ESMA’s Shareholder Rights Directive II (SRD II) may be the most impactful regulatory change you haven’t yet heard about this year. Don’t call it The King, but when SRD II goes live in 2020, it will impact holdings in more than 8,000 listed EU companies representing about €8 trillion in market value. SRD II’s goals are ambitious to say the least. They include:
- Increasing the quality of engagement of asset owners and asset managers with the companies into which they invest
- Creating a better link between pay and performance of company directors by requiring approval of remuneration policies at shareholder meetings.
- Enhancing transparency and shareholder oversight on related-party transactions
- Ensuring the reliability and quality of advice of proxy advisors
- Facilitating the transmission of cross-border information (including voting and corporate actions) across the custody chain
The root of SRD II is a global concern for the evolving pattern of shareholding and the impact of this pattern on corporate governance. The perception of policymakers and regulators is that together with passive or quantitative investment approaches, increased intermediation of shareholdings via asset managers, intermediaries, and funds has diminished the motivation and the capacity of end investors to exercise voting control over positions held in public companies.
In the minds of global regulators, particularly reflecting on the events surrounding the 2008 financial crisis, this has resulted in a dilution of the function of shareholder control over the management and operation of public companies. Their reasoning is that this has led to an effective delegation of corporate decision making to management whose interests may not be consistent with the interests of investors.[i] Essentially, the view of global regulators is that Elvis, the ultimate shareholder, has left the building, and the SRD II is designed to both compel and facilitate his return.
The SRD II Structure
Regulators believe that establishing the duty and ensuring the empowerment of institutional investors and asset managers to exercise shareholder rights (thereby denying any excuse to sit passively on shares) will enhance the long-term stability of public companies. SRD II incorporates several new features that will have significant impacts on the industry, including:
Asset Manager Duties. To promote long-term investment goals, regulators will require:
- Asset managers and institutional investors develop and disclose policies covering how they intend to engage with investee companies, including with respect to how they integrate shareholder engagement into their strategies.
- Asset managers provide enough information to institutional investors, so the latter can assess whether the managers have been acting in their long-term interests.
- Proxy advisers become regulated entities.
- Asset managers demonstrate their performance regarding the above policies and processes.
Significant New Shareholder Rights. The exercise of shareholder rights become more significant because the SRD II gives new rights to shareholders with respect to certain key corporate conduct:
- Remuneration of management must be approved at shareholders meetings.
- Conflict of interest issues must be broadly disclosed and, in some cases, approved by shareholders.
Operational Requirements on Issuers, CSDs, and other Intermediaries. To provide that asset managers and other shareholders can exercise rights and asset managers are able to discharge these new duties, SRD II requires issuers and intermediaries to ensure they process information up and down the chain of custody within tight time constraints:
- Issuers must provide notice of a corporate event to intermediaries on the same day as the legal announcement of the action.
- Intermediaries must transmit all notices on the same day if the notice is received before 4 p.m. and by 10 a.m. the following morning if received after 4 p.m.
- Intermediaries must process shareholder action instructions and confirm the same “immediately and without delay.”
- The last intermediary facing the shareholder must set a deadline for response not more than 3 days prior to any issuer deadline or record date.
- Post-meeting confirmations of votes must be processed within 15 days.
These requirements pose particularly thorny challenges when applied across different time zones and conflicting legal frameworks and in the context that shareholders will frequently change an instruction or an election on a corporate action after it has been submitted and processed.
Company Requests for Shareholder Identification. The SRD II doesn’t only affect shareholder rights. It also establishes the ability of issuers to inquire of intermediaries as to the identity of ultimate shareholders.
- Each intermediary in the chain must process and pass along any shareholder identification request on the same day if the notice is received before 4 p.m. and by 10 a.m. the following morning if received after 4 p.m.
- The last intermediary facing the ultimate shareholder must process the identification of the shareholder and transmit it on the later of the day after receipt of the request or the record date of the request.
The Challenges of SRD II Compliance
The first set of challenges are those that are fundamentally new under the SRD II:
- Investment manager compliance and recordkeeping in connection with shareholder rights exercise policies.
- A significant potential increase in shareholder identification requests. Currently, there are only 14 EU member states that require shareholder identification. Another complication to this is that the definition of shareholder is not specifically defined in SRD II and might refer to beneficial owner, party with authority to instruct with respect to rights on shares, or even a nominal or legal owner. These definitions could vary under member state transposition.
- The interest that might be caused by the ability of shareholder to vote on management compensation and conflict matters.
The second set of challenges are more structural:
- Where shareholders are natural persons, or with respect to personal information that might have to be supplied with regard to natural persons authorized to act for shareholders, GDPR is implicated with its complicated set of security requirements.
- The SRD II does not establish communication protocols for the processing that it requires. To quote Elvis, we’ve all had the experience of “return to sender, address unknown, no such number, no such zone.” Without significant industry coordination, and the cooperation of member states in their transposition process, we can expect to hear that tune a lot. ISO standards and the possibility of distributed ledger technology (DLT) present themselves as possible solutions, but so far, there is no guidance in the regulation.
Finally, there is a cost to all of this, and SRD II gives only broad guidance and this guidance can be implemented in different ways by each member state:
- Intermediaries to disclose publicly any applicable charges for services provided for under this Chapter separately for each service.
- Any charges levied by an intermediary on shareholders, companies and other intermediaries shall be non-discriminatory and proportionate in relation to the actual costs incurred for delivering the services.
- Any differences between the charges levied between domestic and cross-border exercise of rights must reflect the variation in actual costs incurred for delivering the services.
- Member states may also prohibit intermediaries from charging fees for the services required by SRD II, but as these services may be costly to provide, this would be likely to drive up base intermediary costs.[ii]
There’s a lot to consider and coordinate between now and the third quarter of 2020, when SRD II becomes fully effective, especially because member state transposition is not due until June of this year, but all market participants must pay close attention or perhaps be singing another Elvis tune: “I Got Stung.”[iii]
This article was contributed by BBH Senior Vice President in the Office of General Counsel Thomas Andrew.
[iii] (1958) 50,000,000 Elvis Fans Can’t Be Wrong – Elvis’ Gold Records Volume 2 [Go ahead…check it out. You’ve read this to the end and you deserve a little bit of the real Elvis]