With everything going on in the capital markets right now – from trade wars to recessionary fears – you could be forgiven for overlooking the Shareholder Rights Directive (SRD) II, Europe’s latest tweak to its financial regulations.
Even so, it remains surprising that when Hermes Investment Management surveyed institutional investors about the revised directive last year, a whopping 43 percent claimed to have never even heard of it. That’s a big oversight because, while it may be technical in nature and still not fully implemented, the new rules are set to change corporate governance practices across the continent.
SRD II has its origins in the global financial crisis. The first version of the directive, SRD I, came into effect in 2007, just as the wheels were starting to fall off the global financial system.
Following those events, the European Commission (EC) – which is the lawmaking arm of the European Union – decided that weak governance practices and a focus on short-term results were partly to blame for the meltdown. Thus began work on SRD II, with the aim of strengthening corporate governance and encouraging more long-term decisionmaking at companies.
The European Parliament and the European Council officially adopted the directive in 2017, after which individual governments had until June 2019 to transpose most of the rules into national law. The changes relating to shareholder identification have a later deadline of September 2020.
One of the main changes resulting from the directive should be improved dialogue, says Cas Sydorowitz, global head of activism and M&A at Georgeson. ‘Companies should be able to communicate with shareholders better, because the regulations will ensure they have better information on who their shareholders are,’ he says.
‘We also expect investors to become better informed on company matters, including motions at meetings, because of the new requirement that firms pass information on to shareholders. Although we still don’t expect every shareholder will vote, we believe this could lead to an increase in overall voting levels.’
Some of the main changes in the new directive are:
- Investors have the right to vote on a company’s forward-looking pay policy and backward-looking remuneration report
- Investors are encouraged, although not obliged, to publish an engagement policy and report on how they apply it
- Issuers have the right to identify their shareholders by requesting information from intermediaries in the investment chain
- Issuers have new disclosure requirements for third-party transactions
- Intermediaries must pass on information from companies to investors to support the facilitation of shareholder rights
- Proxy advisers are required to make certain disclosures on an annual basis about their research, voting and any conflicts of interest.
The effects of the directive will be felt differently depending on where companies are located. Some countries already have high levels of disclosure and strong corporate governance rules, so SRD II will result in few big changes. Others may find the directive requires them to do some significant catching up.
The new say-on-pay rules are a good example. Under SRD II, investors will have the chance to vote on both the company’s remuneration policy and its remuneration report. The vote on the remuneration policy must take place at least once every four years. In principle, it is binding in nature, but member states may opt for advisory votes instead.
The vote on the remuneration report is advisory and must happen every year, although member states can allow smaller companies to submit the report for a general discussion at the AGM, rather than a vote.
‘If you look at the number of European companies that held executive remuneration votes in 2019, you can see that those in Germany (around 14 percent) and the Netherlands (around 33 percent) had the lowest number of such resolutions,’ says Sydorowitz.
‘This means companies in those markets will experience the greatest impact, because so many issuers will have to include such resolutions in the future. Many other European markets have never had to consider this issue before. This will be a challenge for investors, which will have more remuneration reports to consider. For some companies this may result in some difficult conversations with their shareholders.’
The incoming rules are prompting some companies to reassess their compensation disclosure. ‘In Germany, for example, there will be some changes to the corporate governance code [Kodex] after the introduction of SRD II, which will trigger some required amendments to management remuneration,’ explains Gunhild Grieve, head of IR at German power company RWE.
‘Because any changes to the remuneration scheme will need to be put to a vote at the AGM, it makes sense to also review the other components of the system, like KPIs, vesting periods, minimum shareholding requirement, and so on, to ensure sufficient support. In addition, SRD II asks for an annual vote on the remuneration report. Here, we want to make sure the report fulfils the transparency requirements investors are looking for.’
Another important change for IR teams is the new rules around shareholder ID. The directive stipulates that companies have the right to request information about the identity of their shareholders from intermediaries to facilitate ‘the exercise of shareholder rights and shareholder engagement’.
The threshold for identification should not be more than 0.5 percent of shares or voting rights, according to the directive, but countries are allowed to opt out of this threshold when transposing the rules into national law.
The directive adds a new layer to the existing (and various) shareholder disclosure requirements across Europe. Some countries already have laws offering shareholder ID at certain ownership levels, others do not. The change is an important step in acknowledging the role of shareholder ID in corporate governance, says Richard Davies, founder of IR consultancy RD:IR, which is now part of Equiniti.
‘Now, one could argue that the levels of thresholds that are being applied don’t really facilitate shareholder ID in a very granular way,’ he observes. ‘But it shows that the EC views the transparency of equity markets as an important part of the engagement process. And I think that’s a breakthrough.’
Aside from the technical implications, most commentators expect SRD II to lead to more conversations between companies and shareholders about ESG issues. The directive speaks to this specifically, encouraging investors to take nonfinancial issues into account when assessing company performance and executive pay packages.
More broadly, the focus of the directive on long-term performance should naturally lead to more discussions about ESG – making topics like climate change or corporate governance harder to ignore.
‘People think SRD II is a bit dry and esoteric, but what really jumps out for me is the change around sustainability,’ says Davies. ‘SRD II creates a framework for a higher level of sustainability at companies, in terms of both a long-term investment culture and transparency around issues related to ESG.’
The changes encouraged by SRD II reflect a broader shift within the investment world, Davies adds: ‘The profound direction of travel is toward a more ESG-oriented asset management community. We’ve been talking about long-termism for a long time as something we want to achieve, and SRD II is part of that.’
This article was published in the Winter 2019 issue of IR Magazine.