Why Shareholders Have Little Influence

There was an article in The Times newspaper this morning by Mark Atherton which covers the subject of shareholder voting and the nominee system. I am quoted as saying “The nominee system needs a total rewrite to reflect modern reality and restore shareholder democracy”.

As is pointed out in the article, only 6% of private shareholders vote the shares they own. This is mainly because of the obstruction of the nominee system. The US system is not perfect but they get 31% of shares voted. Everyone agrees that ensuring shareholders in public companies return votes for General Meetings is important. This ensures good corporate governance and “shareholder engagement”. But very few people, and hardly any institutional investors, actually attend such meetings in person. So most votes are submitted via proxies.

Fifty years ago most shares were held in the form of paper share certificates which meant two things: 1) All shareholders were on the register of the company with a name and address recorded and 2) All shareholders would be issued with a copy of the Annual Report and a paper proxy voting form. This ensured a high turnout of votes.

Due to the growth of on-line trading via “platforms” and the “dematerialisation” of shares in Crest, most shares held by “direct investors” (see below for indirect holdings) are now held in electronic form. For retail investors this means a very high proportion are held in pooled nominee accounts. This has resulted in very low numbers of investors actually voting the shares that they “nominally” own. The problem is that the nominee system obstructs both the information flow to investors and their ability to vote easily and quickly.

For institutional investors the turn-out is higher – typically above 60% but such investors often have a low interest in the outcome so tend to vote in support of all the resolutions. Institutions suffer from the “agency problem”, i.e. they are commonly not owners in their own right and thus may have other motives. For example, they may not have the same interest in controlling the pay of directors in companies which has got out of hand of late for that reason. They are keen to retain access to management which can be made difficult if they oppose management proposals or pay.

The nominee system as operated in the UK also undermines the rights of shareholders, creates major problems when stockbrokers go bust (as they regularly do) simply because of the legal uncertainty of who owns the shares. The “pooled” nominee system is particularly dangerous because it means that it is impossible to know who owns which shares in a company.

The nominee system also undermines shareholder democracy (i.e. the influence of shareholders on companies). When every direct investor was on the share register of a company, under the Companies Act one has the right to obtain the register so as to write to all shareholders to raise your concerns or invite support or resolutions (e.g. if a requisition to remove or add directors has been submitted). This is now almost impossible to do as the register simply contains mainly a list of nominee names and the nominee operator will not pass on communications to their clients. The other problem associated with the current system is that it makes it very difficult for even the companies themselves to communicate with their own shareholders.

The high cost of postage also now frustrates communication with shareholders except for very wealthy organisations or individuals. The Companies Act has really not been updated to reflect the modern digital world and the reality of how markets operate and how shares are now held and traded via electronic platforms. It needs a total rewrite to reflect modern reality and restore shareholder democracy.

Many investors and savers now hold shares indirectly via their interest in pension funds, insurance funds or mutual funds of various kinds (OEICS etc).

At the end of 2014, and based on “beneficial” ownership, the Office of National Statistics indicated that individuals held 11.9% by value of shares listed on the LSE. That compares with 16.0% held by pension funds, insurance companies and other financial institutions. But 53.8% of shares were held by foreign investors, which presumably would also be mainly held by institutions. Direct ownership had been falling for many years but seems to have increased somewhat lately perhaps due to more interest in “self-select” ISAs.

Institutions do suffer from the “agency” problem mentioned above and the underlying investors have little influence over the actions of the investment managers. Indeed one problem with funds is that investors often know little about what the fund is invested in – see the recent problems at the Woodford Equity Income Fund for example which most holders of the fund simply did not know about until it was too late. Pension funds are even less “transparent”. This results in perverse outcomes. For example a trade union pension fund might have no influence on the affairs of companies in which the fund is invested even though that might be of very direct interest to the union members.

Mark Atherton suggests investors in funds should have the right to influence how fund managers vote the shares in the fund. But how to enable underlying investors in funds to influence how the fund manager votes their shares, or otherwise influences a company, is an exceedingly complex and difficult problem. Funds can own interests in hundreds of companies and have hundreds of thousands of underlying investors. The latter are never likely to understand or take a close interest in the affairs of individual companies held by a fund. One reason they are investing in funds is so they can ignore the details and rely on the fund manager to look after corporate governance issues.

Even direct investors often don’t bother to vote because they don’t wish to spend time considering the issues or filling out the forms. Making it easier to do the latter by providing on-line voting systems would help but would only be a partial solution. Some collective representation of private investors (such as by organisations such as ShareSoc) might be one answer. Investors would simply give ShareSoc a standing mandate to represent them. But that is currently impossible because of the nominee system as the investors cannot appoint proxies themselves – only the nominee operator can do so.

Clearly it would help to encourage direct investment rather than reliance on funds. This would reduce investors costs (intermediation costs take a very high proportion of investment returns in public companies). Note that the risk of amateur investors underperforming the professionals should be discounted. Professional fund managers mostly perform no better than a monkey with a pin and many funds are now “tracker” funds that simply follow an index. Tracker funds are particularly problematic regarding shareholder democracy as they have no interest in influencing management whatsoever. Their share trading is solely influenced by the market, not by their views on the merits of the company or its management.

The UK, although we have one of the largest stock markets in the world, has very poor legal and operational systems for recording and representing shareholder interests. This probably has arisen from our tendency to stick with Victorian traditions when we were the leader in such matters. The Companies Act, which was last revised in 2006, still primarily assumes paper processes with rather half-baked additions to support digital systems. Stockbrokers have avoided regulation and as a result have implemented electronic nominee systems that protect their own interests rather than that of their clients in ensuring shareholder rights and democracy.

Major reform is needed!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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A Question Answered on Winners and Losers

When I tweeted a mention of my forthcoming presentation on Business Perspective Investing, Andrew responded that he would be interested in a list of my winners and losers over the years and lessons learnt. So here’s some of them.

Health warning: this is not a recommendation to buy, sell or otherwise speculate in these companies. Some of the companies have been sold, or been delisted due to takeovers or other reasons. The notes are only a very trivial analysis of the reasons I purchased them. I will not be advising of future changes to my shareholdings and I have not included relatively new purchases for the same reason.

I give the company name, the year first purchased and the compound annual return (including dividends) reported by Sharescope up to the current date, or when sold. Note that I rarely purchase large holdings at once, but tend to buy more over time if the performance is good. If the performance is poor they are sold so the losses are minimised.

Most of the winning companies show consistent growth in revenue, operate in growing markets, have a high return on capital, positive cash flow, some intellectual property (IP) and competent management. Many of the companies have exploited the internet to provider a quicker or lower cost service.

Some of the Winners:

4Imprint (2016: 31.0%). A simple business distributing promotional merchandise, sold over the internet.

AB Dynamics (2015: 74.6%). Automotive technology gaining from the need for improved testing requirements and automated vehicle needs.

Abcam (2006: 31.1%). Distributor and producer of antibodies and proteins used in medical research, sold over the internet.

Accesso (2012: 32.0%). Visitor attraction software and services. Consolidator in a diverse sector.

Bioventix (2014: 39.3%). Producer of antibodies for medical diagnostics.

Boohoo (2014: 108.8%). On-line clothes retailer. Benefiting from changing shopping habits.

Delcam (2003: 26.3%). Computer aided design software for manufacturing.

Diploma (2015: 28.6%). Specialised technical products in life sciences, seals and controls.

DotDigital (2011: 33.2%). Email and other business marketing services.

Fevertree (2017: 89.4%). Producer/distributor of drinks and mixers. Great marketing and strong branding with outsourced manufacturing.

GB Group (2003: 31.6%). Identity checking internet services, benefiting from the need for quicker ID checks.

Ideagen (2012: 36.0%). Software for GRC applications. Driven by both organic growth and acquisitions, higher regulatory demands and strong sales management.

Judges Scientific (2010: 25.6%). Producer of scientific instruments. Organic and acquisition growth and emphasis on buying small companies that are cheap that can deliver a high return on capital.

Moneysupermarket (2011: 19.6%). Internet price comparison services.

Rightmove (2012: 21.2%). On-line estate agency portal. Benefiting from network effects and being the market leader.

Safestore (2018: 29.5%). Self-storage property company. Growing need to store personal and business items.

Segro (2016: 26.1%). Property company specialising in warehousing. A growing sector from internet distribution need.

Tracsis (2013: 17.1%). Software for rail operators.

Victoria (2012: 74.8%). Floor covering manufacturer led by charismatic manager.

Some of the Losers:

Blancco Technology (2016: -34.1%). IT product erasure and diagnostics. Dubious and inaccurate accounts.

Patisserie Holdings (2017: -100%). Totally fraudulent accounts led by Executive Chairman who failed to watch the detail I suggest.

As you can see, the industries in which the successful companies operate are quite varied but there is a strong focus on “newer technology” companies providing internet services or software. Although technology has been a hot sector in recent years, that has been so for most of my investing life and I expect it to continue. Note how my prejudices against certain sectors are reflected in the above list. Although I have invested in a few mining and oil producers over the years, they were generally not successful investments. Likewise financial businesses with minor exceptions.

The per annum returns may not appear spectacular but it is the high returns over many years that makes them an outstanding investment (or “ten baggers” as some are – for example Abcam has compounded at over 30% per annum for thirteen years). It may be unable to continue to do so but the company still has ambitious growth plans.

The high performing companies listed tend to be smaller ones but my portfolio does hold some larger FTSE-100 and FTSE-250 companies. The more successful ones of those don’t achieve such high returns as the companies listed above but typically more in the 10% to 20% per annum range. I also hold a number of investment trusts and funds which have similar returns. But the lower returns on those are compensated for by the lower risks associated with them.

Some of the companies have changing performance over time. For example Accesso was a strong performer until recently. I tend to top-slice companies when they become over-rated by the market or there are significant changes in the business, and try to buy when they are still cheap.

Andrew also asked “if people didn’t put as much time into it as you, do you think they can make it work?” Effort in any game is rewarded. Likewise the more experience you have the better you get. That usually means some time commitment is required. But whether you spend a lot of time or little, the key is to use the time effectively and not try to research everything in absolute detail. There is more information available than you can hope to handle in the modern world. Experience tells you what is important of course and what can be ignored. My book “Business Perspective Investing” just suggests what is important to look at, and what is not.

Note that I will be giving some overall portfolio performance information at my presentation next Tuesday (the 12th November at the Mello London event).

Incidentally ShareSoc/UKSA have published their joint submission to the consultation on “Intermediated Investments” from the Law Commission. It is very similar in content to my own but even more detailed on the problems of nominee accounts and how they should be fixed. It’s well worth reading. See here:

https://www.sharesoc.org/sharesoc-news/sharesoc-uksa-response-law-commission-review-of-intermediated-securities-call-for-evidence/

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Law Commission Error on Segregated Accounts

In a previous blog post on the Law Commission’s consultation on Intermediated Securities I queried their claim that all investors in nominee accounts had the option to use a segregated account (i.e. a “designated account” where your name is on the share register, not just the nominee operator’s). They claim this is mandated by an EU regulation. This is extremely important because a simple “pooled” nominee account that most stockbrokers use does not give you clear ownership of the shares. If the broker goes bust and has not properly recorded who owns what (as is often the case), you may have difficulty recovering your shares. It also means that the company you own shares in cannot communicate with you and neither can anyone else.

HAVING YOUR NAME AND CONTACT DETAILS ON THE SHARE REGISTER IS EXTREMELY IMPORTANT!

I have now actually looked into the true position with three different stockbrokers I use for ISA and SIPP accounts. This is what they said (in summary, edited for brevity):

  1. We are planning to offer segregated accounts and we expect this to be available mid-next year.
  2. We are working on implementing this with the expectation it will be an option for account holders next year, but it will be considerably more expensive than our current fees.
  3. These requirements come into effect as soon as the CSD, in our case Euroclear, receives its authorisation from the regulator Bank of England as a CSD – this is expected to be Q1-2020. We will offer segregated accounts when obliged to do so. Charges will be materially higher than for a pooled nominee account given the additional processing and operational costs involved.

In summary therefore, they concede it is legally required but they are not rushing to implement it and they will be deterring people from using that option by high and unjustified charges. In essence this is disgraceful.

I will be making this plain to the Law Commission.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Intermediated Securities – You Need to Respond

The Law Commission is undertaking a review of Intermediated Securities. What’s this about and why is it important? It is important because the use of nominee accounts has undermined your rights as a shareholder in public companies.

Nominee accounts have made it difficult to vote your shares at General Meetings, taken away other rights, and defeated shareholder democracy. The inability of companies or anyone else to communicate with all shareholders has also made it exceedingly difficult to tackle management when they are paying themselves too much or are simply not acting in shareholders interests. Individual shareholders have been particularly damaged by the use of nominee accounts which have taken over from paper share certificates for most holdings.

Another issue is that an EU Directive will soon be mandating “dematerialisation” of share certificates. All trading will need to be done in electronic form which implies nominee accounts only unless you happen to have a Personal Crest account (of which there are only 5,000 now) or unless a new “name on register” electronic account is devised.

ShareSoc has issued some information on the Law Commission public consultation on Intermediated Securities which you can read here: https://www.sharesoc.org/sharesoc-news/law-commission-review-of-intermediated-securities-consultation/

IT IS REALLY IMPORTANT THAT AS MANY PEOPLE AS POSSIBLE RESPOND TO THIS CONSULTATION SO PLEASE DO SO!

You can read my personal submission to this consultation here: https://www.roliscon.com/Intermediated-Securities-Consultation.pdf

One interesting point made in the Commissions consultation document is that it says “intermediaries are obliged to offer investors the option of a segregated account” – see page 8. This is now EU law and I understand it is effective in the UK. That means that all ISA and SIPP holders should be offered the option of a segregated, i.e. designated,  account where your name and address are held on the share register and not just the nominee operator’s. Such accounts are much better than “pooled” nominee accounts which almost all brokers use at present and which are positively dangerous as your assets are not separately identified. That means that when your broker goes bust there is frequently a shortfall and recovery of your assets in full is not easy. I am looking into whether my ISA and SIPP operators actually are compliant with the EU legislation and do offer designated accounts. I will advise later on the answer.

However a designated nominee account is still not the ideal solution – all shareholders need to be on the share register of a company, which is what my consultation submission says.

PLEASE MAKE SURE YOU SUPPORT SHARESOC AND RESPOND TO THE LAW COMMISSION’S CALL FOR EVIDENCE

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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SVS Securities Update – Another Example of the Dangers of Nominee Accounts

ShareSoc have published an update on the situation at broker SVS Securities which went into administration recently and has affected 21,000 clients – even more than the number at Beaufort. As has happened before, it looks like some clients will lose money as a result of the “Special Administration” regime and there will be the usual long delays before clients are able to regain control of their shares and receive dividends on them. Read the update here: https://tinyurl.com/y6q82ekp

Yet again this displays the danger of the nominee account system which I have repeatedly campaigned against – see the ShareSoc web site here for more information: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Please do support ShareSoc’s campaign on this issue, and support them by becoming a member. Nominee accounts are positively dangerous and do not protect your investments regardless of what the broker tells you.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Removing Directors, Ventus VCTs, Rent Controls and HS2

Replacing the directors of companies by shareholders can be enormously difficult. Although I have been instrumental in the past in helping that process in several companies, it takes enormous effort and a lengthy timescale to achieve it. ShareSoc director Cliff Weight has published a very perceptive article on the problems of doing so at the Ventus VCTs.

Problems faced by shareholders who are unhappy with the directors of a company are a) communicating with all other shareholders now that many are in nominee accounts and the costly process of writing to shareholders on the register via post (and processing the register into usable format for mailing); b) the existing directors of a company using the resources of the company (i.e. shareholders funds) to campaign actively against any change including the use of expensive proxy advisors to contact shareholders via telephone; c) the role of IFAs who advise their clients or who manage their portfolios and who can influence the shareholder voting; and d) the inertia of institutional investors (or to quote someone from the FT today: about 60% of company investors are passive shareholders and ‘don’t care’).

In the case of the Ventus VCTs, some shareholders are unhappy with the management fees as no new investments are being made by the company and are unhappy with the actions of the directors. They have tabled requisitions for the Annual General Meetings at Ventus VCT and Ventus 2 VCT on the 8th August to remove all the directors and appoint new ones. Of particular concern is the current two-year termination notice on the management agreement which is now being proposed to extend further. It is never a good idea for investment trusts to have long termination periods in contracts with the manager.

You can read Cliff Weight’s blog article here: https://tinyurl.com/y2de9vaa . There is also an article covering this topic in this weeks Investor’s Chronicle under the title “Limits of Influence”. It’s well worth reading.

How to solve these problems? I suggest the following: a) a reform to put all shareholders (including beneficial owners) on the register of companies; b) put shareholders email addresses on the register so that communicating with them can be done at reasonable cost – it’s surely unreasonable in the modern age to only have postal addresses which adds to costs enormously; c) limit how much can be spent on proxy advisors to oppose shareholder requisitions; and d) exclude passive institutional investors who have no interest as owners from voting.

Rent Controls

The Mayor of London, Sadiq Khan, is intending to develop proposals for rent controls in London so as to “stabilise” or reduce property rents in London (or make them “more affordable” as he puts it). That’s despite the fact that he has no legal powers to do so and a Conservative government would likely block such proposals. But Jeremy Corbyn supports the idea. The Mayor clearly sees this as a vote winner for his re-election campaign next year as he claims 68% of Londoner’s support rent controls!

Some of my readers probably invest in buy-to-let properties so such proposals will worry them considerably. On the other hand, those who rent houses or flats in London are undoubtedly concerned about the cost of renting and the rapid rise in rents in London. Some are being forced out of London or have to move to smaller properties.

But rent controls never work and create all kinds of negative side-effects, or unintended consequences. When I moved to London in the 1960s, rent controls were in place and had been since 1945 in various forms (there is good coverage of the history of rent controls in London on Wikipedia). In the 1960s, unfurnished properties were almost impossible to find or were horribly expensive as landlords had withdrawn from the market. Rachmanism to force tenants out of rent controlled properties was also rife and what property there was available for rent on the market was often in very poor condition because landlords simply could not justify spending money on maintenance. We definitely do not want to return to the 1960s despite Jeremy Corbyn’s desire to put us there!

Rent controls are not the answer, as many studies of such schemes has shown. The Mayor needs to do more to tackle the housing problem in London by ensuring more home are built, encouraging movement of people out of London, and discouraging new immigration into the capital from elsewhere. But you can read the Mayor’s press release here if you wish to learn more about his plans: https://www.london.gov.uk/press-releases/mayoral/to-tackle-affordability-crisis

HS2 and Brexit

The latest report that HS2 may cost an extra £30bn, meaning it could cost as much as £85bn in total, surely makes it even less justifiable. Enabling a very few people to save a few minutes on the train journey time from London to Birmingham at that cost makes no sense, although there might be more justification for expanding capacity and speed on routes in the North of England. However, it would surely be much better to spend that kind of money on an improved road network where the benefits are much greater. The Alliance of British Drivers has just published an analysis of road expenditure versus taxation which includes a comparison of road versus rail expenditure. It’s well worth reading – see here: https://www.abd.org.uk/road-investment-and-road-user-taxation-the-truth/ .

Now the Office of Budget Responsibility (OBR) have recently suggested that a “no-deal” Brexit would blow a £30bn hole in the public finances. Even if you accept that is true, and many do not, there appears to be a simple solution therefore. Cancel HS2 just to be on the safe side.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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LoopUp Profit Warning and Brexit Party Policy

Conference calling AIM company LoopUp (LOOP) issued a trading statement this morning which contained a profit warning. At the time of writing the share price is down 47% on the day but it has been falling sharply in recent days which suggests the bad news had already leaked out.

This is an example of what happens when lofty growth expectations are revised downwards. Revenue is now expected to be down 7% on the previous market consensus and EBITDA down 20%. The company blames the shortfall on “subdued revenue across its long-term customer base” driven by macro-economic factors and diversion of sales staff into training new ones.

LoopUp is presenting at the ShareSoc seminar event on the 10th July so it will be interesting to hear what they have to say about this – see https://www.sharesoc.org/events/sharesoc-growth-company-seminar-in-london-10-july-2019/ . This news comes only a month after LoopUp held a Capital Markets Day when there was no hint of these problems. I did a report on that here: https://roliscon.blog/2019/06/07/broker-charges-proven-vct-performance-fee-and-loopup-seminar/

I do hold a few shares in LoopUp but thankfully not many.

Brexit Party Policy

I mentioned in a recent blog post that the Brexit Party is looking for policy suggestions to enable them to develop a platform for any prospective General Election. Here’s what I sent them with respect to financial matters:

  1. The personal taxation system is way too complicated and needs drastically simplifying. At the lower end the tax credit system is wide open to fraud while those on low incomes are taxed when they should not be. The personal tax allowance, both the basic rates, and higher rates, need to be raised to take more people out of tax altogether.
  2. The taxation of capital gains is also now too complicated, while tax is paid on capital gains that simply arise from inflation, which are not real gains at all. They should revert to being indexed as they were some years ago. For almost anyone, calculating your own tax that is payable is now way too difficult and hence requiring the paid services of accountants using specialist software.
  3. Inheritance tax is another over-complex system that wealthy people avoid by taking expert advice while the middle class end up paying it. It certainly needs grossly simplifying, or scrapping altogether as a relatively small amount of tax is actually collected from it.
  4. The taxation of businesses is inequitable with the growth of the internet. Small businesses, particularly retailers, pay a disproportionate level of tax in business rates while their internet competitors often avoid VAT via imports. VAT is now wide open to fraud and other types of abuse such as under-declarations, partly because of the EU VAT arrangements. VAT is in principle a simple tax and the alternative of a sales tax would create anomalies but VAT does need to be reformed and simplified.
  5. All the above tax simplifications would enable HMRC to be reduced in size and the time wasted in form filling by individuals and businesses reduced. Everyone would be a winner, and wasted resources and expenditure reduced.
  6. The taxation of company dividends on shares is now an example of the same profits being taxed twice – once in Corporation Tax on the company, and then again when those profits are distributed to shareholders. This has been enormously damaging to those who receive dividends and the lack of tax credits has also undermined defined benefit pension funds. The taxation of dividends should revert to how it once was.
  7. The regulation of companies and financial institutions needs very substantial reform with much tougher laws against fraud on investors. Not only are the current laws weak but the enforcement of them by the FCA/FRC is too slow and ineffective. Although some reforms have recently been proposed, they do not go far enough. Individual directors and senior managers in companies are not held to account for gross errors or downright fraud, or when they are, they get off too lightly. We need a much more effective system like they have in the USA, and better laws.
  8. Shareholder rights as regards voting and the receipt of information have been undermined by the use of nominee accounts. This has made it difficult for individual shareholders to vote and that is one reason why investors have not been able to control the excesses in director pay recently. The system of shareholding and voting needs reform, with changes to the Companies Act to bring it into the modern electronic world.
  9. The pay of directors and senior managers in companies and other organisations has got wildly out of hand in recent years, thus generating a lot of criticism by the lower paid. This has created social divisions and led partly to the rise of extreme left socialist tendencies. This problem needs tackling.
  10. Governance of companies needs to be reformed to ensure that directors do not set their own pay, as happens at present, but that shareholders and other stakeholders do so. Likewise shareholders and other stakeholders should appoint the directors.
  11. Insolvency law needs reform to outlaw “pre-pack” administrations which have been very damaging to many small businesses. They are an abuse of insolvency law.
  12. All the EU Directives on financial regulation should be scrapped (i.e. there should be no “harmonization” with EU regulations after Brexit). The MIFID regulations have added enormous costs to financial institutions, which have passed on their costs to their customers, with no very obvious benefit to anyone. Likewise the Shareholder Rights Directive might have had good objectives but the implementation has been poor because of the lack of knowledge on how financial markets operate in the UK. Other examples are the UCITS regulations which have not stopped Neil Woodford from effectively bypassing them, or the PRIIPS regulations which have resulted in misleading information being provided to investors.

Let me know if you have other suggestions, and of course the above policies might be good for adoption by other political parties in addition.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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