IT IS early in the life of Professor John Kay’s review into the operation of UK equity markets, commissioned by Vince Cable. But it is already clear both from the responses to the first call for evidence and from John Kay’s reputation that it is going to shine an uncomfortable light on one of the less reputable City practices: the negation of the rights of share ownership that has effectively left UK quoted companies managed in the interests not of the beneficial owners but of investment intermediaries.
An “owner” is somebody who bears the risks and rewards of ownership. Most shareholders do not. Most are intermediaries, with no incentive to use their powers effectively, often with conflicting interests, sometimes with actual disincentives to using their power, occasionally with an active interest in damage.
Private shareholders have been seduced by the allure of nominee accounts. One can only admire from a distance the elegance with which pressure groups influenced the drafting of the 2006 Companies Act in such a way that those with an interest in shareholder power did not even notice they were being undermined. We now know that investors holding shares through nominee accounts are effectively disenfranchised in favour of the broker, except for a small minority prepared to forgo the administrative attractions of such accounts by becoming a Personal Member of Crest. Even that is not available for Sipps and Isas.
All this leaves a private shareholder base of perhaps 30 per cent (nobody knows for certain) holding just 10 per cent of the votes.
Who votes the shares underlying tracker funds and exchange-traded funds? Who knows, but, worse, who cares? Investors in trackers have advertised their disinterest in the performance of individual companies by their choice of investment. No manager of a tracker fund is going to spend a microsecond on the governance of individual companies when his prime duty to his investors is to hold down costs.
Which brings us to free-riding. Is it really so hard for those who put their faith in institutional fund managers providing governance to see that the economics of free-riding torpedoes their efforts? In the world of beating benchmarks, only if a fund is concentrated with large stakes in a small number of companies does the governance effort deliver a commensurate return.
All this leaves large numbers of “free votes” – votes in the hands of those without a beneficial interest but free to vote in their own interests. Most of these votes are institutional votes.
The major financial institutions make money from, among other things, trading, broking, corporate advice, equity funding, debt funding, acquisitions and disposals and leveraged investment. These depend on corporate activity, not corporate wealth creation – volatility not profitability. Given that these same institutions are major holders of free votes it is extraordinary that this conflict of interest has escaped public scrutiny, except from special-interest groups such as the UK Shareholders’ Association.
The regulator has shown no interest; indeed it has no responsibility under its terms of reference to do so. Regulations are instead directed towards trading efficiency and not the preservation of the ownership rights that shares should represent. In discussion document after discussion document the distinction between shareholders and owners has been ignored. Even the mechanics of stock lending (which transfer voting rights to the borrower, whose likely intent is to short the stock) pass without comment.
It is time to reverse the erosion of investor rights that has accumulated over many years. There are no quick fixes, but we hope that Kay’s final report calls for the following:
● Nominee shareholders should be enfranchised. No other developed country allows such neutering of individual shareholder rights
● This should reveal about 30 per cent private shareholders who are true owners. These owners need a voice to combat the power of intermediary votes. Their rights should be represented by elected shareholder committees (which might be better termed owners’ committees).
● Maintaining an effective governance link between corporate owners and corporate directors should be an explicit objective of the regulator – in the first instance the Financial Conduct Authority (FCA).
● The investor protection functions of the FCA (including governance) should be separated from its market efficiency responsibilities. The evidence is that an authority to protect savers and investors does not combine easily with an authority charged with promoting the efficiency of those markets from which savers and investors need protection.
The value of good governance is sometimes put at 1 per cent extra return. If that is the case then bad governance could be costing up to £15bn per year in the UK quoted sector alone. That is the prize for giving control back to the owners. Let’s hope that Kay agrees.
Chris Hulme is chairman of the UK Shareholders Association and a Manchester-based financial services director/adviser.