WHEB Commentary

George Latham

The Kay Review: The end of the beginning not the beginning of the end


On Monday 23rd June I went to the launch of the Kay Review of UK Equity Markets and Long-Term Decision Making and I have to admit that I came away feeling a little anti-climactic. John Kay has long been a writer I’ve admired both for his style and intellect. This is also a subject close to my heart. So I perhaps let a little too much optimism creep in as I cycled over to the headquarters of the Royal Society of Arts on the first sunny and hot day in London I can remember.

The Kay Review is an excellent initiative and one we wholeheartedly welcome in terms of its analysis of the problem. The clear conclusion is that there is a problem with short termism in the UK equity market, and that this is detrimental to companies, evidenced by falling business investment, and to investors. The Review also finds that systemic problems with the culture and functioning of the equity market are at the root of the problem. So far so good, and supportive too of things that we have been writing about on this blog and elsewhere for many years. But my concern is that the scale and robustness of the recommendations fall far short given the magnitude of change required, and the entrenched nature of the vested interests that will try to prevent it.
One particular aspect of short-termism that Kay eloquently describes is the bias towards action at every point in the investment chain. I’ve always thought of it rather too simplistically as people wanting to look busy in order to justify their role (and salary/bonus). Kay sums it up much better as “many people in the financial services industry who claim to be in the business of providing advice are in fact in the business of making sales.”

The central theme of the review is the need to restore trust and build confidence. Kay points out that regulation tends to treat the symptoms and not the cause and what is needed instead is a fundamental change in culture. A culture that creates strong incentives for market participants to invest for the longer term and to engage in good stewardship. If Kay’s portrayal of ‘alpha’ as a zero sum game should lead asset owners to focus more of their energy on beta, then the incentive towards engagement to lift standards across the market will become stronger. However, whilst short termism remains in the ascendency, the efforts of the universal owner through high quality engagement suffers from a ‘tragedy of the commons’, so as one member of the audience pointed out, we need to find a way in which to ‘crowd in’ good behaviour and long-termism.

Unravelling this Gordian Knot is no mean task, and this is why the recommendations look unambitious when set against the excellent summation of the problem which forms the first part of the report. Expanding the scope of the Stewardship code sounds good, but too many managers approach this from a compliance perspective already. The idea of an investor forum for institutional investors does not clearly explain how and why this would be any more effective than the multiple structures that are already in place. Establishing a set of principles of good practise does sound like a more interesting initiative, but also risks falling into the category of the casually observed sign-off.

Sir John Rose (former CEO of Rolls Royce and review advisory board member) remarked that the report is “going with the grain of concern and is intended to be directional in nature.” If that is to be the case, then it is to be roundly welcomed, but what is now required is to drive the momentum from here. There have been good initiatives around this agenda before which have quickly run into the sand and had little impact. What is needed now is for a coalition of the willing that connects asset owners, investors and the companies that they invest in. Then we can start to create the irresistible momentum that will, finally, start to crowd-in more and more of the market.

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