David Paterson, former Head of Corporate Governance at the UK’s powerful National Association of Pension Funds (NAPF), who retired last week (October 18) comes at the subject of governance with the hands-on experience of a portfolio manager. It makes him ideally placed to evaluate the major current governance developments of stewardship and engagement collaboration from the perspective of money management. Paterson ran money for pension funds, investment trusts, unit trusts and governments for more than 20 years from the late 1960s, both in the UK and in Asia, with the venerable investment house, Robert Fleming & Co. Subsequent management positions at ‘Flemings’ saw him work closely on risk management during the mid 90s, which was a ‘new area’ at the time, and then corporate governance later on in the same decade. The Fleming funds arm later became JP Morgan Asset Management in the early part of the new century following a series of buyouts. Looking back, Paterson says: “From the late 80s, voting was done manually and our governance policy was focused on making sure we used our votes effectively in annual general meetings. It really started at the behest of one of the big UK pension schemes, which said voting and corporate governance was important and asked us to use our votes intelligently and tell them what we’d done. The voting decision rested with the portfolio manager, not the corporate governance specialist, although we had a strong influence. The concept of engaging with companies independent of what the portfolio managers were doing didn’t exist.” When the UK government introduced its Corporate Governance Code in 1992 (also know as the Combined Code, based on the government instigated governance review by Sir Adrian Cadbury), Paterson says his governance efforts were focused on applying the “comply-or-explain” basis of the code in a way that was sensible and intelligent: “Our rationale was always that we wanted companies to be successful, so let’s listen to the explanations if they don’t comply!”Paterson says the UK’s biggest pension schemes such as BT, USS and Railpen have gone on to further set the tone on corporate governance over the last 25 years and played an enormously important role in its development. But, he concedes that they are the exception rather than the rule amongst UK pension funds where most have fully delegated management to external investment houses. However, he believes the majority still have a clear business rationale to ‘do’ corporate governance, and that the UK government’s latest governance gambit, ‘stewardship’, is part of the answer. The Stewardship Code introduced in 2010 and overseen by the Financial Reporting Council (FRC), the UK’s independent governance and reporting regulator, comprises seven principles around governance, voting, engagement and related reporting. Paterson says: “I think in the pension fund world the challenge today is how you more effectively measure what your manager is doing for you. This goes beyond corporate governance into general trustee governance. Agency issues are difficult, particularly in smaller pension funds. I’m very much of the view that the more pension funds ask these questions of their managers the more they will be willing and able to deliver better answers, and not just for governance.” In retirement, Paterson will continue to be a trustee of a £500m UK pension scheme and a sizeable medical charity, which, he says, means he can see the challenges of corporate governance from the perspective of the end trustee. The NAPF has provided significant guidance on how pension funds might act, notably its Stewardship Made Simple guide. It has also produced simpler prompts and checklists for smaller funds to ask their fund managers. Paterson says the anecdotal evidence is that stewardship is an area where many pension fund trustees feel reasonably comfortable.
He points out that analysing investment portfolios and performance is tougher because many don’t have the requisite skills and so rely on their consultants to advise them.
“However, asking questions like: Is this business well run? Are we investing in a successful company? This is terrain that trustees, who are quite often middle/senior management themselves – and often from the finance side – understand. Anyone who is reasonably au fait with business issues and reads the Sunday papers can also understand bonus issues and performance. If trustees start asking questions of their fund managers such as how they dealt with the Libor scandal, for example, it’s a good way putting managers on the spot. If the manager did nothing, it begs the question as to whether their analysts are on the case with major financial issues.”
The NAPF has been publishing a set of monthly topical stewardship questions to ask of fund managers. The Stewardship Code has more than 200 fund managers signed up and the NAPF’s Stewardship Framework provides a useful list of each manager’s stewardship statement. But to date, it only has just over 60 pension fund signatories. Paterson says: “We’d like to have more funds sign up, use it, adopt it and thoroughly test managers in the meetings they have once or twice a year. The pushback though is that it’s not a priority: pension funds have issues like the strength of covenant and the next financial valuation to worry about. And to be fair those are legally important, existential issues!” He says another barrier, which he has less time for, is legal advice: “One or two pension funds say they have talked to their lawyers who have said the funds shouldn’t commit to the Stewardship Code until they know they can do it properly: “One can understand their legal apprehension, but not with much sympathy I have to say. It’s another way of not doing something that isn’t seen as a priority. I come back to this trustee governance point though: if you’re trying to manage your agents effectively, what tools do you have to do that?The Stewardship tool is a good one because it is FRC sanctioned, government blessed, and is a relatively simple way of testing whether your manager is managing your money in a way that you and your beneficiaries would deem appropriate.” The second major governance reform area where Paterson has been involved is the creation of a new Investor Forum for corporate engagement recommended by the government appointed Kay Review on UK Equity markets by respected UK economist and journalist, Professor John Kay. A working group, the ‘Investor Working Group on Collective Engagement’ comprising the main investment trade associations, the NAPF, the Association of British Insurers (ABI) and the Investment Management Association (IMA), amongst others, and chaired by James Anderson, Partner at Baillie Gifford, is due to report in November.
Until now, Paterson says when there has been a significant governance issue at a company that concerns multiple investors, the trade associations have helped to orchestrate collaborative meetings: “Those meetings don’t happen that often and we’ve never sought to measure success because they are discursive. It’s the investors that have the shares and the decision. These short-term coalitions for change have tended to be informal and then dissolved. The question for the working group is whether a more formal investor forum would add value to that process. I don’t know what the answer is.” Paterson says discussions are getting to the point now where the group is drawing together conclusions: “It’s been a fascinating exercise and there have been a lot of different views expressed about the merits of collaborative engagement, which is what this is really about. The question is whether you can collaborate to make engagement more effective and what form can
that take? I hope the report will support the fact that it has been a very worthwhile exercise.” The UK government has said it wants to review the effectiveness of the investor forum in the summer of 2014. Paterson says: “The challenge for investors and companies is that engagement is most effective when it is done privately out of the spotlight of the press. But how you then demonstrate that there has been engagement and that you’ve had some influence? I wonder if there is a role for the NAPF or the ABI – reasonably neutral bodies – to report to the wider public or market over the year at shareholder intervention in companies? I’m musing here though…” Looking back over his career, Paterson notes that while corporate governance analysis has become part of the toolkit for the fund managers to make investment decisions, he regrets that it has also become somewhat detached from the actual investments being made: “Asset managers will argue that they are integrated, but the fact is that there are governance specialists and investment analysts and investment decision-makers. I would like to see the investment industry make a real effort to show that there is joined-up thinking across the piece.” He says the globalisation of investment makes that even more important: “I used to be deeply involved in investing in China where the concept of corporate governance didn’t reallyexist, but you were concerned that management was shareholder friendly, to put it mildly. If you invest in parts of the world where governance codes are non-existent or in their infancy, you have to fall back on your judgement of management capabilities and integrity from the point of view of shareholders. The governance philosophy helps you down that road. Governance thinking is embedded in investing in emerging markets in a way perhaps that it has become more detached in developed markets.” Paterson says he believes a similar joined up approach is applicable to responsible investment/ESG more broadly: “I’ve thought for years that environmental and social issues would become more important in investors’ minds. And I think they have because in a sense they are a natural extension of corporate governance.” The NAPF published a well thought through guide in May this year on responsible investment. Paterson says: “Companies are responding to the challenges of environmental and social issues in a way they weren’t doing ten years ago. The corporate world is ahead of investors because these issues are about good management. To reflect that, I’d like to see more asset managers build environmental and social analysis in the way they make investment decisions. The connections are beginning to be made.”