The revised Shareholder Rights Directive (SRD II) is due to come into force in June 2019. Developed in response to the financial crisis, and designed to increase transparency and enhance long-term shareholder engagement to combat previous market shortcomings, SRD II is widely recognised among industry participants as a move in the right direction.
Haroun Boucheta, Head of Public Affairs at BNP Paribas Securities Services, discusses the new directive’s impact on issuers and investors, and the intermediaries that service them.
What are the main goals of SRD II, and the expected benefits for issuers and investors?
The first Shareholder Rights Directive (SRD) came into force in 2007. It sought to foster shareholder engagement by implementing rules around transparency, proxy voting rights and the ability to vote in general meetings via electronic means.
However, the 2008 financial crisis exposed a number of shortcomings with the original directive. The European Commission highlighted the following in particular:
- Shareholders often supported managers’ excessive short-term risk-taking, with too much focus on short-term returns
- Shareholders lacked the means to effectively monitor the companies in which they invested
- Deficiencies were apparent in the engagement and control by long-term shareholders, active managers and institutional investors
- Some directors’ remuneration was felt to be excessive and not justified by their company’s performance
- Exercising shareholder rights was often complicated and costly, especially in cross-border situations where intermediaries could be located in different jurisdictions
SRD II aims to tackle these shortcomings. Its central focus is on encouraging more long-term shareholder engagement, enhancing transparency in the voting process and improving issuer-investor dialogue. SRD II aims at aligning interests between the end investors of institutional investors (life insurance, reinsurance and Pillar II pension funds (IORPs)), asset managers ((e.g. investment firms, AIFMs, UCITS management companies)) and listed companies in the Union, as well as potentially to the development of longer-term investment strategies and relationships with listed companies involving shareholder engagement.
One new requirement for institutional issuers, such as asset managers, pension funds and insurance companies, is to develop and publicly disclose their engagement policy towards their shareholders. If these issuers chose not to do so, they must explain why.
SRD II also seeks to make it easier for shareholders to exercise their rights, and facilitate cross-border voting. To this end, intermediaries will have to ensure they pass relevant information from the issuer on to shareholders, and vice versa.
Another focus is on increasing transparency in the voting process, including where the services of a third party – such as proxy advisors or an investee company – are used. This implies new requirements on shareholder identification so issuers can communicate directly with investors, and transparency of proxy advisor policies.
The other big change is a “say on pay.” This gives shareholders a right to vote during the general meeting on the directors’ remuneration policy, as well as on the remuneration report that details individual directors’ remuneration in the previous financial year.
BNP Paribas Securities Services supports these goals. As we noted in an earlier regulation memo, increased transparency could facilitate more dialogue between issuers and their shareholders. And when combined with other initiatives targeting long-term engagement and funding source diversification for issuers, SRD II could lead to longer-term engagement and investment in issuing companies.
What does SRD II mean for custodians and other intermediaries?
SRD II needs to be read in conjunction with the Commission Implementing Regulation 2018/1212, dated 3 September 2018. This contains a prescriptive list of obligations for both issuers and intermediaries, including custodians and other securities services providers.
The first new requirement is technological. Under SRD II and the Implementing Regulation, any transmission between intermediaries will need to be made in electronic and machine readable ISO formats.
Other new requirements affecting intermediaries relate to the organisation of general meetings and corporate events, in an effort to enhance the efficiency of the chain of intermediaries and improve the transmission of information along it.
For instance, the last intermediary in the chain must confirm to the shareholder (or a third party nominated by the shareholder) their entitlement to exercise their shareholder rights in a general meeting. Intermediaries must also transmit to the issuer updated notices of shareholder participation in the general meeting, while the last intermediary must ensure the information regarding the number voted is consistent with the entitled position. The receipt, recording and counting of votes need to be confirmed as well.
The information to be provided on corporate events gives intermediaries strict deadlines regarding corporate actions and shareholder identification processes. Notably, the first intermediary, and any other intermediary that receives information regarding a corporate event, should transmit that information to the next intermediary in the chain without delay, and no later than the close of the same business day. This emphasis on immediate information transmission is challenging both technologically and practically.
Likewise, any request to disclose a shareholder’s identity should be transmitted by intermediaries to the next intermediary in the chain without delay, and no later than the close of the same business day on which the request was received. Responses to such requests must then be provided and transmitted by each intermediary to the addressee defined in the request without delay, and no later than during the business day immediately after.
The Implementing Regulation driving these changes will be applicable from 3 September 2020.
What does SRD II mean for institutional investors, asset managers and their end investors?
SRD II obliges institutional investors and asset managers to be more transparent about their investment strategies, their engagement policy, and the implementation thereof. Thus, they will have to develop and publicly disclose a policy on shareholder engagement or explain why they have chosen not to do so. The policy on shareholder engagement will have to describe how institutional investors and asset managers integrate shareholder engagement in their investment strategy, which different engagement activities they choose to carry out, and how they do so.
In order to foster responsible stewardship of assets, SRD II requires institutional investors to publicly and annually disclose how their strategy is consistent with the profile and duration of their liabilities, as well as how it contributes to the medium to long-term financial and non-financial (environmental, social and governance) performance of their assets. If they have mandated an asset manager, details of this arrangement should also be publicly disclosed, in particular as regards the alignment between the manager’s strategy and the investor’s long-term liabilities.
On their side, asset managers will have to adequately inform institutional investors so that they can assess whether and how the manager acts in the best long-term interests of the investor and whether the asset manager pursues efficient shareholder engagement. In addition, asset managers will be required to report to investors on the key material medium to long- term risks associated with the portfolio investments, including corporate governance matters.
Moreover, asset managers will be required to disclose to institutional investors the composition, turnover and turnover costs of their portfolio as well as their policy on securities lending (through the annual report required under UCITS Directive and AIFM Directive, or periodic communications required under MiFID II).
These transparency requirements may lead to some extent to the duplication of existing reporting requirements under UCITS Directive, the AIFM Directive, and MiFID II.
Can technology – and distributed ledger technology (DLT) in particular – redefine the relationships between issuers and their shareholders?
Where there is a chain of intermediaries, especially in cross-border situations, and the parties have to transmit specific information in ISO format and using electronic means along that chain without delay, then new technologies, could help firms meet the new requirements.
DLT is one of the options the industry is investigating, as by its nature the technology would enable us to comply with the directive’s transparency requirements. In addition, the Implementing Regulation requires intermediaries to transmit the relevant information immediately, something for which distributed ledger technology is well-suited.
DLT use cases have been relatively limited to date, but there is a real trend emerging for market players and market infrastructures to leverage the technology. For example, the Australian Securities Exchange (ASX) plans to go live with a new DLT-based equity clearing, settlement and registry system by 2021, which it expects to result in better record keeping and data quality, streamlined reconciliations and more timely transactions.
Whether DLT can provide the solution to our SRD II obligations remains to be seen. But whatever solution we arrive at, we are confident technology can help market participants provide the new services demanded by the directive.
Will SRD II be applied in a harmonised way across Europe?
The fact that SRD II is a directive, rather than a regulation, means EU Member States have some discretion in how they transpose the rules into their respective national laws. That creates the potential for different interpretations.
This potential for divergence is exacerbated by specific provisions within the directive itself, which allow Member States to deviate in key areas. In particular, Article 9.c.6 indicates that Member States may elect to exclude certain transactions from the scope of the directive, namely:
- Intragroup transactions.
- Certain types of transactions for which national law requires approval by the general meetings.
- Transactions regarding remuneration of directors.
- Transactions entered into by credit institutions when financial stability is at stake.
Another question mark is whether end investors will be able to choose not to receive general meeting information. Will such an “opt out” possibility be written into national laws when the directive is transposed? If so, intermediaries would need to filter information and customise reports based on what each investor wants to do, which would be an administrative headache.
That said, SRD II has some extraterritorial scope. Its provisions apply to third-country intermediaries if they provide services for shares of companies whose registered office is in the EU, and the shares are admitted to trading on a regulated market in the Union. Third-country proxy advisors would also be subject to the directive as soon as they carry out their activities through an establishment in the Union, regardless of their form. Post-Brexit, UK-based institutions, as third-party providers, would therefore be captured by the directive’s provisions if they want to continue offering services within the EU.
Similarly, an industry-wide IT solution would need to cope with all Member States’ requirements. Harmonising the rules would help such a utility to generate the greatest possible efficiencies.
The wording of the EU directive 2017/828 can be downloaded here