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Sunday, 22 April 2012

UK seeks views on corporate governance, audit

The clock is ticking. It doesn't stop just because the economy has and because nothing very much has changed. But it's time to revisit corporate governance again. The UK Financial Reporting Council adopted its latest provisions two years ago, so it's time to crank up the consultation machinery to fine tune them. But the consultation follows several other initiatives that have not yet become policy, so this paper concerns in part what the consultation itself will not address. It won't look at board diversity – it has done that last year. It's also not seeking views on remuneration, subject of a different government inquiry. The FRC is seeking views on two interrelated themes:
  • Corporations and boards: The 2010 UK Corporate Governance Code narrowed the scope of this iteration to concentrate on what boards do and how they are built. Some small issues have arisen in the implementation of it, and the FRC will take another look. More fundamentally, it wants to make a big revision to the notion of compliance. "The FRC also proposes to set out in the Preface to the Code the features that it regards as the characteristics of an informative explanation," it said. That means incorporating the themes of a paper it published in late February entitled: "What Constitutes an Explanation under 'Comply or Explain'?" It wants the code itself to help companies understand "what was expected of them when they choose to deviate from the provisions of the Code, and to provide shareholders with a benchmark against which to judge explanations".
  • Audit: Boards will need to state in the annual report the reasons why they consider the report to be fair, balanced and understandable. The remit of the audit committee will be extended expressly to advise the board on this issue. More informative reporting by audit committees, including on the process for appointing the external auditor, will be encouraged. And the 350 largest companies will be expected to put the audit contract out to tender at least every 10 years.

In addition, the FRC is consulting separately about the Stewardship Code, which concerns the actions of shareholders and in particular institutional investors.

Source document: The overview page has links to the consultation paper and two appendices.

What is stewardship? The FRC wants to know

The UK watchdog for accounting and corporate governance plans to take a fresh look at how shareholders related to the companies whose shares they own, and it would like your views. Just two years after the launch of its Stewardship Code, the Financial Reporting Council thinks it's time to "to build on a promising start by reinforcing it where necessary, but not fundamentally changing it". It notes that a similar view was expressed in the interim report of the Kay Review, published in February. "For that reason the FRC does not propose to change or add to the Code's seven principles," the FRC said, but neither that nor the prospect that John Kay's final review, due in July, might rethink the nature of stewardship gives the FRC reason to pause in its revision. Its draft revised Code "does look rather different" from the one launched in 2010, when these themes were removed from the old Combined Code so they could achieve greater attention. The reasons for the proposed new introductory sections include:
  • Definition: The FRC said: "it has become clear that there is no common understanding of what is meant by the term 'stewardship', or of the respective roles and responsibilities of asset owners and managers". It attempts to provide greater clarity.
  • Lending: The first iteration of the Stewardship Code deliberately left out consideration of the practice of stock lending, wanting its other provisions to become bedded into practice first. It's time now to take a look at whether investors who have lent shares – often to support short-sellers – should be allowed to recall them for voting purposes.
  • Bug fixes: The FRC also wants to take into account various lessons learned in implementation of the code, including those highlighted in its "Developments in Corporate Governance" report, published in December.

Among its specific measures, the FRC wants to encourage the practice of companies discussing major strategic moves with their key investors before those plans are fully developed. It follows a case where a planned merger involving one of the UK's largest 100 companies faltered, owing to investor displeasure over the terms. It suggests investors provide named individuals who would become "off market", that is, would not trade shares for a time, who could then become insiders in advance of deals being disclosed.

The new draft also seeks to incorporate a change in the discourse, one viewed skeptically in parts of the investment landscape but promoted by the powerful lobbying force of insurers and pension funds: the concept of "asset owner" as a way of focusing attention on the beneficial owner often lost in the investment supply chain. The consultation paper puts it this way: "Where a statement in the Code refers only to one type of firm the words 'institutional investor' have been replaced with either 'asset manager' or 'asset owner'. Where a statement refers to both managers and owners, the term 'institutional investor' is used. Lastly, the word 'shareholder' has been replaced with 'investor', to avoid debate and confusion over whether the asset manager or owner is considered the shareholder."

It also wants views about the use of proxy voting agencies, another hotly contested theme that the first version of the Stewardship Code set aside for attention later.

Source document: The consultation paper is a 13-page pdf file.

UK seeks tougher sanctions on auditors

The UK's Accountancy and Actuarial Discipline Board thinks it's time to get tough with misbehaving auditors. In a consultation paper, the ASDB, an operating body of the Financial Reporting Council, revealed plans to give guidance on possible sanctions that the tribunals hearing abuse cases could follow. "There is considerable precedent for such guidance," it said. "Sentencing guidelines are widely used and provide a structured approach to determining the appropriate sentence while still allowing for judicial discretion. Sanctions guidance has been adopted by a number of other disciplinary regulators, including the General Medical Council and several of the AADB's Participants."

Source document: The consultation paper is a 47-page pdf file.

ICSA guidance on voting at annual meetings

Proxy votingFirst the good news: participation at company annual meeting in the UK is on the rise, with voting at annual meetings of the top 100 companies now above two-thirds of the shares in issue. The Institute of Chartered Secretaries and Administrators takes heart in that, especially in view of the rise in share ownership by foreign investors, who have traditional been less likely to vote. But then there's the bad news: Criticisms of UK processes persist. Cross-border voting still seems to result in lost ballots. ICSA's Registrars Group blames a lack of clarity and loss of control within the intermediated forms of shareholding. Miscommunication of voting instructions and entitlements results in votes failing to be lodged. Into the breach comes new guidance, concerning the amount of notice needed, setting the proxy deadline and record date, how long voting should be open, what happens after the proxy deadline, and more.

Source document: The registrars' guidance note is a nine-page pdf file.

FSB details progress on G20 regulatory agenda

The Financial Stability Board has provided an update on the progress made in the three years since it came to live as a creature of the Group of 20 nations. It comes in the form of four separate reports. First is a letter providing an overview of the work on making financial institutions more resilient and dealing with shadowing banking and derivatives. Second is a progress report on ways of dealing with banks that are too big to fail, while the third deals with strengthening the regulatory and supervisory infrastructure. The fourth, a joint report of the US-based Financial Accounting Standards Board and the International Accounting Standards Board, discusses the issues in seeking convergence between their respective systems and the governance of the IASB.

Source document: The FSB news release, a two-page pdf file, has links to the specific documents.

Turner on the 'inherent danger' in shadow banking

Lord TurnerShadow banking is the term commonly given to activities of certain type of investors and intermediaries that take on the substance – if not quite the appearance – of lending. The growth of securities markets trading in obligations assembled from banking lending instruments like mortgages had quite a lot to do with creating the financial crisis. Lord Turner, chairman of the UK Financial Services Authority, thinks that securitisation itself has brought from benefits. But in a thoughtful lecture at Johns Hopkins University in Maryland, he argues that the resulting developments in shadow banking were "inherently dangerous". Moreover and more generally, financial innovation has brought benefits, but he concludes: "there are fundamental reasons why innovation and finance tends to be less likely to produce beneficial social impact and more likely to produce rent extraction, than innovation in other sectors."

Source document: The Turner speech is a 54-page pdf file.

ESMA provides technical advice on short selling

We all know what short selling is, right? It's when you sell something you don't own. Except the practice is something rather different, involves repurchase agreements, implicit interest charges, delayed settlement dates and a lot of technicalities of market trading. The European Securities and Markets Authority has produced its final report, providing technical advice about short selling to support a new Regulation of the European Union on short selling. A Regulation, in the language of the EU, is a law binding in all member states and not subject to local interpretation. ESMA tries to define what is and is not a short sale, looking separately at practices in a variety of instruments: shares, sovereign debt, credit default swaps.

The concept of ownership in the Member States concerning securities is not harmonized," it said. "This issue may be considered by the Commission in its future proposal on the Securities Law Directive. This Delegated Act should not anticipate that proposal. For the meantime, it seems appropriate to define legal and beneficial ownership according to the respective civil law or securities law applicable for the relevant sale."

Source document: The ESMA final report is a 92-page pdf file.