UK: institutional investors and corporate governance

The Cadbury Committee observed in its report that "the way in which institutional shareholders use their power to influence the standards of corporate governance is of fundamental importance" (para. 6.10). It is not difficult to see why: UK and overseas institutions own the great majority of shares traded on the London Stock Exchange. Institutional investors are therefore central to the UK's market based based model of corporate governance and the principle of "comply or explain". 

The role of institutional investors was the topic of a speech delivered yesterday by Hector Sants, the chief executive of the Financial Services Authority, at a conference organised by the National Association of Pension Funds. Mr Sants explained his view on the role of institutional investors within the corporate governance framework and made clear what changes he hoped to see, including earlier intervention and greater collective action. Here are several extracts from his speech: 

A lesson for you [institutional shareholders] from this crisis must be that greater interrogation of how well a company is managed and the adequacy of its risk controls are all material factors fundamental to investment management. A focus of a firms' risk control framework must be an effective risk and audit committee and knowledgeable non-executives with a willingness to challenge senior management. Investors must play a role in ensuring such a framework is in place and effective.

Shareholders must also take responsibility to be active individually and more importantly, in collaboration with other investors, to engage with senior management and Non-Executive Directors in companies and question the effectiveness of the construct of their boards.

There are also specific questions around how institutional investors voice concerns and exercise their rights through voting; particularly where there are concerns about business strategy and also management or performance. Once an issue has reached the stage of a public vote, often the stakes are too high to vote down. We would like to see earlier intervention.

Reform is needed to the global regulatory structure but it is important to understand the limits of regulation. Regulators make no claim to be infallible. It is critical to recognise that the principal responsibility for managing firms responsibly remains with the management of the firms and that shareholders are the principal mechanism for holding these managers accountable. Shareholders going forward, have a duty, an obligation to make that oversight role more effective. In order to discharge this obligation you not only have to be more focussed and engaged in individual institutions but also you need to give careful consideration to how you more effectively achieve collective action"