The European Commission has presented a proposal for the revision of the Shareholder Rights Directive with the aim of improving the corporate governance of listed companies in EU countries. The proposed measures are particularly intended to encourage greater shareholder engagement on the part of institutional investors and asset managers, to strengthen certain shareholder rights and to remove obstacles to cross-border voting by shareholders. The most important elements of the proposal are as follows:
- institutional investors and asset managers will be encouraged, by means of a set of disclosure requirements, to pursue an investment strategy that contributes to the medium- to long-term performance of companies in which they invest;
- proxy advisors will be subject to transparency requirements regarding the preparation and quality of their voting recommendations;
- improvements to cross-border voting: intermediaries will be required to facilitate the exercise of voting rights and to co-operate in the identification of shareholders;
- shareholders will have the right to vote on the remuneration policy and on the annual remuneration report ('say on pay');
- significant related-party transactions, e.g. a transaction between the company and a director or a major shareholder, will require the approval of shareholders.
Following various rounds of consultations, the European Commission has identified a number of defects in the corporate governance of listed companies. There appears to be little involvement on the part of shareholders in the companies in which they invest. The investment policy of the most important categories of shareholders – institutional investors and professional asset managers – is, in practice, overly focused on short-term financial performance. Consequently, such shareholders often do not consider it worth their while to invest in 'shareholder engagement', e.g. actively monitoring individual business enterprises, entering into dialogues with the relevant company boards and exercising their own voting rights.
For this reason, the Commission wishes to encourage greater shareholder engagement on the part of institutional investors and asset managers, as it is expected that this will have a beneficial effect on the long-term performance of listed companies. To this end, the Commission has proposed the addition of a set of new provisions in the Shareholder Rights Directive. The intention to revise the Directive had already been announced as part of the Action Plan on European company law and corporate governance, adopted at the end of 2012. In addition, the Commission has adopted a (non-binding) Recommendation aimed at improving the quality of corporate governance reporting.
In its current form, the Commission's proposal will have consequences for – among others – European listed companies and their shareholders, as well as asset managers, intermediaries and proxy advisors. However, the relevant negotiations with the European Parliament and with EU member states have not yet commenced and it therefore remains to be seen whether the amendments to the Directive will be adopted as proposed. This newsletter sets out the most important of the new rules proposed by the Commission.
The Commission proposes a number of new obligations for institutional investors (pension funds and life insurance companies) and asset managers (investment firms and AIFMs). Most of these obligations are in the form of disclosure requirements and, as such, are intended to influence the conduct of these parties by requiring transparency.
Institutional investors and asset managers will be expected to develop an engagement policy in relation to the companies in which they invest and to report on that policy annually. The policy must relate to the monitoring of the investee companies, the establishment of dialogues with them, the exercise of voting rights on shares in such companies and co-operation with the other shareholders. The policy must also cover the management of conflicts of interest. Information about the engagement policy must be published on the institutional investor's or asset manager's website. If an institutional investor or asset manager does not wish to develop such a policy or to publish information about it, it must state this on the website together with an explanation of its reasons ('comply or explain').
Because it is clearly contemplated that these shareholders will co-operate with other shareholders in appropriate cases there is a risk that, in the event of such co-operation, the shareholders will be regarded as having 'acted in concert' and be required to make a mandatory bid. ESMA has previously issued guidelines intended to protect shareholders who consult with each other regarding corporate governance issues against that risk. See our newsletter on this subject.
The proposed rules on the development of an engagement policy and the obligation to report on this policy closely resemble, in terms of their content, the best practices under Principle IV.4 of the Dutch Corporate Governance Code. They also resemble the Eumedion best practices for shareholder engagement. Assuming that the proposed rules are adopted in their current form, they could be implemented through statutory provisions imposing a 'comply or explain' obligation, the same approach taken with respect to the rules in the Dutch Corporate Governance Code.
Disclosure of investment strategy and asset management mandate
The Commission is concerned that institutional investors which use the services of an asset manager often base their investment decisions excessively on short-term considerations. To counteract this, institutional investors will be required under the revised Shareholder Rights Directive to disclose to the public (on the basis of a 'comply or explain' obligation) how their investment strategy contributes to the medium- to long-term performance of the companies in which they invest. Asset managers will in turn be required to report to the investors on a half-yearly basis and to show in such reports that the investments are in line with what has been agreed.
Quality of voting recommendations
Institutional shareholders with highly diversified share portfolios frequently use the services of proxy advisors, which vote on their behalf or advise them on how to vote. Consequently, these advisors have a substantial influence on voting behaviour and outcomes. Under the revised Directive, proxy advisors will be required to adopt and implement adequate measures to guarantee that their voting recommendations are accurate and reliable. They will be required, among other things, to disclose on an annual basis:
- information relating to the preparation of their voting recommendations (methods, information sources);
- whether they have consulted with the companies which are the object of their voting recommendations;
- the total number of staff involved in the preparation of the recommendations and
- the total number of recommendations provided in the last year.
In addition, they will have to disclose to their clients and the relevant company any potential conflicts of interest which they might have, such as where the proxy advisor provides advisory services to a company in which he/it has recommended investing. This will enable shareholders to compare the quality of the various proxy advisors.
This proposal is in line with the new Best Practice Principles for Shareholder Voting Research & Analysis issued on 5 March 2014. The principles apply to voting advisory firms and relate to the quality of their services, the management of conflicts of interest and the firms' communication policies. The principles were drawn up by the sector itself and use the 'comply or explain' approach. Here too, the Commission's proposal will shift the emphasis from self-regulation to statutory rules.
Improvements to voting process
An often-heard complaint is that the voting chain in listed companies does not work properly, especially in cross-border situations. There is usually a chain of intermediaries between a shareholder and the company in which he/it invests, as a result of which it is sometimes unclear whether a vote has actually been cast and, if so, whether it was cast in accordance with the instructions. Listed companies in turn do not know the identity of their shareholders, making it difficult to exchange information and establish a dialogue with them. In order to improve the voting process, the Commission proposes rules under which intermediaries will be required:
- to offer companies the possibility to have their shareholders identified and, on request, to provide their contact details;
- to transmit to shareholders information relating to their shares;
- to facilitate the exercise of voting rights; companies are required to confirm in each case the votes cast.
Intermediaries from non-EU member states will have to comply with the above obligations if they have a branch within the EU. All intermediaries will be entitled to charge fees for these services.
Since 1 July 2013 the Netherlands has had rules governing the identification of shareholders. Unlike the rules proposed by the Commission, however, these rules include a threshold intended to protect smaller shareholders. See our newsletter on the Corporate Governance Act. The significance of the Commission's proposal for the Netherlands lies mainly in the new obligation of intermediaries to ensure that information from the company reaches the shareholders and that shareholders' votes are cast in accordance with their instructions.
Say on pay
An important aim of the proposal is to give shareholders of listed companies more influence over the remuneration of directors. In the Commission's opinion there should be a stronger link between the remuneration and the performance of directors, and shareholders should play a more active role in this regard. For this reason, the Commission proposes not only that shareholders vote on the remuneration policy every three years, but also that they vote every year on the remuneration report issued by the supervisory board. This proposed rule will therefore give shareholders the opportunity to express their disapproval of bonuses that have been granted. Where the shareholders vote against the remuneration report, this does not necessarily mean that the bonus(es) must be adjusted or clawed back. It must, however, be explained in the next remuneration report whether or not and, if so, how, the vote of the shareholders has been taken into account.
At present, shareholders of Dutch listed companies only have the right to vote on the company's future remuneration policy. They do not have any influence on the determination of the remuneration in individual cases; it is generally the supervisory board that is vested with this power. Following the entry into effect of the Clawback of Bonuses Act on 1 January 2014, listed companies are required to include the implementation of the remuneration policy as a separate item on the agenda of the general meeting at which the annual accounts are to be adopted, but the shareholders do not have a right to vote on the implementation. The Commission's proposal therefore represents a change in this regard. If the measures proposed by the Commission are adopted, this may in practice lead to a change in the dynamics of the relationship between shareholders and management board members. For example, it is possible that shareholders will vote against the remuneration report as a means of expressing a more general feeling of dissatisfaction with the board, as currently occurs with shareholder votes on the discharge of management board members from liability.
Another change proposed by the Commission is that the remuneration policy must explain the ratio between the average remuneration of directors and the average remuneration of other employees. At present, similar rules are being drawn up in the Netherlands for companies employing 50 or more individuals. Under those rules, the remuneration ratio will have to be discussed with the company's works council as a separate agenda item.
Approval of related-party transactions
With related-party transactions, there is an increased risk that the conclusion of the transaction in question will not be in the interests of the company. Examples of such transactions are where the counterparty is a director or a major shareholder of the company. In this regard, 'related party' is defined in the same manner as in the IAS accounting standards. On various occasions, there have been calls by both legal commentators and practitioners for EU-level rules on this subject.
To protect shareholders against disadvantageous transactions, the Commission proposes the following:
- a listed company must publicly announce transactions with related parties where the transaction represents more than 1% of the company's assets;
- the announcement must be accompanied by a 'fairness opinion' drawn up by an independent third party and providing certain information on the terms of the transaction;
- transactions with related parties representing more than 5% of the company's assets or having a significant impact on the company's profits or turnover must be submitted to a vote by the shareholders in a general meeting. Where the related party is a shareholder, that shareholder may not take part in the voting.
EU member states will be allowed to exempt transactions between group companies from the above rules. They will also be allowed to permit companies to annually obtain advance approval for specific recurring transactions with related parties. This will essentially entail an authorisation by the shareholders to the company's board for a maximum period of 12 months to enter into these specific transactions.
In the Netherlands, the phenomenon of related-party transactions is not a common one in listed companies: according to the impact assessment accompanying the Commission's proposal, no related-party transactions were reported in the annual accounts of Dutch listed companies over the last three years. Furthermore, there is already a statutory rule that prohibits management board members and supervisory board members from participating in consultations and decision-making on any subject or transaction in relation to which the relevant board member has a conflict of interests. However, no such rules apply where there is a conflict of interests on the part of a major shareholder.
Recommendation on the quality of corporate governance reporting
Besides the proposed changes to the Shareholder Rights Directive, the Commission has published a (non-binding) Recommendation intended to improve the quality of corporate governance reporting by listed companies. Under the current rules, the management report of a listed company must include a description of the company's corporate governance and must state how the company is applying the national corporate governance code. According to the Commission, the quality of those statements leaves much to be desired, thereby undermining the effectiveness of the 'comply or explain' approach. The Dutch Corporate Governance Code Monitoring Committee has also called attention to this problem on numerous occasions.
In the Recommendation, the Commission urges listed companies to describe how they are applying the Code's main provisions. If a company has departed from a Code provision, the Commission urges it to not only give the reason(s) for the departure but also provide insight into the decision-making process leading up to it. In this way the Commission is trying to prevent the use of standard answers and to consequently ensure that shareholders are given real insight into the company's corporate governance.
The proposed measures will give a new impulse to shareholder engagement. They will most likely be amended during the negotiating process, but the extent of the amendments cannot be predicted. In any event, it will be quite a while before changes to Dutch law are required. If you wish to express your views on the proposed measures, you can participate in the ongoing market consultation that has been initiated by the Ministry of Security and Justice.