In 2007, the EU introduced the first version of the Shareholder Rights Directive (SRD), a piece of legislation designed to strengthen the rights of shareholders invested in listed European companies.1 A decade later and after a series of corporate governance failures, EU regulators felt they had little alternative but to tighten up the existing rules by pushing through with SRD II2. SRD II, with a full implementation date of September 2020, has several aims. In summary, it encourages and supports greater shareholder engagement with listed companies; accelerates the exercise of shareholder rights; enhances transparency during the intermediary processes; and expedites the communication of information between issuers and investors.
SRD II’s impact will be felt extensively, primarily affecting issuers (i.e. EU listed companies), intermediary providers in the custody chain (custodian banks, central securities depositories (CSDs), institutional investors and asset managers, and proxy advisers.3 Moreover, the rules are highly extraterritorial and do not only apply to EU regulated institutions holding European-listed equities. In fact, any global institution exposed to EU listed assets – irrespective of whether it is domiciled in the EU or not – will be expected to comply with SRD II’s rules.4
SRD II puts intermediaries, proxy advisers and investors on alert
The heart of SRD II focuses on transparency. Currently, it is often quite laborious for companies to properly identify who their underlying shareholders are, mainly due to extensive intermediation between issuers and investors, especially on a cross-border basis.5 To remedy this, SRD II proposes that issuers be given the right to receive information on shareholders (e.g. their name, address, email, Legal Entity Identifier [LEI] details, number of shares held)6. Member states can exclude shareholdings of less than 0.5 per cent. The responsibility for disseminating shareholder information back to the issuer falls mainly on the intermediary providers, principally the custodians or CSDs, who will also be required to relay the relevant data without delay, which many experts interpret as being either in near real-time or on a same day basis.
Simultaneously, information (i.e. general meeting notifications, corporate events) will need to be distributed to end-investors so that they can exercise their shareholder rights, highlights Joe Mernagh, Senior Product Manager, Global Custody at HSBC Securities Services. In addition, any subsequent shareholder instructions or requests must then be submitted back to issuers without delay by the same intermediaries. “One of the components of SRD II is that intermediaries must confirm shareholders’ proxy votes that have been cast electronically and have been received and counted. This is a major improvement on existing proxy voting practices, but there is a dependency on issuers being able to provide this information,” says Mernagh.
Proxy advisers – which offer proxy distribution services to intermediary providers – will face similar challenges to custodians and CSDs. “Operationally, there will be an increase in the number of messages we transmit,” says Rudi Kuntz, Executive Director and Head of Global Proxy Distribution at Institutional Shareholder Services (ISS), a leading provider of end-to-end governance and responsible investment solutions to institutional investors and asset managers as well as intermediaries. Furthermore, proxy advisers’ institutional businesses will also come under growing scrutiny as a result of SRD II. “Proxy advisers who provide research and voting recommendations to institutional investors and asset managers will be required to demonstrate their adherence to best practices as well,” continues Kuntz. By this, proxy advisers will now be obliged to publicly disclose their codes of conduct, the reasoning behind their voting suggestions and any potential conflicts of interest that they may have.7
All of these initiatives are designed to promote greater institutional investor and asset manager engagement with the underlying companies that make up their portfolios. To ensure that investors are taking their SRD II responsibilities seriously, they will be obliged to publicly disclose their approaches towards shareholder engagement and outline how their voting rights have been exercised.8 The rules also demand that investors publish information about their voting decisions on their websites on an annual basis.9 In doing so, European regulators are confident that these measures will help stimulate long-termism among institutional investors and improve corporate governance standards moving forward.
Obstacles and solutions to SRD II
However, the provisions are likely to create some serious issues for all participants involved. “One of the biggest challenges around implementation is that many local EU markets have yet to transpose SRD II into law. This has led to uncertainty,” explains Kuntz. For instance, some EU member states may opt to increase or even lower the 0.5 per cent ceiling on share holdings, meaning intermediaries – in a worst case scenario – might need to factor in dozens of different thresholds across various markets10. This risks making the entire SRD II exercise very cumbersome. Elsewhere, Brexit could potentially cause problems although Kuntz expects the UK will implement SRD II into national law irrespective of the outcome.
Adding to the regulatory uncertainty is that a number of intermediaries will need to automate their operational processes to accommodate for the massive swell in data transmission volumes and communications. This could pose challenges for organisations which have yet to fully embrace automation and STP (straight-through-processing). Nonetheless, Mernagh says that more providers are now starting to automate their internal processes to ensure compliance with SRD II’s exceptionally tight deadlines, although he concedes some market participants have made more progress than others.
One of the key criterions of SRD II is that transmissions across the intermediary chain are performed electronically in a machine-readable ISO format. This will in effect force organisations to transition away from antiquated communication conduits such as fax machines, post or email. Standardisation in terms of how information is disseminated will be required between different counterparties. As such, experts believe that SRD II will likely result in greater industry-wide adoption of the SWIFT ISO 20022 messaging format.11
While automation is not without its challenges, experts are broadly supportive of what SRD II is trying to achieve. “For HSBC, SRD II is an opportunity to further automate our business and enhance overall customer satisfaction,” says Mernagh. Meanwhile, proxy advisers are integrating STP so that they too can help support their intermediary clients, according to Kuntz. SRD II is also encouraging some providers to look towards disruptive technologies for answers. While the jury is still out on Blockchain’s applicability, experts believe APIs (application programming interfaces) could serve a useful purpose in facilitating greater connectivity throughout the intermediary chain, helping firms with their SRD II compliance.
With SRD II’s implementation date rapidly approaching, investors and intermediaries are now starting to familiarise themselves with the regulation. “We have received more enquiries from clients in the last few months about SRD II, as many organisations are simply looking to ensure their readiness for the new regulations,” says Kuntz. Stuart Warner, European Head of Direct Custody, Clearing and Broker Outsourcing Product at HSBC Securities Services, concurs, adding the bank is educating customers about the ramifications of SRD II. “As a bank with a global reach spanning 38 direct custody markets and 96 global custody markets, HSBC is in a strong position to support clients globally – who may be trading EU listed securities – with their SRD II requirements,” he says.
It is pivotal that impacted organisations use their time wisely to establish the systems and processes to ensure they are SRD II-ready. Not only will SRD II help intermediary providers acquire widespread operational efficiencies via automation, but the rules are poised to play a valuable role in solidifying shareholder/issuer engagement and participation.
2 Directive (EU) 2017/828 of the European Parliament and of the Council of 17 May 2017 amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement (Text with EEA relevance)
3 Deloitte (January 11, 2019) The Shareholders Right Directive II – Towards a greater transparency of the investment mechanisms
4 Euroclear (June 25, 2019) Meeting the requirements of SDRII
5 Loyens & Loeff (July 22, 2019) Luxembourg implementation of the Shareholders’ Right Directive II
6 Broadridge (September 2017) Shareholder Rights Directive: Advancing to a State of readiness
7 Deloitte (January 11, 2019) The Shareholders Right Directive II – Towards a greater transparency of the investment mechanisms
8 Philip Lee (July 2, 2019) Second Shareholders Rights Directive: An Overview
9 Broadridge (September 2017) Shareholder Rights Directive: Advancing to a State of readiness
10 Deloitte (January 11, 2019) The Shareholders Right Directive II – Towards a greater transparency of the investment mechanisms
11 Euroclear (June 25, 2019) Meeting the requirements of SDRII