The UK equity market
In 2010, only 11.5 per cent of UK shares were owned directly by individuals. In the early 1960s this figure was as high as 54 per cent. The major investment decisions which affect British companies are now taken by asset fund managers around the world who work for firms which control billions, often trillions, of pounds. We have heard that the rise of the institutional investor and the growth of intermediaries has been accompanied by a shift from 'owning' to 'trading'. The structure of the equity market has changed beyond recognition over the past few decades and regulation has not kept pace with it. Furthermore, there is a growing concern that asset managers do not behave in a way that benefits the long-term health of the companies in which they invest. At the heart of the issue is the incentives connected to the different links in the investment chain; from the owner, to the fund manager, through to the executives of the companies themselves.
The Kay review
Professor Kay's review of the UK equity market sought to improve long-termism in the market and to address the relationship between owners and fund managers. Currently this relationship is defined by short-term measurement of success at every stage. Players are encouraged to think ahead by only months, weeks or even days. Fund managers are expected to produce tangible results in very little time. This is as a direct result of the way the success of such managers is gauged. Fund manager pay and bonuses are benchmarked against the performance of other managers on a short-term basis and this feeds through to the information and behaviour expected of company executives. We make clear recommendations for the Government to bring about a cultural change in the incentives driving fund-manager behaviour to and develop a set of longer-term measures of success.
Mergers and acquisitions
Professor Kay's remit also included the issue of mergers and acquisitions, an area that our Committee has often reported on. Professor Kay recommended that the Government should take a more 'sceptical' view of the benefits of large takeovers and should be much more proactive in its monitoring of such activity. We recommend that the Government goes further. It should publish an assessment of the take-over regimes of other similar economies to learn about the impact that takeovers have had on their companies and economies; clarify what actions it will take over the next six months to be in a position to effectively monitor all merger activity in the UK; and produce a feasibility study which clearly outlines the risks and benefits of introducing a policy that will differentiate the voting rights of long-term owners and short-term traders during a takeover.
Financial Transaction Tax
The practice of High Frequency Trading (HFT) and the fact that shares are now traded and held for a matter of milliseconds epitomises the challenges faced in regulating the market. While there was support for such a Financial Transaction Tax, concerns were raised about the practicality of implementing such a tax unilaterally. We recommend that the Government considers the viability, benefits and risks of a Financial Transaction Tax on HFT with the objective of changing the behaviour of very short-term investors.
Commitment to change
Professor Kay published his final Report in July 2012 and we have scrutinised both his Report and the Government's response to it. This Report follows in the wake of previous Reviews, particularly the work of Lord Myners in 2001. It is a huge disappointment that previous Governments have not implemented the recommendations of previous works nor have they kept regulation in line with the rapidly changing nature of equity investment. There is no point in commissioning a Review of the industry unless the Government is challenged to move forward and make radical changes to align the incentives facing every link in the investment chain. The Government has to deliver on the recommendations made by Professor Kay and the issues raised by his analysis. It must bring forward proposals to enhance the culture of long-termism, transparency and accountability.