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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 969 - ii
House of COMMONS
TAKEN BEFORE the
Business, Innovation and Skills Committee
The Kay Review OF uk equity markets and long-term decision making
Thursday 14 February 2013
Lord Myners CBE
Evidence heard in Public Questions 83 - 133
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Taken before the Business, Innovation and Skills Committee
on Thursday 14 February 2013
Mr Adrian Bailey (Chair)
Mr Robin Walker
Examination of Witness
Witness: Lord Myners CBE, Former Financial Services Secretary and author of Institutional Investment in the United Kingdom: A Review, gave evidence.
Q83 Chair: We are slightly early, but I see no reason why we should not start. Can I thank you and welcome you? Obviously, you have a unique insight into this particular issue, and we would welcome the opportunity of questioning you on it. I understand that you would like to make a short opening statement, so I will invite you to do so now.
Lord Myners: Thank you, Mr Chairman and members of the Committee, for inviting me to give evidence. By way of disclosure, I am a director of three investment funds and three public companies. It is a pleasure to be here in the Wilson Committee Room on the 50th anniversary, to the day, of Harold Wilson becoming Prime Minister for the first time.
I have spent 20 years in the investment management industry, most of them as a CEO of an investment company in the City. I have also been a director of a sovereign wealth fund. I spent a dozen years as a corporate director of companies, including chairing Marks & Spencer and Land Securities, the largest quoted real estate company in Europe. As such, I have seen the issues covered by Professor Kay from the perspective of both the institutional investor and the company director, and also from the perspective of being a trustee of pension schemes.
I have done five reviews for Government on issues relating to ownership and stewardship. I did two for the Department of Trade and Industry during the previous Conservative government. The broad thrust of those was evidenced in their titles: one was called Developing a Winning Partnership, and the other was called Creating Quality Dialogue. They focussed on this space between companies and their owners, or their surrogate owners. I also produced three reports for the Treasury: one on institutional investment in 2000-01, another on the governance of mutuals, and a third one on the financing of high-tech companies.
Professor Kay has produced for us an academic treatise, which is very well argued. It identifies the core issue, which is the emergence over the last 30 years of a transactional relationship between companies, investors and intermediaries, and the dominance of the financial intermediaries, matched by a steady erosion of trust as the basis for commercial relationships. Essentially, we have seen the adoption of an "eat what you kill" culture in the City, as opposed to a culture in which one behaves more as a GP would towards a patient.
However, the Professor fails to come up with many practical proposals beyond wishful thinking. I sense that he lost heart towards the end. He was worn down by the weight of institutional lobbying, and we can see similar evidence of that in the response from the Secretary of State. I do not think that the Professor’s report will add a jot or tittle to the prosperity of the UK economy and the success of our businesses. If the test is whether, in 2022, we will look back and say, "10 years ago in the UK we had the Kay Review report, and everything changed," I think that test will most assuredly fail.
Kay offers no route to reversing the decline in the relative expenditure in the UK economy on research and development, or the decline in the commitment of fixed capital in support of employees. There is nothing in the Professor’s report that will end the dominance of markets over users; there is nothing in the Professor’s report that offers the prospect of the stock exchange becoming a primary source of new capital, as opposed to a secondary trading market; and there is nothing in the Professor’s report that seriously challenges the value and job destruction associated with reckless merger and acquisition activity.
The Professor barely penetrates the carapace. In some places, he is contradictory. He wants less intermediation, and yet he proposes a new intermediation body. The Professor faces both ways on short trading, as Mr Walker exposed in his cross-examination. There is a lack of consistency. In other areas, the Professor simply misunderstands the issues. When discussing stock lending, he fails to understand that these are not lending transactions: rather, these are re-purchase transactions. He focuses on reward, and almost completely ignores risk.
In other areas, the Professor’s recommendations are irrelevant. The recommendation on risk modelling is one that both the Secretary of State and the industry have almost completely failed to understand. I cannot work out what he is really getting at. The Professor also gives up in other areas: we have a lot about M&A, containing an element of xenophobia, but in the end he comes up with absolutely nothing in terms of a tangible recommendation.
However, I reserve my greatest disappointment as far as the Professor’s report is concerned for his complete failure to follow up on some of the very best ideas originally floated in his interim report. We find nothing of any significance in his final report on the subject of taxation, or why a trading culture is promoted by tax exemption. We find nothing in his final report about a financial transaction tax, which would slow down the pace of hectic activity in the City that sees trading now timed in microseconds of ownership, rather than anything that represents the sort of vision the Professor would like us to believe in.
He says nothing about employee ownership. He does not build on the work of the Bullock Report, released 36 years ago: he completely ignores it. He says nothing about slowing down the speed of merger and acquisition activity. In fact, he endorses the Takeover Code changes that speed up takeover activity in an economy that already has the most permissive rules in the developed world for taking over companies. There is no other economy in the world where it is easier to acquire a company than in the United Kingdom.
Despite having mentioned it in his interim report, he says nothing about the stewardship model in Scandinavia. In this model, the institutional investors sit on the nominations committee. They choose the directors. They make sure the directors are truly accountable to the owners of the business, as opposed to the directors being appointed through a process that is largely dominated by the Chairman, and through a voting outcome that even the North Koreans would be embarrassed by. He says nothing about differential voting. He says nothing about repairing the flaws in the voting system.
He misses major areas of great significance and importance. Even more fundamentally, he does not ask what the purpose of a public company is. He says early on in his report that public listing is now not a major source of capital for investment, but he does not get deeper into the question of whether we have too many public companies. He does not ask whether it would make more sense if our institutional investors owned these companies as private businesses, owned perhaps by two or three pension funds, who were able to appoint their own directors. This is as opposed to them owning 2% or 3% of each company and taking little interest in how those companies are managed. If I may say, in promoting private ownership of companies, I am not promoting private equity. I am simply saying that large pension funds could own private companies. They do not need liquidity.
In closure, Chairman, the industry’s response to Kay is, I think, one of considerable comfort. It might be summed up with: "Move along, Sir. Nothing much to look at here." There has been no disturbance or disruption to a highly remunerative business model. I doubt whether anybody who comes to give evidence to you will have much concern regarding Kay, other than, conceivably, the people from FairPensions.
I am nearly finished, Chairman. I know I am stretching your indulgence. I apologise for that, but I am trying to give a sense to the Committee of where I come from. I know it is important for you to read your own report into evidence that is given to you.
One area in which Kay approaches tangible recommendations, as opposed to wishful thinking, is that of a forum for investors. I have previously endorsed this concept myself. I have talked at length about ownerless corporations, and the need to create a better nexus. However, Mr Chairman, little progress has been made on establishing this forum. One or two people are trying; Daniel Godfrey, of the Investment Management Association, is one. However, what we will end up with is a forum that is dominated by trade associations, and trade associations’ modus operandi-their purpose for existing-is to protect the status quo. It is not to change things. I think you will find that, at best, this is run on a part-time basis. It will not have a fully paid secretariat. It will not have a significant budget. Sovereign wealth funds will stay well away. There may be some face-saving approach in which they are given associate or observer status, but they will have no interest in being part of this investment forum.
I will be one minute, Mr Chair, or less than one minute.
Chair: We would like to get some questions in.
Lord Myners: The Secretary of State should, in my view, have taken a much stronger line. He should have said, "I want to see this forum established." He should have invited two or three people to produce a short report over 30 days regarding what the options are, and he should have said that this can be financed out of the PTM levy, which is the £1 charge that appears on a contract note. This is used to pay the City institutions who staff the Takeover Panel, so this works well for the City institutions. Why can that not be used to pay for stewardship? Why can directed commissions not be used to pay for stewardship?
Likewise, on the issue of looking into the legal issues around fiduciaries, as far as I am aware, Mr Chairman, very little progress has been made with the Law Commission.
Chair: We will be asking questions on that.
Lord Myners: I think, sir, that we ultimately have a report where the reviewer and the Secretary of State have both been nobbled by existing interests. The British Horseracing Authority would probably order an investigation if they received a similar report that was so lacking in penetrating analysis or strong recommendations.
Q84 Chair: Thank you. I am not sure whether I would draw a parallel between this Committee and the British Horseracing Authority, but we will certainly be holding a similar sort of inquiry.
That is a pretty comprehensive opening statement. It may have anticipated some of the questions we intended to ask, but I think it is fair to say that it could generate further questions, which may or may not be picked up today. Once we have read the transcript of your opening statement, we may well write to you with some further points to be clarified. Your opening remarks are a pretty robust criticism of the Kay Report. You yourself made a report 10 years previously. In many ways, your approach was quite similar to Kay, in terms of commitment to the voluntary approach. What parallels would you draw between the two reports, and why are you so critical of Kay, given that there is not a great deal of difference in approach from your own, 10 years earlier?
Lord Myners: That, Chairman, is a very fair comment. The answer is that I am very disappointed in the lack of progress after my report on institutional investment in 2001. As you say, it relied on the same statements on principles of best practice that Kay is continuing to rely on. I have come to the conclusion that there are some fundamental flaws in our current approach to corporate ownership, in which most of our very large companies are owned by an extraordinary number of institutions, all of whom own a tiny percentage. None of these institutions feels empowered or obliged to act like a true economic owner. All of them, with a few noble exceptions, see selling as a better option than getting actively involved when they see a company failing to invest or perform well.
That is why I come back to the conclusion, Chairman, that what I have described as the "ownerless corporation" can only be successfully addressed if we see a fundamental change. There needs to be more concentrated ownership, and more activist shareholders who are properly equipped and empowered to become involved. Another important step in that respect would probably be for a smaller proportion of our economy to be in the hands of publicly listed companies.
A number of the areas that Kay picks up, such as the costs of transaction and the failure of investors to get actively involved, are ones that I have previously addressed. He seems to address them as though they are novel and have not previously been looked at. In fact, there is a long succession of reports on these areas, including that of the Wilson Committee, which I think was before the Bullock Committee. There is very little in Kay’s early chapters that represents any fresh and additional perspective on these issues.
Q85 Chair: One of the problems, as I see it, is that both you and Kay were pretty strong on analysis but both reports have been weak on providing a route map from the analysis to the objective that you would like to achieve. You talked about more concentrated ownership. How can you get more concentrated ownership without intervening in the market in a much more direct way?
Lord Myners: The answer here is, I think, the same one that I gave in 2001. The ultimate owners-in most cases the trustees of pension funds or endowments, or the directors of insurance companies-need to ask themselves whether this current model is working successfully from their perspective. Kay makes the point, from which I do not dissent, that the current model works very well for the agents. It works well for the fund managers and for all those who are giving advice, such as the consultants and other intermediaries. What we need here is a more fundamental review by asset owners regarding whether this model works.
As I said, my contention would be-and it is interesting that some of the sovereign wealth funds are moving in line with my contention-that they do not particularly want to invest in listed companies. They would rather invest in private companies, where they can exercise more control, or, importantly, they want to invest in companies that have anchor shareholders. These are strong, significant, long-term shareholders who are represented on the board of directors and who take a real interest in what the company is doing, rather than people who are just trading bits of paper. The problem is that our big companies are now owned by share traders. They are not owned by investors.
Q86 Chair: How can you proscribe that?
Lord Myners: I don’t think you can proscribe it with absolute confidence, Chairman. However, I do think that Kay is right on the issue of fiduciary duty. I think it would be beneficial to have a more serious set of statements about fiduciary duty, in which, for instance, the trustees were placed under an undoubted and undeniable obligation to properly account for how they align the way in which they invest with the best interests of members of the scheme.
Q87 Chair: I am going to ask some questions subsequently on fiduciary duty. If I can just come back, I believe you told the FT in 2011: "You can sum up my report in four words: a call for action." That goes back to your report in 2001. The fact that we have had the Kay Report does demonstrate that that level of action has not actually been generated. It comes back to this core issue: how can you change a market that seems to work well for some, when they have such a strong vested interest in sustaining the model as it now is, irrespective of the economic benefit to the actual investors?
Lord Myners: I think my own report-which was a call for action, and primarily a call for action by asset owners-did have some impact. I think that the direction of travel was right. I am a naturally impatient individual, and therefore the speed and length of travel was not as great as I would have liked.
One of the phrases I like in Kay’s report, Chairman, is about market abuse. He says the very fact that we call it "market abuse", rather than "customer abuse", tells us how our whole thinking-including the regulators’ thinking-demonstrates that we believe the market is our saviour here. The market is not our saviour. We have learned that markets are not as efficient as an economist might suggest. We know that markets lead to crowding, in terms of everybody moving in the same way. We know that a reliance on markets does not ensure safe outcomes for clients of financial services companies and investors. We need to reassert, or assert, the primary interest of the asset owner.
The problem is that most of the people who have contributed evidence to Kay, who are listed at the back of his report, are agents. They are people who say, "This system works very well for me. I don’t want to change this at all." How, therefore, do we give voice, power and expression to the people through their savings and investment schemes? There are radical options, which I think Kay should have considered. He does not consider employee ownership at all. He does not ask whether it would be better if we found a system where, for instance, companies were required to put 0.5% of their new shares into an employee trust each year, until such point as the employee trust became the largest shareholder in the company. For most companies, Chair, it would take seven or eight years to get there if it was 0.5% per annum.
It would not take very long at all, and there would not be much dilution, but it would represent a fundamental change in the market. Kay does not consider anything as radical as that at all. He stays in these very narrow tramlines of conventional thinking, with nothing in his report that disturbs the City institutions.
Q88 Chair: I am sure those comments will be music to the ears of the employee-share ownership movement. Looking at the market, and trying to understand what has happened for us to get where we are at the moment, you reported in 1999 that only 15.3% of UK shares were held by individuals. Kay reports that in 2010 that figure had fallen to 11.5%. Why has this happened, do you think?
Lord Myners: Data around ownership is highly suspect, because of the way in which shares are registered through nominee companies. For instance, if a UK pension fund is managed by Fidelity, which is an American company with a UK office, is that registered as American ownership or British ownership?
One should treat the data with some caution, but the central thrust of the decline in individual ownership is undoubtedly correct. I would venture to suggest, Chair, that the financial services industry has been very successful in lobbying government to ensure that people are encouraged to invest through funds, rather than themselves. Funds have a tax-preferred status: if you invest yourself, you pay capital gains tax, but the fund does not pay capital gains tax. If you want tax protection through an ISA, you have to make it through a fund. If you want to invest in venture capital, you have got to do it through EIS or a VCT. The industry, at every point-whether on charges within funds, on disclosure, on tax enabling, or on regulatory restrictions-has consistently directed Government and Government policy towards the promotion of fund-based investment rather than individual investment.
Q89 Chair: That is an interesting point-that the industry has exercised pressure on the Government. There is a whole range of government saving schemes that would conform to the model to which you have just referred. You feel that has come from pressure from the industry, rather than from a Government approach to adopt the most risk-averse way of encouraging the public to save?
Lord Myners: Government may well have been persuaded-indeed, was undoubtedly persuaded-that it was an outcome that was risk-averse and in the customer interest. Government was equally persuaded that previous restrictions on maximum charges for unit trusts should be lifted, and of other things that suited the industry very well. What we know, Chairman, is that most unit trusts-90% over periods of more than five years-underperform the index. This is extraordinary. 90%-nine out of 10-professionally managed funds produce a worse return than you would get by throwing a dart 50 times into the back page of the FT and buying the shares where the dart penetrated the paper. Somehow, Government has been persuaded that this is a safe and good outcome for the customer, when the data might at minimum suggest it is not as simple and straightforward as suggested. However, it is an outcome that has suited the fund management and banking industry very well.
As you hear, Mr Chair, I am quite cynical. I have been in this industry for a long time. I was also, of course, a junior Minister-a very junior Minister-for 18 months in the previous Government. I had first-hand experience there of seeing how the financial services industry lobbies HMRC, the FSA, and the Treasury.
Q90 Chair: You spoke earlier about the difficulty of identifying the true ownership of UK shares. You can quibble about figures, but it does seem to me that there has been an increasing level of ownership based outside the UK. When you did your original report, did you anticipate that, and did you factor that into the recommendations that you made?
Lord Myners: No, I did not, Chair, but it was an extrapolation of a trend that has been in place for a long time. Of course, there is a reverse to this as well: more foreign institutions own a significant part of the UK quoted sector, but more UK institutions now have their money invested outside the UK, and there is a lot of academic evidence as to why it makes sense to diversify portfolios geographically. The consequence, as far as the Professor’s report is concerned, is that generally speaking-one has to be careful about too much high-level generalisation, because there are commendable exceptions like BlackRock and Fidelity-overseas investors take less interest in issues of governance and ownership in their non-domestic markets.
This is also true of our institutional investors, who are much more focussed on the governance of UK companies than they are on the governance of Indonesian, American or Mexican companies in which they may have invested the savings of their British clients. This is a global trend, Chair. It cannot be reversed within the limitations of the public company model.
Q91 Chair: It is an interesting observation. On the basis of what you have said, with the increase in globalisation of share ownership, there is potentially a decrease in quality governance throughout the world.
Lord Myners: Yes.
Chair: It is difficult enough to get action in this country, but do you think that there is a case for trying to get some sort of international model?
Lord Myners: I will be very interested, Chair, to read the transcript from when you interview people who are supposedly establishing this investor forum, and to see how successful they are in convincing you that they are going to set up something that is really meaningful. My suspicion is that you will have significant doubt. I would then suggest to you that, if they cannot do it alone in this company, it is going to be almost impossible to do it globally.
If I may briefly add another point here, Chair, I am less concerned about the internationalisation of ownership than I am about the agglomeration of ownership in the hands of a small number of very large investment institutions. The problem we have here is that a large institution might own 5% of a company’s capital. Therefore, for the company, this institution is very important. They are the largest shareholder: they own 5%, and the company will want to have an active dialogue. However, for the large institution, it might be an infinitesimal amount of their total assets under management.
The company will want a close engagement, and Kay talks about the appointment of directors and these sorts of things. Although the company wants and expects that, the institution will have thousands, tens of thousands, or hundreds of thousands of these little investments. How can they possibly think and behave like true economic owners? That, Chair, is-I believe-the fundamental flaw here. We have come to believe that the public company model is a superior one, and it clearly is not. It is failing in terms of its primary economic purpose.
How can we fix it in the interim? There need to be more activist shareholders who take significant shareholdings, around 10% or 15%. They need to appoint people to the board, which means they need to be engineering that themselves in terms of the skills they need to do that, and they need to commit long term to be an anchor shareholder in that company and have the right skills to work in the board of directors. That is a radically different model from the one that we have at the moment, which I have characterised as the "ownerless corporation", where nobody cares much about what happens in a company. If it looks like it is all going to go wrong, we simply sell our shares to somebody else and exit.
Q92 Ann McKechin: Good morning, Lord Myners.
Lord Myners: Good morning, Ms McKechin.
Ann McKechin: You talked in your own report, back in 2001, about the importance of attempting to seek an effective approach that does not rely on direct government intervention in banning or directly determining behaviour. Professor Kay recommended a fairly similar approach. However, this morning, you have mentioned a more activist shareholder base, and you have talked about employee share ownership. Presumably, you cannot actually achieve employee share ownership without a certain amount of compulsory regulation. In what way do you think that your original "comply or explain" principle did not work, and do you think that there is now an argument for greater compulsion?
Lord Myners: There are many things in my original report that I stand by. In particular, I stand by the importance of having trustees who are better qualified, more knowledgeable and more independent-minded, and who approach their responsibilities in a more business-like way. However, there are issues around the public company model that I see with greater clarity now than I did 10 years ago. I perhaps failed in that respect. There are areas where I think Government could, and should, intervene. Government should force the creation of this investor forum, and it should say that the financial means will be placed there for it, potentially through a contract note tax. The tax I referred to earlier on is £1 per bargain, and even then only applies to more than ten thousand shares. It is noise. I would like to see that forum correctly funded, properly staffed, and truly independent of trade bodies.
I would like to see the Secretary of State take a much stronger line on takeovers. I look back at Dr Cable’s speech to the Liberal Democrat party conference in September 2010, in which he talked about speculators dominating our economy; businesses being destroyed by short-term gain; and vandalism, aided and supported by City accomplices.
Chair: We will be talking about takeovers in a moment.
Lord Myners: I then look at what he says in response to Kay. One can only assume that his words are drafted by the same officials who worked with Kay, because they are marking their own homework. They are saying, "Everything is alright, guv. We don’t really need to do much on takeovers," but we do. We need to put a public interest test into takeovers and we need to slow the process of takeovers down, in order to give companies an adequate opportunity to prepare alternative proposals for their shareholders.
Chair: Could I just intervene? We do actually want to talk about takeovers in a second.
Lord Myners: I apologise.
Q93 Ann McKechin: You have mentioned several times this morning the institutional reluctance to change and how dominant their lobby has been in all aspects of their work. Professor Kay generally said the problem was that, although you can certainly change the regulatory environment, there is always a danger of people trying to find another option that they believe will be more preferable to them. You may also get a culture of box-ticking and false security. I wondered how you try to navigate these problems. If the institutional resistance is great, how do you try to nudge people into a better behavioural pattern?
Lord Myners: It is extremely difficult, Ms McKechin. Your colleagues on the Banking Commission down the corridor are wrestling with the same issue around the ring fence.
I think Kay is absolutely right in emphasising this issue of fiduciary responsibility. We need to place great clarity around the concept of the intermediary-the adviser-acting wholly and unquestionably in the best interest of the client. At the moment, we know that is not the case. The test is one of fairness and disclosure, and Kay himself makes the point that in, for instance, the area of what he calls "stock lending", disclosure is inadequate. For the life of me, I cannot understand why the Department for Business, Innovation and Skills has not got on with the process of getting the Law Commission to work on the Kay recommendation. I am hopeful that, as a result of what I say here and what you are doing, Dr Cable will be able to tell you that this work has started by the time he gets here. I am pretty confident that, at the moment, it has not stared. There needs to be clarity about fiduciary responsibility, backed up by a tough regulatory regime that says: if you misbehave, you are out-and out for good.
Q94 Chair: Can I just intervene on both you and Ann with a question I was going to ask later? I think it is appropriate to do so. There has been criticism of this recommendation to give it to the Law Commission to look at as just another way of kicking the issue into the long grass. How do you feel? Do you feel that this is a fair criticism?
Lord Myners: I have often found in my professional career, and also in the work I have done on reviews, that I have been given too much time. I am now a great fan of saying, "Let’s get these reviews done quickly. You will get 90% of the answers in 30 days. You may get the last 10% if you make it 300 days." That is why, if I were the Secretary of State, I would have had the Law Commission addressing this already, and would have had that investment forum up and running.
Kay is a man whose motivations are unquestionably good. I just do not think he has dug deep enough, or been radical enough. I think Kay’s recommendation here is a serious one, and it would be good to have more clarity about fiduciary duty. Maybe this is one for the Financial Conduct Authority-which is about to be launched-to deal with. There should be an absolute, undeniable obligation never to abuse a conflict; always to disclose conflicts; and, indisputably, never to disadvantage the client or put your own interest first. If you look at the language around financial regulation, you will find that it is a bit mealy-mouthed. It is a bit qualified. It is caveated, and we need to have absolute clarity here.
Q95 Chair: Would it be fair to describe your approach to this as saying that, although it is the right course of action, it could be done a lot more quickly?
Lord Myners: Yes. It would have been very nice if, in the Secretary of State’s responses-which are all couched in the language of officialese-we had felt a little bit of Dr Cable himself. That was not there. There are about three or four ways in which Dr Cable could have been much more forceful than he has been, if he really believed in these issues and if he really went back to the spirit of his views in September 2010.
Chair: Sorry, Ann, I will bring you back in.
Q96 Ann McKechin: Thank you very much. You carefully set out a series of principles to codify the model of best practice for institutional investors, and pension schemes in particular. Two years later, the Government conducted a review of the take-up of these principles in the industry. I just wondered how satisfied you were with the progress that was made on that issue.
Lord Myners: The subsequent two-year review watered down my original recommendations. That was, I think, the product of successful lobbying by vested interests. Past experience of mine-and, dare I say, of yours-might suggest that, when we get the 2014 summer review of Kay, we may well find that there has been some watering-down then. There are very few parallels where you would say, two years on, "It was tightened up." The whole pressure of vested interests, here as in so many cases, will be to reduce impact. I was a tad disappointed.
Q97 Ann McKechin: Did it get weaker after that two-year review?
Lord Myners: Yes, it did. It gets weaker every year.
Q98 Ann McKechin: It is constant effort. Professor Kay has published a new set of principles, called "Good Practice Statements". The Government has, again, taken a rather hands-off approach, saying that they should prompt market participants to consider their current progress and inform industry-led standards of good practice. How long would you recommend that we wait to see if that approach works, or would you say that we should have moved a lot quicker?
Lord Myners: I think we could probably wait until this afternoon.
Ann McKechin: It is not going to happen.
Lord Myners: It is not going to happen. Despite the protestations of others, who will now come and say, "You had Lord Myners here, and what he said was totally unfounded," I rely upon your expert judgments of people and institutions, and your experience, to form a view as to whether you think much is going to happen here. My strong sense is that it will stay as it is.
Q99 Ann McKechin: You have mentioned fiduciary duty, and you have also mentioned conflict of interest. That is interesting, because conflict of interest should be quite clear to establish. Are you saying that has got to be the real emphasis, and people have got to be pressed very, very hard about conflicts of interest and the rules should be enforced rigidly?
Lord Myners: Conflicts of interest are inherent in all business transactions and, indeed, in all aspects of life. What is needed here is an absolutely clear statement of those conflicts, but I do not think statements are sufficient in themselves. I think a legal obligation is required. I was brought up in Cornwall, and my mother was a hairdresser. She knew nothing about business. She once said to me, "You manage £6 billion. Can you write that down for me?" I wrote it down, and she said, "That is an awful lot of noughts. Why would anybody trust you?"
Trust is of a very, very high order. I know this is different from LIBOR, but what we have seen-and Kay’s central observation about the need to get back to trusted behaviour is correct-is that many, many people have lost that sense of honouring the trust placed in them.
Ann McKechin: Thank you very much.
Lord Myners: Thank you.
Q100 Paul Blomfield: Lord Myners, your breathtaking critique of the Kay Report is hugely engaging. One of the things that Professor Kay talked to us about was the difference between equity markets as they are and as they were historically. Companies basically now finance investment through debt and retained earnings.
Lord Myners: Yes.
Paul Blomfield: You would agree with that?
Lord Myners: Yes, I do.
Q101 Paul Blomfield: I guessed that you would. We have had evidence from the Quoted Companies Alliance that disagrees with this, saying that "equity markets remain an essential source of capital for new investments in British business". Given these conflicting views, what future role do you see for the equity market in the long term?
Lord Myners: I have suggested-and this has been one of my key arguments-that perhaps too many companies are publicly quoted, and that for some of them it would be better if they were institutionally owned than private. The primary source of new flotations and new capital in the UK stock market in recent years, and the primary provider of funds, has been Her Majesty’s Government in their financing of the banks. It is a bit naughty of the Stock Exchange to include that as evidence that the capital markets are performing a function: I would argue that the capital markets had clearly failed, which is why the taxpayer had to step in.
Of course, we have also seen a lot of Eastern European and emerging market companies coming to the market, but there are very few examples of UK companies coming to the stock market with what is called an "offer for subscription", as opposed to an "offer for sale". An offer for subscription is when a company raises new capital: they issue new shares to new investors to support investment. An offer for sale is when the existing owners, be they private equity, oligarchs, or whoever else, sell the shares that already exist. The capital has already been invested. In many cases, you see companies saying in their prospectus that "the company has no present plans for the use of the funds raised" when there is an offer for subscription.
The fact is that often offers for subscription do not have a clear investment programme linked to them. In any case, offers for sale dominate over offers for subscription, and more small UK companies withdraw from the stock market, rather than come to the stock market. This all seems to me to pull the rug completely out from under the argument that the Stock Exchange is a key provider of capital for British industry.
Q102 Paul Blomfield: Thank you. I know Robin is itching to get in on takeovers and acquisitions, and to follow that discussion further. I wonder if I could just ask about one other point that you raised. You criticised Kay for saying nothing about a financial transaction tax. If you listened to the report on Radio 4 this morning, you would have heard a debate around the movement within Europe: whether all 11 countries could, on a Europe-wide basis, move towards an FTT. It was all about the money that was raised. In your criticism of Kay, you were talking about microseconds of ownership, and some of us struggle to understand this. What is your view on the FTT in terms of changing behaviour, as opposed to raising revenue?
Lord Myners: I did not listen to the radio this morning, Mr Blomfield. I was a bundle of nerves in preparation for coming here, and so I did not allow myself to be distracted. I know I have been critical of Kay, but, as I have said, it is a good analysis. I am just fearful that not many other people coming before you are going to give contrary arguments, so I probably over-emphasised some of my criticism to ensure the balance of argument there.
I am positively inclined in support of a financial transaction tax to slow down the pace of hectic deal-making and trading. I am not much persuaded by arguments to hypothecate the proceeds for one reason rather than another. I think the primary economic argument for a financial transaction tax would be to reduce the super-hectic activity, which, to me, is epitomised by these high-frequency, algorithmic traders. These are people for whom physically getting their computer closer to the stock exchange, or using even faster bandwidth cables, is critical for business success because they own the shares for microseconds. What have we done? How have we ended up in a situation where the evidence and responsibilities of ownership of our major companies can be traded in milliseconds? I don’t think Kay really got to grips with that at all.
Q103 Paul Blomfield: What about the argument that, if we do move towards FTT for that reason, it has to be all or nothing? There has to be complete international agreement, or it will damage our financial services sector.
Lord Myners: The Government is correct in arguing in favour of, ideally, a global FTT. It is quite difficult to introduce. It is quite interesting that EU proposals seem to be extra-territorial, and will apply to transactions conducted in UK securities and by UK-based institutions. I do not think the Treasury has ever looked seriously at the economic case. I think they have been somewhat dismissive, because they see it as threatening to the City. One thing that I think both Professor Kay and I would agree on is that we have too often been concerned about things that are threatening to the City, and have missed the point that, at times, the City is threatening to the economy. I find myself increasingly drawn towards a financial transaction tax: ideally, one that is established globally.
What if it were not global? This is a bit like offshore financial centres. My simple solution to offshore tax centres is that we should not allow any bank in a developed company to establish a branch or a subsidiary in an offshore centre that does not comply with the OECD’s white list of financially compliant economies. You could do something similar in terms of transactions. You could say to the Barclays, the Citibanks and the Société Générales that, if they put transactions through a non-FTT-compliant jurisdiction, they would lose some of their financial privileges from being in well regulated markets. I think these things could be achieved, Mr Blomfield, if there is the will to do them.
Paul Blomfield: Thank you.
Q104 Chair: Before I move on, did you consider doing those things when you were a Minister?
Lord Myners: There are lots of things I wish I had done when I was a Minister. I wish I had spoken up more than I did. I came in as a Minister just after the collapse of Lehman Brothers, specifically to do work on the recapitalisation of the British banking system within the Treasury. I was very rarely consulted by colleagues on tax matters, but I do wish I had spoken up on this issue.
Chair: Thank you.
Q105 Mr Walker: Lord Myners, you have given us plenty to chew on. It has been a very interesting discussion so far. I want to touch on M&A, but, first, a broader question. I think that you and Professor Kay have been very clear in your criticisms of the current nature of the City, the way it treats companies, and the way it has changed the nature of ownership. I think we can all feel sympathy with some of the criticisms that have been made. However, are you not both open to the accusation that you are trying to turn back the clock to a mythical time in which all investors behaved well and understood their fiduciary responsibilities? Are not some of the changes really to do with technology, the rise of globalisation and the fact that we are living in much smaller world, where investors have much freer movement of capital? Is it not unrealistic to think that we can necessarily change all of that through legislation or regulation?
Lord Myners: That is a very good question. Your background in financial PR shines through. No, I don’t think I am trying to take us back to some golden age. I am asking whether everything that is listed under the heading "improvement" is actually an improvement. One does need to emphasise that, on the whole, fund portfolios now have more holdings than they used to. That is a high-level generalisation, because you have got some very commendable activist funds that hold investments in only eight or 10 companies, but, generally speaking, portfolios have become more diversified. Academia has encouraged this though modern portfolio theory and capital pricing models.
I am suggesting that it has gone too far. I think high-frequency trading has gone too far. I think M&A-which I know you want to come back to, Chairman-has been hugely damaging to the UK economy, and yet it has suited City institutions. I want to see the voice of the true owner expressed in these areas. Actually, if I look at the people who are giving evidence to you, I do not think you have got a single true owner giving evidence to you. You have always got intermediaries. There is a sort of hankering element. I hope I am not giving the impression that I think all progress is retrogressive, but I cannot, for instance, persuade myself that high-frequency trading is a good thing and that we would all be worse off if it had not been invented.
Q106 Mr Walker: Coming on to M&A, we have looked at evidence that described the Cadbury-Kraft deal as a disaster for the UK. You yourself have said that this is something that is undermining the position in the UK. Do you think that your recommendations, when you put out your report, should have been different in the light of the M&A we have seen? What would you have changed?
Lord Myners: I was a younger man, and my views have hardened. I said very little about M&A in my report, other than to point out that most M&A transactions do not deliver the outcomes that are suggested. I have subsequently gone on to say that the Takeover Code is rather like the British guns in Singapore in the Second World War: they were pointed in the wrong direction. The Japanese invaded not from the sea but from the Malay Peninsula. The Takeover Panel largely focuses its attention on the shareholders of the target company, and not on protecting the interests of those in the acquiring company, who are often subject to serious value destruction as a result of the egos and hubris of company executives. I wish I had been more critical of takeover activity.
The problem, Mr Walker, is that the prevailing sense throughout most of my career in the City has been that takeovers are good because they sort out badly performing businesses. If you do not run your business well, it will be taken over, and the new people will run it much better. That has suited the intermediaries. It has suited the investment banks, the stockbrokers, the fund managers, the lawyers, and the accountants. They, in turn, have persuaded the regulators that this was good, but the actual evidence just does not support that conclusion. In fact, takeovers on the whole fail. We should have a warning rather similar to that on a packet of cigarettes on the sort of takeover documents that you and I have worked on in our careers: "This type of activity tends to destroy value."
Q107 Mr Walker: Surely the logical extension of what you are saying is that this is, in many ways, a call for greater shareholder activism, which is a point you made.
Lord Myners: Yes.
Mr Walker: Would you say that, therefore, you ought to have the acquirer having a vote amongst their shareholders as to whether they should be going ahead with deals, rather than the target voting whether they should be taken over? You might see more shareholders speaking up against deals.
Lord Myners: That is correct. However, the problem there is that we have had one or two examples-I can think of two in the last 20 years-where shareholders in the bidding company have persuaded the board not to proceed with the bid. I guess G4S might be the most recent example. It is quite a nuclear solution, because there is a fear that, if you say to the board, "We do not support your recommendation," you are effectively saying that you do not have confidence in the board, and the shareholders do not want to lose the management necessarily. It is a rarely exercised option.
Another issue that we have here, Mr Walker, is that most of the institutional investors who come before you will say, "We don’t like being made insiders. We don’t like to give up our right to deal. We love dealing. If we are going to be made insiders, we only want to be made insiders for 24 hours." The right approach, used by the activist investors that you refer to-and I am involved with an activist fund-is to say, "We relish the opportunity of being insiders. We would like to be insiders. If that means we can’t deal for a month or so, that’s neither here nor there if we get the chance to have a voice."
However, most of our institutions do not want to be insiders. They do not want to get involved with a company and say, "We really don’t think making that bid makes sense. That isn’t what we want you to do." Institutional investors should be saying to companies, "We don’t want you to diversify. We diversify in our portfolio. You stick to what you do really well." That voice does not, on the whole, get expressed.
I have sat, Mr Walker, on the board of-I think-11 or 12 FTSE companies in my career. I therefore speak with some experience regarding the fact that there is very little contact between companies and their shareholders, other than meetings in which the shareholders are seeking information on the company that gives them a possible trading insight. Most of the dialogue between companies and shareholders is one in which the companies speak and the shareholders listen. The shareholders rarely speak back in terms of their priorities. Activist shareholders do that. They are rather like the white blood cells in the system: they are a force for good.
Q108 Mr Walker: That is a very interesting analysis. Obviously, you are speaking both from the perspective of having worked with companies and having worked with an activist shareholder. I would say, though, from my experience, management tends to be rather wary of activist shareholders. They tend to be rather defensive when activist shareholders take a stake in their company.
I just want to move on to the issue of short-term share ownership. Coming back to the Cadbury-Kraft example, about 5% of the company was owned on an ongoing basis by short-term shareholders. When the takeover was under way, that rose to about 30%, and we have seen that in a whole range of M&A situations. It clearly has an impact on the likelihood of M&A deals going through. Do you think there is any way of differentiating between the voting rights of short-term and long-term shareholders, and do you think that is something we should be looking at?
Lord Myners: This is not easy. I was made Chairman of Marks & Spencer three days after the bid by Philip Green and Goldman Sachs. Over the six weeks that it took us to prepare our defence proposal regarding the other option, namely remaining independent, short-term share traders acquired nearly a quarter of our shares. Many of the long-term institutions sold out, with the commendable exception of Standard Life, who absolutely said, "We will do nothing until the company has a chance to speak." Many other shareholders sold out.
The short-term investors have a very different interest. They are not long term. They are not persuaded by an argument that says, "This is actually a really good company that has not been particularly well-managed in recent years. Stick with the company; invest in the future. The company looks after its employees and its customers well," etc. That argument appeals to a long-term owner. It is an irrelevance to a short-term investor who is here today and gone tomorrow.
Some restriction on voting by short-term investors has a certain appeal. However, as Ms McKechin said, the City is rather good at finding ways around these things, through contracts for difference, etc. I am un-persuaded. My key recommendations on takeovers, Mr Walker, are these: firstly, the Secretary of State should exercise far more powers to intervene to stop the level of takeover activity, and to direct companies more towards self-investment.
Secondly, I would recommend that the pace of takeovers needs to be slowed down to give companies more opportunity to put alternatives forward. You can take over a British company in less than 30 days. There is no other developed economy in the world where it is easier to take over a company, and so we get a bad outcome. Kraft is a huge conglomerate that is not going to be a good owner of Cadbury. Cadbury and its products, people, culture and values will be lost within the enormous business of Kraft. Most of the investors in Cadbury had the choice: they could have invested in Kraft, but they were not invested in Kraft. They were invested in Cadbury. They recognised that Cadbury was superior, and yet these short-term pressures led them to sell out. I would much rather be an investor in an ongoing Cadbury than in a Kraft, a company that struggles to make a profit in excess of its cost of capital.
Q109 Mr Walker: Following up on that, and this area around foreign takeovers: you accused Kay of being almost xenophobic in your opening comments earlier, but you are also saying that there ought to be a greater public interest focus. You are saying that the Secretary of State ought to be being more interventionist in these processes. There are challenges with that. I mentioned to Kay two weeks ago that one of the deals I worked on was the Arcelor defence against Mittal. You had a lot of countries there that were very keen to be interventionist, but at the end of the day, they were brushed out of the way by the overpowering will of the hedge funds and short-term investors, who wanted to force through a deal. Despite the fact you had politicians in France, Luxembourg and Holland jumping up and down about it and saying that it should not go ahead, the weight of shareholders won out eventually. If there were to be some kind of public interest test or some kind of role for the Government in protecting UK companies, how would you say that would work?
Lord Myners: I think that as much damage is done by M&A of British acquirers of British companies as is done by foreign acquirers of British companies. I am not being xenophobic here: I am simply saying that our rules seem to be extraordinarily permissive, and one might sit back for a moment and ask whether it is actually in the benefit of the economy and society, and why we have concluded that we want to make it so much easier to take over companies than elsewhere. Martin Lipton, who is one of the leading lawyers on takeovers in America, told me recently that there had not been a significant successful hostile takeover of an American company in the last six years. We have had dozens in the UK over the last six years.
These things link together. Fiduciary duty would require the ultimate owner and, through contract, the fund manager-whether it be a good activist or another type of investor-to be able to defend the actions that they took on the grounds that they were in the best long-term interests of the beneficiary. It is quite clear that selling out to the highest bidder is not always in the interest of a long-term investor. I think that Section 172 of the 2006 Companies Act needs a bit more clarification as to what is right. Selling your Cadbury shares today to Kraft, rather than saying no and seeing the Cadbury share price fall if Kraft fails, is not necessarily contrary to the interests of the end owner. It is only contrary if you are addicted to market accounting and think that shares are for trading. I would be very happy to take the side of the argument that says, "I would rather have retained my investment in the old Cadbury than invested in Kraft." Cadbury was an international company: 40% of its shares were in international ownership. I do not think, Mr Walker, that that argument is ever really given a chance to be expressed now under the rules and approaches that we have for takeovers. We regard shares as things to be bought, sold and traded, rather than having some deeper entitlement and obligation.
Mr Walker: Thank you very much.
Q110 Chair: Just to pick up one point: in your opening remarks, you said that the Takeover Code in effect encourages the speeding up of takeovers. Could you just clarify that point?
Lord Myners: There were number of modifications to the Takeover Code announced. I am trying to see if I can find the evidence, sir, in the Secretary of State’s response. I think it was recommendation 14, in which the Secretary of State lists a number of areas where changes have been made to the Takeover Code, such as the "put up or shut up" period being limited. There is uncertainty around this. It is a technical issue, and I am happy to write to the Committee.
Chair: That would probably be best.
Lord Myners: Having read Kay several times-in fact, it could well be my chosen subject on Mastermind-I have still, at this point, failed to find the relevant section. I would essentially say that the fate of no company should be determined in less than six months. Some will say that this will cause tremendous uncertainty, and ask how a company can survive during that uncertainty. They will argue that this must be resolved very quickly. The people saying that are the agents and fee-chargers: the accountants, the lawyers, and the investment banks. We often lose sight of the fact that companies have a heart. They employ people; they have customers; and they have got communities dependent upon them. Those voices do not get heard at all.
Q111 Chair: Isn’t one of the accusations made by the financial services industry and participants against the 28-day "put up or shut up" period that it is not enough time, and that it actually blocks takeover activity? I believe there is a six-month period after that in which they cannot make the same approaches.
Lord Myners: You are absolutely correct, Chair. I have just not been persuaded that this argument that companies cannot be kept under siege for a long time is necessarily the right way to see the issue. I think the argument that companies should not be placed under extensive siege has been used to reduce the period that is available to assemble a credible alternative. When a company receives a takeover, the duty of directors is to carefully evaluate that proposal, but to also evaluate other proposals, including the possibility that the company has in some way or another failed to deliver its true potential to make necessary changes. When I became chairman of Marks & Spencer, we replaced the chief executive at the same time. We brought in a new chief executive, and we gave the shareholders a better option than the one they had previously been given. In the end, for a number of reasons, that is the option that they were happy to support. I would like to write to you on the "put up or shut up" period. It is quite a narrow area.
Chair: It is quite a narrow area, and your points seem contradictory to a certain extent.
Lord Myners: They are.
Q112 Mr Walker: In the Marks & Spencer case, what happened at the end of the day is the shareholders decided that you were presenting them with a better option. In many cases, that can be the case. So much of what you are saying about takeovers is really a call for more activist shareholders. Shareholders should be voting with their money, putting their money where their mouth is, and-if they believe in the long-term future of the company-should be willing to buy the shares away from those short-term investors and make sure a takeover does not go through. That is not necessarily an argument for greater Government intervention.
Lord Myners: We have not talked about short-term reporting, or the focus on data, measurement and companies reporting. I am broadly sympathetic with the direction in which Kay goes, although I think he again misunderstands what goes into an IMS. If you have a portfolio that is over-weight Marks & Spencer-you have got more than the index weighting-and along comes Goldman Sachs and Philip Green with a bid and the share price goes up by 50%, and you have got 5% of your portfolio in that, that is a very nice lift to your quarterly performance.
You are quite reluctant to say to the client, "We underperformed last quarter by 0.1%. If we had accepted the Marks & Spencer bid, we would have outperformed. That would have added a quarter-percent to our performance: i.e. plus 0.35% for the portfolio for the quarter. In our professional judgement-which we are happy to explain and defend-it was in your best interest that you retain your investment in this company, given that you are a long-term investor. We do not think the market is of much concern: to the extent that the share price falls after the bid is withdrawn, then we will know more about the company, and we have actually increased our investment in the company." That is the way a mature and well rooted approach would be formulated, but it is not the way it works at the moment. All of the focus is on short-term performance.
Q113 Chair: That anticipates a question I was going to ask on quarterly reporting. It is proposed that it will be removed, and replaced by "narrative" reporting. Do you think there is a risk that companies will simply stop producing quarterly reports and not do anything about the narrative reporting, or do narrative reporting in such a way that it is totally unhelpful?
Lord Myners: It is quite interesting that, when Gordon Brown was Chancellor, he was very attracted by narrative reporting for a while. He wanted to introduce what he called an "operating review" in annual reports and accounts. In around 2007, he suddenly dropped it without any real explanation as to why he had. I have never asked him why he did that.
I have sat on the boards of American companies, where there is much more narrative reporting. In some ways, it is harder for the directors to pull the wool over the eyes of the shareholders in narrative than it is in numbers. In numbers, you can fudge all sorts of things. You can put apples with pears and call them lemons, and your auditors may well allow you to do that. It is when you come to express in words what is happening in the company that the directors get quite exercised about their legal liability if their statements are not full, clear and unlikely to be ambiguous.
I quite like the idea of narrative reporting. I think where Kay is wrong, Mr Chairman, is that the IMS issued by most companies is a single page. It does not say very much.
Q114 Chair: Coming on to that, what do you think should be the standard elements in a quarterly narrative report?
Lord Myners: You might start off by saying to the directors of the company, "Let us assume that you are a non-executive director on a board. You probably own no shares, or very few shares, in the company in practice. You attend board meetings one day a month, and you have got other things that you are doing, so you are not very busy. Let us assume that, by some act of fate, you have suddenly become the owner of the whole company. You, the independent director, have now become the owner of the whole company. However, you also have multiple responsibilities, which means that you can only meet with the management once every three months, and you can only afford them 10 minutes. What would you want them to tell you in that 10 minutes? What would you want to know in that 10 minutes? You are the owner of this business in perpetuity. You cannot sell the shares-you are not much interested in the share price, because there is not a share price-and you only have a short period of time. What would you want to know about the company in that 10-minute meeting every quarter? Write that down, and then compare it with what you tell your shareholders, and try to reconcile why there is such a huge difference between the two."
Q115 Chair: That is a very interesting way of answering the question. Since we only have a very short period of time, could you very succinctly say what you actually think should be in them?
Lord Myners: I think you would want to know about the long-term health of the business. I would want to know: "What have you done, during the three months, to make this company stronger?" I would want to know about customer relations. I would want to know about employee relations and supplier relations. I would want to see the company in its network, essentially, rather than in isolation. I would like to know what you were doing in terms of investment in research and development. I would probably like to know the five things you have done in the last quarter that you are most proud of, and the five things you feel you have made a hash of. That might push it for 10 minutes, Chairman. A brief financial schedule with a focus on how much cash the business has generated and how that cash has been spent would be sufficient for my purposes.
Q116 Chair: Thank you. That is helpful. I would now like to ask you about something that I have difficulty in understanding, which is "asset allocation asymmetric information". In the introduction to your review, you said, "A particular consequence of the present structure is that asset allocation … is an under-resourced activity." Can you just explain that to me as a layman?
Lord Myners: There are two different issues. There is asymmetry of information: everybody is trying to get the same information. Our approach to efficient markets has been that, if everybody has the most up-to-date information available and they all have the same information, then we get efficient valuation of companies and rational allocation of capital. That has, perversely, restricted the flow of information between companies and their investors. That is why I think that the activist investor who says, "I want to be an insider, and I want to sit on the board of directors," is so much more positive for a company than this widely distributed ownership. The asset allocation model in the way in which Kay uses it is, I think, how a pension fund splits its money between bonds, equities, private equity, property, etc. It is how the fund gets to the optimal point on the efficient frontier of the balance between risk and return. I have spent too much time reading Professor Kay’s academic works if I can give an answer like that.
Q117 Chair: Could you just explain this "under-resourced" bit?
Lord Myners: There is an inverted pyramid in investment management, in which the least important functions receive the greatest attention and the highest pay, and the most important function receives little attention and, frequently, no pay. Let me expand on that. Multiple dealers of listed equities in active portfolios who are pursuing what the trade calls "alpha" are trying to out-perform each other. They cannot in aggregate, by definition, out-perform. There cannot be aggregate alpha, so this is a complete waste of time. There is an awful lot of dealing activity in which some will succeed and others will fail. As Kay says, there is very little evidence of sustainability of advantage: this is to say that, even if you have succeeded in the last five years, it is rather like flipping a coin. The fact that it has come up heads five times in a row does not actually tell you that it is going to come up heads next time, but the City seems to work on the basis that it does. This is an area that receives a lot of pay and a lot of attention. Some of the richest people in the country owe their fortunes to this type of activity.
By contrast, the decision on asset allocation for a pension fund-which is about understanding what your optimal level of risk is, creating a risk budget, and then saying that you will invest X percent in bonds and Y percent in equities-is taken by trustees who are often unpaid; who are generally not professionals, or particularly economically knowledgeable; and who are led by the nose by consultants. The most important decisions are taken by the people with least economic incentive and interest in the outcome, little reward, and little experience. On the other hand, the decision that adds no added value at all is hugely rewarded and in receipt of intensive scrutiny 24/7.
Q118 Chair: That is very helpful. Kay actually seems to think that developing this concept of fiduciary duty may help in making that asset allocation more efficient. Do you agree with him?
Lord Myners: I do. I think anything that makes clear where responsibility lies would be advantageous. Kay and I were aligned on that. Kay, if he read this transcript, would probably say, "Paul, you were very unfair, because there is much more that we have in common than we do not." I would agree with that. I might have sounded coruscating in my comments on Kay, but I just wanted to make sure that you do hear that there is an alternative view to the one that I think most people are going to give you over the next few weeks.
Chair: Thank you.
Q119 Mr Walker: That is a very helpful clarification. One of the things that you and Kay seem to agree on as well is the complexity of the intermediary chain between companies and the equity markets, and you commented that that has been becoming steadily more complicated since the 1960s. Kay has said he thinks that is a problem for the market. Is there any way we can change it? Is there any way that complexity can be broken down?
Lord Myners: I think an informed group of trustees would begin to look at how many people are eating off this carcass. We have got the guards, the guards of the guards, and the guards of the guards of the guards, and in a low-inflation, low-economic growth environment, the amount of investment return that is being absorbed by unnecessary fees is, in my view, quite high. I have made it quite clear to the Committee that I am a keen supporter of activist shareholders. I believe that activist shareholders, if they do their job well, are really a force for creating good and strong companies. I find myself much less persuaded that the hyper-dealing activity of algorithmic trading, etc, adds value. I think one of the things that should happen here, Mr Walker, is that the trustees of pension funds should be much more questioning about whether there is a different way to do things; whether they need to be paying all of these fees; and whether they are convinced that they are getting value for the fees.
Q120 Mr Walker: Is there an issue with the structure of the sell side-the intermediaries-and the way that has changed, particularly since the Big Bang and the shift towards a trading mentality that is transaction-based rather than relationship-based? I think I asked this question of Kay: is there any way of turning the clock back on that? Is there any way of having a more relationship-focussed set of intermediaries who are going to be talking directly to those investors and developing long-term relationships with them and with the companies?
Lord Myners: I have never been convinced that the so-called "sell" side is the optimal way of providing a bridge between investors and companies. If you speak to most companies, they say they would like to have long-term investors with whom they can have a sustainable, continuing dialogue and relationship. They would like to have fewer shareholders, so that they have fewer people to meet. The standard for a chief executive of a company is that, twice a year, they announce their results, and then they spend four or five days, meeting 10 institutions every day, in London, Edinburgh, New York, Boston, and San Francisco. They would much rather only have a couple of shareholders to meet, or four or five shareholders. They would prefer to spend longer with them, rather than have an adviser looking at their watch and saying, "It’s 10 minutes to the hour: we have got to be moving on."
The model in which we have a huge number of shareholders, and where the bridge between the company and the shareholder is often through the form of a sell-side analyst, seems to me to perpetuate that constant movement in ownership. The sell-side analyst makes their money from transactions, Mr Walker, as you and the Committee know. The company says they want to have a stable, long-term shareholder base. Yet, when they communicate with their owners, they often do it through the use of a sell-side analyst whose own economic model is predicated on the absolute reverse, which is an ownership that changes every hour.
I think there is an opportunity. The transactional approach that Kay has identified as being very different from the old model has been a global phenomenon, not just limited to the UK. It is not easy to reverse, but the right way to change it is to be clearer as to the deficiencies of the current model.
Q121 Mr Walker: You have been quite critical of Kay for not suggesting more specific things that could be done. We can be clear about the deficiencies, and we have been very clear in our analysis of what the problem is, and I suppose that a financial transaction tax could potentially be part of that solution. Are there any other practical changes that you think could deal with that culture of very complex and aggressive intermediaries who are effectively pushing a transaction model?
Lord Myners: He who pays the piper calls the tune. The problem has been that the person who pays the piper has been somnolent, and has expressed no particular preferences for any type of tune, or even the quality of playing. He who pays the piper is the trustee of the pension scheme. In that area, I absolutely remain on rock-solid ground with my own review on institutional investment, which could be summed up as saying that the pension fund trustees have just got to get smarter and be more on the ball. That is a source of change, Mr Walker. Achieving that is more important than anything else, but I think that areas like fiduciary duty, an investor forum and more disclosure are all helpful. However, it is getting the trustees as close as you can get to the ultimate owner, which in most cases is the director of the investment company or the trustee of the pension scheme, to ask more fundamental questions about whether there is a better way of doing this.
What we have seen in the Kay Report is that public companies and the public company ownership model, as we currently know it, is not producing good economic outcomes. I will come right back to the beginning: is there anything in Kay that is going to enhance the performance of the UK economy, and lead to greater and broader prosperity and a stronger society? I do not think there is anything in Kay that is going to make any significant progress in that direction. We need to keep focussed on that core aim and ambition.
Q122 Mr Walker: Just one more question, if I may. You talked about the position of the pension fund trustee, and their motives are very clear: they want to get the best return for their pensions, which is very worthy. You yourself have talked about sovereign wealth funds and the role that they can play, and you have talked about the more concentrated ownership they can provide and the fact that sometimes they will be investing in private companies, rather than just public ones. Is there not a concern, looking from a UK plc perspective at sovereign wealth funds, that their motives may not be quite so transparent? Their motive, rather than simply being to get a good return for their shareholders, may be something more than that: something political, or something about access to resources when a sovereign wealth fund takes a stake in a company. Is the role of sovereign wealth funds not something that other investors ought sometimes to be a little wary about?
Lord Myners: That is another very good question. The taxonomy of sovereign wealth funds is very broad and complex, and it is therefore quite difficult to generalise. Some sovereign wealth funds undoubtedly have a quasi-political objective. Other sovereign wealth funds have actually eschewed that, and are almost frightened of appearing to be too engaged as owners, through fear that they will be accused of seeking to exploit extra-territorial political influence. One has got to look at it case by case. I could list those sovereign wealth funds that I thought were more politician and those that were less political, but, as you can imagine, I could not possibly do that in a public forum.
Q123 Rebecca Harris: Good morning, Lord Myners. As someone with no prior background in this area, today has been an education for me. I am delighted that this inquiry looks to be a lot more engaging than the rather dry one that, I confess, I was expecting. Thank you. My first question is: could we, or would we, be able to use pay and remuneration to try to incentivise a better alignment between shareholders, fund managers, directors, and the wider public?
Lord Myners: I am sure there are plenty of dry sessions to come. I use the word "alignment", which is a word that intermediaries quite like. Increasingly frequently, fund managers now put on company directors the same objectives by which they are themselves rewarded. The fund manager is told by his client, "We want you to out-perform the index over rolling three-year periods," either a broad index or an industry-specific risk. So what do the shareholders do? We need to always be clear about the difference between a shareowner and the fund manager.
The fund managers then try to put similar obligations on the company chief executive, and the board directors are told that their bonus is dependent upon how well the share price does over a rolling three-year period. The fund manager feels under a short-term performance pressure, and so they absolutely replicate that in the arrangements put in place for company bonuses. It is not surprising, therefore, that many companies say they feel under great short-term pressure. Academic evidence shows that, when asked in confidential questionnaires-admittedly, in America, but I do not think it is necessarily different here-company directors say that they would probably cut back on research and development that they really thought would produce good results if that would enhance their share price. We have got an alignment that is the wrong sort of alignment. We have got an alignment around a common interest in short-termism.
If we go back to my model of where I would be if I suddenly found I had inherited the whole company, I would be much more interested in saying to the chief executive at the end of that conversation, "I think you have done a good job. I like what I hear, and I am going to make a judgmental decision because you are building a good, long-term company. I am just not interested in short-term performance." But at the moment, Ms Harris, I think the alignment has been around enforcing short-termism, rather than the reverse.
Again, under this fiduciary responsibility, the shareowners ought to be asking whether putting the chief executive under a cliff-edge pressure not to underperform the index over a rolling three-year period really creates great companies. There is a profound belief that the market values companies correctly at the beginning and the end of the period, which I think is deeply questionable. If you underperform the index over a rolling three-year period, you will get no bonus, or very little bonus.
So what does the chief executive do? The chief executive gets out on the road. He tells the story of the stock. He re-levers the balance sheet. He buys in and cancels shares. He does an opportunistic M&A bid about which he can talk positively for a short period of time before it becomes evident that the bid has not worked, in which case he is then on a treadwheel of doing another one. We have reinforced a short-term focus through remuneration, which is very distinct from the behaviours that you see in true long-term, great companies. These are frequently unlisted. Some of the best companies in the world are either unlisted, or are listed and have a significant anchor shareholder who focuses on the long term and not the short term.
Q124 Rebecca Harris: Professor Kay specifically recommended that performance incentives for company directors should be shares, held at least until they have retired from the firm. That makes sense to me, as I come from a small family firm: from my perspective, that is how business always was. What do you think about that?
Lord Myners: Conceptually, it is rather attractive, but it is wholly unenforceable. Logically, you would sell your interests through derivatives. You might leave the company in order to be able to sell. There is a point, Ms Harris, where a director can actually have too much of their wealth invested in the company. They become too obsessed with the share price.
Most of the people I truly admire in business are not motivated by money alone. Most of them are motivated by wanting to create great companies. Kay makes some very interesting points about ICI and GEC. He contrasts how they used to be with how they became when the City got a grip on them. Look at banking: when I was a young man, to be director or regional director of Barclays Bank or Martins Bank was not a recipe for making huge amounts of money. You were well off-you were a prosperous and respected member of the community-but you did not have private jets and all of the things that Mr Bob Diamond and others seem to have ultimately been motivated by. If the only way you can keep your management team is by paying them more and more, then you probably have not got the right management team.
Q125 Rebecca Harris: It is not necessarily about paying them more money; it is about paying them in the long term. Is the point not that your rewards are a long way away?
Lord Myners: I can understand that, but I might reverse it. I might say that it is not the fact that your rewards should be a long way away; it is the fact that your vision should be to the longer term. Are you doing things that will create a better company in the long term? One of the other problems we have in remuneration is that most of these remuneration agreements are now very formulaic. They are based on things like total shareholder return, etc, and weak and lazy directors have come to rely upon formulaic decision-making rather than exercising judgment. A really good board of directors would look at it and say, "Madam Chief Executive, we think you are doing the right things. We think you are creating a stronger company with a significant future. The stock market does not necessarily agree with that at the moment; we are not much concerned with that. We know more. We are going to give you a reward that we think is appropriate to the value we think you are adding long term." That is not the way it works now. Thinking long term is important, but I do not think that thinking long term necessarily means that the disbursement of the reward should be long term.
Q126 Rebecca Harris: It is just that I can see the attraction. You realise it is many years down the line, and if you have not made sure the company is in good health for the future, then it does not work for you.
Lord Myners: It is rather romantic. You can say that you cannot realise these shares until your retirement, but the fact is that most of us are not in wealth-accumulation mode when we get to retirement; we are in wealth distribution mode. It would be odd to live on a modest income until the age of 60, and then suddenly have wealth beyond the dreams of avarice dumped on you as the reward for 40 years of loyal service. I somehow do not think that would work.
Q127 Rebecca Harris: We have already covered quite a lot this morning about short-termism. You and Professor Kay might agree on the need to adjust the timescales in which success is measured for asset managers. Is there anything you would like to add on that, in terms of getting extra clarity?
Lord Myners: Most asset managers would welcome anything that encouraged them to believe that their clients would support them over a longer term; that their clients were less focussed on the very short term; and that their clients were less focussed on how they did against the index. One of the terms that you hear in the fund management industry is "tracking error". Tracking error is how you measure the extent to which a portfolio deviates from the index. Most active-as opposed to activist-fund managers monitor very carefully the extent to which there is a risk of them markedly deviating from the index.
Most fund managers regard themselves as in some ways enslaved by this, and would say in their true hearts that they would rather be able to run a portfolio with a higher tracking error. This would deviate from the index over short and medium time periods, but would produce superior long-term returns because it held fewer investments and was a more concentrated portfolio. Kay and I are both in favour of more concentrated portfolios. However, Kay does not get to grips with these things. He talks about the benefits of concentrated portfolios, but does not ask, "Why is this happening?" He does not seriously explore why portfolios are so substantially diversified, which is disappointing.
Q128 Rebecca Harris: I was going to ask you a question about FTT, which you largely covered in your discussion earlier with Paul Blomfield. You were very convincing on the benefits of this as a means of reducing short-termism, but how would you counter the argument that this is simply a tax on pension funds, and another point at which there is feeding on the carcass?
Lord Myners: The primary purpose of tax is to raise money to support programmes approved by Parliament, but there is a secondary function of tax, which is to achieve what are judged to be economically or socially beneficial outcomes. My thesis would be that a sensibly constructed FTT would actually be of benefit to pension funds. That is to say, it would calm down the excessive trading and deal-making that represents a significant cost to pension funds. In an environment in which trading was significantly diminished by a sensibly constructed tax, the net cost of the tax would be lower than the net gain of excessive trading. I come back to my core observation here, which is that hyperactive trading can add no value. For every winner, there is a loser. It is not even as good as that: if there were a winner for every loser, then there would be no disadvantage. There is disadvantage, because every trade bears a cost. There is what is called a bid offer spread between the price at which people will buy your shares and the price at which they will sell them on, which is leeching money out of the system to the benefit of intermediaries.
Q129 Chair: Thank you. Just moving on, and trying to pull all of your comments together: you conducted your own review. We have had Kay 10 years subsequently. Kay has made a lot of recommendations in theory, although there are issues about how robust they are, and exactly how they involve some sort of positive action by the Government. Given the experience you had when you did your report 10 years ago, and looking at Kay and his recommendations, how would you beef up those recommendations to actually achieve the sort of ends that you and Kay are broadly in agreement on?
Lord Myners: A number of Kay’s recommendations are very much motherhood and apple pie.
Chair: I described them as such, too.
Lord Myners: They are good-I do not dissent from them-but they are not going to happen unless there is more of a forcing mechanism. The key in the report is that the fiduciary responsibility obligation potentially has the ability to be more of a forcing obligation. The Government’s response to Kay was very vapid. I could not really tell from reading it whether the Secretary of State was punching the air and saying, "This is just what I wanted: this is going to make the change that I want," or whether he was saying, "This is another thing I can cross off my to-do list until I get called in front of Mr Bailey and his Committee." I have a slight inclination that it was more of the latter than the former.
I think that the Secretary of State has really missed a point on this investment forum, Chairman. He should have said to the investment industry, "I am going to invite three people to set up a group to tell me how this forum is going to be established. I am going to get them to set out what the options are. I am going to get the industry signed up, and I am going to give them 30 or 60 days to get that done." As far as I am aware, there has been a lot of discussion and very little progress on creating this investment forum. However, I am confident that by the time they come to talk to you they will have done it, because I fingered them for not making progress. On M&A, there is a single sentence from the Secretary of State that says he is going to look at competition policy and mergers and acquisitions, and that he hoped to produce something in, I think, early 2013. One of the things I learned as a Minister was that the phrase "early in the year" can, in Government, apply to anything up until 30 June.
Chair: We have found the same.
Lord Myners: Reports produced for the summer, as well, can often stretch well into October or November. I would like to have seen Dr Cable get much more involved and engaged here than he has done, and I still think that there is an opportunity for him to do that. I have nothing else to add, Chair. I think Kay has got a beta-plus for this report from me.
Q130 Chair: We could probably second-guess the Secretary of State’s position on this for quite a long time, but it could be that Kay was set up to give recommendations-to do the work and make the recommendations-to provide the basis for a policy initiative by the Government. It has not really delivered on that. What would you put in to actually give the Secretary of State something to say in terms of, "We have got the evidence. These are the recommendations. I believe that we should go forward on them"? At the moment, he has not really got those recommendations to go forward on.
Lord Myners: Having authored a number of reviews, I have become familiar with the process under which the review team prepare the report with the reviewer. They then pass it from their left hand to their right hand, and they draft the Secretary of State’s response to the review team. I have never seen a review in any department of state in which the Secretary of State has said, "This has fallen lamentably short of what I had in mind. I wanted something that was going to address the vandalism and the speculative damage done to British business, etc," which Dr Cable was talking about before he came into government and, indeed, after he came into government-in September 2010. It would be refreshing if at some point the Secretary of State were to say, "This report does not get as deep into the issue as I would like."
What would I like the Secretary of State to do? I would like the Secretary of State to say, "I want a more fundamental understanding of whether public companies are providing a good purpose. I would like to really understand why institutional investors do not seem to regard themselves as owners of businesses. I would like to understand why there are so few people in fund management who have any practical experience of business management. I would like to question whether the idea that fund managers should talk to companies about strategy, organisation and incentive would actually be testing them on issues where they have a competence." Most fund managers have not done anything other than work in the City, in fund management. They have never run a business.
I am one of a small group, Chairman, of maybe not more than two dozen people who have had some serious City career experience on both sides of the table. If I were sitting down as the Secretary of State with Professor Kay, those would be the sorts of questions I would be asking. I would say, "John, this is what I really need to find the answer to." The first five or six chapters of John Kay’s report are an academic book on market efficiency and agent–principal conflict of interest. It could well be that Professor Kay was not asked questions with sufficient clarity.
Q131 Chair: You talked about being on both sides of the table. Could you just put yourself in our position, and be on our side of the table here? We are doing an inquiry. We want to make recommendations. What sort of recommendations do you think that this Committee should be making to the Government?
Lord Myners: I would almost like you to recommend that the Secretary of State go away and do this exercise again, either with Professor Kay or with somebody else. I would like you to say that there are questions that Kay has only analysed on the surface, and not asked deeply enough.
Chair: That is what Lord Adonis says.
Lord Myners: If you want to stick to saying, "He is not going to do that, Paul; let us just stick with Kay has produced," I would pick out three or four things in the Kay report and say, "I want urgency about these. I want urgency about the investment forum and about fiduciary duty. I want to completely look again at the issue of how companies communicate with shareholders." It would be good if the Secretary of State spelt out in as much detail as possible that his summer 2014 review will be a serious review, rather than a review conducted by officials who would say that everything is broadly alright and that we are going roughly in the direction that Kay set out. He should say, "I am going to staff this up properly."
I would also come back, Chair, to my point that the Secretary of State could have got a grip on the recommendation about the investor forum. He could have said, "There will be a way found to fund it through a £1-per-deal contract note tax," which, as I said, goes to pay the fees of the people who are seconded to the Takeover Panel. That would set a good precedent there. If this investor forum is a grouping together of trade associations, it will absolutely support the continuation of the status quo, and will move at the speed of the slowest ship in the convoy. You need an investor forum that combines serious and committed spokespeople on behalf of the ultimate asset owners-the trustees and directors of investment funds-with some people from the corporate side of the table as well.
Q132 Chair: The first problem with another review is that it would be seen as Government indecision. The second thing, of course, is that it could well come up with conclusions that were just as inconclusive as the Kay review. You have outlined some positive steps that we could take as a Committee. It does seem to me that there is a very real dilemma for Government here. It does not want to get in a position of regulating the industry, with huge potential unforeseen consequences, but it has to find a way of making those participants act in a more responsible and long-term manner. I think, generally, there is a consensus about the sorts of principles that should be involved in doing that. Who do you think should be responsible for trying to ensure the compliance of asset managers, asset brokers and company directors? It seems to me that one way of doing this is to have some sort of body that would actually exercise some monitoring influence and, potentially, control over these people.
Lord Myners: If we emphasised the fiduciary responsibility, it would ultimately be a matter for the courts. If trustees or directors were failing, then they would run a risk of challenge from those who have placed them in a position of trust. I look at bodies like the FRC and the new FCA and somehow, Chair, I cannot convince myself that they are going to be able to make much change. The FRC, I think, is in a comfort blanket of believing that its stewardship code is making any real difference. When you speak to most company chairmen and chief executives-and I speak a lot with those people-they say, "Has the stewardship code changed? Are things fundamentally different and better?" They do not really see any change, but the FRC is able to say 200 fund managers have signed up to it and it is all terribly good. If there were clarity about fiduciary duty, the courts would be the ultimate enforcer .
To just go back to the early part of your question, I do not think it would be a failure or a U-turn for the Secretary of State to say, "Quite frankly, this report has asked lots of questions. Kay set out what the issues are. Where he has not done as well is in coming up with practical solutions. Having identified half a dozen key questions, I want to ask why this is happening and what can be done, and I need another report that comes up with very practical solutions, well rooted in understanding of the real world." Bear in mind that Professor Kay is a very nice man, but he is an academic. I think the only business experience that he had was when he was on the board of part of what eventually became HBOS. I think, maybe, one might say, "Let’s hand this over now to ladies and gentlemen who have practical and real experience."
Q133 Chair: I think that concludes our questioning. Can I thank you? It was a longer session than I think we anticipated, but it is also fair to say that it has been more entertaining and illuminating than we perhaps anticipated. You have given us a body of comment and evidence that we may well be able to recycle in our questions to asset managers, Government, and so on. Can I thank you very much for that? I say this to all witnesses, but it is perhaps more appropriate than normal in your case: we may well, on examining your evidence, feel that there are further questions that we would like to ask. We will write to you, and we would be grateful for any reply that you could give. There was, of course, the issue of the Takeover Code and the 28-day "put up or shut up". If you could provide us with further information on that, that would be very helpful.
Lord Myners: Chairman, may I also thank the Committee for giving me as much time as you have? I am very grateful to you for that. When I read the transcript and the numerous places where I have failed to explain myself clearly, I will write if I think that might help you. I do describe things, Chairman, with a degree of passion. I really do believe very seriously that there are things here that could be a lot better. I would ask your Committee to point us in a direction, bearing in mind the test of: "Will the economy be better?" That is the starting line, and I do not think that Kay has quite met the test. Thank you very much for your time, Chairman, and the Committee
Chair: Thank you.