Making a Case for Regulating Institutional Shareholders’ Corporate Governance Roles

Drawing on the disconnect that currently exists between the social expectations associated with the corporate governance role of institutions and the institutions’ private interests, our article suggests that the current English legal framework does not adequately promote an optimal corporate governance role for institutions and does not meet the public interest of safeguarding investors’ long-term saving needs and sustaining a sound wealth-creating corporate sector in the long term.

Our starting point is that investor-led governance, as aspired to by UK policy-makers, is not only a matter of achieving beneficiaries’ private investment objectives through maximizing long-term shareholder-value, but also a matter of public interest. This is apparent in much of the policy rhetoric surrounding the UK Stewardship Code. However, the assumption made by UK policy-makers that the corporate governance interests of institutional shareholders are aligned with the public interest of long-term wealth creation in the corporate sector is arguably misplaced. Shareholder engagement has either been lackluster as institutions lack commercial incentives to take this up, or has been used by dedicated shareholder activists i.e. hedge funds in particular, as instrumental means to generate investment performance for their funds. The commercial incentives driving such behavior cannot be assumed to be aligned with the public interest in saving through investment in the corporate sector.

Next, we argue that the private law of obligations in trust and contract that governs the relationships between the funds and their savers is increasingly unable to address those public interest concerns as it does not deal adequately with the collective nature of investment management, the growth of the investment chain and the public interest consequences of long-term investment. We then turn to the company law and corporate governance framework governing the expectations and behaviour of institutions as shareholders, and contend that the overall policy support for shareholder empowerment in the UK and the soft law of stewardship has failed to adapt to the changing profile of institutional shareholders and is overwhelmingly focused on shareholders’ private interests disregarding wider public interests. These inadequacies have only led to reinforcing a governance deficit for institutional shareholder behavior and have left the dubious quality of institutions’ behavior to market forces.

To address this governance deficit we make a case for governing the institutions’ shareholder behavior through securities and investment management regulation. We first suggest that securities regulation ought to be applied to institutions to compel more disclosure. In particular, intentions-based disclosure is not required under UK or EU law, in contrast with the requirements imposed by the US Securities Exchange Commission. We argue that such intentions-based disclosure is important for the market, and should be considered for reform in the UK and EU. Next, we suggest that institutional shareholders, although regulated in many ways under existing regulatory regimes in terms of prudential management, ought to be more precisely regulated in terms of their relations with investee companies as part of conduct of business regulation. We point out that private law in the UK is no longer a robust source of funds’ governance for conduct of business by funds as beneficiaries are less and less able to influence the investment management of the funds they invest in.

To support our case we look at recent examples of EU policy-making that re-orient institutions’ investment management and corporate governance roles towards the public interest of meeting their savers’ expectations and contributing to the long-term wealth-creating role of the corporate sector. In particular, we look at the EU Undertakings in Collective Interests in Transferable Securities (UCITs) Directive of 2009 (amended in 2011) that imposes direct conduct of business regulation on fund managers, as accountable to beneficiaries, to illustrate how nascent regulatory endeavors are made to address the gap in governing institutions’ increasingly powerful corporate governance roles in their investee companies. We see this example as a template that can be applied more generally across funds, such as pensions and alternative investment funds. Further, we also refer to the proposed amendments of the European Shareholder Rights Directive (as of late 2016) to show that policy makers are interested in making institutions and their asset managers and service providers, such as proxy advisory agencies, more accountable and better governed.

Our article calls further regulation to govern institutions’ corporate governance roles in order to ultimately deliver the public interest in this aspect of financialisation – where the investment sector is tasked with the social responsibility of delivering a wide range of financial needs for the ordinary citizenry by investing in the corporate economy. Our proposed regulatory approach, despite being antithetical to the UK tradition of self-regulation in corporate governance, marries together the public-private paradigms, the common interests of investor protection and shareholder conduct, and it can be supported on public policy grounds of making investment management long-termist and accountable. Public regulation is able to infuse public interest into institutions’ roles and call institutions to account in light of the increasing weakness and irrelevance of private channels of accountability.

Dionysia Katelouzou is a Lecturer in Law at King’s College London and Iris Chiu is a Professor of Corporate Law and Financial Regulation at UCL Faculty of Laws.