Editor’s Opinion: The Kay Review is a missed opportunity

The Kay Review on the problems of short-termism in UK equity markets may have fingered many of the serious problems in the institutional investment chain, as you would expect of an incisive economist of Professor John Kay’s stature. But it spectacularly overlooked a major cause of short-term investment behaviour by failing to address the most important relationship, and failure, of all in the investment chain: that of the contract between asset owner and asset manager. True, Professor Kay does, in his suggested good practice statement for asset holders, say that they should set mandates which focus asset managers on achieving absolute returns in line with long-term investment objectives, and review performance no more than is necessary. They should also “encourage and empower” managers to engage with investee companies to improve performance. And Kay has some interesting points on how managers should be incentivized. Beyond that, however, there is little of substance that might change the incentives of the fund management industry. For example, there’s nothing on the professionalisation of trustees or the pooling of pension assets to increase the resources that might make better oversight possible. And Kay almost completely ignores the pivotal role played by investment consultants in asset owner decision-making in the UK. There are no specifics about mandate design or duration. This is a huge missed opportunity because the mandate design stage is the anchor for the entire investment chain: asset management culture flows from client desire. The International Corporate Governance Network’s innovative but fledgling ‘model mandate’, which seeks to put long-termism, environmental, social and governance (ESG) requirements and ‘systemic responsibility’ into mandate contracts, gets a passing reference, but that’s it…The report also makes no mention of possibly the most significant development in institutional investment in the past 10 years, the UN Principles for Responsible Investment. The PRI is not perfect, but it has created a climate of investor engagement globally that did not exist before, and which Kay advocates strongly. Likewise there is no reference at all to the Carbon Disclosure Project (CDP), the Global Reporting Initiative (GRI) and Integrated Reporting. They are all projects that are in different ways addressing some of the main problems Kay identifies. Similarly there is no acknowledgement of ESG indices such as FTSE4Good or the Dow Jones Sustainability Indices, which, again, enable investors to meet some of Kay’s objectives. There is also no analysis of how proxy voting firms and other advisors can help asset owners develop a view about a company. They are wrongly rejected as just another link in a too-long chain. Kay doesn’t answer the obvious question: which link in the current investment chain would voluntarily remove itself? Furthermore, there is good empirical evidence to suggest that Kay’s proposed investor forum would do little that hasn’t already been tried (and failed) or might replicate the existing PRI Clearinghouse, creating yet another layer of complexity. For Kay not to acknowledge these initiatives’ existence or put his proposals into that broader context is an oversight, although the economist is on record as saying that he believes the PRI has yet to show itself as anything more than an asset gathering initiative. An idea not taken up by Kay is mandatory voting disclosure, where investors would have to say how they voted at company AGMs. This may sound technical, but it would show what investors are doing and why. Much more disclosure also on investor-company engagements would lift the lid on the back-rooms where decisions are taken.

Kay says shareholders should also be consulted over board appointments, but the devil is in the detail. Surely investors can already express their opinions at AGMs – why de-value that process? He has also fudged the issue of whether changes to voting rights or dividend policy could be a useful lever to generate change. Vince Cable, the UK Business Secretary will have breathed a sigh of relief knowing that he won’t be obliged to steer new legislation through parliament or draw up new regulations on the back of Kay’s review. It’s business as usual as far as policy is concerned. Perhaps those were the unwritten terms of this report? The onus, as ever, is on the industryto resolve its problems, but Kay doesn’t even advocate comply-or-explain. His approach is “it would be nice if you did this”. We have seen though where light touch regulation has taken us. The UK has had a comply-or-explain governance regime for years but the corporate scandals keep coming. Unfortunately Kay has provided too few specifics to genuinely bring about the change he desires. The Kay Review should have been the roadmap for institutional investment in the second decade of the 21st century. What it presents is a rough guide and not the GPS coordinates we so badly need.