The Kay Review: Adviser perspectives

A panel discussion and Q&A with Professor John Kay
November 27, 2013


From left to right: Sir George Cox, Henry Tapper, John Kay, Bronwen Maddox and Martin Gilbert © Sophia Schorr-Kon




Listen to the event here

On 19th November Martin Gilbert, CEO of Aberdeen Asset Management, hosted an event on short termism in equity markets in association with Prospect. On the panel were Professor John Kay, Henry Tapper and Sir George Cox.The debate was chaired by Bronwen Maddox, Editor of Prospect.

Professor John Kay, the economist and Financial Times columnist, explained to a large audience at Aberdeen Asset Management’s London office, the reasoning behind his report into equity markets, which was published 18 months ago. The report, explained Kay, pointed out that public exchanges were a product of the 20th Century and were designed to suit the purposes of large manufacturing corporations such as rail companies. But 21st Century exchanges are composed of companies that are much less capital intensive. Companies now, especially technology companies such as Google, Facebook and Twitter, can become cash generative much faster. So when Facebook issued equities, and in doing so raised £16bn, it made clear afterwards that it had no idea what to do with the money.

Kay said UK markets were no longer a significant source of funding for new investment by UK companies and equity markets were now dominated by asset managers, consultants and other intermediaries. The raison d’être of equity markets he said was not however intended to be the intermediaries but rather the savers whose funds are invested and the companies in which those funds are invested.

A cultural change is required across the entire equity investment chain, said Kay. The system should be simpler, involve fewer intermediaries and should require a greater number of specialists and fewer conglomerates. Martin Gilbert stressed that the conduct of firms intervening in the investment chain should be driven by the overarching principle of putting customers first. This implies exceeding the principles of treating customers fairly and in that sense involves a greater degree of responsibility to be demonstrated by firms in servicing investors.

The “hyperactivity” in evidence in equity markets was, Kay told the audience, a measure of the “decay” of those markets, not of their health. Investors should place their money with asset managers for much longer periods—and those managers, he said, should face an entirely different regulatory framework. Kay noted that the regulation of the past 20 years had not worked, and that its principle failure was that it was supervisory. Instead of being rules-based, said Kay, regulation should be structural. Kay also pointed out that asset managers were largely accepting of this point, saying that the dysfunctional structure of regulation interfered with their operations.

When asked about the response to his report, Kay said that the broad response was positive—but not from politicians. Kay lamented their failure to use the “bully pulpit” to call for change in equity markets and said it was disappointing that the reflexive reaction of Westminster was simply to call for more regulation.

Sir George Cox, the Pro-Chancellor and Chair of Warwick University, then commented on the importance of company formation, asking rhetorically where the companies were going to come from that Britain needed. What are we going to sell to the world? Cox asked, before saying that Britain was not growing companies in the necessary way because a culture of short-termism was diminishing the commitment to long-term investment. The government, he said, was driving such short-term thinking. Cox pointed out that public companies were expected to report every quarter and staff performance was also assessed on that time-frame. Both of these factors lead to a short-term outlook and this, said Cox, is a problem for all public-listed companies. He contrasted this with the example of Jaguar Land Rover—when the company was acquired by Tata, a multi-year programme of company reform was put in place and the results, said Cox, were very strong. This kind of long-term planning could never be done with a public company, Cox said.

Henry Tapper, Director of First Actuarial, said that technology could help to empower the end users of equity markets, in allowing more people to have a voice in influencing the direction of change in markets as well as encouraging more stringent governance. Technology, he said, allowed for disintermediation: for people to cut out middle-men.

Martin Gilbert said that his firm looks to hold equities for the long-term, in many instances for 10 years or more and in some cases up to 15 years. He agreed with Kay’s point that there was too much intermediation in equity markets, and felt that fund managers should pay for their own research, a change that was being pursued by the Financial Conduct Authority (FCA). Commenting further on the work of the FCA, Gilbert said that the review into dealing commission, announced recently by the regulator, was going to speed up reduction in overall fund charges and therefore reduce costs to investors.

Towards the end of the discussion, Kay turned to the question of pay and incentives for financiers. Bonuses that were paid on the basis of hitting targets, he said, tended to increase the likelihood that those targets would be met. It is the same in financial services or the NHS, he said, that targets necessarily distort activity. Should the chancellor be paid according to the GDP statistics?, asked Kay, wryly. If so, he continued, this would have little effect on living standards, but the GDP calculations would certainly be interesting.

To this, Martin Gilbert responded that he felt bonuses should remain, but that a greater part of these should be paid in shares, meaning that the recipient would have a long-term interest in the health of the company in question.

In conclusion, Kay showed a muted optimism. His biggest concern, however, was the possibility of another financial crisis, brought about by failure to address the lessons of the last one. Populist politics were, he said, making such an outcome more, not less likely.