Overview of the EU Shareholder Rights Directive II
What is the law?
Directive (EU) 2017/828 (“SRD II”), amending the Shareholder Rights Directive (2007/36/EC), came into force on 9 June 2017 [link]. SRD II introduced new transparency obligations on “institutional investors”1 (life assurance undertakings and occupational pension schemes) and “asset managers”2 (alternative investment fund managers (“AIFMs”) (excluding sub-threshold AIFMs), MiFID firms providing portfolio management, UCITS management companies and self-managed UCITS) investing in shares listed on a regulated EEA market.3
What is the impact of SRD II on asset managers with regards to their ESG programmes?
Shareholder Engagement Policy - One of the reasons for amending the Shareholder Rights Directive was to obtain greater shareholder engagement in corporate governance, since it is “one of the levers that can help improve the financial and non-financial performance of companies,”4 including as regards environmental, social and governance (“ESG”) factors, in particular as referred to in the Principles for Responsible Investment.5
SRD II requires in scope institutional investors and asset managers to develop and publicly disclose an engagement policy that describes how they integrate shareholder engagement in their investment strategy. The policy must describe, amongst other things, how they:
- monitor investee companies on relevant matters, including strategy, financial and non-financial performance and risk, capital structure, social and environmental impact and corporate governance;
- conduct dialogues with investee companies;
- exercise voting rights and other rights attached to shares;
- co-operate with other shareholders;
- communicate with relevant stakeholders of the investee companies; and
- manage actual and potential conflicts of interests in relation to their engagement.
On an annual basis, institutional investors and asset managers that are subject to SRD II must publicly disclose how their engagement policy has been implemented, including a general description of voting behaviour, an explanation of the most significant votes and the use of the services of proxy advisors. Alternatively, asset managers can publicly disclose a clear and reasoned explanation as to why they have chosen not to implement a policy.
This information must be available free of charge online.
Transparency of Asset Managers - SRD II requires asset managers to report certain information, on an annual basis, to institutional investors for whom they act either with the annual report referred to in Article 68 of the UCITS Directive6 or in Article 22 of the AIFMD,7 or in periodic communications referred to in Article 25(6) of MiFID II.8 This information includes details on the use of proxy advisors for the purpose of engagement activities and how they make investment decisions based on evaluation of medium to long-term performance of the investee company, including non-financial performance. Such information should indicate whether the asset manager adopts a long-term oriented and active approach to asset management and takes ESG factors into account.
Transparency of Institutional Investors - Where an asset manager invests on behalf of an institutional investor, whether on a discretionary client-by-client basis or through an investment fund, it must disclose on an annual basis to the institutional investor how its investment strategy and implementation thereof complies with the arrangement and contributes to the medium to long-term performance of the assets of the institutional investor or of a fund managed by the institutional investor. Key requirements from an ESG perspective include:
- how that arrangement incentivizes the asset manager to make investment decisions based on assessments about medium to long term financial and non-financial performance (including ESG factors) of the investee company and to engage with investee companies in order to improve their performance in the medium to long-term; and
- how the method and time horizon of the evaluation of the asset manager’s performance and the remuneration for asset management services are in line with the profile and duration of the liabilities of the institutional investor, in particular long-term liabilities, and take absolute long-term performance into account. Directors’ performance should be assessed using both financial and non-financial performance criteria, including, where appropriate, ESG factors.
Asset managers investing on behalf of institutional investors need to be able to justify their investment decisions and show that they have assessed a company’s long-term performance both financially and non- financially (i.e. taking into account ESG factors). Where the arrangement with the asset manager does not contain one or more of these elements, the institutional investor must give a clear and reasoned explanation as to why this is the case. For institutional investors regulated by the Solvency II Directive9 this information may be included in their solvency and financial condition report referred to in Article 51 of that directive.
What is the timeline and what actions need to be taken?
EU Member States had until 10 June 2019 to transpose the provisions of SRD II into national law. As such, asset managers should now have adopted SRD II compliant shareholder engagement policies or disclosed a clear and reasoned explanation as to why they have chosen not to comply with this requirement.
How might non-EU asset managers be effected by the SRD II?
It is worth emphasising that although the principal impact of SRD II will be felt directly as a regulatory matter by EU asset managers, non-EU asset managers may also be indirectly in scope of the requirements of SRD II. For example, delegate investment managers located in third countries (e.g. US registered investment advisers in the United States) may be required to provide details of their shareholder engagement policies and procedures to assist ‘in scope’ asset managers implement their policies. This indirect impact on non-EU asset managers is not unique, indeed similar indirect impact can be seen under other pieces of EU legislation, such as the Non-Financial Reporting Directive10 and the proposed ESG driven amendments to the AIFMD and the UCITS Directive.11
1) ‘institutional investor’ means: (i) an undertaking carrying out activities of life assurance within the meaning of points (a), (b) and (c) of Article 2(3) of Directive 2009/138/EC of the European Parliament and of the Council (4), and of reinsurance as defined in point (7) of Article 13 of that Directive provided that those activities cover life-insurance obligations, and which is not excluded pursuant to that Directive; (ii) an institution for occupational retirement provision falling within the scope of Directive (EU) 2016/2341 of the European Parliament and of the Council (5) in accordance with Article 2 thereof, unless a Member State has chosen not to apply that Directive in whole or in parts to that institution in accordance with Article 5 of that Directive.
2) ‘asset manager’ means an investment firm as defined in point (1) of Article 4(1) of Directive 2014/65/EU (MiFID II) that provides portfolio management services to investors, an AIFM (alternative investment fund manager) as defined in point (b) of Article 4(1) of Directive 2011/61/EU that does not fulfil the conditions for an exemption in accordance with Article 3 of that Directive or a management company as defined in point (b) of Article 2(1) of Directive 2009/65/EC or an investment company that is authorised in accordance with Directive 2009/65/EC (UCITS Directive), provided that it has not designated a management company authorised under that Directive for its management.
3) The UK’s Financial Conduct Authority has gold-plated the definition of “regulated market” to include any European Economic Area (EEA) regulated market and certain markets situated outside the EEA.
4) Recital 14 SRD II.
5) For more information on the Principles for Responsible Investment, please see our article Overview of the Principles for responsible investment.
6) Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities.
7) Directive 2011/61/EU on Alternative Investment Fund managers.
8) Directive 2014/65/EU on markets in financial instruments.
9) Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance
10) For more information on the Non-Financial Reporting Directive, please see our article ESG Snapshot - Overview of the EU Non-financial-reporting Directive
11) For more information on the ESG driven amendments to AIFMD and UCITS Directive, please see our article ESG Snapshot - Overview of the ESG driven amendment-to-AIFMD and- the UCITS Directive.