FSO Alert: Commission proposes Directive on institutional long-term shareholder engagement
In April 2014, the European Commission proposed a Directive on the encouragement of long-term shareholder engagement by institutional investors and asset managers, and on elements of listed companies’ corporate governance practice, including remuneration.
The proposed Directive aims to:
- Improve engagement of institutional investors – life insurers and pension funds – and asset managers
- Strengthen the link between pay and performance of directors
- Improve shareholder oversight on related party transactions
- Enhance transparency of proxy advisors
- Facilitate the exercise of rights flowing from securities for investors
The proposal amends the Shareholder Rights Directive as regards the encouragement of long-term shareholder engagement.
At the same time, the Commission adopted a Recommendation on the quality of corporate governance reporting (“comply or explain”).
Institutional investors and asset managers
Institutional investors and asset managers will be required to develop a policy on shareholder engagement. This engagement policy will determine how institutional investors and asset managers conduct all of the following actions:
- Integrate shareholder engagement in their investment strategy
- Monitor investee companies, including on their non-financial performance
- Conduct dialogues with investee companies
- Exercise voting rights
- Use services provided by proxy advisors
- Cooperate with other shareholders
The engagement policy should include policies to manage actual or potential conflicts of interests in respect of shareholder engagement.
Institutional investors and asset managers will be required to publicly disclose their engagement policy on an annual basis along with an explanation on how it has been implemented and the results thereof.
Where institutional investors and asset managers decide not to develop an engagement policy or decide not to disclose the implementation and results thereof, they will have to give a clear and reasoned explanation.
Institutional investors will be required to disclose how their equity investment strategy:
- Is aligned with the profile and duration of their liabilities
- Contributes to the medium to long-term performance of their assets
When an asset manager invests on behalf of an institutional investor, either on a discretionary client-by-client basis or through a collective investment undertaking, the institutional investor will be required to disclose to the public the main elements of the arrangement with the asset manager on an annual basis, including:
- Whether and to what extent it incentivizes the asset manager:
- To align its investment strategy and decisions with the profile and duration of its liabilities
- To make investment decisions based on medium to long-term company performance and to engage with companies as a way of improving company performance to deliver investment returns
- The method and time horizon of the evaluation of the asset manager’s performance
- How the structure of the consideration for the asset management services contributes to the alignment of the investment decisions of the asset manager with the profile and duration of the liabilities of the institutional investor
- The targeted portfolio turnover or turnover range
Asset managers will have to disclose to institutional investors, on a half yearly basis, inter alia, the following information:
- Whether investment decisions are made on the basis of judgments about medium to long-term performance of the investee company, and if so, how
- Portfolio composition, and significant changes
- Portfolio turnover
- Portfolio turnover costs
- Securities lending policy and implementation
- Any actual or potential conflicts of interest, and how they have been handled
- Use of proxy advisors
Proxy advisors will have to adopt and implement adequate measures to guarantee that their voting recommendations are accurate, reliable and based on a thorough analysis of all the information available to them.
Each year, they will have to publicly disclose information, inter alia on:
- Features of the methodologies and models applied
- Main information sources used
- Whether or not national market, legal and regulatory conditions are taken into account and, if so, how
- Nature of dialogues with the companies which are the object of their voting recommendations
- Total number of staff involved
- Total number of voting recommendations provided in the last year
Listed company transparency
Shareholders of listed companies will be given the right to vote on the remuneration policy applied to directors.
The remuneration policy must be clear, understandable and in line with the business strategy, objectives, values and long-term interests of the company. It also has to incorporate measures to avoid conflicts of interest.
The remuneration policy will have to, inter alia:
- Explain how it contributes to the long-term interests and sustainability of the company
- Set clear criteria for the award of fixed and variable remuneration
- Indicate the maximum amounts of total remuneration that can be awarded, and the relative proportion of fixed and variable remuneration
- For variable remuneration, indicate financial and non-financial performance criteria to be used, and specify deferral periods, vesting periods and retention of shares after vesting, and clawbacks
- Indicate the main terms of the contracts of directors
- Explain the decision-making process leading to its determination
Companies will be required to draw up a clear and understandable remuneration report, providing a comprehensive overview of the remuneration, including all benefits in whatever form, granted to individual directors, including to newly recruited and former directors.
The report will have to contain, inter alia:
- The total remuneration awarded or paid split out by component
- The relative change of the remuneration of directors over the last three financial years, its relation to the development of the value of the company
- Any remuneration received by directors of the company from any undertaking belonging to the same group
- The number of shares and share options granted or offered, and the main conditions for the exercise of the rights
- Information on the use of the possibility to reclaim variable remuneration
- Information on how the remuneration of directors was established, including on the role of the remuneration committee
Related party transactions
The proposal requires:
- Public disclosure of important related party transactions involving 1% of companies’ assets accompanied by a report from an independent third party assessing whether or not it is on market terms
- Shareholder approval of the most important related party transactions involving more than 5% of companies’ assets, or transactions which can have a significant impact on profit or turnover
Comply or explain principle
The European Commission’s Recommendation on the quality of corporate governance reporting aims to improve the way listed companies apply the “comply or explain” principle. This principle gives companies the possibility to depart from parts of the applicable corporate governance code provided that they explain the reasons for doing so.
Listed companies are requested to provide information about specific aspects of their corporate governance arrangements in a corporate governance statement.
According to the Recommendation, companies should describe how they have applied the relevant corporate governance code on the topics of most relevance for shareholders in a clear, accurate and comprehensive manner.
Companies that depart from their applicable codes are recommended to:
- Explain how the company has departed from a recommendation of the applicable code
- Describe the reasons for the departure
- Describe how the decision was taken
- Where the departure is limited in time, explain when the company envisages complying with a particular recommendation
- Where applicable, describe the measure taken instead of compliance and explain how that measure contributes to good corporate governance of the company
The information should be accurate, comprehensive and clearly presented to enable shareholders, investors and other stakeholders to assess the consequences arising from the departure from a particular recommendation, and therefore have a better understanding of the manner in which the company is governed.
Intermediaries holding shares of companies on behalf of shareholders will be required to disclose the contact details of shareholders to the company. Such information would allow listed companies to:
- Communicate directly with their shareholders
- Proactively engage with shareholders
- Enter into discussions on relevant issues, including corporate governance matters with shareholders
If a company decides not to communicate directly with its shareholders, the intermediaries will be required to transmit to shareholders the information related to their shares, without undue delay.
This exchange of information may only be used for the purpose of facilitating the exercise of shareholder rights.
 Directive 2007/36/EC on the exercise of certain rights of shareholders in listed companies.
Download the FSO Alert (pdf, 304kb).