The Kay Review: How to change the City

26th July 2012

The most dangerous time for a report which sets out to change the way the world has been turning for two decades is in the days immediately following publication. And so it could prove for the John Kay report on financial services.

It garnered wall to wall coverage – in the UK but ignored elsewhere  – on release day.  And – including this Mindful Money piece, comment was uniformly positive.  No one was willing to go public suggesting that the status quo of short termism – or even the proposal to go back to half yearly company reporting from quarterly figures – was wrong. But many are now questioning how or whether the proposals are implemented.

But what happens now? 

The Kay report's main thrust has been well known for months as he published an interim version early on this year.  In best political tradition, however, MPs decided to await the finished product. And given the holiday season (plus the distractions of the Olympics as well as appalling figures from the economy), the chances of this report ever re-appearing from the long grass could be low.  The odds against enactment of its proposals are even slimmer.

The City that Kay takes to task – the short termism, the hyper-trading, the layers of costs and the stratra of obfuscation – does not need actively to oppose the report. It can simply rely on political inertia and media boredom to do the job for it. 

Using Kay to bash Clegg

Enter Vince Cable, the business secretary. He commissioned the report in the first place and he knows that he must ensure some dividend – the bigger the better – from Kay's labours if he is to push forward his open candidacy to replace Nick Clegg at the head of the Liberal Democrats at the next election. There can be few City spread-betters willing to take a positive view on the present deputy prime minister's long term survival chances.

There's an old Hollywood saying along the lines of there is "no such thing as bad publicity" – provided you stay in the public eye, it does not matter what the comment is negative or positive.

At some time, we should expect some adverse blogs – perhaps from David Buik, the markets commentator at hedge fund BGC Partners, whose writing in support of the banking world, marks him as unusual, especially as this piece from the Slog has launched a pre-emptive attack.

It says: "Anyway, it's no surprise that Kay is calling for an end to quarterly reporting, and more organic growth/less M&A greedy profit-seeking. And as The Slog has been in favour of this for over a decade (in 2005, The Economist published figures showing that 60% of M&A ventures knackered shareholder value) I'm chalking this one up as a victory for right-headedness. I once spent twenty tortuous months fronting up quarterly results meetings, and it confirmed my sense that immediate greed not sustained growth was ruling the Bourse roost. All we have to do now is pray that somebody in the Tooting Norton set has enough brain matter to turn this into legislative reform. If nothing else, it will be one up the bum for David ‘Muppet Features' Buik."

Genies and bottles are not the best of mates

Again, Kay has written a lot of good sense – will government follow up and how will it do so?  The big problem is stuffing the short term genie back into the bottle.

Neville White at Ecclesiastical says: "Kay has identified many of the faults inherent within the financial services supply chain and articulates some useful remedies. By definition, this affects many parties and workable solutions are far from simple. One also has to accept that a global market requires global responses from which the UK is not an isolated party. However, the UK has a commendable record as a global leader in devising market mechanisms that enhance value, such as the Cadbury Code twenty years ago. We certainly subscribe to the view as a long-term investor that companies would welcome renewed focus on the long term and many of Kay's recommendations therefore make good sense for business and investors alike. Given the need for reform however, there has to be real motivation for change and Kay represents a wise contribution to debate"

Management Today counts Kay among its writers so it is naturally supportive while stressing the political dimension.

It says: "As expected, and doubtless to Cable's pleasure, Kay attacks the City's obsession with short-term profits and argues that the current insistence on "making the numbers" is wrecking Britain's recovery with its focus on instant gains without much regard for a healthier long term view. He wants action on fat cat executive compensation, and an end to the "tyranny" of quarterly company reporting." 

Old fashioned values and hedge fund managers

But Management Today is sceptical that a return to old-fashioned City values would work in a world of hedge funds. It cites fund manager Hugh Hendry at Eclectica who is "currently busy shorting the equity of Chinese state owned enterprise and using credit default swaps to bet against Japanese companies such as Toshiba." 

It says: "In an ideal world we'd all have our pension pots looked after and grown steadily by cuddly, wholesome long-term horizon types. But the old-fashioned investment industry in the UK – for which read many of the pension funds – have not exactly covered themselves in glory in recent years. Not only are their returns often poor but they fill their boots outrageously.

"Hendry doesn't care how he makes his fund pile grow larger. He is an opportunist who would doubtless short his granny given the chance.  What does matter is that last year his $460 million flagship fund grew by 12.1 %. It has returned
a compound annual growth rate of nearly 10 % since it began back in 2002. How many of us would not mind a piece of that? Hendry believes strongly that speculation plays a vital role in a market economy. He's not likely to be heeding much of what John Kay says."

Management Today concludes: "Kay should not be used as an excuse to defend the poor performance of many of the old-fashioned mediocrities out there who continue to peddle bad companies and bad investment plans to the rest of us."   

The big ask from north of the border

In The Scotsman, Terry Murden says: "The recommendations by John Kay aim to change the relationship between companies and investors. It's a big ask, but that's not to say there are no answers. Vince Cable promises his response by the end of the year. Only if he can force the required revolution upon an entire industry he will have found the silver bullet that Kay himself admits he cannot produce.

"Has he succeeded? That will best be tested by the measures the government chooses to introduce and how effective they prove to be. Arguably, cultural change is best achieved when there is consent, inclination and willingness to do something differently. However, if the voluntary route fails, legislation may offer the only alternative."

The Guardian believes that against a background of eurozone crisis, summer holidays and sport, "how to reverse the dangerous decades-long drift away from long-term perspectives in equity markets, will struggle to be debated. There is a danger that the Kay Review will be left to gather dust.  That would be a shame because Kay's list of 17 recommendations would represent a huge, and much-needed, cultural shakeup if adopted.  To the sceptics, the Kay report will read as a longing for a world that disappeared 20 years ago – one where the investment landscape was dominated by large fund managers with concentrated portfolios; where private investors were still a force; where index-tracking, and index-hugging, was a minority sport; where hedge funds and ultra high-frequency traders barely registered.

"There is indeed a strong sense that the horse has bolted. But that's hardly Kay's fault. He should not be blamed for pointing out simple truths, such as the fact that long-term decision making will lose out if chief executives are incentivised via schemes that pay out in cash during a term of office that tends to last about four years."

Pension funds – martyrs or murderers of value?

Chris Hitchen, currently chief executive at RPMI and a former chairman of the National Association of Pension Funds, said Professor Kay's report made a "compelling argument" for trust in equity markets to be re-established.

"If savers are to achieve good long-term returns, they need everyone in the investment chain to be aligned with them," he said.

But whether many pension funds – including the so-called balanced funds sold as a default option to personal pension buyers – have failed to produce value because of their structures or because they are competing against more agile hedge fund opponents must be a matter of debate.


More on Mindful Money:

The Kay Review: What investors need to know

Olympic sponsorship: Gold medal or wooden spoon?

Record UK Dividends: Companies are rewarding shareholders rather than the wider economy

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