With the aim of enhancing the stability and sustainability of EU companies, in May 2017, the European Parliament and Council agreed an amendment to the 2007 Shareholder Rights Directive (the Directive). The objectives of the Directive are to enhance transparency in the investment chain and to hold investors accountable for the integration of Environmental, Social and Governance (ESG) factors in investment decisions, the level and quality of long-term shareholder engagement and the alignment of investors’ investment strategy and remuneration structures with the medium-to-long term performance of their clients’ assets. All asset owners and asset managers operating in Europe will be required to comply with the national laws implementing the amended Directive.
The Directive will introduce new shareholder responsibilities, in addition to further rights, and is part of a wider push to align interests along the investment chain – companies’ boards/managers, asset managers and owners and end beneficiaries – as well as with broader stakeholders. Investors will be required to report publicly on their engagement activities and voting decisions, on a comply or-explain basis. This is a watershed moment in the evolution of shareholder responsibility and the investment industry as a whole will need to materially step up with implications for their investment processes and resourcing to meet the Directive’s requirements.
For too long, the majority of the investment community has neglected its fiduciary responsibilities; whilst investors focused on short-term financial returns, most failed to notice the approaching global financial crisis (GFC). Alarm bells should have rung across investment houses as increasingly complex financial models, inadequately managed risk taking and inappropriate incentive structures led to poor corporate behaviour and endangered the savings of millions of pensioners.
In the years leading up to, during and following the GFC, Hermes has consistently and vocally advocated for change and helped shape capital markets through public policy and market best practice engagement with legislators, regulators, industry bodies and other standard-setters. We have benefited from extensive experience in the implementation of a number of stewardship and governance codes globally and engaged with businesses on the importance of integrating relevant ESG opportunities and risks into their business strategies to develop sustainable business models. These actions have delivered higher industry standards and in turn, driven legislation such as the Directive.These changes will have significant implications for asset managers’ investment and client reporting teams. Those who do not engage with investee companies will find themselves on the wrong side of the Directive. To engage effectively and advise companies on issues of long-term sustainability, investors will need to bring new skillsets into their investment teams.However, Hermes research suggests investors remain poorly informed and under-prepared for these paradigm shifts with just over half (58%) of participants aware of the Directive. This may seem low, but of greater concern is the finding that just 3% of total respondents believe their organisation already meets all the requirements of the Directive, suggesting significant and rapid strategic business changes will be required. There is a real danger that the lack of understanding and awareness reported in our survey will result in the Directive failing. In our survey, we observed a strong correlation between those who show greater awareness of the new rules, and those who believe they do not meet the requirements. It seems the more people are aware of the Directive and what is expected of them, the less they believe they currently comply or could do so within a reasonable time period. Conversely, those who have a more limited understanding assume that they already comply and appear not to realise the significant steps they will need to take.
Whilst our survey found confusion amongst respondents around their roles and developing responsibilities, it is encouraging to see that the industry recognises the importance of ESG issues and concerns. Overall, more than two-thirds (68%) believe that companies which focus on ESG factors produce better long-term returns. This represents an upsurge from 48% of investors who were asked the same question in 20174 , however given the increased prominence of ESG in some investors’ marketing literature, a cynic may question why it is not higher. That said, it is clear that many asset owners and asset managers are supportive of the goals of the Directive. Over a third (37%) of respondents claim to be frustrated with capital markets putting pressure on companies to deliver on short-term performance goals to the potential detriment of their long-term business needs. Many also cited compliance failures such as bribery and corruption, emissions cheating and money laundering amongst the issues causing the greatest frustration (23%). With this in mind, most respondents hope the Directive will improve both the quality and level of shareholder engagement (66%) and lead to greater transparency across the system.
Asset owners, asset managers, member states and relevant regulators have more work to do on understanding and implementing the Directive Asset owners, asset managers, member states and relevant regulators have more work to do on understanding and ensuring effective implementation of the Directive if we are to achieve its objectives – namely more sustainable companies, and ultimately, economies. All these entities – plus, importantly, end beneficiaries and society – stand to benefit if the Directive is implemented effectively.
To view the rest of our survey results, including country-specific figures, click here for our interactive infographic.
For professional investors only. This document is for information purposes only. It pays no regard to any specific investment objectives, financial situation or particular needs of any specific recipient. Hermes Equity Ownership Services Limited (“HEOS”) does not provide investment advice and no action should be taken or omitted to be taken in reliance upon information in this document. HEOS has its registered office at Sixth Floor, 150 Cheapside, London EC2V 6ET.
This article was sponsored by Hermes Investment Management and RI editorial staff were not involved in the creation of this content