RI Backgrounder: the EU’s revision to the Shareholder Rights Directive

The proposed revision of the Shareholder Rights Directive is not getting the attention it deserves.

There’s a big story coming out of Europe, but it’s not the ‘Grexit’ drama. Perhaps due to its complexity or regulation fatigue, the proposed revision of the Shareholder Rights Directive (SRD) is not getting the attention it deserves.

The story is big because the parliamentary draft law of “SRD 2” would, for the first time ever, require companies to report taxes and profits on a country-by-country basis, make board director pay more uniform and allow shareholders to take binding votes on corporate executive pay.

The draft law even permits employees at a company to express their view of what corporate executives should be paid and, in the interest of long-term investing, rewards shareholders that own a company for a least two years with special voting rights (known as ‘loyalty shares’) or tax incentives.

This being the EU, the text that the Parliament will eventually vote on is not what will ultimately take effect. That’s because there is a another competing draft law of SRD 2 that the European Council, which represents the 28 governments of the bloc, has finalised.

That text contains none of the sweeping measures called for in the Parliament’s paper and also provides for implementation on a “comply or explain” basis. But whatever emerges from the Parliament must be reconciled with the Council’s text. This should prove a difficult task given the great disparity between the two texts. So how will these two fundamentally divergent views about corporate governance be reconciled? To make sense of all this, RI poses, and answers, the key questions about SRD 2.

Why is the Directive being revised at all?

It goes back to the wave of financial regulation that former Internal Markets Commissioner Michel Barnier proposed in response to the global financial crisis of 2008. Barnier felt the SRD had to be overhauled to promote long-term investing and shareholder engagement for better governance. The thinking was that such measures could help prevent crises like the one in 2008.

Barnier was probably right. Yet since he left office in 2014, SRD 2 has grown into a far bigger project than intended, with amendments added to the Parliament’s text requiring the country-by-country disclosure or the introduction of loyalty shares.

The Parliamentary text also deviates from EU norms by requiring implementation instead of stipulating a ‘comply and explain’ basis.

Indeed, in a letter to Members of the European Parliament (MEPs), corporate governance lobbies BusinessEurope, ecoDa and Europeanissuers blasted the text for ignoring “the comply and explain principle which has become the unanimously accepted basis of corporate governance in Europe for the last 20 years.”

They argue that the flexibility that comply or explain affords is important when the corporate governance systems in the EU are so different.What were some of the original provisions of SRD 2?

Barnier’s revised SRD called on institutional investors like pension funds to disclose their engagement policy with companies as well as how they voted at annual general meetings (AGMs). The Council’s draft, which is very much in keeping with Barnier’s original proposals, further states that the voting need only be disclosed among companies where investors own 1% or more. Asset managers investing on behalf of institutions must also disclose medium to long-term investment risks as well as portfolio turnover and costs. Other major points in the Council’s draft law include subjecting proxy firms to a code of conduct and paving the way for shareholder votes on executive pay at AGMs – though the votes can be advisory in nature.

These proposals seem reasonable enough, why has SRD 2 become controversial?

The Parliament’s legal affairs committee (JURI) made radical changes. A vote by the Parliament’s plenary had to be postponed until early July so that JURI can tone it down. The committee has its work cut out, considering that it provides for binding shareholder votes on executive pay, country-by-country reporting and loyalty shares. The current text further states that employees “should be entitled to express a view on the remuneration policy (for corporate executives) before it is submitted to a shareholder vote.”

Not surprisingly, the text has prompted bitter responses from BusinessEurope, ecoDa and Europeanissuers. They say in their letter to MEPs that beyond the problem of the text ignoring comply and explain, the amendments regarding uniform director pay, country-by-country reporting and loyalty shares are “completely out of place.”

Taking country-by-country reporting as an example, the lobbies say it had to excluded as “this is already being dealt with such initiatives such as the accounting directive and the in the 2015 Commission communication on tax transparency.” Country-by-country was included in SRD 2 in reaction to the sensational “Lux Leaks” report from November 2014. Lux Leaks revealed that Luxembourg had enabled big international corporations to pay low taxes on their European earnings – a practice that several MEPs now want to curtail.

The outrage from European companies is noted. How do institutional investors feel about SRD?

PensionsEurope, the Brussels-based lobby for European pension schemes, can live with SRD 2 as long as its provisions – for example regarding voting disclosure – are implemented on a comply or explain basis. If they are required, the lobby says this would lead to “unnecessary red tape” for its members. PensionsEurope is also unhappy about the disclosure concerning its members’ contractual arrangements with asset managers (mandates), though again would be mollified by comply or explain.

Other investor lobbies like Eurosif and Eumedion, the Dutch corporate governance platform, are satisfied with SRD 2 for the most part but have criticised the loyalty shares section included in the Parliament’s text. In a separate letter to MEPs from late May, Eurosif and Eumedion said that granting additional voting rights to specific shareholders ran counter to shareholder democracy (i.e. one share, one vote) and could lead to less, and not more shareholder engagement.What happens next?

The European Parliament is to vote on a re-worked draft from JURI in early July. After then, there will no doubt be some very difficult negotiations on the final legislation between the Council, the Parliament and the European Commission. But some form of compromise is the most likely outcome, as that is the EU way. EU watchers don’t expect SRD 2 to emerge before late 2015. Once it does, the 28 members of the bloc will need about 18 months to transpose it into national law.