From the decks of UK corporate capitalism, John Sunderland, chairman of Cadbury Schweppes and president of the CBI employers' group, delivered a broadside to institutional investors last month, inveighing against their lack of transparency and accountability. He made some practical suggestions and proposed wrapping these up in a code of conduct for institutional investors. These are powerful points which the investment industry needs to take seriously.
The analogy of the UK's Combined Code on corporate governance, implemented in late 2003, is in some ways a good one. It has been hugely successful and is the world's leading model of best practice. It provides clear standards, which all participants understand; it is flexible, rather than prescriptive; and it is effectively policed through disclosure, scrutiny and dialogue. The bedding-in of the code has been so smooth that one tends to forget the rigour of its precepts: look, for example, at how the code has changed thinking on chief executives also being, or becoming, chairs. This has been a huge step for UK governance; yet achieved without dogmatic rules or legislation. In stark contrast to the US, we get better outcomes but with less regulation.
I believe institutional investment is already following a comparable evolutionary path, using a similar best practice approach, but as Mr Sunderland argued, it lags behind. What are the main strands? My review of UK institutional investment in 2001 proposed a best practice solution to crucial governance problems in that sphere: most importantly, the weakness of pension fund trustees and associated problems, including over-reliance on advisers, inadequate support for trustees and lack of clarity on investment objectives and time horizons. Following my review, the Institutional Shareholders Committee introduced a set of practical voluntary principles.
What needs to be done now? On pension funds, the UK government's recent check showed some progress but more is needed, particularly on strengthening trustee boards. And pension funds' statements of investment practice are pallid in comparison with companies' Combined Code disclosures - I do not believe trustees take them half as seriously as directors regard a Combined Code sign-off. On the ISC's voluntary principles, the lack of transparency in public disclosures suggests that despite progress, we have yet to see a best practice environment of real rigour. One specific question is why the trend to public disclosure of voting by fund managers is so slow; there is surely a strong case for making such disclosure mandatory, as the Company Law Review recommended some years ago.
Mr Sunderland suggested some ways in which companies could reinforce institutional accountability and transparency. I am intrigued, for example, by the suggestion that they help investment consultants develop fund manager engagement rankings. Ultimately, however, the most important contribution companies can make is to continue sharpening the management of their own pension funds. As my review argued, if we want more effective accountability from fund managers, then we need a more exacting customer. That in turn requires a continuing step-change in the quality of boards of pension fund trustees, many or most of whom are appointed by plan sponsors.
Some commentators bemoan the disappearance of the tradition of amateurism in UK pension fund management. I would like to see it accelerated. It is the true governance hole at the heart of Britain's investment industry and tackling it is the real solution. This brings me to the area where Mr Sunderland and I part company: the role of hedge funds. There may well be legitimate questions around their transparency and perhaps around their charging structures. But overall, I do not see hedge funds' role as detrimental to the investment system. Rather, I see them as healthy (if expensive) competition to the incumbents. Indeed, one could argue it is only because of the tendency of the conventional investment institutions to leave money on the table that hedge funds are able to survive at all.
So does it make sense to take all this forward under the umbrella of a new investor code for the institutions? I am not sure about the form - probably any new code should subsume rather than add to existing ones - but I am clear about the substance. Mr Sunderland has laid down a powerful challenge. The investment industry must respond.
The writer, chairman of Marks and Spencer, is a former fund manager and in 2001 produced a report on institutional investment for the UK Treasury