Rebuild system for savers, not market makers


Fifty years ago, private individuals owned the majority of shares in British companies. That figure has declined steadily. Privatisations and mutualisations during the 1979-97 Conservative government increased the number of shareholders: but did not reverse the steady growth of institutional shareholding. In the early 1990s, 40 per cent of shares were held by insurance companies and pension funds.

But that was the peak of institutional shareholding. Of course, in one sense there is no such thing as institutional shareholding – it is all savers’ money: your pensions, your insurance policies. In the following two decades, occupational pension schemes were closed, and the popularity of endowment insurance policies waned.

Large institutions outsourced the management of their portfolios. Regulation and accounting standards discouraged insurers and pension funds from investing in equities.

Insurance companies and pension funds are today very large holders of UK government stock, on microscopic yields. They now account for less than 20 per cent of UK shareholding, slightly less than the share of private individuals.

As markets have become more global, UK institutions have a larger proportion of their funds outside the UK, and foreign institutions a larger share of the UK market.

Sovereign wealth funds – representing governments such as those of Norway, Singapore and Gulf states – are a significant force. But the major holders of UK equities today are professional asset managers – UK businesses such as M&G, Legal & General and Standard Life, and the UK operations of American fund managers such as BlackRock, Fidelity and Capital Group. Some of the funds are the pension and insurance policies of British and US savers, some of them are unit trusts and their mutual funds.

People often talk about share ownership, but this term is confusing. Ownership has many aspects. Whose name is on the share register? Who makes the decision to buy or sell? Who determines how the votes the share carries will be exercised? Who has the title to the shares, ie who can demand the shares be delivered to them? And who is the saver who holds the ultimate economic interest in the shares? In modern equity markets, it is possible – and common – for each of these rights of ownership to be held by a different person.

The key players in this chain are the saver – the investor or prospective pensioner, and the asset manager, whose role is to make the buy and sell decisions, and most frequently decides how the shares should be voted. But the far longer chain of intermediaries linking the saver to the company is far longer.

There are registrars, custodians, nominees, fund managers, fund of fund managers, trustees, investment consultants, platforms, independent financial advisers – and more. Some of this proliferation represents efficient specialisation – but most results from people looking over each other’s shoulders.

The proliferation of intermediaries and intermediation adds to the costs of the equity investment chain. It also creates misalignment of interests as each of these intermediaries pursues the goals of its own business. In the last 12 years, the outcome is that many individual companies have done well enough, financial intermediaries have done very well indeed, and savers have done badly.

Financial intermediation allows savers to achieve diversification and liquidity by placing funds with borrowers about whom they know little. Successful financial intermediation can work only through trust relationships – when savers have confidence in the intermediaries with whom they place funds, and intermediaries distribute their funds to companies in which they have confidence. These results cannot be achieved by trading between anonymous agents.

But as the financial sector has become global, deregulated and regulated over the last 30 years, transactions and trading have increasingly replaced trust relationships.

We need a shorter, simpler investment chain, founded on trust and confidence. This is not a matter of public relations, as many people in the financial sector who talk about rebuilding trust appear to think. Trust and confidence are established, or lost, by behaviour, and you do not establish trust by delivering lectures on how honest you are. It is time to begin the long and arduous task of re-establishing a financial system that is designed around the needs of savers and companies rather than the interests of market participants.

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