Review Sets Out Reforms for U.K. Equities Markets

Terry Flanagan

A shell-shocked City of London was told today that it needs to forget its obsession with making short-term profits and that an overhaul of the regulatory system is needed.

The report, written by John Kay, a professor at the London School of Economics, was commissioned by the U.K. government and comes as the stock of the British banking sector has never been at a lower ebb following a seemingly constant run of scandals from rogue trading to interest rate fixing.

Professor Kay, who took a year to write his report, said that there were too many middlemen in the City focused on short-term gain and that their renumeration reduced returns for investors. Kay said that job losses could result from his recommendations. He also attacked annual bonuses and said that executives’ pay should be locked up until they reach retirement to encourage more longer term thinking. In addition, Kay wants to see the mandatory need for U.K. publicly quoted companies to publish financial results every three months scrapped and said that even annual reporting for some companies may be too long.

The report also said that the U.K.’s regulatory landscape needs a rethink. Instead of more regulation, Kay wants to see a more simplified and less prescriptive approach to regulation that prevailed before the 1970s and 1980s that serves the end users—the savers and companies—of the equity markets better.

“Equity markets must work more effectively in the long-term interests of investors and savers, who need to be able to see that they are getting value for money,” said Joanne Segars, chief executive of the National Association of Pension Funds, a UK body which represents 1,200 pension schemes with collective assets of around $800 billion.

“Most pension funds delegate responsibility for company engagement to an investment manager, and Kay is right that this relationship needs to be reshaped if good corporate governance is to develop further.
“Pension funds need to hold their managers accountable for delivering long-term returns, and quality stewardship should be a key factor when picking or reviewing investment managers.”
High-frequency traders were also criticized for their myopic behavior in the report.

“Examples of short-term behavior in capital markets are easy to find,” the Kay report stated. “A high proportion of dealing in equity markets today is conducted by high frequency traders, whose time horizons are typically measured in fractions of a second. More generally, the trading floors of investment banks exemplify hyperactive behavior.”

Although Kay resisted calls to curb the growth of short selling, saying it had been used successfully in the past as a check to poor or corrupt company managers.

Kay wants his recommendations to be taken on board not just by the U.K. government, but also by regulators and market participants.

“Although Kay’s reforms are focused on the U.K. market, the global nature of the U.K. stock market means this will strike a chord that will echo around the world,” said Penny Shepherd, chief executive of the U.K. Sustainable Investment and Finance Association, a trade body which supports the U.K. finance sector in advancing sustainable development through financial services.

“And after the recent scandals about major financial institutions, this report offers a path towards a better culture of long-termism, responsibility and good stewardship across the financial community. It’s an opportunity to rebuild public trust in U.K. equity markets.

“When it comes to long-term investment it is pension funds and other asset owners who are best positioned to drive change by incentivizing their managers to invest over a longer horizon than most currently do. There are some great examples of this among U.K. pension funds but many more, especially corporate pension funds, need to hear Professor Kay’s message and follow their lead.”

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