Shareholder Rights Directive: Aiming for more transparency and active ownership

Below we present the main highlights and conclusions from the meeting:

Jesper Lau Hansen opened the meeting with some introductory remarks. He noted that many different elements have been included in the new Directive, and he was afraid that regulators have chosen some second-best solutions based on wishful thinking and not optimally designed to solve the problems identified by the European Commission, especially corporate governance shortcomings of listed companies. In Jesper Lau Hansen’s view, the contents of the new Directive is very much influenced by the UK way of thinking and takes as its point of departure an ownership structure dominated by small ownership interests – and not an ownership structure with very large or dominating shareholders like in the Nordic region. The absence of major shareholders in the UK who can monitor and discipline management has led to a pressure on institutional investors to be “active owners” by way of stewardship codes; a second-best solution since many institutional investors quite sensibly prefer to diversify their portfolio and minimise engagement to keep costs down. It is a solution that is likely to increase the use of proxy advisors, which will only double the agency problems; a self-inflicted problem that the Directive also tries to solve.

The contents of the Directive

Regulation of more players

The revised Shareholder Rights Directive reflects EU regulators’ wish to encourage long-term shareholder engagement, which Jesper Lau Hansen finds is a venerable objective, but not necessarily one that can

be further encouraged by legislation. In consequence, new rules for institutional investors, asset managers and proxy advisors have been included in the Directive – to pave the way for active ownership.

According to the Directive, institutional investors will have to publish:

• A shareholder engagement policy and a yearly report on their implementation of and compliance with the policy together with a description of any voting rights exercised in listed companies (alternatively prepared by the asset manager)
• An investment strategy
• A description of any services received from proxy advisors.

The new rules are based on a 'comply or explain' approach and largely reflect the Recommendations for Active Ownership (strongly inspired by the UK stewardship code) recently presented by the Committee on Corporate Governance in Denmark.

In Jesper Lau Hansen’s view the new rules will cause extra costs and demand more resources for investors, asset managers and proxy advisors, as investors will more or less be obliged to be active owners – regardless if they want to, and regardless if it is a natural part of their business model or investment strategy, because the comply or explain approach is effectively a command to comply with very few actors having the inclination to explain their wish to act differently even if it may make sense for reasons of costs or otherwise.

For proxy advisors the new rules require disclosure of information about:

• Their business model
• The application of the code of conduct they apply
• Conflict of interests.

The UK’s experience with stewardship codes has not been successful and major reforms are now contemplated, which does not bode well for the Directive’s desire to follow this path.

Remuneration policy and "say on pay"

According to the new rules listed companies are to publish a remuneration policy laying down the detailed rules on fixed and variable remuneration of members of the management. Shareholders will have a say on remuneration practices as they are given the right to vote on the remuneration policy at the general meeting (advisory or binding vote). Furthermore, listed companies must publish a remuneration report at the annual general meeting outlining all benefits granted to individual executives and the shareholders will be permitted to vote on the report (advisory vote). Jesper Lau Hansen was sceptical of whether increased transparency would reduce the payment packages offered to senior management. The transparency may just as well create an upward push, as it becomes clear who pays what, which is bound to influence company pay policy when companies try to recruit the best and brightest. This is not to deny that states without major and controlling shareholders face problems with “fat cats”, i.e. managers who essentially set their own pay at exorbitant levels. Also in that respect the solution is to engage shareholders who are professional enough to gauge the competitive level of pay, not to pander to the public and the press, who may take issue with any pay that is considerably above ordinary wages.

The new rules on remuneration are very similar to the existing Danish practice.

Related party transactions

During the negotiations of the Shareholder Rights Directive the proposal on related party transactions was among the biggest hurdles. The reason was again that it was inspired by UK thinking, where major shareholders are rare. Consequently, the original proposal suggested that if a shareholder was involved in a related party transaction, that shareholder could not participate in a vote to approve the transaction. This was detrimental to all jurisdictions where major shareholders are common and often engage in transactions with the company, and in these jurisdictions minority interests are protected in other equally efficient ways. There was considerable opposition from most of the EU member states, notably Germany and the Nordics, which resulted in a change. Fortunately, it was solved in a reasonable way.

The new rules will require listed companies to make sure that any material transactions (not market-based transactions) with related parties are approved either by the company’s board of directors or by the shareholders at the annual general meeting, and to publish these transactions.

Shareholder identification and contact

The new rules will give companies the right to identify their shareholders (with the possibility for states to set a threshold not higher than an equity interest of 0.5 percent). It will oblige the chain of intermediaries to pass on relevant information, including information on general meetings, and to facilitate exercise of shareholder rights, including voting and electronic attendance at general meetings. Moreover, companies are required to confirm the votes cast at the request of the shareholder.

This is intended to make communication and interaction between companies and investors possible and more efficient. However, many problems arise, including technical problems, when there is more than one intermediary between the listed company and the shareholders, especially in cross-border situations and where the actors are placed outside the EU/EEA.

On 5 April 2017, the European Securities and Markets Association (ESMA) published a report intended to assist the European Commission in implementing the requirements of shareholder identification and transmission of information relating to the process, format and timeline. ESMA concludes that the level of harmonisation varies across the various areas and proposes that the Commission's implementing acts achieve harmonisation across national regulatory frameworks for the identification of and communication with shareholders. In addition, the report suggests ways in which the new requirements could be best implemented.

Conclusions

Following his presentation of the contents and implications of the revised Shareholder Rights Directive, Jesper Lau Hansen concluded:

• The new Directive implies significant regulatory interference in party autonomy to promote transparency, but where it is not obvious that the concerned parties require public transparency or that transparency will be beneficial.
• The Directive is expected to make only a minor contribution to support the political aim of building increased active ownership. Active ownership by engaged shareholders with in-depth knowledge of the company is important to monitor and discipline management and promote long-term investment, but that is very difficult to foster by legislation alone, especially where engagement is forced on actors that may not prefer to play that role.
• The Directive implies comprehensive cross-border and extra-territorial challenges – especially as regards technical solutions to handle shareholder identification and exercising shareholders’ rights.
• The Directive is expected to increase costs for listed companies.

Links

Read more about the Shareholder Rights Directive: “Shareholder Rights Directive has been approved”

The revised Shareholder Rights Directive is the latest piece of EU capital market regulation. You can read more about the overall picture within capital market regulation in the article “Has capital market regulation gone too far? – be prepared for more to come”. In the article, Professor Jesper Lau Hansen of the University of Copenhagen and David Moalem, partner at Bech-Bruun, give their views on the implications of recent years’ capital market regulation and make a guess on the future development within this area.