The Financial Conduct Authority (FCA) has recently published a consultation paper on proposals to implement the provisions of the revised Shareholder Rights Directive (SRD II). Comments on the consultation are due by 27 March 2019.
What is the Shareholders Rights Directive?
SRD II is a European Union directive which aims to promote effective stewardship and long-term investment decision making. Effective stewardship relies upon an appropriate flow of information between asset owners, asset managers and investee companies. SRD II seeks to assist this by enhancing the transparency of both engagement policies and investment strategies across the institutional investment community.
Who will be affected by the proposed changes?
The proposals will have direct impacts for FCA-regulated asset managers and life insurers, as well as to issuers of shares which are admitted to trading on the London Stock Exchange or other UK regulated markets.
The FCA intends to implement its proposed changes with a territorial scope going beyond that envisaged in SRD II, capturing:
- UK branches of non-EEA investment firms;
- engagement by UK regulated managers and certain asset owners with investee companies admitted to trading on both EEA regulated markets and comparable markets outside the EEA; and
- Overseas listed companies with UK secondary listings, who will have to make some additional disclosures to the market, if they are not already subject to a similar regime in their home jurisdiction.
What changes does the consultation propose for those affected?
Asset managers (including AIFMs, but excluding small ones, and UCITS managers) will require to:
- develop and publicly disclose shareholder engagement policies which include statements on how they
- monitor investee companies on:
– financial and non-financial performance and risk
– capital structure
– social and environmental impact
– corporate governance;
- engage in dialogue with companies that they invest in;
- exercise voting rights and other rights attached to shares;
- cooperate with other shareholders;
- communicate with relevant stakeholders of companies that they invest in;
- manage actual and potential conflicts of interest from their engagement.
Where a firm has chosen not to include a policy on any of these specific elements, it must publicly disclose a clear and reasoned explanation of why.
- publicly disclose annually how these policies have been implemented (in each case on a ‘comply or explain’ basis). Annual reporting will include a general description of voting behaviour, an explanation of the most significant votes and details of any use of the services of proxy advisors; and
- make disclosures (at least annually) to the firms and funds they provide services to:
- explaining how their investment strategies are consistent with the medium and long-term performance of the assets of the asset owner or fund;
- giving information on key medium and long term risks, portfolio composition and turnover (and related costs), use of proxy services and policy on securities lending;
- explaining whether (and how) they evaluate based on medium to long term financial and non-financial performance;
- on conflicts arising and how these have been addressed.
Firms managing investments for certain professional clients are, of course, already obliged to disclose the nature of their commitment to the FRC’s Stewardship Code (or, if they do not adopt this, their alternative strategy). As noted below the FRC is proposing significant changes to the Stewardship Code and the FCA is not currently proposing any change to this rule pending the outcome of the FRC consultation. The FCA has, however, indicated that it would welcome any views on the interaction between this rule and the new proposals described above.
Life insurers subject to Solvency II will require to:
- develop and publicly disclose their engagement policies on the same basis as asset managers as described above;
- publicly disclose how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities, long-term liabilities, and how these elements of their strategy contribute to the medium to long-term performance of their assets;
- make disclosures about their arrangements with asset managers including:
- explaining how the arrangements incentivise alignment with the profile and duration of the insurer’s liabilities;
- how the arrangements incentivise assessment of medium to long term financial and non-financial performance and engagement;
- how their arrangements for evaluation of the asset manager’s performance and its remuneration align with the profile and duration of the insurer’s liabilities;
- how portfolio turnover is assessed and how turnover costs are monitored; and
- the duration of arrangements.
UK companies with shares admitted on a regulated market will be required to disclose and seek board approval for third party transactions. The UK Listing Rules already have extensive related party requirements for premium listed companies, often more stringent than the minimum requirements included in the Directive. The changes broadly leave the existing premium listing regime intact with only limited additional disclosure requirements. So for premium listed companies little will change (although as the definition of “related party” for this rule follows IAS 24 (which is wider than the Listing Rules definition), there will be some slight expansion of the transactions caught. However, as noted above, the new rules will increase disclosure requirements for those without a premium listing, who are not subject to the related party regime in the Listing Rules. This will, as noted above, include some overseas companies with secondary listings in the UK.
How does this relate to other ongoing consultations on Stewardship?
This consultation paper has been issued at the same time as the Financial Reporting Council’s (FRC) own consultation paper on proposed changes to its Stewardship Code and the FCA’s Discussion Paper on the design and operation of a regulatory framework for “effective stewardship”. FCA clearly views the proposed changes as part of a continuum in this area and further developments should be expected.
Commenting on the FRC’s proposals for the 2019 Stewardship Code Sir Win Bischoff, Chair of the FRC said:
“The new Stewardship Code will play a key role in complementing the stronger corporate governance provisions that took effect at the start of this year. The FRC conducted extensive outreach in early 2018 to inform this review of the Stewardship Code. It recognises the significant changes in the investment industry and stewardship landscape since the 2012 revision. It sets both higher expectations for stewardship practice and introduces more rigorous public reporting with a focus on outcomes and effectiveness. We believe the changes proposed put it at the forefront of stewardship internationally.”
The FCA’s view is that effective stewardship activities enhance the quality and integrity of the UK’s financial markets and in its companion Discussion Paper the FCA notes that:
“We have an opportunity to ensure any new UK standards that are developed contribute to establishing global best practice. This is not only in the interests of investors and investee companies, but should also have a clear benefit for the broad institutional investment community on which individuals and households increasingly rely to look after their financial interest.”
What about Brexit?
The FCA has drafted the proposals presuming a transition period for EU withdrawal is agreed (with EU law continuing to apply to the UK until 31 December 2020). On this basis, SRD II must be implemented in the UK by 10 June 2019. However, if the UK departs from the EU without an implementation period, the FCA has indicated that it will not proceed with the proposals in their current form but will be developing further proposals.