Ruth Kelly – 2003 Speech at the National Association of Pension Funds Investment Conference

The speech made by Ruth Kelly, the then Financial Secretary to the Treasury, in Edinburgh on 12 March 2003.

I am very pleased to be here today.

The National Association of Pension Funds is an important organisation, the principal UK body representing the interests of the occupational pensions movement.

Taken together, your members – large and small companies, public sector and local government – provide pensions for over 7 million employees and 4 million people in retirement.

11 million customers, more than £700bn of assets under management, and a membership of consultants, actuaries, lawyers, trustees, administrators, information technology technicians, and investment professionals. The NAPF will be a powerful partner, not just as we take forward our pensions policy, but also as we seek to improve the way markets work, for savers and investors, and ultimately for longer term health of our economy.

We all recognise that these are tough times for the pension industry.

Part of the context for the Pensions Green Paper is increasing concern about the level of pension saving and the ability of the current system to enable individuals to provide adequately for their old age. Some of these concerns are legitimate but some have been overstated. Most people are being paid the pension they were promised. Most are saving for their retirement, either in pensions or in other forms.

Nevertheless there are areas of concern: longer life spans, a decline in pension provision by some employers, complexity of products, and too many people leaving employment too early.

The Green Paper addresses these concerns. It sets out our proposals to renew the pensions partnership between the Government, individuals, employers and the financial services industry – long the mainstay of the UK pensions system.

Within that partnership, occupational pensions – both defined benefit and defined contribution – have been and remain crucial to delivering secure retirements for our citizens.

I want to take a moment to address recent incorrect press reports about the number of people likely to be affected by the Government’s proposals to radically simplify the taxation of pensions published at the end of last year.

These proposals are a massive boost for people saving for a pension.

The Government stands by its estimate that around 5,000 people could have a pension pot larger than the proposed £1.4m lifetime limit. This includes both people in occupational and personal pensions.

It is simply wrong to assume, as these reports have, that everyone contributing to a pension is currently free to put as much as they like into their pensions.

In fact, two-thirds of people with occupational pensions have until now been subject to absolute limits on their annual pension savings. The lifetime limit is equivalent to the maximum pension that these people could have built up under these existing limits.

Of the other third, only a small minority will have managed to accumulate a pension pot worth more than £1.4 million. And while these people will be unable to make further tax-free contributions, their existing rights will be guaranteed.

So far from losing out, the vast majority of people will be better off because they will have

– more choice about when and how much they save,
– more choice about when they retire
– more choice about how they draw benefits from their pension
– and in many cases a larger tax-free lump-sum.

There is also of course concern about the broader financial market environment. The recent falls in global stock markets – with US markets (S&P500) now down 47 per cent since their peak, UK markets (FTSE-100) down 50 per cent, France (CAC-40) down 64 per cent and Germany (DAX) down 71 per cent – reflect ongoing international uncertainties and risks which have also triggered turbulence in oil prices and exchange rates. This has demonstrated once again that no country can insulate itself from the ups and downs of the world economy.

We can’t predict the future of the stock market and how this might affect pension funds, but in the longer term, stock market performance is likely to reflect the underlying performance of the economy. And the fundamental drivers of a successful economy – high employment, low inflation and low interest rates – are in place, and are delivering a secure environment conducive to investment and long-term planning.

The macro-economic fundamentals are sound. But savers and investors, as well as workers and pensioners, also require the micro-economic fundamentals to be sound; for companies to be well run; and capital markets to operate efficiently and transparently. Since today’s conference is about investment, these are the issues I want to focus on today.

The Government has undertaken a number of important strategic reviews on a whole range of issues relevant to your conference today. The Pensions Green Paper itself. Cruickshank and Sandler on how to promote competition in banking and retail savings products respectively. Pickering on pensions legislation and Myners on the chain of relationships around pension fund investment. The discussions which followed Myners on transaction costs and shareholder activism. Higgs on non-executive directors, the Smith Review on Audit Committees, And the CGAA on accounting and auditing.

In all this, our objectives for savings policy and efficiency in capital markets have gone very much hand-in-hand. Our capital markets have a vital role to play in efficiently allocating capital in the economy, thereby meeting the needs of millions of savers. They do so through a long chain – in the case of pensions for instance, from trustees, through investment consultants, to fund managers and in turn to companies and their boards – a relationship which itself is crucially dependent on reliable audit and effective non-executive directors. The more effectively this chain works, the better-served will be our economic objectives and the interests of savers. Yet as we have found, each link in the chain raises its own complex policy issues about competition, incentives and accountability. Our contention is that these issues matter.

I certainly won’t attempt to go over all the ground today, though I do have one or two specific things to say in a moment about where we are on Higgs and the follow-up to Myners.

What I’d like to do first is step back a little and take a quick look at some important points which we can easily get lost in the debates on the detail.

First, I want to pick up some consistent approaches running through all these pieces of work. I would describe these as:

– a strong presumption in favour of promoting and enabling greater competition;
– a consistent emphasis on the importance of wealth creation and long-term value; and
– a belief in strengthening the hand of the customer and the shareholder.

All themes of course which tie very strongly with the Government’s broader economic objectives of promoting economic growth and productivity.

But second, I would argue that we have been deliberately careful throughout about the scale and nature of Government intervention that is merited or makes sense, even in response to the most powerful of analysis. Throughout the work, there has been a consistent caution about the hazards of kneejerk legislation and regulation in this area. Contrast the approach of Higgs and the CGAA, for instance, with that of Sarbanes-Oxley.

In fact, where possible, these reviews have actually opened the door to some significant deregulation – for instance, through Myners’ powerful critique of the weaknesses of the MFR and Sandler’s scruitiny of conduct of business regulation.

Third, I want to suggest that as a result of all this work, there is now a vastly better understanding within Government of the commercial realities of your industries than there ever has been before. Whatever anyone thinks of the conclusions of any of these pieces of work, they have been exhaustive, strongly rooted in evidence and analysis, and open.

Taken together, therefore, I suggest they give us, for the first time, a coherent approach towards policymaking as it affects the investment industry across the piece, rooted in a clear understanding of the chain of relationships in the investment industry and how all the decision-makers and incentives fit together.

In my book, that’s progress.

I know there are concerns in the industry about the potential for review fatigue. I can’t promise, as some have suggested I should, that we might never undertake any further review on any issues relating to investment. But I will say that I believe the challenge for us all now is much more about implementing and driving through work we have already done than about commissioning further pieces of new thinking.

I also firmly believe all this work has been very good for the long-term future of the investment and savings industry in Britain and certainly for a better and more intelligent foundation for Government policy and the ways it affects you – and through you, the interests of millions of savers.

As I see it, we now have a clear approach to this broad corporate governance and capital market agenda, which operates at three distinct levels.

First, at the level of the individual company, we need to promote the interests of shareholders, in relation to the interests of management. As is well-recognised, there should be mechanisms in place designed to identify the conflicts of interests which managers inevitably face, and ensure that they are managed effectively. And companies themselves need to make timely and accurate financial reports.

Second, we need a set of external stakeholders whose actions will promote and reinforce good governance. In particular we need shareholders to be accountable and active in making use of the ownership rights they exercise. And we also need independent auditors, comprehensive and robust accounting standards, and fair and timely market commentary from analysts and ratings agencies.

Third, as an over-arching pressure, we need capital markets which can act as a discipline to poorly performing management. A vigorous market for corporate control through takeovers is a cornerstone, but promoting competition in capital markets, and market access across national boundaries will also be important. And of course we need to pursue vigorously the Myners agenda to improve the framework for investment decisions made by the institutions, and pension schemes in particular.

Within all this three pieces of work deserve particular attention: the work on accounting and auditing, the action flowing from the Higgs review of corporate governance; and of course the ongoing work on Myners.

On the first, we all recognise that there are issues about “who guards the guards” – the role of the auditor, the relationship between the accountancy profession and the regulatory bodies, and the enforcement of standards.

Corporate failure, of course, will always occur; indeed, it must be able to occur if markets are to work effectively. Nevertheless, public confidence in the accountancy and audit profession has been shaken by a series of scandals. And we are putting in place a coherent and proportionate package of measures intended to reinforce the existing strengths of the corporate governance regime in the UK.

But as the nature of the corporate world changes so too the structures we create to govern our companies must change with it; they must be reinvigorated and made relevant to the concerns of modern investors.

Derek Higgs was appointed by Patricia Hewitt and Gordon Brown to review the role and effectiveness of non-executive directors in April 2002 and his report was published in January of this year. Inevitably, Derek’s report was seen in the context of Enron and its backwash – though I would argue that his work is just as much, perhaps more, about the positive challenge of promoting shareholder value as it is about trying to prevent wrongdoing.

The report suggests a significant strengthening of the role of the non-executive director. Higgs also emphasises the importance of formalising the appointment processes and encouraging more candidates with a wider diversity of experience to take appointments in the boardroom. And it proposes stronger arrangements to ensure that shareholder views are heard in the boardroom – something many here stressed to us in the context of the debate on shareholder activism.

We welcomed Higgs’ proposals in full when the report was published earlier this year, based on his thorough analysis and considered recommendations – not least because it provides a robust way forward which avoids a need for clumsy legislative intervention. That remains the Government’s view.

Derek’s report is a careful and well-balanced package. But it has also prompted much debate. And there is some danger that this debate is starting to generate more heat than light. So I would like to take the opportunity of today’s conference to make some observations from the Government’s perspective and suggest some principles which it may be helpful to keep in mind.

First, the Government has a clear objective, if at all possible, to avoid the UK corporate governance framework becoming a matter for regulation as it has elsewhere, for instance to some extent now in the United States through Sarbanes-Oxley.

That is not because we believe corporate governance is unimportant or that there are not public policy interests at stake. It is because we believe a governance framework should ideally leave room for judgement – and these judgements are, in the end, best exercised by shareholders.

This is the philosophy that runs throughout Derek’s report and, provided there is real willingness to make this approach work, it has the Government’s strong support.

Our concern at present is that the present debate – at any rate in the media – is starting to lose a sense of proportion.

– on the one hand, Derek’s report is plainly not the intrusive rulebook some critics have sought to claim.

– but on the other, the debate has shown some signs of a disturbing complacency in places about the UK corporate governance framework.

I do not believe any complacency is justified. We may not have seen an Enron in the UK. But we have not been immune from numerous home-grown cases of large-scale corporate value destruction, either.

Some might say these cases were all unavoidable. Others might argue that stronger corporate governance could never have helped. I doubt both views, and I do not think either represents a fair consensus.

Now Myners pointed to the potential for strengthening the role of shareholders in relation to this sort of case, and we have had a sensible and productive dialogue with you about how to promote that. But one message came through loud and clear from you, the investment community, in the course of the discussions we had.

You repeatedly told us that you could not be effective as shareholders without stronger and more effective non-executive directors in companies, and without better communication flows so shareholder views were heard more clearly – and earlier – in the boardroom.

Derek’s report proposes practical and workable arrangements for furthering these objectives within the framework of the unitary board.
Many shareholders have already welcomed that, and it is vitally important that shareholder voices continue to be heard in the debate on Derek’s report.

At the same time, Derek’s report deserves a more careful reading than some critics have allowed him. Odd myths seem to have sprung up. Derek has not, for instance, somehow invented the role of a senior independent non-executive director. On the contrary, this role is already incorporated in the existing Combined Code. It already works well in many large companies. And nowhere does Derek suggest the senior non-executive should or could be some sort of rival to the chairman – whose role remains rightly central, including in leading on relations with shareholders.

Nor, to be clear, does Derek anywhere propose or envisage that the Combined Code should become a rulebook. The Code is and should remain a statement of best practice. How far companies comply with its provisions, and at what speed, is rightly a matter between them and their shareholders.

The final myth is that Derek’s report is not being properly consulted on. It is. Derek consulted widely and sought comments on his proposals from the main representative bodies, including the CBI. The independent Financial Reporting Council, on which both business and investors are well represented, are now taking the proposals forward into a new Combined Code. The FRC have indicated clearly that they do not want to duplicate Derek’s review. They therefore start from the presumption that Derek’s proposals should, in the absence of a clear case to the contrary, be implemented. We strongly support them in that. But the FRC is hearing and listening carefully to all comments, not just on points of detail. It will then be for them to consider all the inputs and make the judgements they see fit before a new Code issues.

Turning to Myners

Myners identified the key role that pension fund trustees have in ensuring the effective management of savings, in being clear about what decisions are being made by whom and why, and in exerting intelligent pressure on intermediaries to ensure they are acting in the interest of the fund. This was the role of the Myners principles, which I’ll come back to in a moment. At the same time, we remain clear that it is right to legislate to require appropriate expertise from trustees taking investment decisions and we reaffirmed that commitment in the Pensions Green Paper. It seems to me hard to argue against this proposition. Those looking after large sums of other people’s retirement savings clearly need to have an adequate understanding of the issues. Even with the benefit of the excellent advice trustees receive from many in this room, they still need to be questioning and intelligent customers for that advice.

Both Andrew Smith – who is leading on this work – and I are committed to working with you to ensure we get the most practical and workable solution and to establish what expertise trustees do need, and how those requirements should be set out, reviewed and enforced. I know DWP Ministers will be interested in your input – indeed, I understand that the NAPF, and others, recently had a substantial, and helpful, discussion on all this with officials as part of the Pensions Green Paper consultation process.

As Myners emphasized, enhanced engagement from pension fund trustees is part of a wider process as we work to ensure that appropriate pressures are exerted – both on fund managers and on the companies in whom they invest. There is an emerging consensus around shareholder activism as an important part of this process. Shareholders are right to take a close interest in the companies in which they invest, and we are right to recognize that shareholder activism is a vital force in keeping management up to the mark. And they are right too to emphasise that strong and effective non-executive directors have a vital role to play in this context.

So we welcome the work of the Institutional Shareholders’ Committee on its statement of principles on the responsibilities of institutional shareholders and agents. Active engagement will build stronger companies and better returns for the members and beneficiaries of pension funds. The revised principles are a very welcome initiative. However, as we said at the time of the statement, the key test will be the impact on industry behaviour.

The challenges raised by Myners on transaction costs remain. The objectives must be to promote proper transparency of the trading costs for pension funds and to deal effectively with any unnecessary costs – maximizing the amount that goes into the pensions pot – and to promote the overall efficiency of the capital markets. It is important these objectives are met. In the first instance, the FSA will – in the very near future – be coming forward with proposals for consultation, following the completion of it’s review in the area of soft commission and bundling. We shall then consider, in the light of the FSA’s conclusions, how best to address this challenge for trustees and the wider investment industry in the review I am launching today of progress on the Myners principles.

Myners’ recommendations have been implemented, in the first instance, through voluntary guidance. I know that the fund management industry has welcomed that flexible approach and, in government, we want to give you the chance to demonstrate that you can deliver. But that does not mean we are any less serious about improving the quality of investment decision making.

So the review will set out a clear picture of progress toward the implementation of the Myners recommendations and enable us to develop a clear understanding of where the voluntary approach is working and where it is not. Our aim is to be objective, thorough and focussed on how the investment process has changed. On that basis, we will be able to decide how best to continue to drive Paul Myners’ agenda forward.

So we welcome the work that has already started on implementing the Myners recommendations. And we welcome the NAPF survey – an important contribution to the debate. Now is the time to cast our net more widely, to develop a substantive and thoroughgoing understanding of the progress the industry has made.

I can today announce that the Government has asked Consensus Research to conduct the review. I’m sure many of you will have come across them through the market research work they have done for in many areas of the financial services industry.

Their work will fall into two parts – a qualitative survey concluding with a report this summer – and informing a major quantitative survey to conclude toward the end of the year. We want this to work, we want it to be balanced and we want it to be thorough. That means we want you to be involved, to be open about where progress has been made, and where more work still needs to be done.

I am not going to pre-empt the conclusions of the report, or anticipate what action – if any – the government should take. We believe in the Myners principles – and establishing the conditions necessary for a dynamic and flexible industry to operate in the public interest. So we are serious about change.

Accounting, auditing, corporate governance, Myners and the work flowing from that – we have covered a lot of ground in the last year. At times, it can seem that there is a bewildering array of reports, voluntary guidelines, principles, and committees. But I believe, and I am sure that as the experts in the industry you will recognise, that all of this work flows from the same essential understanding and drives toward the same shared ideal.

We all want to see the partnership which sits at the heart of the pension industry reinvigorated. We all want to see people saving more for their retirement, more of that saving going into the pension pot and all of it channelled efficiently through the capital markets to drive growth across the wider economy. We all know that that means action from government to strip away outmoded and outmoded restrictions on the pension industry – the Green Paper points the way forward. We all know also that it means action from the industry: intermediaries operating within a competitive market and making investment decisions free from conflicts of interest; institutional shareholders engaging with the companies they invest and upholding high standards of corporate governance; accountants and auditors operating within a robust and transparent system – providing a flow of information the markets can trust.

I started today by talking about partnership. Recognising responsibilities on both sides and acting on those responsibilities is what partnership is about. That is how, going forward, we can reinvigorate the pensions system that has served this country so well, and that is my message for you today.

Thank you.