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Bottom-up approaches to corporate governance in the financial sector

This short paper by authors from Finance Watch, Frank Bold, ShareAction and WWF calls for a series of “bottom-up” corporate governance improvements to help institutional shareholders and pension funds align their actions more closely with the wishes of savers and pension beneficiaries.

It notes how savers and pension beneficiaries are increasingly interested in how their money affects wider issues such as social and environmental justice but they often lack the structures and processes to influence pension governance and the decisions taken by their pension schemes. This, in turn, affects the intermediaries’ influence over corporate governance policies in investee companies.

The paper calls for broader representation of societal concerns within financial sector governance and a strong regulatory framework to support an engaged and constructive relationship between beneficiaries and pension scheme managers.

Interest of beneficiaries in responsible investment

Europeans continue to experience the impact of the financial crisis, including unemployment, lost savings, and financial insecurity. Ordinary citizens have little or no say in how financial institutions are governed, yet suffer as a consequence of corporate governance failures. The link between corporate governance and a broad range of stakeholders has never been clearer and robust. Corporate governance reform, particularly of the financial sector, is needed to ensure that the long-term interests of stakeholders are taken into account and that the objectives of the Capital Markets Union are realised.

Much has been said about the role of large, institutional shareholders in the financial crisis. However, it should not be forgotten that these large shareholders typically invest on behalf of ordinary, hardworking citizens, who are their end beneficiaries.  These citizens save money through retail investments and pensions, which is then invested in companies (as well as other asset classes).  They have a stake in the success of the company, as an investment, but they also have an interest in avoiding the negative effects that flow from poorly governed companies, which include adverse social and environmental impacts in the wider community.

Increasingly, pension beneficiaries and savers express an interest in how their money contributes to wider issues of social and environmental justice:  The June 2015 YouGov survey prepared for the PRI found that a majority of respondents (64%) agreed or strongly agreed that the way in which a company managed environmental, social, or governance issues gave them an insight into how the company is run and any possible impacts this may have on their pension. However, only 3% said they felt like their pension scheme listened to their concerns and acted upon them, with 7% saying that their scheme responded in a timely manner to their queries. 49% of respondents said that the only communication they received from their pension scheme was their annual statement. Additionally, Legal & General’s October 2016 UK survey found that, after assessing what choices are important and whether they’ve been given options, 72% consider they’d be likely to move or recommend to their employer moving to a responsibly investing pension and 84% would prefer a pension that uses investments to encourage companies to be more responsible. When deciding amongst different pension options, 76% would opt for the one that is a more responsible investor.  Thus, there is a clear situation in which pension savers have a stake in the way companies are run and many have an interest in this.

From this, we draw an important conclusion: Beneficiaries have both the interest and the ability to influence corporate governance in such a way that will benefit not just his or her own interest, but those of the wider community of shareholders. We believe that the missing link to the puzzle in terms of research are the structures and processes through which participants of pension schemes influence pension governance and the decisions taken by their schemes, as they, in turn, influence corporate governance policies in investee companies. Regulations and guidelines that support this relationship are crucial in subsequently understanding the interaction of institutional investors (such as pension schemes) and corporate governance.

Policy framework for responsible investment and engagement

The inclusion of environmental, social and governance (ESG) language in the revised Institutions for Occupational Retirement Provision Directive (IORP II) and the engagement requirements of the revised Shareholder Rights’ Directive (SRD II) are crucial developments in creating a framework for responsible investment and shareholder engagement. We consider, however, that more work needs to be done in order to ensure the effectiveness of these two instruments.

We underline the importance of SRD II in complementing the effectiveness of the Non-Financial Reporting Directive. Beneficiaries have a vital interest (as shown by the surveys above) in promptly accessing and scrutinizing non-financial information disclosed by the companies their schemes invest in. In turn, this scrutiny can produce a positive loop by which companies expect their non-financial information to be reviewed by their individual shareholders, and could subsequently create market incentives for better non-financial performance. A regulatory framework to encourage and cement such market incentives would be a great step in assisting these changes.

Indeed, while the causes of the crisis are complex and the remedies that have been proposed are multifaceted, yet too little attention has been given to issues of corporate governance, investor/shareholder responsibilityand its link with the nature and effectiveness of integrating corporate governance considerations into the investment process. To be sure, regulatory weaknesses at the national and international levels, but also poor corporate governance practices as implicated in the risk management standards prevailing in many large financial institutions.

Moreover, it is increasingly recognized that many of these governance weaknesses also apply to other key sectors of our global system.

Indeed, research shows that investors, lenders, suppliers and other parties have an interest in transparency and accountability and in their role in remedying the structural issues exposed by the financial crisis. Moreover, evidence shows how good governance ensures constructive engagement with interest groups and seeking for long-term economic wellbeing and proper consideration of the interests of beneficiaries.


In light of the foregoing, further review is needed of how to remedy the cultural and behavioural changes that transformed the financial sector from serving the real economy to a key contributor to the crisis. In order to facilitate a reshaping of the financial sector’s business model and its purpose, policy action is needed to rectify the unbalanced representation of the interests of European citizens within the governance of large financial institutions. Broader representation of societal concerns within financial sector governance would promote outcomes in the best public interest. [1]

A strong regulatory framework is needed to support an engaged and constructive relationship between beneficiaries and pension scheme managers. As set out above, beneficiaries will tend to promote responsible engagement where they are able to input into their pension schemes’ decision-making. A report published by ShareAction in 2015 [2] identified several parameters that promote an effective bottom-up approach to pension scheme governance and, by extension, corporate governance:

1) Motivation and alignment of interests

A central finding of the Kay Review is that misalignment through the equity investment chain undermines the ability of the saver to engage constructively in governance decision and influence the way their money is invested.

2) Saver Representation in Governance

Misalignment of interests is greatly served by “skin in the game” mechanisms, allowing for the inclusion of saver elected representatives in governance structures.

3) Employer Representatives

Employers sponsoring occupational pensions should have roles in the governance structures of schemes to encourage employer scrutiny of pension providers.

4) Independence and Diversity

The Walker Review of Governance in UK banks and financial institutions identified a “disciplined process of challenge” as crucial for sustainable institutions. The UK government’s 2011 review of “Women on Boards” concluded that governance structures aiming to be diverse, and setting the stage for such a process of challenge, should look at the representation of different age groups, ethnicities, sexual orientations, professional backgrounds, mind sets (cognitive diversity). In his book, “The Difference”, University of Michigan Professor Scott Page draws on evidence to prove that such diverse groups out-perform non-diverse groups in tasks such as innovative problem-solving. This research, while focused on corporate boards, could offer useful insight in pension governance and, as an extension, the quality of corporate governance in the companies the pension schemes invest in.

5) Balancing experts and stakeholders

The Kay Review was highly critical of the trend towards relying exclusively on professional experts in the making of governance decisions, which may contribute to trust amongst stakeholders breaking down, negatively influencing governance decisions.

6) Clear allocation of powers and responsibilities

An international study of pension fund governance by the Rotman International Centre for Pensions Management found that clarity concerning the powers and responsibilities of the board is often lacking, and a major factor impeding governance decisions.

7) Accountability and transparency

The breakdown of trust between scheme and saver can also be improved by formal and structured channels of engagement between scheme and beneficiaries. Actual contact with beneficiaries is crucial in reminding management who they work for. Member representation on boards must be complemented by mechanisms for effective communication and engagement with the wider membership, a conclusion also reached by the UK Pensions Regulator, who provide such engagement guidance.


In conclusion, the aim of this document is to recommend both short-term and long-term measures to introduce structured bottom-up approaches to corporate governance within the financial sector, including  systematic links with beneficiaries, given the fact that:

(i) The financial sector has the key role and responsibility to guarantee that capital and credit are allocated as per society’s and real economy’s needs;

(ii) Financial crises generate dramatic direct and indirect negative externalities on European society and economy at large;

(iii) Crises have been often the result of lack of transparency and accountability of the financial sector activities;

(iv) Notwithstanding post-crisis regulatory policy, the social cost paid by European taxpayers – and beyond – calls for an ambitious institutional reply including a systematic and harmonized consideration of the footprints that investment and management behaviours can have on economic, social and environmental aspects of our global system.

In particular, the impact of both savers and institutional investors on corporate governance must be more carefully examined, as:

(v) evidence from the cross-cutting issues mentioned above points to how a bottom-up approach to corporate governance is better able to consider produce long-term positive externalities on beneficiaries and the wider community of stakeholders;

(vi) fiduciary duties are traditionally interpreted narrowly as focusing solely on maximising the financial returns through short- and medium-term investments, while a greater representation of different societal interests in governance structures will support a culture-based approach to facilitate the consideration not just the expected return on investment, but also the associated risks (including ESG-related risks), liquidity, capital value and the time horizon of the investment in the public interest; Furthermore, there is now greater recognition that ESG risks can be financial risks – as such, clarification of the fiduciary duties of investors, such as pension schemes, are necessary.

Giulia Porino, Finance Watch

Paige Morrow, Frank Bold

Bethan Livesey, ShareAction

Eleni Choidas, ShareAction

Sebastien Godinot, WWF

Julia Linares, WWF

[1] See e.g. Finance Watch “Representation of Public Interest in Banking”

[2] De Ste Croix, Camilla. (2015). Realigning Interests, Reducing Regulation: A vision for reforming UK workplace pensions”.

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