Good evening, it’s a real pleasure to join you this evening. The ABI’s membership ranks as perhaps the most significant grouping of institutional investors in the UK - although of course, we have the whole of the insurance industry represented here, and not solely investors. So I would like to start by congratulating Tidjane Thiam on his appointment as the organisation’s new chairman.
I would also like to pay tribute to Tim Breedon, and the important work the ABI has done under his chairmanship. The insurance industry and Government have been exploring ways of enabling more private sector investment in infrastructure - an important strand of efforts to get the economy moving again. Tim has been instrumental in setting up the Insurers’ Infrastructure Investment Forum, which is examining how projects can be structured to meet the investment objectives of insurance companies.
He has also shown real leadership around issues of corporate governance and, in particular, directors’ pay. And that is the issue I would like to focus on this evening.
But before I do so, I would like to say a few words about the topical issue of the day.
I recognise you’re part of the financial services industry but you are very different. You are not the banks, you didn’t need a bailout from the taxpayer, but you are now being negatively affected by association.
Following the revelations of the past few weeks I have some observations to make about the vital role that shareholders play in banking. We have taken a few positive steps down a long and arduous road towards stable and useful banking.
Properly functioning banks are vital to our economy, settling transactions and bridging the gap between savers and investors. They circulate money and credit just as the heart circulates blood. To do this well, they need a base of secure capital. There are models based on mutual or cooperative principles which may have a bigger role. But the capital of private banks comes from the shareholders - from many of you, in fact.
When investing in bank shares is only for the brave, something has gone dreadfully wrong.
Bank shareholders have been subjected to a hair-raising rollercoaster ride of risk, from the subprime crisis straight into a major recession, then a sovereign debt storm - and now serious revelations about behaviour that strikes many observers as bordering on the criminal.
Investing in banks needs to be boring again - otherwise, recapitalising our financial system will be impossibly expensive or dangerously risky.
We in the Government are doing our bit. We are getting on with banking regulation that everyone agrees is vital. We have done everything we can to get ahead of the curve and deal with macroeconomic risks. But we can’t do this along, and it is increasingly clear that the management of many banks still don’t get it. They want to choose the high-risk, high-reward path - seeking high returns on shareholder equity - when it is vital for everyone else that they don’t.
And now we are learning that this daredevil behaviour included taking blatant risks, once again to the detriment of the shareholder. The day the true extent of the LIBOR scandal was revealed, bank share prices plummeted.
The ABI showed the way forward in the last year. Last winter you demanded face to face meetings about our of control bonuses that were draining away bank equity. Your voice was loud during the shareholder spring, and you have proven vital support to the reforms we are now pushing through Parliament.
But a problem that built over decades will not be solved in one season.
Now every shareholder needs to make their views clear: that they want a secure, stable return when they invest in a bank, not a ticket to the casino. The question “why on earth are you doing this?” needs to be heard far more often.
The ABI has proved to be an effective advocate for greater responsibility and transparency in corporate Britain. When such a respected body goes public in demanding restraint it serves to illustrate that the notion of responsible stewardship of companies is not just an idealistic myth.
Far from it. Thanks to the efforts of the ABI and others it has become vivid reality, as a string of companies have found themselves being held to account. Companies such as Trinity Mirror, WPP and William Hill have all been confronted as the so-called shareholder spring has gained momentum.
It is clear the status quo is beginning to shift. Historically, institutional investors have been reluctant to challenge the ceaseless ratcheting up of remuneration packages. Where they have objected, companies have too often been able to ignore them.
At the same time, the impenetrably complex structure of pay packages has made the job of scrutinising them even harder. Indeed, in 2011, base salary accounted for less than 20% of total remuneration for FTSE 100 CEOs, with the remainder made up of bonuses, long-term incentives, share options and pensions.
But there is increasing recognition in the corporate and investment sectors that this state of affairs is not sustainable. And the ABI is to be commended for the strong public stance it has taken in several instances, where it felt the rewards being given to executives were excessive.
More generally, the shareholder spring demonstrates that investors have the will to act as responsible, long-term owners, securing better returns on investments and making a positive difference to the companies they own.
These changes need to be sustained so they take root. Let me be clear - there is a place for generous rewards for exceptional performance. And as I have previously made clear, nobody wants to see private sector salaries being set in Whitehall.
But the government has a legitimate role in finding answers to the ‘rewards for failure’ culture, which constitutes a market failure with significant implications.
This is the reason I have just brought forward a number of measures to boost transparency and to enable shareholders to exercise effective control.
There is a clear consensus that company pay reports contain too much data and too little information, making it difficult for investors to assess whether directors are being incentivised and remunerated appropriately.
Draft regulations, published for comment last Wednesday, will require reports to be divided into two sections. One section will set out future pay policy; the other will describe how existing policy has been implementing over the past year. At the moment, many reports are a bewildering mix of the two.
The future pay policy report will set out the key elements making up remuneration packages, how these link to company strategy, and the performance measures that will be applied. Factors taken into account when setting pay policy, such as employee pay levels and employee views, will need to be included. The proposed approach to exit payments must also be explained.
The implementation report will provide details of payments made and will list a single figure for each director’s total pay, including bonuses and long-term incentives, for the year. It will also detail progress against performance measures and compare company performance with pay. Any exit payments during the year will also need to be itemised.
Nevertheless, transparency only gets us so far. Alongside more information, shareholders need new powers to hold the board to account.
A binding vote on a company’s pay policy, requiring the support of a majority of shareholders, is a groundbreaking but workable way forward. Following our consultation with institutional shareholders we have agreed that the vote will be held annually, unless the remuneration policy remains completely unchanged, in which case it will need to be put to shareholders every three years as a minimum. Once approved, companies will not be able to make pay awards outside its scope.
The binding vote will also encompass the policy on exit payments.
The departure of a director will trigger the need to issue an immediate public statement of what exit payment was made, so no longer will shareholders have to wait months to find out this information.
This should mean that when making an exit payment, which may not exceed what shareholders have previously endorsed, companies give more thought to the presentational considerations and exercise a greater degree of restraint.
Alongside the binding vote, shareholders will continue to have an annual advisory vote on the implementation of pay policy in the preceding year, including the actual sums paid to directors. If this advisory vote is lost, the company will be required to put its overall pay policy back to shareholders in a binding vote the following year.
Finally, the Financial Reporting Council is looking at updating the Corporate Governance Code to stipulate that companies should make a statement when a significant minority of shareholders vote against a pay resolution.
Taken together, these reforms will help support the wider transformation in corporate culture that is required to fix the disconnect between pay and performance. Boardroom behaviour needs to change, and no amount of micromanagement from Whitehall can bring that about.
That is why investors are being given the tools to demand a reasonable distribution of returns. It is now up to you to use them. I hope these reforms will trigger a lively debate about what is expected of boards so some consistent standards emerge.
Such co-operation is important in an environment where shareholdings are more internationalised and dispersed than ever. To establish new norms, major investors must forget their historical divisions and make common cause in engaging companies more coherently and effectively than in the past.
This is not just true for UK institutional investors who make up ABI membership, but also foreign investors; and not just asset owners, but also asset managers.
In practice, this means starting to focus now on how companies should apply the new pay framework; setting guidelines for boards on what investors will and will not accept; and then having the resolve to enforce them.
I am aware that work is getting underway on these issues, and I would encourage you to move forward with it.
Broader corporate governance issues
As you do so, it is important to locate an agreed approach to directors’ remuneration within a broader strategy for effective stewardship of the companies you invest in.
Pay is just one of many issues of interest to investors, albeit the one where behaviour has been most egregious. Scrutiny is also required to ensure companies have right the strategy and business model to incentivise and deliver long-run returns.
To support that, we are introducing changes to the narrative reporting regime for the largest companies in order to ensure investors have clear information on the company’s strategy and management of risks.
We want companies to focus reporting on their strategy, and intend to publish draft legislation later this year. We have also made it clear that we think there is scope to remove some unnecessary requirements that have little value.
We will work with the Financial Reporting Council as they create up-to-date guidance that will enable companies not only to get the content of their reports right, but also encourage them to cut the clutter and hit the right tone.
The aim here is to improve the quality of reporting while giving companies the flexibility to develop a regime that is right for them.
Our intention is that, by overhauling and improving the information available, the shareholder activism seen over pay will be brought to bear more widely on company performance and strategy.
That shift will be swifter if investors use all the powers and tools available to them under our improved corporate governance regime.
The revised Stewardship Code is a good starting point, providing a sound framework for engagement with investee companies.
Amendments to the FRC’s Corporate Governance code requiring the annual re-election of directors give shareholders an effective means of challenging board performance.
And I would expect that as more coherent, collaborative relationships develop, investors demonstrate a greater willingness to table resolutions to address governance issues.
My point here is that effective stewardship and engagement are about a great deal more than just voting at AGMs. They are founded upon ongoing dialogue.
Yes, this will require investment by asset managers and others: it’s no good cutting resources devoted to engagement hoping to free-ride on others. But, as we expect John Kay to argue when he publishes his review of equity markets, investors can only improve their long-run returns by taking concrete action to improve the performance of companies they own.
In part, that means throwing open the door to the boardroom and letting in some fresh air, fresh thinking and fresh faces. Doing more to ensure companies are recruiting their boards from a wider pool of candidates so they are getting the best people.
It is self-evident to me that more diverse boards will have broader, better experience - and be better able to resist the lure of group-think about pay or anything else.
Looking at many FTSE 350 boards, which are largely comprised of people of the same sex, ethnicity and social background, I have to wonder whether that is always the case at the moment. This is a matter of business performance as much as one of equality: it makes no sense to squander the talents of substantial sections of the workforce.
And it is in companies’ own interests to broaden the range of perspectives and expertise informing their strategy. Diverse talent, drawn from professional services, academia, the charitable sector, or the ranks of entrepreneurs, can bolster and challenge corporate boards.
We are going to shine a light on this area by requiring companies to report on their boardroom diversity policy from October this year.
It is true that since Lord Davies conducted his review we have made some headway in increasing the number of women on FTSE 100 boards, including many from non-corporate backgrounds. I am grateful for the efforts investors have made to drive progress. But the momentum of change needs to be maintained and, among smaller listed companies, progress has to accelerate.
Ultimately, if the prevailing culture is to change, there can be no substitute for leadership from companies themselves and their owners - whether on diversity, directors’ pay, or the pursuit of long-run returns rather than short term rewards. Government cannot legislate for the broader transformation in thinking that these issues demand.
That depends on investor action, not apathy. So I shall end by challenging you to be active.
There is growing evidence to suggest that effective shareholder engagement is vital in achieving sound investment returns. This Government has provided a wide range of tools to make the job easier - and we stand ready to do more, if that is what’s needed.
The onus is now on you, as investors, to use these powers in your own best interests and ensure the shareholder spring proves to be more than just a fleeting phenomenon.