Much has been discussed over recent years in relation to the importance of stewardship by investors, and this is not to be diminished. But should you be contractually agreeing to comply with it in your client agreements?

The first version of the FRC’s UK Stewardship Code (the “Code”) was published in July 2010, which was preceded by the Institutional Shareholders Committee’s “The Responsibilities of Institutional Shareholders and Agents: Statement of Principles” from 2002, and converted to a code in 2009. The Code applies on a “comply or explain” basis, meaning that if an Institutional investor adopts the Code they must comply with the principles or explain why it hasn’t complied. The Code was updated in September 2012.

In December 2010 the FCA (formerly the FSA) published a new rule in COBS (2.2.3R) which required firms to clearly disclose on their websites the nature of their commitment to the Code or its alternative investment strategy. It is interesting to note here that this rule did not specifically make it into COBS 8, which contains the rules in relation to client agreements.

The Code applies to Institutional investors with equity holdings in UK Listed Companies.  However, the Code expects that Institutional investors that apply the Code should use their best efforts to apply its principles to overseas equity holdings as well.

How does all this impact investment managers (“Firms”)?


  1. Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities;
  2. Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship which should be publicly disclosed;
  3. Institutional investors should monitor their investee companies;
  4. Institutional investors should establish clear guidelines on when and how they will escalate their stewardship activities;
  5. Institutional investors should be willing to act collectively with other investors where appropriate;
  6. Institutional investors should have a clear policy on voting and disclosure of voting activity; and
  7. Institutional investors should report periodically on their stewardship and voting activities.

The first two principles are not difficult for Firms to comply with, as Firms will have in place voting and conflict policies and conflicts will be managed strictly in accordance with SYSC 10. Principles 4 and 5 can be covered in a Firm’s voting policy, and Principle 7 can be met as part of a Firm’s standard quarterly client reporting.

However, Principle 3, and applying the detailed guidance of Principle 4, begins to cause problems for Firms. Firms operate different strategies which are based on different fundamentals (i.e. formulaic, dividends, risk hedging, LDI etc). There are only a small percentage of portfolio managers that operate equity strategies that are based on stewardship activities such as the company fundamentals and activist activities that are listed in the guidance of Principles 3 and 4. In addition, firms that operate these types of strategies don’t vote on every line item of stock, which can be virtually unmanageable for large portfolios and would come at significant costs to clients (Principle 6). So many Firms will be left having to explain non-compliance with Principles 3, 4 and 6.

In light of the practical reality, it comes as a surprise that 83% of Firms refer to stewardship responsibilities in their mandates from clients (“Adherence to the FRC’s Stewardship Code, At 30 September 2013, Investment Management Association, May 2014, page 14. The sample size of the poll was 82 Firms:

Perhaps it is not the best idea to agree to comply with the Code in client mandates (investment management agreements), when in most cases firms will not be able to comply with the letter of the Code?

The Code sets good standards and says itself that it doesn’t intend to create “a rigid set of rules”, so our suggestion is don’t make it legally binding in your client agreements, as it creates a strict compliance obligation on the Firm.

Should you require any further advice or information on the UK Stewardship Code, Cleveland & Co, your external in-house counsel, are here to help.