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A new era of transparency for shareholders and investors

EU Shareholder Rights Directive will increase reporting and compliance requirements for buy-side investors in public companies

Change is coming. European Union (EU) Member States have until June 2019 to implement the second Shareholder Rights Directive (SRD II), which will bring a sweeping regime of transparency and disclosure for publicly listed companies. Asset managers and institutional investors are a key focus of the new regulatory scheme and will likely face increased compliance responsibilities once it comes into effect.

Key insights

  • The EU's updated Shareholder Rights Directive will introduce a sweeping new regime of transparency and disclosure for publicly listed companies
  • Enhanced engagement and communication requirements will encompass the whole ownership chain in publicly listed companies and will increase the compliance and reporting burden on institutional investors and asset managers
  • Asset managers and institutional investors will need to engage more closely with investee companies and be more transparent about their investment objectives and the integration of shareholder engagement into their investment strategies

A revamped post-crisis investment landscape

SRD II (the Directive) updates the EU's original 2007 Directive on shareholder rights.1 The update was prompted by the soft corporate governance standards which became evident during the 2008 financial crisis. SRD II specifically notes that there is “clear evidence that the current level of 'monitoring' of investee companies and engagement by institutional investors and asset managers is often inadequate and focuses too much on short-term returns". SRD II is also part of a larger effort by the European  Commission (EC) to shape the future of the bloc's investment landscape, which includes the regulation of European long-term investment funds2 and the plan for a European-wide capital markets union.3 The broad objective of SRD II is to enhance engagement and communication across the chain of ownership in publicly listed companies, including company directors, buy-side investors, intermediaries and shareholders.

Facilitating shareholders' rights

A significant focus of the Directive is the facilitation of shareholders' rights. SRD II will require that the identities of investors and shareholders be disclosed when their holdings exceed a stipulated threshold of a company's issued capital. The default share threshold is set at 0.5% but Member States will have until June 2019 to inform European regulators if they intend to opt out of the threshold.

The broad objective of SRD II is to enhance engagement and communication across the chain of ownership in publicly listed companies

Intermediaries, such as banks, will be obliged to facilitate the exercise of rights by shareholders, whether shareholders exercise those rights themselves or nominate a third person. SRD II introduces the requirement that intermediaries must transmit the general meeting agenda and voting information “without delay" to shareholders in a standardized format. The EC is expected to provide more clarity on format requirements. Proxy advisors will also face increased reporting requirements. Once the Directive comes into effect they will need to disclose details of their methodology, information sources, and the procedures in place to ensure quality of voting instructions, research and advice.

SRD II grants shareholders the right to vote on companies' remuneration policies and for those votes to be binding or advisory. It also requires that any material transaction, which is to be defined by national regulators, between a listed company and a related party must be announced and approved by the shareholders. Taken together, these provisions are likely to considerably increase the compliance burden on intermediaries and proxy advisors, as well as the companies themselves.

The buy-side burden

The chain of transparency will also affect relations between assets managers and allocators

The buy side will also be compelled to take action once the Directive comes into effect. The EC's view is that greater transparency from the buy-side about its investment objectives can be a useful mechanism to guide executive performance, improve signalling to the market and help attenuate the influence of quarter-to-quarter short-termism in the management of public companies. In practice, SRD II will require institutional investors, defined as life insurance firms, pension funds and asset managers, to engage more closely with investee companies and be more transparent about their investment objectives and the integration of shareholder engagement into their respective investment strategies. The Directive stipulates that this information must be reported annually and made available on buy-side firm websites.

The chain of transparency will also affect relations between assets managers and allocators. Asset managers will be compelled to align investment strategies and decisions with the risk profile and long-term investment requirements of their institutional investor clients. This will greatly increase the communication requirements placed on asset managers, as they will also have to disclose information about portfolio composition and portfolio turnover.

The Directive asserts that, “The level of portfolio turnover is a significant indicator of whether an asset manager's processes are fully aligned with the identified strategy and interests of the institutional investor and indicates whether the asset manager holds equities for a period of time that enables it to engage with the company in an effective way. High portfolio turnover may be an indicator of a lack of conviction in investment decisions and momentum-following behaviour, neither of which is likely to be in the institutional investor's best interests in the long term, especially as an increase in turnover raises the costs faced by the investor and can influence systemic risk. On the other hand, unexpectedly low turnover may signal inattention to risk management or a drift towards a more passive investment approach."4

The ambiguous shape of implementation

The precise form of SRD II's implementation within individual Member States remains unknown. The EC is set to publish implementation technical standards later in 2018. For now, however, there remains leeway for national regulators to interpret and transpose the Directive. Buy-side firms will need to closely monitor the dialogue between the EC and individual regulators over the coming year, especially in the jurisdictions where their operations are concentrated.

 

 

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Sources

  1. European Union (May 17, 2017) Directive (EU) 2017/828
  2. European Parliament (April 29, 2015) Regulation (EU) 2015/760
  3. European Commission, General Information on the EU Capital Markets Union
  4.  Ibid. European Union