Just before Easter, the European Union finally adopted the Shareholders’ Rights Directive that is encouraging institutional investors to behave more as active and responsible owners. After ten years of dispute, the European Council followed the EU Commission and Parliament and gave its green light for the comprehensive directive that applies to more than 8.000 listed companies. The member states have now up to two years to transpose the new provision into domestic law.
Active and responsible ownership is the main element of the new EU directive which aims to encourage a more long-term approach compared to the short-term investment horizons that added up to the financial crisis. EU explicitly calls for the active ownership used to strengthen listed companies’ environmental and social issues. In addition, EU objectives are to create a closer link between extremely high fees for CEOs and their performance. The communication between shareholders and the companies they invest in, should also be less disturbed by “intermediary agent” as proxy voting companies and other financial service companies.
Strengthening active ownership
The new directive encourages institutional investors and asset managers to formulate a long-term policy for their investment and active ownership, incorporating social and environmental factors among other things. According to the directive, “institutional investors and asset managers should be more transparent in their approach to active ownership. Either they must develop and publish a policy of active ownership or explain why they have chosen not to do this”. A ‘comply or explain’ approach is similarly applied in corporate governance codes and stewardship codes.
The policy of active ownership should describe how institutional investors and asset managers integrate active ownership in their investment strategy, which engagement activities they have chosen and how they conduct the engagement. This applies especially to the management of their voting rights through proxy voting which, according to the EU, is an essential part of active ownership. To avoid excessive administrative costs, it should be possible to abstain from voting on the portfolio companies in which the interest is relatively lower than in other companies or where the individual investor did not have much impact. Voting should follow a clear policy and actual voting of the individual companies should be in line with the published EU directive.
The engagement policy should also include guidelines for handling conflicts of interest, especially in situations where institutional investors, asset managers and their partners have significant business interests in relation to the portfolio companies they wish to influence.
“Say on Pay”
Apart from the need for more active and responsible ownership, the new Shareholder’s Rights Directive also outlines a number of other elements which may be important for companies and investors both inside and outside the EU. A key point is greater openness about proxy voting advisors. They are encouraged to publish more information about the reasons for their recommendations and advice.
The directive also strengthens the opportunities for institutional investors in terms of cross-border voting as the new provisions will facilitate the process for shareholders resident in another EU country than their investee companies. Conversely, companies should have better opportunities to identify their shareholders. The purpose is to obtain a more direct contact between the two sides, between the outside layer of the advisors and service providers which, according to the European Union, can be a barrier to the information flows between them and the shareholders. Moreover, the directive will require companies to publicly disclose material related party transactions. These rules aim to protect minority shareholders against abuse.
Finally, EU wishes to encourage greater transparency and accountability regarding director’s remuneration. As highlighted by the EU it “plays a key role in aligning the interests of directors and shareholders and ensuring that the directors act in the best interest of the company”. In the future, shareholders should have better information on the level of payments to corporate top management and should be better equipped to ensure that the remuneration is commensurate with the financial results.