Analysis of the European Shareholder Rights Directive II from an investment fund perspective
Arendt & Medernach, Luxembourg
Maria Daniela Poli
Arendt & Medernach, Luxembourg
The objective of the Shareholder Rights Directive II
The European Shareholder Rights Directive II (SRD II) seeks to encourage long-term shareholder engagement and to increase transparency between companies and investors, by introducing new requirements with regard to: (1) the identification of shareholders, the transmission of information and the facilitation of exercise of shareholder rights; (2) the transparency of institutional investors, asset managers and proxy advisors; (3) the right to vote on the remuneration policy; and (4) the transparency and approval of related party transactions.
This analysis aims to identify the impact of the SRD II on investment funds as well as on the service providers typically involved in the operations of an investment fund.
Investment funds as issuers of shares
The SRD II addresses companies that have their registered office in an EU Member State and whose shares are admitted to trading on a regulated market situated or operating within a Member State.
The relevant companies, as issuers, are required to provide certain information to their shareholders before each general meeting of shareholders, to facilitate the exercise of shareholder rights and to establish a remuneration policy with regard to their directors
The SRD II allows Member States to exempt from its scope of application: (1) UCITS; (2) alternative investment funds (AIFs); and (3) cooperative societies. Luxembourg opted for the exemption. Therefore, Luxembourg-domiciled investment funds are not concerned by the SRD II as issuers of securities. Even if investment funds have their shares traded on a regulated market, they are not subject to the aforementioned obligations regarding, among others, the identification of their shareholders, the transmission of information and the facilitation of exercise of shareholder rights by their shareholders.
Nevertheless, the exemption does not cover the transparency obligations applicable to institutional investors and asset managers with respect to their investment in shares traded on a regulated market. The rationale behind this choice is the consideration of the key role played by institutional investors and asset managers in the corporate governance, strategy and long-term performance of listed companies.
To the extent that they invest on behalf of their clients or funds in shares traded on a regulated market, asset managers (ie, MiFID investment firms, authorised AIFMs, UCITS management companies (ManCos) and self-managed UCITS (SIAGs)) have to develop and publicly disclose an engagement policy and its implementation, which must be available free of charge on the asset manager’s website.
The engagement policy comprises the following aspects: the integration of shareholder engagement into their investment strategy; the monitoring of investee companies on relevant matters; the conduct of dialogues with investee companies; the exercise of voting rights and other rights attached to shares; their cooperation with other shareholders; communication with relevant stakeholders of the investee companies; and the management of actual and potential conflicts of interests in relation to their engagement.
The report illustrating the implementation of such engagement policy, to be published on an annual basis, should include a general description of voting behaviour, an explanation of the most significant votes and the use of the services of proxy advisers and a public disclosure of how they have cast votes in the general meetings of companies in which they hold shares. In this respect, it is expressly foreseen that votes that are insignificant due to the subject matter of the vote or the size of the holding in the company may be excluded by such disclosure.
An exemption from the aforementioned engagement policy is possible only if there is a clear and reasoned explanation for noncompliance and provided that this latter is publicly disclosed.
Institutional investors (ie, life insurance companies or pension plans) are subject to the same requirements as asset managers regarding the development and public disclosure of an engagement policy and of its implementation. In addition, institutional investors must also publicly disclose how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities and how they contribute to the medium and long-term performance of their assets.
Furthermore, where an asset manager invests on behalf of an institutional investor, the latter must publicly disclose its arrangements with the asset manager. In addition, while investing on behalf of an institutional investor, asset managers must disclose, on an annual basis, to the relevant institutional investor how their investment strategy and implementation thereof contributes to the medium to long-term performance of the assets of the institutional investor or of the fund.
Proxy advisers are defined as legal persons that analyse, on a professional and commercial basis, the communication of firms and, where relevant, other information of listed companies with a view to informing investors on their voting decisions by providing research, advice or voting recommendations that relate to the exercise of voting rights.
Proxy advisers must publicly disclose any reference to a code of conduct that they apply and report on the application of that code of conduct. They are also required to disclose on, an annual basis, key information in relation to the preparation of their research, advice and voting recommendations.
UCITS and AIFs, or their asset managers, frequently have recourse to the services of proxy advisers while investing in shares traded on regulated markets. As a result of the implementation of the SRD II, the relevant investment funds will be able to rely on the annual disclosures made by proxy advisers in order to assess the accuracy and reliability of the activities provided by the relevant proxy advisers.
Intermediaries are persons – such as investment firms, credit institutions and central securities depositaries – that provide the services of safekeeping of shares, administration of shares or maintenance of securities accounts on behalf of shareholders or other persons.
Intermediaries must, without delay, communicate information on shareholder identity to the investee company and send to the shareholder all information that the company is required to provide to them, to enable the shareholder to exercise the rights deriving from its shares. Furthermore, intermediaries must facilitate the exercise of rights by the shareholder, including the right to participate and vote in general meetings.
Investment funds often do not invest directly in target companies whose shares are traded on regulated markets, but rather through intermediaries or chains of intermediaries. The new provisions aim at preventing such indirect holding structures from constituting an obstacle to shareholder engagement. Thus, investment funds will now be able to rely on their intermediaries in order to obtain the information that the investee company is required to publish and to exercise their rights as shareholders in general meetings of the investee company.
Some aspects to be considered in practice
Given the lack of abundant market practice, it is not yet possible to evaluate the concrete impact of the SRD II on the investment fund sector. Furthermore, there are also some open issues that deserve to be analysed.
In case of delegation of portfolio management to a delegate based in the EU that qualifies as a MiFID investment firm, authorised AIFM or ManCo, the delegate itself falls within the scope of the definition of an asset manager and, as a consequence, within the scope of the SRD II. Nevertheless, it is unclear whether the transparency obligations apply only at the level of the delegated portfolio manager or at both the level of the delegate and the level of the AIFM, ManCo or SIAG that is delegating the portfolio management. The existence of an engagement policy at the level of the delegated portfolio manager could be likely to be regarded as a sufficient justification for an exemption of the delegating AIFM, ManCo or SIAG. However, as part of the initial due diligence requirement and ongoing monitoring of delegates, the MiFID investment firm, authorised AIFM or ManCo must verify whether the engagement policy put in place by the delegate complies with the SRD II and whether the delegate publicly discloses its engagement policy and its implementation.
If the delegate is a third country entity and/or does not qualify as a MiFID investment firm, authorised AIFM or ManCo, the situation becomes more complex. Indeed, even if such entities are considered to be outside the scope of the SRD II, it could be argued that the delegation of portfolio management should not lead to any bypass of the transparency obligations provided for by the SRD II. Therefore, when delegating the portfolio management to a third-country entity, it would be in the interest of the relevant AIFMs, ManCos and SIAGs to contractually oblige the delegated entity to put in place an engagement policy and to comply with the relevant disclosure requirements.
An additional element of complexity is constituted by the overlap between the obligations set forth under the SRD II, on the one hand, and UCITS as well as AIFMD rules, on the other hand, in terms of transparency and voting rights strategy. Indeed, investment fund managers are already obliged under both the UCITS and AIFM regimes to report on investment activities, portfolio composition, turnover costs and conflicts of interests. Furthermore, UCITS ManCos and AIFMs are also required to develop an adequate and effective strategy for determining when and how voting rights attached to instruments held in the managed portfolios are to be exercised to the exclusive benefit of the UCITS/AIF concerned and its investors. Therefore, a key issue for asset managers in the near future will be how to deal with the aforementioned overlap that could lead to an ‘unnecessary duplication of duties for asset managers’.
It is also important to highlight that, despite the silence of the SRD II on this aspect, it seems possible to have a single engagement policy at group level. In such case, the asset manager may insert a link into its own website referring to the website of the group entity where the engagement policy and its annual implementation disclosure are published.
Moreover, since the SRD II does not require the asset manager to have one single engagement policy, it would also be reasonable to permit the asset manager to establish separate engagement policies for each strategy or type of fund or sub-fund it manages in order to take into account their specific features.
Finally, given the great importance attached to environmental, social and governance (ESG) criteria, it is worth mentioning that the engagement policy shall describe, among others, how institutional investors and asset managers monitor investee companies on social and environmental impact and corporate governance.
The development and implementation of an engagement policy requires an investment in people and processes. Engagement with an issuer on a particular issue or theme may last months or years. This requires an extended commitment of skilled experts to monitor assets, prioritise issues for engagement and engage credibly and constructively. Many asset managers see their engagement with investee companies as a competitive advantage. However, some of these benefits accrue not only to the asset manager that incurs the costs of exercising engagement, but also to all other investors.
On the one hand, implementing an engagement policy means challenging issuers’ strategies and decisions, influencing the corporate strategy to further the issuers’ interests, engaging deeply with investee companies, closely monitoring and engaging with boards and management of investee companies. On the other hand, asset managers of UCITS funds will have to assess how such implementation of an engagement policy is compatible with legal investment restrictions applicable to UCITS, pursuant to which a UCITS may not acquire any shares carrying voting rights, which would enable it to exercise significant influence over the management of an issuing body.
Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement, OJ L 132, 20.5.2017, p. 1-25.
European Fund and Asset Management Association, EFAMA’s Views on the European Commission’s legislative proposal for a Directive amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement – ‘Revision Shareholders’ Rights Directive’ (October 2014), p 2, https://www.efama.org/Publications/Public/Corporate_Governance/14-4068_FinalPositionPaperSRDII_290914.pdf