The Kay Review - a missed opportunity

The Government commissioned Professor John Kay to review activity in UK equity markets and its impact on long-term performance in June 2011 and the review appeared in July.  There is much to applaud in the review – and it picks up on several themes of previous Forum work- but from the sustainability perspective a significant opportunity has been missed.  

But let’s start with the good. Among many recommendations the review:

• Calls for more trust throughout the system.  This is a laudable aspiration and well worth articulating
• Encourages companies to use high quality, succinct reporting to help transmit key messages which are material to investors. This will be good for reducing “noise” in the investment area
• Calls for executive pay to relate to long-term, sustainable business performance, and for fund manager pay to align with investor interests and timescales. Good full stop!
• Calls for fund managers to make full disclosure of all costs charged to the funds they manage. This will highlight important costs such as transaction fees
• Calls for the Law Commission to review fiduciary duty, the burden on pension fund trustees “to do the right thing”. Uncertainty over this concept is delaying more environmentally sustainable investment and review will help
• Calls for less prescription from regulators and more use of informed judgment. This should reduce activity driven by box-ticking compliance with rules

The second, third and fourth recommendations all echo the Forum’s thinking expressed in our report on Overcoming the Barriers to Long-term Thinking in Financial Markets.

Particularly welcome to me as an an ex-fund manager is the whole of paragraph 6.24:

Our very clear sense, after an extended series of meetings and consultations with those involved in the equity investment chain, is that the vast majority of people employed in it want to derive satisfaction from doing a good job: a good job in the sense in which we have defined it, which is developing a financial services system that promotes high performing companies and delivers good and secure returns to savers. Conscientious stewardship is, for most people, an inherently satisfying activity.

I firmly believe that the City is full of individuals who want to exercise “conscientious stewardship” and are hampered by the system; by recognising that not everyone is simply a bonus grabber Professor Kay injects some useful objectivity into the debate on City behaviour.

So what’s wrong with the review from the sustainability perspective? Well, the fundamental problem is that it doesn’t stress the obvious link between long-term financial performance and sustainability issues. As most people now understand, the further ahead one looks the more issues such as climate change will bite with direct consequences on company operations and asset values.

Good long-term investment must now consider these issues but the review doesn’t make that point as forcefully as it should have done.

This is shown most clearly in the statements of best practice proposed for company directors, asset holders (e.g. pension funds and insurance companies) and fund managers.  The statement for directors includes the obligation to consider long-term factors “including relevant environmental, social and governance issues”. But the other two -for the people who own and manage the assets- do not have the same language. It is arguably implicit in some of the clauses, but why isn’t it explicit? Especially since the body of the review says at one point:

“…institutional investors acting in the best interest of their clients should consider the environmental and social impact of companies’ activities and associated risks among a range of factors which might impact on the performance of a company, or the wider interests of savers, in the long-term.” (My emphasis)

Any prudent fund manager should be considering those factors and any entity owning assets should be checking that their fund manager is doing so. But by not making it a listed item of best practice the pressure on every fund manager to do it is lessened. That is a significant failing. (For our thoughts on what’s needed for a more sustainable economy click here.)

So will the review change attitudes and practices in investing? Will it encourage improved consideration of the “long-term”? Well, with the caveat that some further action by Government may be required I think the answer is a qualified yes, the recommendations will encourage some change in some areas and that is to be welcomed. But by missing the opportunity to put key long-term issues such as the environment firmly on agendas throughout the equity investing chain the review doesn’t go as far as it could have done. That is disappointing.