By Simon Miller

The regulatory structure of the equity markets serve brokers and traders over investors according to the interim report into the UK equity market by Professor John Kay.

According to the review, business figures have also called for asset managers to act as "stewards" of the firms in which they invest over the short-term gains of buying and selling shares. 

Kay pointed out that stewardship extended more widely than the set of issues commonly discussed as corporate governance: "Asset managers concerned with stewardship would be expected to engages with, and be committed to, the companies in which they held stock."

However, citing Sir Terry Leahy, Kay said that there was too little stewardship of this kind. Leahy said that he had not enjoyed such a relationship with analysts and fund managers during his time at Tesco.

"[Leahy] further told us that he felt that the interaction had deteriorated rather than improved: that analysts and fund managers had become more concerned with quarterly numbers and with earnings guidance, and less with the strategic direction of the business," Kay added.

Despite welcoming the report, the CFA Society of the UK - which represents the investment profession - dismissed the argument that asset managers "discharge that function most effectively by acting as stewards of the corporate assets they control by virtue of their management of these funds" as flawed.
In its statement, the CFA commented: "The asset manager’s primary responsibility is to the client – the investor. The client’s interests may be best served by active engagement with the companies in which the fund is invested. However, the report provides little evidence to suggest that investors achieve the outcomes that they seek (their risk-adjusted return objectives over their expected time horizons) more often as a consequence of active engagement."

In addition, the CFA was concerned at the report’s narrow scope as it dealt exclusively with the UK equity market. 

"If the review is concerned with UK plc’s access to capital, it should consider extending the review to take in the corporate sector’s engagement with the bond markets and bank lending (by far the biggest provider of capital)," said the society.

Although the interim report did not make any recommendations, the final report will look at legal changes so that equity markets functions for the benefit of trade companies and savers such as pension funds rather than the asset management industry.

The report added that market efficiency should allow companies to make long-term decisions and savers to make financial plans rather than the smooth functioning of the markets which only benefited intermediaries. 

Kay wrote: "Our view is that every regulatory action must be justified by its contribution to efficiency in that sense. The performance of equity markets should therefore be assessed by their effectiveness in allowing companies to make long term decisions appropriate to their business and in allowing savers to make financial plans appropriate to their objectives."

CBI's director for competitive markets Matthew Fell said it was right to focus on long-term performance and that Kay recognised "the value of having strong and successful businesses, both to savers investing in shares and the economy as a whole". 

However, he warned: “The tax system can play a role in encouraging long-termism, for instance when it comes to share ownership. But introducing a tax on banking transactions, such as the Tobin tax, would only push up capital raising costs for businesses and reduce their growth potential.”

Business secretary Vince Cable, who commissioned the report, said: "One of the big overriding themes in economic policy has to be generating - in both equity markets and corporate Britain generally - a belief in the importance of the long-term perspective."

The full report will be presented in the Summer and the deadline for further reponses is Friday 27 April 2012. The interim report can be found here.

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