Institutional investors in the UK are under notice to become more active owners of the companies they invest in after last week’s proposals from Sir David Walker in a review commissioned by the UK government.

They will be required to disclose whether and how they engage with investee companies on a comply or explain basis under a Stewardship Code. If the recommendations are adopted by the government, this will be overseen by the Financial Reporting Council, which also oversees the Combined Code that governs best practice in corporate governance.

Shareholders who fail to exercise governance oversight on essential issues such as board selection, composition and performance are “effectively free-riding on the governance efforts of those that do”, the Walker report says.

Mark Goyder, founder director of Tomorrow’s Company, which last week published a report on stewardship, does not think the review goes far enough.

He expects institutional investors to follow one of three routes in response to the review. They may do nothing; they may try to engage occasionally, which he does not regard as real stewardship; and a small group with a vested interest in stewardship principles will engage with company boards. “For the foreseeable future, the minority will engage,” he says.

Getting institutional investors to acknowledge they have stewardship obligations and to say whether these are being exercised is a step forward. “Creating an awareness of free riders will reduce the problem,” says Mr Goyder. “But we need to be more radical if we are to have real impact on the problem of ‘ ownerless corporations’ identified by Lord Myners.”

He believes rewarding good stewardship through an industry ranking scheme will be the way to tackle free riding. “Hopefully this would create a desire for others to follow and would be good for winners and a spur for losers,” he says.

Others believe the main incentive for fund managers should come from asset owners’ mandates. “Engagement is resource intensive. If fund managers are not pushed by asset owners through active monitoring then they will not do it rigorously,” says Simon Wong, managing director at Governance For Owners, an independent partnership between big institutional share owners.

Experts agree transparency is key to raising corporate governance standards. “More transparency from fund managers and asset owners on how they engage with companies and on their voting policy is vital,” says Jean-Nicolas Caprasse, European governance head at RiskMetrics Group.

The free-rider issue is even more widespread in Europe, according to a study co-ordinated by RiskMetrics on monitoring and enforcement practices in the European Union published this month by the European Commission.

Only 100 of 2,000 European institutional investors responded to an invitation to participate in a survey for the study on corporate governance issues. Almost half this group were UK-based investors. “The survey suggests there is a direct link to the low response and investors free riding on what others are doing,” says Mr Caprasse.

The majority of investors who did not participate claimed a lack of resources or expertise to fill in the questionnaire. Mr Caprasse also says some institutional investors support transparency and good corporate governance practices but prefer to remain anonymous about what they do.

Peter Butler, chief executive of Governance for Owners, proposes creating a framework for corporate democracy that would eliminate the free rider problem. This would involve a compulsory levy, payable partly by companies and partly by investment funds, to create a pool of money to support tackling the problems facing responsible owners.

“As an institutional shareholder you could decide to pay the levy and satisfy the fiduciary responsibility to engage in that way, or demonstrate you can exercise that responsibility in another way and be excused the levy by [carrying out] in-house activities,” he says.

However, not everybody views free riding as a sticking point. Stilpon Nestor, managing director of Nestor Advisors, which focuses on corporate governance, is a “bit baffled” as to why it should be an issue. The most important thing is that “a better job can be done by asset managers for clients”, he says.

Among large companies that have about five big investors, including most of the UK banks, “pooling the effort and talking about the profile and adequacy of the board and looking more in depth at issues” will benefit shareholders, he says.

He believes the real problem is getting asset owners to ask for corporate governance to be carried out. “A mandate from the shareholder is the real driver,” he says.

Lord Myners, Treasury minister, agrees. “More fund managers should go out and sell their ability [to asset owners] to add value through governance,” he says.

Mr Nestor is sceptical about what the Walker review can expect from institutional investors in terms of challenging the boards of banks on their risk appetite.

“Shareholders cannot wave a red flag on issues such as risk oversight because they do not have enough information in a timely manner,” he says.

However, Lord Myners takes a different view. Speaking before the Walker review was published, he said more needed to be done. “[Responsible ownership] means industry as a whole playing its part to drive up standards so that governance becomes the norm and responsibility of all, not limited to governance geeks.”

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