance to supplement the proposed legislation?
2.5 We disagree with the comment made in paragraph 17 of the document, to the effect that no further elaboration is necessary of the word 'familiarity' in the draft new standard of care. The term 'familiar' does not express sufficiently exactly the level of understanding of investment matters which is to be required of trustees. In particular, it is not sufficiently clear whether the trustee is to be expected to have a passive acquaintance with investment matters or some degree of competence in dealing with them. This needs to be clarified, as does the term 'investment functions'.
2.6 Given the nature of the problem that the Government is addressing, we also consider that it would indeed be desirable for there to be supplementary guidance available to explain to trustees in plain English the practical implications of the proposed legislation.
Q4. Should the proposed UK legislation extend to fund managers and custodians as well as trustees?
2.7 In determining what should be the appropriate duty of care, trustees should not be treated in the same way as professional fund managers and custodians. As the document acknowledges, the majority of trustees are not experts in investment matters, and the Government adds that it does not intend to require them to become so. Fund managers, on the other hand, are supposed to have a high degree of expertise in these matters. The standard of care should accordingly be different.
Q5. What will be the training implications of the proposals?
2.8 The training implications will be substantial. In our view, it is likely that the majority of trustee boards will feel it necessary to submit their members to some form of training, either specifically tailored to investment matters or more general training on trustee duties. Trustees of smaller schemes, which are more likely to be Defined Contribution schemes, are likely to feel particularly exposed in the light of the proposed new duty of care. There will be a particular need to communicate the implications of the changes to such schemes and to encourage them to arrange training for their trustees.