1) What are the main goals of SRD II, and the expected benefits for issuers and investors?
The first Shareholder Rights Directive (SRD) came into force in 2007. It sought to foster shareholder engagement by implementing rules around transparency, proxy voting rights and the ability to vote in general meetings via electronic means.
However, the 2008 financial crisis exposed a number of shortcomings with the original directive. The European Commission highlighted the following in particular:
- Shareholders often supported managers’ excessive short-term risk-taking, with too much focus on short-term returns
- Shareholders lacked the means to effectively monitor the companies in which they invested
- Deficiencies were apparent in the engagement and control by long-term shareholders, active managers and institutional investors
- Some directors’ remuneration was felt to be excessive and not justified by their company’s performance
- Exercising shareholder rights was often complicated and costly, especially in cross-border situations where intermediaries could be located in different jurisdictions
SRD II – which was published on 17 May 2017 and is scheduled to take effect during Q2 2019 – aims to tackle these shortcomings. Its central focus is on encouraging more long-term shareholder engagement, enhancing transparency in the voting process and improving issuer-investor dialogue.
One new requirement for institutional issuers, such as asset managers, pension funds and insurance companies, is to develop and publicly disclose their engagement policy towards their shareholders. If these issuers chose not to do so, they must explain why.
SRD II also seeks to make it easier for shareholders to exercise their rights, and facilitate cross-border voting. To this end, intermediaries will have to ensure they pass relevant information from the issuer on to shareholders, and vice versa.
Another focus is on increasing transparency in the voting process, including where the services of a third party – such as proxy advisors or an investee company – are used. This implies new requirements on shareholder identification so issuers can communicate directly with investors, and transparency of proxy advisor policies.
The other big change is a “say on pay.” This gives shareholders a right to vote during the general meeting on the directors’ remuneration policy, as well as on the remuneration report that details individual directors’ remuneration in the previous financial year.
BNP Paribas Securities Services supports these goals. As we noted in an earlier regulation memo, increased transparency could facilitate more dialogue between issuers and their shareholders. And when combined with other initiatives targeting long-term engagement and funding source diversification for issuers, SRD II could lead to longer-term engagement and investment in issuing companies.
2) What does SRD II mean for custodians and other intermediaries?
SRD II needs to be read in conjunction with the Commission Implementing Regulation 2018/1212, dated 3 September 2018. This contains a prescriptive list of obligations for both issuers and intermediaries, including custodians and other securities services providers.
The first new requirement is technological. Under SRD II and the Implementing Regulation, any transmission between intermediaries will need to be made in electronic and machine readable ISO formats.
Other new requirements affecting intermediaries relate to the organisation of general meetings and corporate events, in an effort to enhance the efficiency of the chain of intermediaries and improve the transmission of information along it.
For instance, the last intermediary in the chain must confirm to the shareholder (or a third party nominated by the shareholder) their entitlement to exercise their shareholder rights in a general meeting. Intermediaries must also transmit to the issuer updated notices of shareholder participation in the general meeting, while the last intermediary must ensure the information regarding the number voted is consistent with the entitled position. The receipt, recording and counting of votes need to be confirmed as well.
The information to be provided on corporate events gives intermediaries strict deadlines regarding corporate actions and shareholder identification processes. Notably, the first intermediary, and any other intermediary that receives information regarding a corporate event, should transmit that information to the next intermediary in the chain without delay, and no later than the close of the same business day. This emphasis on immediate information transmission is challenging both technologically and practically.
Likewise, any request to disclose a shareholder’s identity should be transmitted by intermediaries to the next intermediary in the chain without delay, and no later than the close of the same business day on which the request was received. Responses to such requests must then be provided and transmitted by each intermediary to the addressee defined in the request without delay, and no later than during the business day immediately after.
The Implementing Regulation driving these changes will be applicable from 3 September 2020.
3) Can technology - and distributed ledger technology (DLT) in particular - redefine the relationships between issuers and their shareholders?
Where there is a chain of intermediaries, especially in cross-border situations, and the parties have to transmit specific information in ISO format and using electronic means along that chain without delay, then new technologies, especially DLT, could help firms meet the new requirements.
BNP Paribas Securities Services is currently involved in various discussions and market initiatives in this area. For example, we are collaborating with a number of large custodians and market infrastructures on the potential to create some independent utilities or market standards to function as a golden source that all intermediaries along the chain can use. BNP Paribas Securities Services strongly believes only a market-driven solution will have a chance of being successful.
DLT is one of the options the industry is investigating, as by its nature the technology would enable us to comply with the directive’s transparency requirements. In addition, the Implementing Regulation requires intermediaries to transmit the relevant information immediately, something for which distributed ledger technology is well-suited.
DLT use cases have been relatively limited to date, but there is a real trend emerging for market players and market infrastructures to leverage the technology. For example, the Australian Securities Exchange (ASX) plans to go live with a new DLT-based equity clearing, settlement and registry system by 2021, which it expects to result in better record keeping and data quality, streamlined reconciliations and more timely transactions.
Hong Kong Exchange and Clearing Limited (HKEX) is also working with Digital Asset on a post-trade allocation and settlement initiation platform to process China-listed A-shares under the Stock Connect programme. HKEX believes blockchain could help tackle the post-trade operational challenges that result from the tight settlement cycle for mainland China transactions.
Whether DLT can provide the solution to our SRD II obligations remains to be seen. But whatever solution we arrive at, we are confident technology can help market participants provide the new services demanded by the directive.
4) Will SRD II be applied in a harmonised way across Europe?
The fact that SRD II is a directive, rather than a regulation, means EU Member States have some discretion in how they transpose the rules into their respective national laws. That creates the potential for different interpretations.
This potential for divergence is exacerbated by specific provisions within the directive itself, which allow Member States to deviate in key areas. In particular, Article 9.c.6 indicates that Member States may elect to exclude certain transactions from the scope of the directive, namely:
- Intragroup transactions.
- Certain types of transactions for which national law requires approval by the general meetings.
- Transactions regarding remuneration of directors.
- Transactions entered into by credit institutions when financial stability is at stake.
Another question mark is whether end investors will be able to choose not to receive general meeting information. Will such an “opt out” possibility be written into national laws when the directive is transposed? If so, intermediaries would need to filter information and customise reports based on what each investor wants to do, which would be an administrative headache.
Brexit poses a further complication, since the date for Member State transposition is after 29 March 2019, when the UK is due to leave the European Union.
That said, SRD II has some extraterritorial scope. Its provisions apply to third-country intermediaries if they provide services for shares of companies whose registered office is in the EU, and the shares are admitted to trading on a regulated market in the Union. Third-country proxy advisors would also be subject to the directive as soon as they carry out their activities through an establishment in the Union, regardless of their form. Post-Brexit, UK-based institutions, as third-party providers, would therefore be captured by the directive’s provisions if they want to continue offering services within the EU.
Similarly, an industry-wide IT solution would need to cope with all Member States’ requirements. Harmonising the rules would help such a utility to generate the greatest possible efficiencies.
The wording of the EU directive 2017/828 can be downloaded here