The UK Stewardship Code 2020, published on 24 October 2019 and effective from 1 January 2020, retains a focus on long-term investment and significantly increases the scope, standard and also the application of “stewardship”. The publication of this, the third edition of a UK stewardship code by the Financial Reporting Council (FRC) (the FRC Code), follows a significant period of consultation across the financial services industry. The UK Stewardship Code 2020 includes a more outcomes-based approach to stewardship with application to a wider range of investment market participants than the two previous editions of 2010 and 2012. Embedding culture into institutions to facilitate stewardship is an increasingly important theme in the FRC Code, as is “culture” more generally in the regulation of the financial services industry. There is also a much greater emphasis on environmental, social and governance (ESG) issues than in previous FRC Codes. 

Defining stewardship

The shifting emphasis of the FRC Code is clear from the concept of “stewardship”. In the UK 2020 Stewardship Code, “stewardship” is introduced as “the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society”. This definition broadens the application of the FRC Code to asset classes beyond the more mature markets of UK listed equities and the “benefits” to the “economy, the environment and society”. Previously, the “benefits” of Stewardship were expected to accrue to “companies, investors and the economy as a whole”.

Standard raised - activities and outcomes based approach

The UK 2020 Stewardship Code sets out principles, the intended outcomes of applying the principles and the activities required to foster these outcomes. Reporting obligations are more onerous than in the earlier versions of the FRC Code. Signatories should report in some cases on the context of each principle within the institution and in each case on the activities undertaken to apply the principle and the resultant outcomes. There is also a great focus on communications with clients, whether seeking their input on stewardship or explaining why internal stewardship and/or investment policies have not been followed.

Extended in application and scope

The first section of the enlarged FRC Code, for asset owners and asset managers, is divided into four sections: purpose and governance; investment approach; engagement; and exercising rights and responsibilities. Principles number twelve rather than the seven in the 2012 FRC Code. There is also now a second section, which sets out principles applicable to service providers, such as investment consultants (advising pension funds, for example, on the merits of different asset managers), proxy advisors (which need to adopt a code of conduct) and data and research providers.  The annex sets out a useful summary of other UK regulatory requirements applicable to various categories of signatories whether asset owners, asset managers or proxy advisors.  The Financial Conduct Authority (the “FCA”) has received mixed feedback on the quality of some of these service providers and notes The Treasury is due to consult on whether to bring investment consultants under FCA regulation.

In terms of asset classes, the UK Stewardship Code 2020 notes in particular the growth in other asset classes such as fixed income, real estate and infrastructure. Investors in these asset classes have different investment horizons, rights and obligations. As noted in the October 2019 FCA stewardship feedback paper, although stewardship of equities with voting rights may be easier to achieve than for other asset classes, bondholders can exert influence over debt covenants and disclosure requirements for their investments.

Culture and continuous improvement

There is a much greater focus on entrenching values culturally in institutions in this edition of the FRC Code and a new principle of review and quality assurance. The focus on culture is consistent with changes in the financial services industry including the implementation of the Senior Managers & Certification Regime.  By way of an example, institutions must now explain how they have resourced and incentivised their employees to integrate stewardship and investment decisions. An institution should ensure its employees with responsibilities for stewardship are properly trained and sufficiently senior to have credibility within the institution. Institutions should also then explain the effectiveness of the approach adopted and how such an approach could be improved.

ESG

The UK Stewardship Code 2020 also includes a principle for asset managers and asset owners that they ““systematically integrate stewardship and investment”. The principle includes “material environmental, social and governance issues, and climate change”, a new requirement in line with the broader industry theme of ESG investing. Signatories need to disclose how they have prioritised areas for investment, reflecting ESG themes. Similarly, for service providers, there is a clear requirement for them to support their clients’ efforts to integrate stewardship and investment, including these ESG requirements, and to demonstrate how they have done so. Climate-change, already a feature in this FRC Code, and greenwashing remain a focus for further study by the FCA.

Next steps

The UK Stewardship Code 2020 comes into effect on 1 January 2020.  However, institutions can still apply to be signatories to the 2012 FRC Code by submitting their annual stewardship reports to the FRC up to 31 December 2019.  In their stewardship reports, the institutions need to explain how they have applied the 2012 FRC Code over the previous 12 months.  The list of signatories for the UK Stewardship Code 2020 will be first published in 2021. To be included in this list, institutions need to submit their final stewardship reports to the FRC by 31 March 2021.

There are already requirements under the FCA’s Conduct of Business Sourcebook for asset managers to disclose the nature of their commitment to the relevant FRC Code or where they do not commit, their alternative “investment strategy”. Additionally, in 2020 the FCA will be considering how to extend its current rules on stewardship and shareholder engagement to SIPP operators.