From questionable corporate incentives to excessive risk-taking, there were plenty of red flags that should have warned asset managers of the impending financial crisis in 2008.
And yet, many turned a blind eye, ultimately choosing to risk people’s pension savings for the sake of short-term gains.
Since then, codes of practice have been introduced around the world to ensure that companies are scrutinised and held accountable for their actions, with the UK being the first country to launch a voluntary stewardship code back in 2010.
Essentially, the code set out to improve communication between asset managers and the companies which they are invested in, while ensuring that institutional investors take a long-term stance when investing on behalf of end consumers.
Other countries have since followed suit, and in May 2017, the European Union agreed on amendments to its Shareholder Rights Directive.
Due to come into force in June this year, these changes will mean that asset managers have to be completely transparent with how they engage with companies they are invested in. The directive is compulsory – if firms don’t comply with the rules, they will have to explain why.
Other rules include giving shareholders more say over directors’ pay, and making it easier for them to vote in general meetings, even if they reside in a different EU country.
Behind the times
Brexit aside, the UK is expected to abide by this European-wide regulation. However, despite Britain being an early adopter of stewardship, UK-based asset managers are worryingly unprepared for the incoming changes.
According to a report published by Hermes Investment Management last week, just eight per cent of companies think that their organisation meets all the requirements, and 47 per cent were unsure.
Surprisingly, awareness of the directive was poor too, with just 45 per cent of investment firms clued-up about the refreshed rules.
By comparison, investors in Germany and the Netherlands are ahead of the game – with 88 and 79 per cent respectively having a good handle on the directive.
The question now is: why is the UK so behind?
It’s thought that this lack of awareness could reflect the fact that UK regulators have only recently clarified the criteria that needs to be added to our own stewardship code in order to meet the EU-wide directive’s requirements.
That said, Hermes points out that these issues are being resolved through an ambitious update to the UK stewardship code, which will make sure that its requirements are not just aligned with those of the directive, but go beyond it.
Andy Jones, engagement professional at Hermes, reckons that this updated code will raise the bar for stewardship.
“In Britain, we can expect to see a three-tier system emerge: the highest being those who voluntarily choose to comply with the UK code, the middle being those who comply with the EU directive, and, at the lowest end, those who choose to not to comply with the directive, but provide an explanation about why they are not compliant.”
The UK may have been the first country to implement a stewardship code, but it’s still got a long way to go to convince investors of the merits of environmental, social, and governance (ESG) criteria.
In fact, despite efforts by policy-makers to change perceptions, the Hermes study found that just 47 per cent of UK investors thought that ESG investing achieved higher returns than non-ESG investing – the lowest score of any country.
The irony here is that ESG-compliant companies tend to be the most forward-looking, and therefore have the biggest potential for gains in the future.
Perhaps investors see more value in stewardship, where they can affect positive change in companies, than simply investing in companies that happen to meet a broad set of ESG requirements.
So while the directive will have significant implications for asset managers, what changes should end investors expect to see?
By considering investment strategies in the context of the performance of investee companies, Jones says that this will align objectives with longer-term focused retail investors, such as those saving for retirement.
But stamping out bad practice will also make it less likely that investors will lose money, by reducing the risk of corporate failure, and even helping to prevent another financial crisis.
Finally, the directive seeks to improve the way that investment returns are delivered, encouraging institutional investors to monitor investee companies on their environmental and social impact. Jones adds: “As stakeholders of society, retail investors also stand to benefit from these broader outcomes.”
“For too long, the majority of the investment community has neglected its fiduciary duties,” says Saker Nusseibeh, chief executive of Hermes. “The directive represents a historic opportunity to address some of the systemic problems in capital markets, ensuring a more sustainable capitalism.”
And if asset managers get themselves in gear, perhaps it could also help restore trust in an industry that is still damaged from the financial crash.
One thing is certain: the asset management industry will never fulfil its potential to improve society unless it changes.
With end investors becoming increasingly vigilant about where they allocate their money, the demand for ESG funds is only going to increase. And as a result, the lifespan of badly behaving companies will only get shorter.