Let’s get (more) engaged: Stewardship in the UK

The FCA has published a consultation paper (CP19/7) with its proposals for implementation of parts of the EU Shareholder Rights Directive II (SRD II). This includes its proposed rules requiring:

• asset managers and life insurers to have and disclose an engagement policy
• life insurers to make certain disclosures about their investment strategy and arrangements, and
• asset managers to disclose certain information to the firms they provide services to, so that asset owners can assess whether and how the manager is acting in their best interest.

CP19/7 also includes the FCA’s proposals for a new related party transaction regime, as required by SRD II. This new regime will require UK companies with shares admitted on a regulated market to disclose and obtain board approval for material related party transactions.

Comments on CP19/7 are due by 27 March 2019.

SDR II

SDR II amends the Shareholder Rights Directive to strengthen shareholder engagement and increase transparency. SRD II must be implemented into national law by EU Member States by 10 June 2019. As the implementation date is after the UK is scheduled to exit the EU, the FCA states that these proposals will only be implemented if the UK exits the EU with a transition period. Otherwise the FCA will wait to see how the government proceeds, as various measures in SRD II will need to be implemented through UK legislation.

Stewardship in the UK

On 30 January 2019, the Financial Reporting Council (FRC) published a consultation on its proposed changes to the UK Stewardship Code. At the same time, the FCA and FRC jointly published a discussion paper, starting an examination of how effective stewardship can best be supported by the regulatory framework in the UK.

In CP19/7 the FCA states that the implementation of SRD II through its proposed new rules for asset owners and asset managers “sets an important baseline in a continuum of measures to drive effective stewardship. The revised Stewardship Code aims to encourage higher standards beyond this baseline.” It also states that the discussion paper gives stakeholders an opportunity to tell the FCA their views on the right balance between minimum regulatory expectations and code-based measures such as the revised Stewardship Code. The proposals in CP19/7 need to be considered in this broader context.

Proposed new rules in CP 19/7

Which firms will be in scope?

The FCA is proposing that the rules will:

• apply to asset managers and life insurers for whom the UK is the home state (as set out in SRD II), and
• be extended to branches of non-EEA investment firms which the FCA authorise.

Specifically, the proposed rules would apply to FCA-regulated life insurers subject to Solvency II requirements and to asset managers. Where there are obligations on asset managers to provide information to asset owners (who are in this context directly or indirectly the client of the asset manager), the rules apply to all relevant clients. This includes occupational pension schemes that are regulated by the Pensions Regulator and asset owners in an EEA country.

Asset managers are defined as:

• MiFID investment firms who provide portfolio management services
• alternative investment fund managers (AIFMs), excluding small AIFMs
• UCITS management companies, and
• UCITS funds without an external management company (a self- managed UCITS).

Which investee companies will be in scope?

The rules will apply to shares held by regulated firms in all investee companies admitted to trading on an EEA regulated market or on a comparable market outside the EEA.

Where are the new rules?

The new rules will be in the Conduct of Business Sourcebook and the Senior Management, Systems and Controls Sourcebook.

What are the proposed rules about engagement policies?

Life insurers and asset managers will be required to develop and disclose publicly a policy on shareholder engagement or to explain why they have chosen not to do so.

A firm will have to state in its engagement policy how it:

• monitors investee companies on these relevant matters:
  • strategy
  • financial and non-financial performance and risk
  • capital structure
  • social and environmental impact
  • corporate governance
• engages in dialogue with companies it invests in
• exercises voting rights and other rights attached to shares
• cooperates with other shareholders
• communicates with relevant stakeholders of companies it invests in
• manages actual and potential conflicts of interest from its engagement.

Where a firm has chosen not to comply with any of these specific elements, it must publicly disclose a clear and reasoned explanation of why not.

Life insurers and asset managers will also have to disclose, publicly and annually, how they have implemented any engagement policy, along with certain detailed information. They must explain the most significant shareholder votes that they have participated in, and how they use proxy advisors. They must also disclose how they have cast votes at general meetings but will have an option not to disclose insignificant votes.

This information will have to be available free on the asset manager’s or life insurer’s website.

A life insurer will also have to include, in its website disclosure, a reference to where voting information has been published by any asset manager which implements the engagement policy, including voting, on its behalf.

As SRD II requires conflicts of interest rules to apply to engagement activities, the FCA is proposing to apply the relevant conflict of interest rules for asset managers.

As the FRC is consulting on significant changes to the Stewardship Code, the FCA is not currently proposing any change to the existing rule that firms that manage investments for professional clients, which are not natural persons, must disclose the nature of their commitment to the Stewardship Code or, where they do not commit to the Code, their alternative investment strategy.

The FCA is also keeping its rules on funds that require fund management firms to have strategies for the exercise of voting rights as it considers them to be complimentary.

Life insurers’ investment strategy and arrangements

Life insurers will have to disclose publicly how the main elements of their equity investment strategy are consistent with the profile and duration of the liabilities of their long-term liabilities, and how they contribute to the medium to long-term performance of their assets.

Where an asset manager invests on behalf of a life insurer, whether on a discretionary client-by-client basis or through a collective investment undertaking, that life insurer must (on a comply or explain basis) ensure that their arrangement with the asset manager is publicly disclosed. This public disclosure should include the following information:

• how the arrangement with the asset manager incentivises the asset manager to align its investment strategy and decisions with the profile and duration of the liabilities of the life insurer’s long-term liabilities
• how that arrangement incentivises the asset manager to make investment decisions based on assessments about medium to long-term financial and non-financial performance of the investee company and to engage with investee companies to improve their performance in the medium to long-term
• how the method and time-horizon of the evaluation of the asset manager’s performance and the remuneration for asset management services are in line with the profile and duration of the liabilities of the life insurer, in particular, long-term liabilities, and take absolute long-term performance into account
• how the life insurer monitors portfolio turnover costs incurred by the asset manager and how it defines and monitors a targeted portfolio turnover or turnover range, and
• the duration of the arrangement with the asset manager.

Where the arrangement with the asset manager does not contain one or more of these elements, the life insurer will have to give a clear and reasoned explanation why this is the case.

This information will have to be available free of charge on the life insurer’s website. It should be updated on an annual basis unless there is no material change.

Transparency of asset managers’ activities

Asset managers will have to disclose certain information, at least annually, to the firms they provide services to so that asset owners can assess whether and how the manager is acting in their best long-term interests and to assess whether the asset manager’s strategy allows for effective shareholder engagement.

Asset managers will have to disclose:

• how their investment strategy and its implementation contributes to the medium to long-term performance of the asset owner or fund
• the following information:
  • the key material medium to long-term risks associated with the investments
  • portfolio composition
  • turnover
  • turnover costs
  • whether the asset manager uses proxy advisors for the purpose of their engagement activities
  • their policy on securities lending and how it is applied to fulfil engagement activities, if applicable, particularly at the time of general meetings of companies they invest in
• whether and if so how they make investment decisions based on an evaluation of medium to long-term performance, including the non-financial performance, of the companies they invest in, and
• whether any conflicts of interest have arisen in their engagement activities, and, if so, what they are and how the asset manager has dealt with them.

When will the new rules apply?

The proposed rules will come into effect on 10 June 2019. The FCA state “For an initial period after they come into effect, we consider it would be possible for a firm to comply with the relevant rule by explaining what it is doing to develop an engagement policy. This may include, for example, explaining that it is in the process of developing one, or that it is considering whether to have one. This explanation would need to be added to a relevant webpage by 10 June.”