Association of British Insurers Conference
Good afternoon. Your industry is a massive and important one employing around 275,000 people and responsible for investments of over £1.5 …
Good afternoon.
Your industry is a massive and important one employing around 275,000 people and responsible for investments of over £1.5 trillion, the insurance industry is one of the UK’s strongest sectors. Ours is the largest insurance market in Europe and the third largest in the world.
Your influence, in fact, far exceeds the insurance market alone - for the ABI’s membership constitutes perhaps the most significant grouping of institutional investors in this country.
The scale of assets that your industry manages is testament to the confidence placed in you both in this country and globally. It is a confidence which hasn’t materialised by accident. Industries that rely on trust need to stay alert to changing circumstances to maintain that trust. From the establishment of the industry in Restoration London to the global business of today, insurance has shown this ability to innovate and adapt; a continuous process of scrutiny and improvement that has kept Britain at the forefront.
There can be no doubt that the insurance industry will play an important part in restoring growth and rebalancing the economy. It can demonstrate, for example, the sort of financial innovation that we need to tackle the challenges thrown up by an ageing population. For example, there is the long-term savings needs of pensioners which provide a good fit with the long term investment needs of UK infrastructure - indeed, the insurance industry has strongly encouraged us to seek an ambitious model for the Green Investment Bank. That is a big subject for another day.
I would like to focus today on the work we are doing in Government to foster strong corporate governance and properly functioning capital markets in the UK which we see as part of our pro business, pro growth agenda.
Let me begin by acknowledging there is much that is good about our corporate governance framework. In many respects, the UK has led the world in establishing high standards, most recently by introducing the Stewardship Code, which sets out the role of shareholders in holding directors to account. And the new Advisory Council of the Institutional Investor Committee is a promising sign that investors are starting to work together.
But the financial crisis has intensified long-standing concerns about whether there are systemic flaws in the way companies are owned and managed in the UK.
What I specifically want to talk about is the issue of “short termism”. The enduring health of our economy relies on the prudent accumulation of long-term assets. Major infrastructure and industrial projects require a time horizon of decades rather than years or months. I speak as someone who came into Parliament via the oil and gas industry - where a major offshore gas venture and the associated infrastructure could be expected to last 50 years.
Yet, over the last decade, while private investment in fixed capital assets stagnated - in particular in infrastructure and manufacturing- the banking sector in particular was seeking to ramp up its return on equity by speculative trading and dabbling in exotic financial engineering.
The conventional wisdom at the time was that shareholders knew what they are doing. So too did fund managers and company executives. The Theory of Efficient Markets ruled the roost.
Now, there is disquieting evidence that markets were neither efficient nor rational. The wreckage of the banking sector is Exhibit No. 1. But I was also fascinated by the paper published last month by Andrew Haldane and Richard Davies of the Bank of England, which analyses the pricing of companies’ equities.
What they found was significant evidence of short-termism in investment decisions - and evidence that it is a growing phenomenon not declining. They also found evidence that long-run returns are being seriously undervalued. As they put it: “myopia is mounting”.
In my job I travel around the world promoting British investment and frequently meet leading French, German, Japanese, Chinese and Indian companies who are baffled by the short-term perspective of their British counterparts. This confirms what I have heard from many UK investors and managers: about executives being given incentives to pursue strategies not in the long-term interest of their shareholders; about shareholders allowing takeovers that destroy value. And, at times, it seems like the ultimate owners of the assets are powerless to intervene, because of the complexity of the investment chain.
So confidence in our system of ownership and management needs rebuilding. It is of the utmost importance to our economy as it returns to economic growth. How the UK’s largest companies are managed and controlled will help to determine UK competitiveness, as well as provide legitimacy for our system of shareholder capitalism.
Moreover, the UK’s reputation as a financial centre has made it the location of choice for companies from all around the world to base their financial activities, including where they are listed. I welcome this. But I also have to say we have recently seen the ethics of the Wild East risking the collective reputation of UK based business. The interests of our investors, and the integrity of our markets, depends on those who base themselves here following our principles.
Corporate Britain review
To get a better understanding of the factors that drive investment and management decisions, we issued - last October - a wide-ranging call for evidence.
The responses we received to A Long Term Focus for Corporate Britain made it clear there is real scope for improvement.
There was a consensus that fragmentation in the ownership of big UK companies makes it even more important that remaining large investors engage with the companies they have stakes in.
But the way the investment chain operates in the UK often hinders rather than help this kind of engagement - a problem compounded by a lack of transparency.
The turnover of shares seems to rise inexorably.
Often, the executives we spoke to were keen to keep up a strong dialogue with their owners - but they were at a loss to work out exactly who these owners were!
We were told that increases in executive pay are out of proportion to improvements in company performance.
We heard concerns from the ultimate owners of assets that the way fund managers are incentivized is short-termist.
Others claimed that the rise of proxy voting agencies and the use of index funds mean that shareholders are less interested in acting like owners.
There were a lot of issues raised and we cannot ignore them. Britain needs long-term investment. Our aging society needs a safe way to fund a growing pension bill. And there are increasing demands for companies to be transparent - whether about ownership, tax, or greenhouse gas emissions.
Review of equity investment
It is especially urgent that we work out how the equity investment regime can be recalibrated to support the long-term interests of companies as well as underlying beneficiaries, such as pension fund members.
Serious commentators from the business community are also raising probing questions. Richard Lambert, for example, in a recent piece in the Financial Times has suggested expanding a board’s fiduciary duties to make directors give higher priority to the long-term; boosting shareholders rights for long term investors to give them greater voting power than short-term traders; executive performance being determined to a greater extent than it is today by long-term performance; he also suggests that the Government could use the tax system to penalise short-term share trading and encourage long-term investment.
These questions reflect many of the issues raised in our Call for Evidence. For this reason, I am launching today an independent review of investment in UK equity markets. I am very pleased that Professor John Kay has agreed to conduct the review. He brings a wealth of expertise to the task, and as anyone who reads the FT knows, his is one of the most incisive, original brains in the country.
John, with the support of an expert panel, will examine investment in UK equity markets and its impact on the long-term performance and governance of UK quoted companies.
He will look at behaviour right along the investment chain - from company boards, through pension funds, advisers and fund managers, to ultimate beneficiaries. And he will consider what is needed to make sure that the UK can be the home to successful companies, with access to the capital they need to deliver reasonable returns.
I have asked John to make recommendations in a number of specific areas:
- how best to ensure that the timescales over which companies and fund managers operate match the interests of clients and beneficiaries;
- ways to strengthen engagement between institutional investors and quoted companies;
- the most effective means of boosting transparency for clients, underlying beneficiaries and companies themselves; and
- the legal duties and responsibilities of asset owners and managers.
I have also asked him to consider the implications of increasingly fragmented share ownership in the UK.
The review team will produce a report with final conclusions next year.
Executive pay
A second area where I want to see progress is in bringing excessive, unjustified, executive pay under control.
I know that this is something that bothers investors too.
Britain does have some world class executives and one of the real privileges of my job is dealing with them.
But let’s not forget that, using the FTSE 100 as a benchmark, investors have barely seen a return since the turn of the century. For most of that time, they would have been better off investing in government bonds.
And yet, in 2010, average total pay for FTSE 100 chief executives was 120 times that of the average UK employee. Back in 1998, the multiple was 45.
At a time when real wages are being squeezed, it is right that we ask why this is happening.
Sky-high remuneration and the need to show immediate results, however illusory, is surely a factor driving the push for short-term profitability at the expense of long-term value.
There is a failure here both on the part of companies and major shareholders to ensure accountability. Ridiculous levels of remuneration are going unchallenged as the norm, when there is no clear evidence of a correlation with performance.
It is actually outrageous that last year median earnings for FTSE 100 chief executives rose 32 per cent, whereas the share index rose only 7 per cent - and average employee pay rose by less than 2 per cent, barely half the rate of inflation.
I can cite the incoming President of the CBI, Roger Carr, who said as much earlier this month. I quote: “What is unacceptable is soft targets delivering high returns. I think what is acceptable and properly beneficial for everybody is very challenging targets being achieved and those achieving it being rewarded accordingly. Providing it’s focused in that way, it’s an acceptable position. In the other, it’s intolerable - and the payment for failure is unforgivable.”
Too often in the recent past, politicians have been wary of even touching upon this subject - or like my predecessor have even gone out of their way to proclaim how “intensely relaxed” they are about what he called the ‘filthy rich’. I am intensely relaxed about generous returns for entrepreneurs and outstanding executives. But I am not relaxed at all about rewards for failure. And while nobody wants to see private sector salaries set in Whitehall, the government has a legitimate role in seeking answers to what is clearly a manifest market failure with wide-ranging implications.
Of course many of the distortions originate in the banking sector. As part of the Merlin agreement the banks agreed to greater pay disclosure of executives outside the Board, on a voluntary basis, for the participating banks. We are now examining how to go further and introduce such requirements on a mandatory basis. But we also need to consider whether such transparency should be extended more widely in the corporate sector.
Next month I will be launching a consultation on changes to company reporting that will propose tougher provisions on disclosure of executive pay and its link to company performance. It is the culmination of a body of work on narrative reporting that will make company reports clearer, shorter and more relevant.
Transparency, of course, only gets us so far - and may have the perverse effect of encouraging a race to the top. So I intend to explore other ways to intervene sensibly and, in particular, to put an end to the culture of rewards for failure.
As a first step, I will be holding talks with interested parties including remuneration committee chairs in the next few weeks to explore various policy options, with a view to announcing further action in this area in the autumn. Needless to say, I shall be watching intently any decisions taken in the meantime.
I and my colleagues are under a lot of pressure to intervene in dirigiste ways; even to turn back the clock to the days of pay control. The European Parliament and Commission are also flexing their muscles. I recognise in a complex, globalised world, heavy handed controls of that kind aren’t going to work and will do damage. That is why I want creative thinking on this problem to match that of Will Hutton in his work on “fat cat” pay in the public sector, or of the Dodd Frank proposals in the United States.
Ultimately there is no substitute for leadership from companies themselves and their owners. Remuneration committees and institutional investors need to take a much stronger line - and uphold the Corporate Governance Code, which makes it clear that executive remuneration should be tied to performance and a company’s long-term success.
To be frank, I don’t see much evidence that remuneration committees have been living up to their responsibilities, or that major shareholders have been holding them to account.
That has to change, and - in future - they need to act collectively to prevent rewards for failure; to insist on decency and responsibility in pay rounds.
Women on boards
I want to turn now to a third subject. I am looking to industry to show leadership on enabling more women to reach senior decision-making positions in our largest companies.
Lord Davies’ report, published in February, revealed the stark reality of British boardrooms today: women comprise just 12.5 per cent of FTSE100 boards; 7.8 per cent of FTSE 250 boards.
I strongly believe the best boards are those that draw on a wide range of experience and perspectives. This is an issue of business performance, not one of political correctness. It makes no sense to squander the abilities of 50 per cent of the workforce. Indeed, evidence suggests that companies that have high numbers of women at senior level outperform those that do not.
Mervyn Davies recommended a company-led approach to this issue, with all chairs of FTSE 350 companies publishing aspirational targets for the number of women they expect to have on their boards in 2013 and 2015.
I strongly urge all chairmen to publish their aims by his deadline of September this year. And I encourage investors to focus the attention of the boards of the companies they have interests in, applying moral pressure to do the right thing.
At this stage, we propose to see what results can be achieved through a voluntary approach. But we will be taking a very close interest in how much progress is made.
I know that the ABI will be making its own statement of intent in the autumn, and I welcome the lead that the organisation is taking. I hope others follow suit.
Conclusion
These, then, are three of the issues we will be focusing on in bolstering corporate governance, and encouraging every company to meet the standards of the best.
Our conclusions will be underpinned by a commitment to rebuilding trust, a determination to empower shareholders, and an emphasis on protecting long-term value.
An effective corporate governance regime, which promotes long-term equity investment and company strategy, is essential for successful and competitive private enterprise in UK.
But it requires investor and industry buy-in. So I shall end with a challenge to you all - to embrace reform in the areas I have outlined, and work with us to secure the long-term success of the UK’s companies.