The European Council and European parliament recently gave their approval to a new EU Shareholder Rights Directive (SRD II) which will have a significant impact on rights and responsibilities of investors in the European market. This Directive will likely result in significant changes to shortcomings in corporate governance and will encourage long term and active engagement by shareholders.
So what do organisations need to understand about this new directive and what changes are needed? Bram Hendricks, Client Relations Manager, Europe for Kessler Topaz Meltzer & Check tells Lawyer Monthly everything you need to know and then some.
The financial crisis had revealed that significant weaknesses in corporate governance of financial institutions played a role in the crisis. In particular, there is a perceived lack of shareholder interest in holding management accountable for their decisions and actions, compounded by the observation that many shareholders appear to hold their shares for only a short period of time. It was therefore that the European Commission in April 2014 presented a proposal for the revision of the Shareholder Rights Directive.
Shareholder Rights Directive: What’s in it?
The new rules establish rights and requirements for shareholders and companies, as well as other actors in the investing chain, including proxy advisors in the following ways:
Related party transactions
Transactions with related parties may cause prejudice to companies and their shareholders as they may give the related party the opportunity to appropriate value belonging to the company (to the detriment of other shareholders). The Directive provides that material-related party transactions are subject to a vote by the shareholders or the board of directors in order to protect the interests of the company. Companies should also publicly announce material transactions and provide sufficient information to give other shareholders and creditors the opportunity to assess the fairness of the transaction. Precise identification of the related party is among others necessary to better assess the risks implied by the transaction and to challenge this transaction, including through legal action. The Directive does not provide a definition of material related party transactions and therefore leaves it up to the Member States to define which transactions are subject to the provisions.
Vote on executive remuneration
In order to ensure that shareholders have an effective say on the remuneration policy, they should be granted the right to hold a binding or advisory vote on it. Based on the provisions in the Directive, shareholders will be able to express their view twice. First they will vote ex ante on the remuneration policy, which lays down the framework within which remuneration can be awarded. The vote on the remuneration policy will in principle be binding, which means that companies are only able to pay remuneration on the basis of the policy approved by shareholders. The remuneration policy should contribute to the business strategy, long-term interests and sustainability of the company and should not be linked entirely or mainly to short-term performance objectives.
To ensure that the implementation of the remuneration policy is in line with the policy, shareholders are granted with an advisory vote on the company’s remuneration report. In case a majority of the shareholders vote against a company’s remuneration report in a given year, the company should explain in its next remuneration report how the vote of the shareholder has been taken into account. Member States will also have the possibility to replace the advisory vote by a discussion at the general meeting.
Additional disclosure requirements European based institutional investors and asset managers will become subject to additional disclosure requirements. Under the new rules they will be required, on a comply or explain basis, to develop and disclose a policy on how they intend to engage with investee companies. The policy on shareholder engagement should describe among others how institutional investors and asset managers integrate shareholder engagement in their investment strategy. They are also expected to disclose information about the implementation of their engagement policy. This should also include information about how they have exercised their voting rights. Institutional investors should also annually disclose to the public how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities.
The Directive also touches on the relation between the asset manager and its institutional investor client. Asset managers should give proper information to institutional investors, in order to allow the latter to assess whether the manager acts in its best long-term interests. According to the Directive this information includes corporate governance matters, as well as other medium-to-long-term portfolio risks. Asset managers should also disclose to institutional investor clients information about portfolio turnover, portfolio turnover costs and their policy on securities lending. At the same time institutional investors should disclose to the public certain key elements of their arrangements with asset managers e.g. how asset managers are incentivised to align their investment strategy and decisions with the profile and duration of the liabilities of the institutional investors.
Shareholder identification
In the Directive a provision is introduced that listed companies should have the right to identify their shareholders in order to be able to directly communicate with them. Intermediaries should have an obligation to communicate to the company, at their request, the information regarding shareholder identity. This also applies to intermediaries outside of the EU, which provide services with respect to shares of companies that have their registered office in an EU Member State and whose shares are admitted to trading on a regulated market in the European Union. As a result of this provision in the Directive it becomes easier for companies to pro-actively engage with its shareholders.
Vote confirmation
As part of their stewardship responsibilities many institutional investors make use of their voting rights at shareholder meetings of investee companies worldwide. Electronic proxy voting is the principal means by which most shareholders exercise their voting rights. The voting chain is long and complex. The Directive recognizes that it is important for shareholders to know whether their votes have been correctly taken into account. Therefore the provision is introduced that a confirmation of receipt of votes should be provided in case of electronic voting. Also shareholders who cast a vote in a general meeting should have the possibility to verify after the general meeting whether the vote has been validly recorder and counted.
The proposed EU Shareholder Rights Directive has the objective to overcome certain corporate governance short comings in European listed companies and to encourage a more long-term oriented investment process and active engagement by institutional investors and asset managers. This should contribute to the long term sustainability of listed companies based in the European Union (‘EU’) and to enhance the growth, job creation and competitiveness of the European economy.
