The nature of investments and investors has changed with the passage of time. The institutional investors participate in or monitor corporate activities by direct and indirect methods. The aim of investment is to minimise the investment risks through diversification of holdings. The general principles of the law of trust are also applicable to the unit trust and pension funds for specific purposes. The occupational pension scheme is normally established or organised as a trust. It is presumed that the unit trust is merely an extension of the private trust into the corporate sector. Historically, there are four themes relating to the perception of unit trust and company. The expression 'mutual funds' is familiar in the American Continent. The courts of common law jurisdiction are lenient in applying the principles of company to resolve issues relating to unit trusts. The unit trust and investment trust are different as to their constitution and expression.
Keywords: Institutional shareholders; combined code on corporate governance; law of trust; company law.
Introduction
The nature of investments and investors has changed with the passage of time. Private individuals were the dominant type of investor in the 19th century. In the transformation of the ownership distribution of financial securities, the domination of institutional ownership grew to become much more significant than individual ownership in the post-Second World War era. There were several factors behind this development, the most significant being the collective investment schemes and the emergence of insurance companies. Insurance companies, pension funds, unit trusts and investment trusts are the four main types of institutional investors in the United Kingdom. They participate in or monitor corporate activities by direct and indirect methods. In the direct method, corporate actions are carried out by institutions and regular dialogue with a company's management has a long history of direct monitoring; while in indirect methods, institutions act through proxies such as the Institutional Shareholders' Committee, or non-executive directors on portfolio companies' boards.
There are two concepts of investment in economics. One is direct or real investment relating to land or machinery; the second is portfolio investment or investment in financial instruments such as shares and bonds. Institutional investors may invest directly but they prefer their investment to relate to financial instruments. They are independent in taking investment decisions for providing finance towards direct investment projects of enterprises, because their aim is to minimise their investment risks through diversification of holdings. Several established theories relate to firms' investment and institutional investors — the neoclassical theory, the theory of agency, the theory of transaction cost economics, the nexus-of-contracts theory, and the property rights approach. The collective action theory and over-regulation theory are two important theories relating to institutional investments.
Insurance Companies
There are three main sources of insurance companies' investment funds: first, life funds comprising the premiums paid by policyholders, which can be organised on a with-profit or unit-linked basis and are available to meet claims on life policies; second, claims reserves relating to non-life policy funds; and last, shareholders' capital and reserves. In the UK, major insurance companies are working in three groups: public companies limited by shares and listed on the London Stock Exchange; subsidiary companies including overseas insurance groups and banks; and mutually owned companies whose members are the policyholders. The policyholders enjoy contractual rights but they have no ownership interest in the investment fund, because the assets of the funds are owned by the insurer, which is a separate legal entity.
Insurance policies are legal contracts whereby one person (the insurer) undertakes, in return for consideration (the premium), to pay another person (the assured) a sum of money on the happening of a specified event which is of a character adverse to the assured. Long-term and general insurance are the two main activities in the insurance business. The general insurance business comprises fire, accident, motor and marine insurance which involve incurring liabilities to meet claims from policyholders for losses within a specified period. Long-term insurance activities are concerned with life assurance along with permanent health insurance and capital redemption business. Life assurance companies allocate investment returns arising from the funds representing premiums paid by with-profit policyholders; the with-profit system works by allocating annual (reversionary) and final (terminal) bonuses to individual policies. A unit-linked policy is allocated units in the fund which are priced on a daily basis with reference to the investment.
Pension Funds
A pension fund is an arrangement by which a specified sum is paid regularly or in a lump sum to a person who has reached a certain age or retired from employment until death. An occupational pension scheme and a money-purchase system are the two main modes in which such arrangements can be structured in the UK. A new form of low-cost pension, the stakeholders' pension, was introduced for those who do not have access to an occupational pension scheme. Occupational pension schemes can be divided into two categories: Defined Benefit (DB) schemes, in which the employer pays a pension based on a fixed percentage of the employee's salary; and Defined Contribution (DC) schemes, which consist of the contribution from the members. The self-administered schemes and insured schemes are kinds of occupational pension schemes; both have the secure right of pension even if the employers were to go out of business. In self-administered schemes, the fund itself bears the actuarial risks, while in insured schemes the trustees pay their contribution to the life office which bears the actuarial risks and manages the investment.
Collective Investment Schemes
Under Section 235 of the Financial Services and Markets Act 2000, a "collective investment scheme" means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property. The arrangements must be such that the participants do not have day-to-day control over the management of the property, and must have either or both of the following characteristics: the contributions of the participants and the profits are pooled; or the property is managed as a whole by or on behalf of the operator of the scheme. The Unit Trust and Investment Companies with Variable Capital are the main types of collective investment schemes, but the Investment Trust does not fall within the scope of collective investment schemes.
Unit Trust
A unit trust is a trust based on the simple idea of dividing a professionally managed fund into a number of equal units. The trust is constituted by the trust deed, which is a formal contract between managers and trustees setting out the terms on which the affairs of the trust are to be conducted. A beneficial interest in the trust is obtained by the purchase of units from the managers. The purchased unit entitles the unit holders to a portion of the capital value and income of the fund in proportion to the number of units they hold. Units are valued regularly and management is monitored closely, while the interests of the unit holders are protected by the trustees. The unit trusts are open-ended funds in which individuals invest in order to obtain a larger share in a diversified portfolio. It is submitted that the trust in the unit trust is a creation of contract between the parties, and that the trust is a device forming part of the contractual terms agreed for investment purposes.
Investment Companies with Variable Capital
The investment companies with variable capital are authorised in the United Kingdom as open-ended investment companies (OEICs). These companies were not historically used as a form of collective investment in the UK, but the UCITS Directives introduced them within the EU. The UK introduced regulations to allow the formation of Open-Ended Investment Companies in 1996, subsequently replaced by regulations in 2001; these regulations concern the operational conduct of these companies, while the Companies Act regulates their incorporation.
Investment Trust Companies
Investment trusts are not trusts; they are public companies that have a fixed capital structure and contain share capital. The distinguishing feature of investment companies from other public companies is that their activities consist of managing a portfolio of shares or other securities. Investment trusts are closed-ended funds formed for collective investment in shares and other securities. They take benefit from gearing by being able to issue fixed-interest capital in the form of debentures, loans and preference stocks. An investment trust company is a separate legal entity which owns the investment funds, and shareholders have no direct claim to the investment funds. The internal organisation and rights of the shareholders are regulated by company law, the constitution of the company and the Stock Exchange's Listing Rules.
Impact of the Law of Trust and Company
The internal organisational conduct, internal affairs and the rights of shareholders in the case of shareholder-owned insurance companies are regulated according to the principles of company law; their investment activities are regulated according to the FSMA 2000 and the Listing Rules of the London Stock Exchange. The general principles of the law of trust are also applicable to the unit trust and pension funds for specific purposes, but they are expressly excluded from the scope of the Trustee Act 2000 in England. In Scotland, the Trust (Sc) Act 1921 and the Trustee Investment Act 1961 regulate the affairs of trusts; in England, the powers, rights and liabilities of the trustees are regulated through the Trustee Act 2000 and the Trustee Act 1925. The 'duty of care' owed by trustees to beneficiaries requires them to discharge that duty as an 'ordinary prudent man of business'. Investments should be diversified and suitable for the trust, depending upon risks, duration and liquidity.
The occupational pension schemes are trusts in which the employer is the settlor and the employees are the beneficiaries, and the trustees are responsible to govern the pension trust in the interests of the beneficiaries according to the trust deed and the principles of trust law. The trustees are under a fiduciary obligation to act in accordance with the best interests of the present and future beneficiaries of the trust. The application of the law of trust to occupational pension schemes has been questioned, since the law of trust was not devised with the needs of pension schemes in mind. The deficiencies in the application of the law of trust relating to pension funds were revealed by the Maxwell affair, which led to the Pension Act 1995.
Unit trusts are trusts formed by trust deeds, and the principles of the common law of trust, reinforced by the Trustee Investment Act 1961 and the Trustee Act 2000, are applicable to regulate the investment of a unit trust and its internal affairs. The unit trust is an investment vehicle which is an alternative to the company. It is presumed that the unit trust is merely an extension of the private trust into the corporate sector. Historically, there are four themes relating to the perception of unit trust and company: the company and trust competed for popularity among investors; the relationship of equity and trust was already established in the early days of the company; the deed of settlement and unit trust deed are considered a contractual relationship such as the early joint stock companies; and the investment concept of joint stock was segregation between investor and trader, achieved from the transferability of shares of registered companies, a feature which units in a unit trust inherited.
The directors of a company owe certain duties towards the company and stakeholders. Apart from statutory duties, the directors owe fiduciary duties as trustees. The common law recognised and developed the fiduciary duties of directors, and on the recommendation of the Law Commission, the common law and equitable duties relating to company directors were introduced by the Companies Act 2006. In common law jurisdictions, the Australian courts are lenient in applying the principles of company to resolve issues relating to unit trusts. The unit trust and investment trust are different as to their constitution and expression. An investment trust is a company which is quoted on the stock exchange for investment activity regarding the shares of other companies; the shareholders have no legal and equitable interest in the investment owned by the company.
The Combined Code's Expectations
Companies can secure the confidence and support of investors by adopting high standards of corporate governance. The Annual General Meeting and publication of reports are the key channels of a company's communication with its shareholders. The Institutional Shareholders' Committee's Statement on the Responsibilities of Institutional Shareholders — relating to regular systematic contact, positive use of their voting rights and positive interest in the composition of boards — provides direction to major shareholders regarding their responsibility as owners. The institutional shareholders in the UK — pension funds, insurance companies, unit and investment trusts — held around 60% of shares in listed companies. As the proportion of their holdings increased, they found it difficult to sell large numbers of shares without depressing the market, and now take a more active interest in corporate governance through the exercise of voting rights and regular contact with companies.
The Combined Code laid down three principles relating to institutional investors: first, it is the responsibility of institutional shareholders to make considered use of their votes; second, they should be ready to enter into dialogue with companies based on the mutual understanding of objectives; and third, they should give due weight to all relevant factors when evaluating companies' governance arrangements. The Hermes Principles set out ten principles regarding investment, emphasising honest and open dialogue with shareholders, disciplined allocation of capital, an efficient capital structure, coherent strategies for each business unit, and ethical behaviour with regard to the environment and society. Higgs recommended regular contact and frequent communication among the chairman, non-executive directors and institutional investors, and these recommendations were incorporated, with supporting principles, into the successive Combined Codes.
The occupational pension schemes are governed by sound principles of trust law, and there is an increasing need to apply corporate governance standards to the trustee board itself. The National Association of Pension Funds (NAPF) proposed a Code for pension funds akin to the combined code for listed companies. The Institutional Shareholders' Committee (ISC) drew up a statement of the principles regarding the responsibilities of institutional shareholders and their agents, setting out how they will discharge their responsibilities, monitor performance, establish dialogue with investee companies, intervene where necessary, evaluate the impact of their engagement, and report to the beneficiaries. The company law reform introduced statutory duties of directors designed in the light of modern business needs regarding responsible business behaviour, effective relationships with all stakeholders, and enlightened shareholder value.
The object of the combined code on corporate governance is to establish a practice of accountability of the board and management to the shareholders in order to achieve better company performance. There are two parts of the combined code: the first part regulates the affairs of the board — composition, powers, responsibilities, financial reporting, internal control, audit, the AGM and relationship with shareholders — while the second part describes the modes of active involvement of institutional shareholders. The FSMA 2000 empowered the competent authority (FSA) to make listing rules for the enforcement of the combined code on a "comply or explain" basis. The voluntary compliance approach shows that "one size fits all" is not possible in corporate governance. Whether a company complies with or departs from the code, its disclosure forms part of the annual report; the fear of a fall in the share price in the capital market is attached to a report of non-compliance. It is clear that the monitoring of compliance or departure from the code, and the assessment of the performance of the company, depend upon the active and responsible involvement of the institutional shareholders.