AFM Response to Consultation on the EU Corporate Governance Framework

By e-mail, to:

July 2011

AFM Response to consultation on The EU Corporate Governance Framework

I am writing in response to this consultation paper, on behalf of the Association of Financial Mutuals. The objectives we seek from our response are to:

Comment on the proposals in the framework consultation, and use evidence of corporate governance in mutuals to provide constructive assessment of the proposals.

The Association of Financial Mutuals (AFM) was established on 1 January 2010, as a result of a merger between the Association of Mutual Insurers and the Association of Friendly Societies. Financial Mutuals are member-owned organisations, and the nature of their ownership, and the consequently lower prices, higher returns or better service that typically result, make mutuals accessible and attractive to consumers.

AFM currently has 56 members and represents mutual insurers, friendly societies and health planning providers in the UK. Between them, these organisations manage the savings, protection and healthcare needs of 20 million people, and have total funds under management of over £80 billion.

We agree with the statement in the paper that well-run businesses with good corporate governance contribute to competitiveness, and help instil trust. It is notable that during the UK financial crisis, mutual organisations avoided the financial problems of some large banks and insurers, and retained the confidence of the general public.

As mutual organisations, there is a strong focus in AFM members on ensuring that the actions and interests of the organisation are consistent with those of the customer. This is of course unlike the situation in shareholder-owned companies, where there is a very apparent agency problem and management focus is often centred unduly on short-term rating agency assessments and the share price.

That said, we do not underestimate the need for good corporate governance in mutual organisations. As we describe later in this response, AFM and its members are helping to deliver high levels of governance in UK mutual insurers- even within very small organisations. So whilst we recognise the value of an EU wide framework, we believe that it must be proportionate, and build on the progress that has already been made in many member states.

Our responses to the specific questions raised in the consultation are attached, along with a general description of governance arrangements in the United Kingdom.

We would be pleased to discuss further any of the items raised by our response.

Yours sincerely,

Martin Shaw

Chief Executive

Association of Financial Mutuals

Introduction to Corporate Governance Codes in the United Kingdom

There is a range of governance codes in the UK, with the key ones listed below that fit with specific business models:

Listed companies / There has been a corporate governance code for large listed companies in the UK since 1992. The latest version of the now-called “UK Corporate Governance Code” operated by the Financial Reporting Council was released in June 2010. This is well regarded and has been the basis on which may other codes have been developed; see:
Unlisted companies / The Institute of Directors launched the Corporate Governance Guidance and Principles for Unlisted Companies in the UK in November 2010. For more see: Guidance and Principles
Mutual organisations / The Association of Financial Mutuals runs its own Annotated Corporate Governance Code for Mutual Insurers (see more below); this was launched in 2007. There are similar Codes in place for building societies and credit unions. In 2009 the Government initiated a project to develop a single code for mutual organisations, though this appears to have been moth-balled.

Annotated Corporate Governance Code for Mutual Insurers

The Annotated Corporate Governance Code for Mutual Insurers (ACC) was developed to deliver an approach to governance in mutuals that was as comprehensive and robust as that in large listed companies.

The UK Corporate Governance Code was designed with FTSE 250 companies in mind. However we have imported all the principles from the Code into the ACC, and have only made annotations where necessary to reflect the size and business model of our members (for example, to amend references from shareholder to member, and because UK mutuals do not have institutional shareholders). As a result, even though the vast majority of AFM members are much smaller than FTSE 250 companies, all AFM members have implemented a comparable approach to governance.

The ACC is a condition of membership for AFM members, and is monitored internally by companies, who then provide AFM with a summary of compliance against the main principles, and provide comply or explain commentary as part of their corporate governance statement.

AFM in turn reports back annually to members, HM Treasury and the Financial Services Authority. This reporting highlights that levels of adherence to the ACC are very strong, that members take corporate governance very seriously, and that a self-regulatory approach can deliver high standards, where it is compatible with more general regulatory requirements.

We use other features of the ACC to help support the comments we make in response to specific questions. A copy of the ACC and our latest report on compliance are attached for information.

Answers to specific questions

Preliminary questions:

Should EU corporate governance measures take into account the size of listed companies? How? Should a differentiated and proportionate regime for small and medium sized listed companies be established? If so, are there any appropriate definitions or thresholds? If so, please suggest ways of adapting them for SMEs where appropriate when answering the questions below.

Evidence from the ACC operated in the UK (as described on the following pages) is that on the whole size should not be a key factor in corporate governance arrangements, so long as those arrangements are presented in a proportionate way, enable flexibility and set at the level of principle (allowing firms to implement in a manner consistent with the nature, scale and complexity of the business).

In the ACC we adapt some of the principles to accommodate SME members; the adaptions are very limited, and as the definition used below demonstrates, are only available to very small organisations:

"A small mutual insurer is defined as a firm with:

•an average gross premium income over the preceding three financial years of less than £20 million per annum and

•average assets at the end of the last three financial years of less than £100 million.

Both conditions have to be met to qualify as a small mutual insurer."

Should any corporate governance measures be taken at EU level for unlisted companies? Should the EU focus on promoting development and application of voluntary codes for non-listed companies?

The varying areas of potential conflict of interest in different unlisted companies means a singular approach would be unwelcome. For example, in the UK the Institute of Directors has launched a code for unlisted companies, though this is very different from the codes in place for mutual organisations.

Given the range of unlisted companies across Europe, there would be a risk that an EU level set of measures would discriminate against certain corporate forms in different countries. This would run contrary to encouraging effective competition, and create new barriers to entry. There is also a risk that implementing a European wide approach would conflict in financial services with the different priorities and approaches of EBA, EIOPA and ESMA.

Board of Directors:

Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided?
Should recruitment policies be more specific about the profile of directors, including thechairman, to ensure that they have the right skills and that the board is suitably diverse? Ifso, how could that be best achieved and at what level of governance, i.e. at national, EU orinternational level?

These are already requirements of UK governance codes and regulation. National rules do apply effectively, but given the importance of these dimensions, and the international nature of many listed organisations, we support EU level standards.

Should listed companies be required to disclose whether they have a diversity policy and, if so, describe its objectives and main content and regularly report on progress?
Should listed companies be required to ensure a better gender balance on boards? If so, how?

There are new UK requirements on gender balance on Boards, and we are already starting to see this acting as a catalyst for improving diversity. We believe that if specific targets are set, there are grounds for which some firms, especially smaller, unlisted firms can be exempted. For example, a number of friendly society members of AFM continue to work in male-dominated trades, whose members are elected to serve on the Board from amongst the working population. Overall therefore we see that knowledge, skill and commitment are the most important dimension of a good NED and the value of improving the gender or ethnicity mix must not detract from this.

Do you believe there should be a measure at EU level limiting the number of mandates a non-executive director may hold? If so, how should it be formulated?

We think this is a matter for national supervisors/ legislators to interpret, given they will have a better feel for local conditions and the burden of different roles. Recent pressure was brought to bear on the CEO of Prudential UK to give up the singular NED position he had because it might prevent him fulfilling his core role properly; other NEDs without specific duties might be quite capable of holding down a number of NED positions.

Should listed companies be encouraged to conduct an external evaluation regularly (e.g. every three years)? If so, how could this be done?
Should disclosure of remuneration policy, the annual remuneration report (a report on how the remuneration policy was implemented in the past year) and individual remuneration of executive and non-executive directors be mandatory?
Should it be mandatory to put the remuneration policy and the remuneration report to a vote by shareholders?

These are all currently facets of UK governance codes, as evidenced by our own approach:

in the ACC external evaluation is recognised as worthwhile for larger companies on at least a three year basis, and supplemented by internal review;
AFM members provide comprehensive remuneration reports: a copy of the guidance is attached for reference;
votes on remuneration reports are often advisory: we would be reluctant to make this mandatory as it would be destabilising.

Do you agree that the board should approve and take responsibility for the company’s ‘risk appetite’ and report it meaningfully to shareholders? Should these disclosure arrangements also include relevant key societal risks?
Do you agree that the board should ensure that the company’s risk managementarrangements are effective and commensurate with the company’s risk profile?

Companies need to be much more transparent with their owners (shareholders or members) about the basis by which they undertake business and the risks that those owners will be exposed to. With the move towards Solvency II, there will be much greater transparency around risk appetite within the insurance sector, and there are similar requirements in place for banking.

Shareholders:

Please point to any existing EU legal rules which, in your view, may contribute to inappropriate short-termism among investors and suggest how these rules could be changedto prevent such behaviour.
Are there measures to be taken, and if so, which ones, as regards the incentive structures for and performance evaluation of asset managers managing long-term institutional investors’ portfolios?
Should EU law promote more effective monitoring of asset managers by institutional investors with regard to strategies, costs, trading and the extent to which asset managers engage with the investee companies? If so, how?
Should EU rules require a certain independence of the asset managers’ governing body, for example from its parent company, or are other (legislative) measures needed to enhance disclosure and management of conflicts of interest?
What would be the best way for the EU to facilitate shareholder cooperation?
Should EU law require proxy advisors to be more transparent, e.g. about their analytical methods, conflicts of interest and their policy for managing them and/or whether they apply a code of conduct? If so, how can this best be achieved?
Do you believe that other (legislative) measures are necessary, e.g. restrictions on the ability of proxy advisors to provide consulting services to investee companies?
Do you see a need for a technical and/or legal European mechanism to help issuers identify their shareholders in order to facilitate dialogue on corporate governance issues? If so, do you believe this would also benefit cooperation between investors? Please provide details (e.g. objective(s) pursued, preferred instrument, frequency, level of detail and cost allocation).
Do you think that minority shareholders need additional rights to represent their interests effectively in companies with controlling or dominant shareholders?
Do you think that minority shareholders need more protection against related partytransactions? If so, what measures could be taken?
Are there measures to be taken, and is so, which ones, to promote at EU levelemployee share ownership?

As our companies do not have shareholders we comment only in general terms on these questions.

In our assessment the overt bias in many countries towards the shareholder-owned corporate business model has resulted in excessive short-term focus. Managers are pointed towards short-term success through a combination of the needs to: bolster the share price; retain the confidence of ratings agencies; maintain a consistent level of dividends; and maximise short-term incentive arrangements. As a result, only a balance of legislation to ensure all forms of ownership are treated equally, will avoid short-term focus; as a minimum the EU should pursue with more rigour the concept of a European Mutual Statute.

Mutual insurers are owned by their members (customers) and have no external shareholders; nor do individual members have any differential influence on the organisation according to the size of their holding. Our ACC compliance exercise encourages mutuals to be accountable to their members in a similar way to the way listed companies are accountable to their smaller shareholders in particular. Indeed the principle of “one member one vote” requires this.

In most listed companies the very great majority of shareholder activity is conducted by institutional shareholders who may have significant influence on voting at the AGM, and to some extent on the behaviour of the organisation.

The ACC has in the past included a section on institutional shareholders, though in common with the UK Corporate Governance Code, this has been removed (with the introduction of a UK Stewardship Code). We tended to find the vast majority of our members were not themselves direct investors and therefore principles relating to their behaviours as institutional shareholders either were not relevant, or else applied only to the fund managers that acted on the mutual’s behalf. It is an important point to stress that small companies can seldom make a significant contribution acting alone; indeed even where there are numerous examples in the UK of concern about governance or executive pay in FTSE 100 companies, this has never translated into sufficient shareholder dissent to force a contrary outcome at the AGM.

The comply or explain framework:

Do you agree that companies departing from the recommendations of corporate governance codes should be required to provide detailed explanations for such departures and describe the alternative solutions adopted?
Do you agree that monitoring bodies should be authorised to check the informativequality of the explanations in the corporate governance statements and require companies to complete the explanations where necessary? If yes, what exactly should be their role?

We agree that governance codes should require a comply or explain statement. In our experience, this is a critical part of the compliance process, as it requires the firm to be transparent and open in its assessment. As this is part of the annual report of a company, we would expect it to be open to the same degree of scrutiny as other aspects of the accounts.

We are not convinced that all monitoring bodies should be authorised to verify information in the comply or explain statement, as this risks duplicating much of the work that is already taken, particular in insurance where, with the advent of Solvency II, scrutiny is expected to be much greater.

We believe the compliance approach to the ACC provides a high degree of rigour and exemplar for other governance codes. It consists of:

Management and the Board of a mutual assess carefully how well they comply with each element of the ACC;
Where a company has not complied with any of the principles, it will produce a comply or explain statement within its annual accounts, and explain why it was unable to comply and/ or what action was taken that was more relevant to the organisation;
The comply or explain statement forms part of the audited aspects of the accounts, and increasingly the FSA is seeking higher standards from firms’ external auditors to ensure reporting is consistent with practice;
The company provides a summary of performance to the AFM to enable our monitoring exercise along with explanations of non-compliance;
AFM reports on overall compliance to the UK Treasury and FSA, and after three years self-regulation the FSA conducted a review of the effectiveness of the arrangements, and concluded that on the whole there was no evidence that high standards of governance were not being implemented as a result of the ACC.

Annex: Annotated UK Corporate Governance Code; Directors’ remuneration report

(last updated in 2008)

A.Full report and accounts

A mutual insurer should consider including each of the items of information below1, as it considers appropriate to its circumstances.

Remuneration committee information

•If the mutual insurer has a board remuneration committee: