EU to require institutional investors to develop engagement policy

‘Comply-or-explain’ revision to Shareholder Rights Directive

The European Commission, the executive arm of the European Union, is amending existing legislation to make it a ‘comply-or-explain’ requirement for institutional investors to develop a policy on shareholder engagement with companies.

And under the revision to the Shareholder Rights Directive, investors will have to disclose the policy, how it has been implemented and what results there have been. If they don’t have a policy or decide not to disclose how it is implemented, they will have to give a “clear and reasoned explanation” as to why this is so.

Additionally, institutions will have to disclose how their equity investment strategy is aligned with the “profile and duration” of their liabilities and it how contributes to the medium to long-term performance of their assets.

The key segment of the revision is Article 3f (‘Engagement policy’): “Member States shall ensure that institutional investors and asset managers develop a policy on shareholder engagement.” It will determine how investors and their asset managers integrate shareholder engagement in their investment strategy, monitor investee companies (including their non-financial performance), conduct dialogues with companies, use proxy advisors and cooperate with other shareholders.

The revision also looks at the investor-asset manager relationship, with the former having to disclose how it incentivises the latter to align investment strategy. There are also provisions around the time horizon of performance and portfolio duration – as well as the length of relationship between investor and manager.
The Commission says the “overarching objective” of the planned revision to the directive is to “contribute to the long-term sustainability of EU companies, to create an attractive environment for shareholders and to enhance cross-border voting”.Another element will be moves to strengthen the link between pay and performance of company directors, with the aim of creating more transparency on remuneration policy and the actual remuneration awarded to directors. This Commission stresses it is not regulating the level of remuneration – leaving this to companies and their shareholders.

Proxy advisory firms are also subject to the new regime, in that they will be required to guarantee that their voting recommendations are accurate and reliable.
The rationale behind the sweeping reforms is that the Commission believes there is insufficient engagement of institutional investors and asset managers.

“Long-term shareholder engagement would contribute to a significant improvement in the performance, profitability and efficiency of the companies with which the investor engages,” it says. The idea is to incentivise institutional investors with long-term commitments to provide more “patient” capital to companies.

The plan follows consultations such as 2010’s Green Paper on corporate governance in financial institutions, 2011’s Green Paper on the EU corporate governance framework and last year’s Green Paper on long-term financing.

The Commission is clear that it is not forcing investors to engage with companies or vote at AGMs if they don’t see the benefit of it. It reckons if it did so it would lead to “strict compliance behaviour without appropriate reflection on how to vote or to engage”.

“Today’s proposals will encourage shareholders to engage more with the companies they invest in, and to take a longer-term perspective of their investment,” said Internal Markets Commissioner Michel Barnier.

European Commission’s announcement on the proposed revision and Frequently Asked Questions.