Growth over Governance
London’s ‘risk-on’ reset places a premium on stewardship, as a light-touch approach to governance raises concerns for institutional investors.
The great overhaul of the UK’s capital markets – considered to be the most extensive renovation in four decades – is continuing apace, with the aim of supporting the government’s economic growth agenda and enhancing London’s position as an international destination for initial public offerings (IPOs).
Set in motion by Lord Hill’s UK Listing Review report in November 2020, a significant amount of work has been done that is “multifaceted, with a coherent and pragmatic vision to it”, according to Dame Julia Hoggett, CEO of the London Stock Exchange (LSE).
Speaking at the Capital Markets Industry Taskforce’s (CMIT) UK Capital Markets Reform Update on 6 February, Hoggett stressed the need to get the “risk capital flywheel” turning more effectively again.
CMIT has an ambitious and wide-ranging reform agenda to support its key goal of attracting “the broadest range of issuer” to London by improving the UK’s capital-raising rules and giving firms “the freedom to execute” against strategy.
It seeks to increase the availability of risk capital to publicly listed and private companies, including from institutional investors, but is also keen to revise corporate governance, stewardship and remuneration to the “benefit of all stakeholders”.
“We want to do everything we can to ensure that the UK is the best possible place for great companies to start here, grow here, scale here and stay here. And [ensure] our capital markets have the best possible assets for our policyholders, pensioners and savers to have enough money for life events and old age,” said Hoggett, who chairs the taskforce, having played a key role in establishing it and recruiting its members, which include the CEOs of large asset owner and investment management firms.
“But in order to have the focus and attention that we as an industry have received in the past four years and still need in the coming years, we have to set the objective as being a thriving economy serving issuers and investors.”
Simplified rules
One area of work already completed is the Financial Conduct Authority’s (FCA) revision of the UK Listings Rules, which came into effect on 29 July, 2024. The revisions, including laxer rules governing dual class share structures (DCSS), significant and related party transactions, aim to cater to fast-growing companies, according to the regulator.
But while the UK’s financial watchdog believes that these changes better align the UK’s regime with international market standards, many in the asset owner community have raised concerns around what they perceive as a lessening of shareholder rights and corporate governance standards.
A spokesperson from the Local Authority Pension Fund Forum (LAPFF), a voluntary association of 87 public sector pension funds and seven pools with combined assets of over £350 billion, highlights the potential issues arising when, for example, executives are entrenched by DCSS and can’t be removed, as demonstrated by some US tech companies. “In such cases, there is power without accountability,” they explain.
Many institutional investors have felt that their voices weren’t listened to during the FCA consultation process. There is also much debate as to whether these changes will deliver the hoped-for listings and investments.
The International Corporate Governance Network (ICGN), led by investors responsible for assets under management of over US$90 trillion, wasn’t in favour of the three key reductions in shareholder rights including the introduction of DCSS, the removal of votes to approve merger and acquisition (M&A) transactions, and the removal of votes on related party transactions, according to CEO Jen Sisson.
“It takes many different factors to attract more listings and taking those rights away isn’t going to solve the problem on its own,” Sisson tells ESG Investor. “But it does inject more risk into the system for ordinary people’s savings and investments, which will mean that investors will need to do even more stewardship because that’s their job.”
Risk appetite
In his appearance before the UK House of Commons’ Treasury select committee on 10 December, FCA CEO Nikhil Rathi acknowledged the concerns raised by many pension funds during the consultation about the lessening of investor protection. While admitting that he expected some things to “go wrong” in the coming years, Rathi argued that this was necessary to shift the risk appetite and align the UK with competitor jurisdictions.
But not all hold this view. As part of its response to the FCA’s consultation, the Pensions and Lifetime Savings Association (PLSA) cited examples from other parts of the world that illustrate how the dilution of corporate governance standards and the lessening of shareholder rights can actually inhibit growth. In Japan, for example, policymakers have taken the opposite approach to drive growth by bolstering corporate governance and standards.
The PLSA is determined to uphold strong governance, according to Policy Lead George Dollner. “While offering votes on significant and related party transactions is no longer required by the FCA, we still see this as best practice,” he says.
“In our updated Stewardship and Voting Guidelines, we recommend that investors should consider voting against the chair of the board if companies proceed with a significant or related party transaction without a shareholder vote in advance.”
As the UK Listings Rules came into effect just six months ago, it is too early to say whether the changes will have the desired effect, particularly in the midst of a global turndown in IPOs.
“Will there be more allocation to the UK? Will there be a more vibrant market? We hope so, but it comes with increased governance risk when you take away those protections,” says Sisson. “A focus on good governance and high-quality stewardship – and the UK being a leader in both – is a much more positive message for growth.”
As well as the number of listings attracted to the UK, the success of the reforms will be assessed against criteria including short- and long-term valuations. The LAPFF spokesperson suggested there may be a case for a review of the performance of recent LSE listings, “as there seems to be a systemic problem of overvalued IPOs”. Examples include French media giant CANAL+, which debuted on 16 December at a valuation of £2.4 billion, following its spin-off from parent company, but saw its share price slump by more than a fifth within three hours of listing.
The FCA has committed to formally reviewing the new listings regime in five years’ time to assess the impacts on all parts of the market.
Rules of engagement
Closely linked to Listings Rules revamp in the eyes of asset owners is the Financial Reporting Council’s (FRC) proposed changes to the UK Stewardship Code, which now numbers 297 signatories, representing £52.3 trillion assets under management.
The proposals, published in July 2024, include reducing annual reporting requirements and offering greater clarity on stewardship outcomes. However, a modification to the definition of stewardship – restating that predominant purpose is to ensure financial returns – proved contentious for many asset owners and managers.
When PLSA responded to the FCA consultation on the Listings Rules, it made clear that it sees the code as critical in upholding shareholder rights, reports Dollner.
“We want to ensure that the Stewardship Code – which is voluntary – is rigorous and there to uphold high standards. Organisations don’t have to be signatories, but if they opt in, then we expect that they’re doing so on the basis that they care about good stewardship,” he adds. “We are looking at ways to work with the FRC and the wider industry to retain the reference to environment and social considerations.”
PLSA has set up a stewardship advisory group to explore how the group and its wider membership can engage better and more effectively as a collective.
Ahead of the closure of the consultation on 19 February, the ICGN published its response last week. While supporting the streamlined principles and reporting requirements, the network made several suggestions including a request that the code explicitly recognise stewardship as a core aspect of an investor’s fiduciary duty.
The updated Stewardship Code is expected to be published in early-to-mid 2025 and will come into effect in 2026.
Work in progress
While much work has been done, there is much more to come, as Hoggett highlighted at the CMIT conference, particularly in terms of stimulating the growth of smaller and private firms.
For example, UK prospectus reforms are in train, with the FCA aiming to finalise the rules within the first half of this year.
In addition, the LSE is planning to work with the FCA to review the Alternative Investment Market (AIM) rules, which is tailored to help smaller, riskier, or high-growth companies. It will look at enabling DCSS for AIM firms and whether the documentation burden can be lessened for certain types of transactions, such as reverse takeovers.
The FCA’s consultation on the regulatory framework for Private Intermittent Securities and Capital Exchange System Regulation (Pisces), the first major regulated crossover private-public market, closed on 17 February. Pisces is a new type of trading platform where companies can choose to have an auction of their secondary shares at a time of their choosing, using the same infrastructure and intermediaries as in the public market.
The rules will be introduced by statutory instrument by May, enabling the platform to be active in the FCA’s financial market infrastructure sandbox for five years. Activity on Pisces won’t be subject to the Market Abuse Regulation nor have additional corporate governance requirements, said Mark Austin, Partner at Latham & Watkins and CMIT taskforce member, speaking at the event.
The hope is that institutional money, especially from pension funds, will be attracted to the new opportunities being generated on AIM and Pisces. This will depend in part on the outcome of the government’s consultation on reforming pensions investment, which closed on 16 January.
The reforms are aimed at consolidating local government and defined contribution schemes, but could also change the definition of fiduciary duty to focus on net return – not de-risking and loss avoidance – and increase incentives to invest funds in the UK.
“At our first CMIT meeting, we agreed that we needed to make a national scandal out of the level of pension disinvestment in the UK over the past 20 to 25 years. I call this agenda ‘turning the taps back on’, as you can’t have capital markets without capital,” said Hoggett.
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