Shareholders’ Rights regulation:
the undercover game changer
The Shareholders’ Rights Directive II (SRD II) is an example of a regulation that flew just under the radar for all stakeholders, ever since its negotiation phase before 2017.
Pascal Eber – Partner - Operations Excellence & Human capital - Deloitte
Pascal Martino – Partner - Banking Leader - Deloitte
Simon Ramos – Partner - IM Advisory & Consulting Leader - Deloitte
Benoit Sauvage – Director - RegWatch, Strategy & Consulting - Deloitte
Philippe Hijazin – Senior Manager - Strategy Regulatory & Corporate Finance - Deloitte
Astrid Brandy – Manager - Operations Excellence & Human Capital - Deloitte
Published on 14 October 2019
The purpose of SRD II is to allow retail investors to participate in the life of the companies in which they invest, and ensure long-term engagement.
The EU Commission was of the view that investors were not well informed about their investments, hence too easily willing to dispose of them if news (and stock prices) were not satisfactory. This phenomenon easily created a short-term view of investments, which is adverse to the development of strong EU firms. SRD II is therefore designed to help investors develop long-term involvements and become active in the companies they invest in.
How to meet the goals
The scope of SRD II concerns all investors holding EU equity shares or equivalent instruments. Beyond that, SRD II builds on 5 fundamental axes:
- Information should reach all investors, large and small.
- Investment firms have to communicate their “engagement policies” when they act on behalf of investors through financial product management services.
- Issuers have a right to know who their investors are.
- Issuers have to disclose adequate information (e.g.: directors’ remuneration and material transactions bearing potential conflicts of interests).
- Intermediaries of the investment process have to cooperate.
In a nutshell, SRD II implies that all investors should have access to information about a general assembly meeting, should be able to vote and see the result of their vote. All of these prerogatives must be complied with within pre-determined time frames that are close to real time.
Similarly, in order to better engage with their investors, issuers might wish to ask financial intermediaries if they have investors in their company. The latter will have to process and answer the request for information, within the day following its reception.
SRD II Challenges
A two-phased implementation timeline
On paper, SRD II seems pretty simple, as it aims to facilitate communication between issuers and investors. Nonetheless, the first challenge is often to identify the information to share regarding annual general meetings (AGM) by the issuer itself, although for this article we will assume that this is adequately produced, and move on the next steps.
So, we assume the issuer has the information, and has to pass it to the different intermediaries. The normal process entails that the issuer informs its Central Securities Depositary (CSD), its issuing agent. The CSD connects with its clients, the custodian banks. These custodians pass the information down the chain, until it finally reaches the “ultimate” shareholder, who often is an individual, although it could be a fund, a pension plan or any other legal entity. This requires that at any time, all investors (including ones who may only possess one share) can be identified.
Then a second challenge arises: investors might wish to vote. So far, unfortunately, when (and if) the information reaches the investors, the process often stops there. Investors, unless particularly willing to be active, rarely vote and do not take part in the AGM, which might even be held in a different Member State as a further deterrent. With SRD II, financial intermediaries will have to track information recipients, propose voting options, and ensure that a mechanism to vote exists for all investors, either through traditional voting, or via a proxy arrangement that must be created and formalized.
As a third challenge, when firms manage client assets, they now have to define and disclose their engagement policy (beginning in June 2019), explaining how financial intermediaries, asset managers, and other parties involved will vote when they represent investors. UCITS and AIFs are directly impacted by this aspect of the directive, but other forms of collective management of assets (typically discretionary portfolio managers) should also consider if, and how, they might draft a similar voting policy.
The fourth and probably most complex challenge is related to the fact that, at any moment, issuers can ask to identify who their shareowners are. The underlying difficulty lies in the criteria proposed by the EU Directive: identification might be subject to an ownership threshold of 0.5%. Member States might chose to go below that minimum, down to ownership of one share, with identification to be reported within 24 hours. In addition to the lack of harmonized definition of the notion of shareholder itself, the relevant percentage of detention to identify shareholders therefore varies from one Member State to the other.
Individually, the four previously-mentioned challenges would already weigh heavily on any organization, but in the case of shareholders’ rights regulation, these challenges are combined, with the additional twist that, at the present stage, not all useful templates are fully developed or available to the stakeholders, especially smaller ones.
Potential impacts on the ecosystem
Jumping from SRD to the new digital financial organization
Looking at SRD II requirements, as well as a broader regulatory trend, we can observe, once again, that data management is essential. SRD II includes an obligation to provide access to data in extremely short time windows, which means that manual or ad hoc processes are impossible to sustain on such a large scale.
As SRD II dictates, financial intermediaries must respond to demands from issuers within the same business day that they received the information (and if the request is received after 16:00, the answer should be transferred no later than 10:00 the next business day). Responding requires the identification of any shareholder, potentially even one holding only one share, anywhere in the network (and the globe), and reporting along the channel chosen by the issuer, taking into consideration that not everyone uses the SWIFT communication network. This means that not only should the data be available, but also that this exchange must be fully automated.
SRD II meets data management
This is where we have identified the first major challenge outside of the pure scope of SRD II: granularity of data and accessibility to data. Not only should the financial institution be able to identify its investor clients, but they should also accompany that identification with any relevant information available, either internally or through a network of linked entities (other banks or investment firms). This requires a robust data system, which may also be used as key strategic management tool. Indeed, the implementation of such a data system would allow financial institutions to exploit data, and combine it with artificial intelligence, robo-advising, and similar tools.
This represents a tremendous opportunity for financial institutions to deploy customized services, products, payment schemes, and any other type of tailored offer, provided that GDPR compliance is ensured.
Data granularity and its accessibility in a readily exploitable form will, therefore, become of utmost importance for SRD II, with a collateral potential for business development. Financial intermediaries must be able to locate any investors in any products instantaneously.
SRD II meets ESG requirements
A second, broader point of attention raised by SRD II concerns ESG (environmental, social and governance) policies. There is, indeed, an overlap of SRD and ESG regulatory demands. This will have an impact on the image of financial institutions: are they supporting ESG, and Paris Agreement goals? This will stem from the engagement policy that any representative of investors will have to communicate to the public. When creating a link with ESG regulatoryrequirements, how does the firm engage and use its voting rights for its investors? How does it communicate about this, and, above all, what happens in case of inconsistency between the ESG image that the financial institution wants to project, and the reality of how it can actually act (namely helping via votes in AGM) to force a move towards a more sustainable economy and world?
The SRD II requires financial intermediaries concerned by the directive to disclose on their website how they plan to vote in AGMs. ESG regulations, on the other hand, require firms to publicize and be transparent about their policies and products. Hence a potential risk of lack of consistency, which would be easily spotted by an NGO, or anybody whatsoever. It is therefore highly advisable to ensure that the voting policies are well defined, followed, and communicated so as to be consistent with the ESG strategy.
Instantaneity and transparency, required everywhere, add to the complexity of the challenge. Not to mention other challenges linked to the storage (according to GDPR guidelines), and retrievability of information.
This will, as painful as it may be, force financial intermediaries to upscale their technologies. This forced change notwithstanding, this regulatory demand provides true strategic and business opportunities, compelling financial institutions to face their competition, who are no longer old-fashioned banks, but new digital-native companies, and financial firms that have developed state-of-the-art technologies, both agile and responsive.
A broader view
SRD II is about more than information, it focuses on a mixture of data management, digitalization, and a requirement for real-time data access, so it would not only help to meet a long-standing demand from supervisors and regulators, but would also help financial institutions be better prepared for a future of real-time transparency. Moreover, understanding the mutual dynamics of SRD II, ESG, and data may help better design for the long term, and mutually reinforce business strategies to better serve clients. SRD II is therefore a trigger for a review of data management systems.
Shareholder Rights Directive II
The Shareholder Rights Directive II aims to encourage long-term shareholder engagement, providing the professionals involved in the process of investment on EU Listed Companies shares with various obligations. Our dedicated services help you achieve compliance with this new regulation.