Explanatory Memorandum to COM(2014)213 - Amendment of directives on encouraging long-term shareholder engagement and on certain elements of the corporate governance statement - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2014)213 - Amendment of directives on encouraging long-term shareholder engagement and on certain elements of the corporate governance ... |
|---|---|
| source | COM(2014)213  |
| date | 09-04-2014 |
The importance of creating a modern and efficient corporate governance framework for European undertakings, investors and employees that must be adapted to the needs of today’s society and to the changing economic environment was acknowledged by the Commission’s ‘Europe 2020’ Communication[1] that calls for improvement of the business environment in Europe.
The past years have highlighted certain corporate governance shortcomings in European listed companies. These shortcomings relate to different actors: companies’ and their boards, shareholders (institutional investors and asset managers) and proxy advisors. Identified shortcomings related mainly to two problems: insufficient engagement of shareholders and lack of adequate transparency.
Stakeholders were consulted on two Green Papers ("Corporate governance in financial institution"[2] and 'The EU corporate governance framework'[3]) In relation to what they considered to be the most important issues to be tackled at European level.
Based on these consultations and further analysis, the Commission's Action Plan: European company law and corporate governance - a modern legal framework for more engaged shareholders and sustainable companies i provides the Commission’s roadmap in the area, based the two objectives of enhancing transparency and engaging shareholders. This Action Plan announces a number of initiatives, amongst other, a potential revision of the Shareholder Rights Directive.
Against this background, the overarching objective of the current proposal to revise the Shareholder Rights 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 by improving the efficiency of the equity investment chain in order to contribute to growth, jobs creation and EU competitiveness. It also delivers on the commitment of the renewed strategy on the long-term financing of the European economy[5]: it contributes to a more long-term perspective of shareholders which ensures better operating conditions for listed companies.
This requires the realisation of the following more specific objectives: 1) Increase the level and quality of engagement of asset owners and asset managers with their investee companies; 2) Create a better link between pay and performance of company directors; 3) Enhance transparency and shareholder oversight on related party transactions; 4) Ensure reliability and quality of advice of proxy advisors; 5) Facilitate transmission of cross-border information (including voting) across the investment chain in particular through shareholder identification.
This proposal is also consistent with the existing regulatory framework. In particular, the new Capital Requirements Directive and Regulation (CRD IV package)[6] have, in order to tackle excessive risk taking, further strengthened the framework with regard to the requirements for the relationship between the variable (or bonus) component of remuneration and the fixed component (or salary). These rules apply to credit institutions and investment firms, both listed and non-listed. The rules in this proposal would however only be applicable to listed companies and aim at increasing transparency and ensuring that shareholders have a vote on the remuneration policy and report. Existing rules regulating institutional investors and asset managers, for instance in the UCITS Directive[7], AIFM[8] and MIFID[9] are consistent with this Directive.
At the date of adoption of this proposal the Commission also adopted a recommendation on the quality of corporate governance reporting (‘comply or explain’). The EU corporate governance framework is above all based on the comply or explain approach which allows Member States and companies to create a framework that is in line with their culture, traditions and needs. To support the good functioning of that approach the Commission adopted the recommendation. However, a number of elements of corporate governance should, in view of the cross-border relevance and importance be dealt with at European level in a more binding form to ensure a harmonised approach across the EU (e.g. shareholder identification, the transparency and engagement of institutional investors and board remuneration).
The proposed EU action provides significant added value. Non-national shareholders hold some 44% of the shares in EU listed companies. Most of these investors are institutional investors and asset managers. Only EU action can ensure that institutional investors and asset managers, but also intermediaries and proxy advisors from other Member States are subject to appropriate transparency and engagement rules. Moreover, a significant number of listed companies have activities in several EU Member States. Appropriate standards ensuring a well-functioning corporate governance of these companies with a view to their long-term sustainability are thus in the interest not only of Member States where these companies are based but also of those Member States where they operate. Only common EU action can ensure such common standards.
Contents
- RESULTS OF CONSULTATIONS WITH THE INTERESTED PARTIES AND IMPACT ASSESSMENTS
- LEGAL ELEMENTS OF THE PROPOSAL
- BUDGETARY IMPLICATION
- Consultation of stakeholders and interested parties
- Impact assessment
- Insufficient engagement of institutional investors and asset managers
- Insufficient link between pay and performance of directors
- Lack of shareholder oversight on related party transactions
- Inadequate transparency of proxy advisors
- Difficult and costly exercise of rights flowing from securities for investors
- Legal basis, subsidiarity and proportionality
- Detailed Explanation of the Proposal
- Strengthening the link between pay and performance of directors
- Improving shareholder oversight on related party transactions
- Enhancing transparency of proxy advisors
- Facilitating the exercise of rights flowing from securities for investors
- 5. EXPLANATORY DOCUMENTS
The Commission held a number of public consultations that covered the different topics in this proposal. First, the 2010 Green Paper on corporate governance in financial institutions and remuneration policies and the 2011 Green Paper on the EU corporate governance framework. Moreover, two consultation were held on legislation on legal certainty of securities holding and dispositions which comprised questions on shareholders identification and effective cross-border exchange of information, including voting, across the investment chain. Moreover, the Commission services have maintained regular and wide dialogues with stakeholders throughout the procedure leading to this proposal for amendment.
In its reflection on the functioning of the European corporate governance framework the Commission has benefited from the advice of the European Corporate Governance Forum.[10] Additionally, the Commission sent a questionnaire to the Company Law Expert Group which is composed of member State representatives.[11]
Finally, some corporate governance problems have been discussed in the Green Paper on the long-term financing of the European economy[12] which has initiated a broad debate about how to foster the supply of long-term financing and how to improve and diversify the system of financial intermediation for long-term investment in Europe.
Stakeholders and respondents overall expressed themselves in favour of increasing transparency as regards board remuneration and of granting shareholders a say on pay. They also supported measures regarding monitoring of asset managers by asset owners, more transparency from proxy advisors and reinforcing current rules on related party transactions. They favoured disclosure of voting policies and records by institutional investors. Additionally, a strong call had been made to increase the efficiency of the investment in transmitting information and facilitating cross-border voting by effective intermediary communication among themselves and with shareholders. Finally, clear support was shown for shareholder identification.
The impact assessment undertaken by the Commission services identified five main issues: 1) Insufficient engagement of institutional investors and asset managers; 2) Insufficient link between pay and performance of directors; 3) Lack of shareholder oversight on related party transactions and 4) Inadequate transparency of proxy advisors 5) Difficult and costly exercise of rights flowing from securities for investors.
The financial crisis has revealed that shareholders in many cases supported managers' excessive short-term risk taking. Moreover, there is clear evidence that the current level of “monitoring” of investee companies and engagement by institutional investors and asset managers is sub-optimal. Institutional investors and their asset managers do not sufficiently focus on the real (long-term) performance of companies, but often on share-price movements and the structure of capital market indexes, which leads to suboptimal return for the end beneficiaries of institutional investors and puts short-term pressure on companies.
Short-termism appears to be rooted in a misalignment of interests between asset owners and asset managers. Even though large asset owners tend to have long-term interests as their liabilities are long-term, for the selection and evaluation of asset managers they often rely on benchmarks, such as market indexes. Moreover, the performance of the asset manager is often evaluated on a quarterly basis. As a result many asset managers’ main concern has become their short term performance relative to a benchmark or to other asset managers. Short-term incentives turn focus and resources away from making investments based on the fundamentals (strategy, performance and governance) and longer term perspectives, from evaluating the real value and longer-term value creative capacity of companies and increasing the value of the equity investments through shareholder engagement.
Directors’ remuneration plays a key role in aligning the interests of directors and shareholders and ensuring that the directors act in the best interest of the company. Shareholder control prevents directors from applying remuneration strategies which reward them personally, but that may not contribute to the long-term performance of the company. Several shortcomings have been detected in the current framework. First, the information disclosed by companies is not comprehensive, clear nor comparable. Secondly, shareholders often do not have sufficient tools to express their opinion on directors’ remuneration. As a result, there is currently an insufficient link between pay and performance of directors of listed companies.
Related party transactions (RPTs), i.e. transactions between a company and its management, directors, controlling entities or shareholders, create the opportunity to obtain value belonging to the company to the detriment of shareholders, and in particular minority shareholders. Currently, shareholders do not have access to sufficient information ahead of the planned transaction and do not have adequate tools to oppose to abusive transactions. As institutional investors and asset managers are in most cases minority shareholders, more control rights over RPTs would improve their ability to protect their investments.
The current equity market with its large number of (cross-border) holdings of shares and the complexity of the issues to be considered make the use of proxy advisors in many cases inevitable and thus proxy advisors have considerable influence on the voting behaviour of these investors. Two shortcomings have been observed: 1) the methodologies used by proxy advisors to make their recommendations do not always sufficiently take into account local market and regulatory conditions and 2) proxy advisors provide services to issuers who may affect their independence and ability to provide an objective and reliable advice.
Investors face difficulties in exercising the rights flowing from their securities, especially if the securities are held cross-border. In intermediated holding chains, especially when they involve many intermediaries, information is not passed to shareholders from companies or shareholders' votes get lost. There is also a greater likelihood of misuse of the voting rights by intermediaries. Three main causes affect the systems: the lack of investor identification, a lack of timely transmission of information and rights in the investment chain and price discriminations of cross-border holdings.
Overall the described shortcomings lead to sub-optimal corporate governance and a risk of suboptimal and/or excessively short-term focused managerial decisions which result in lost potential for better financial performance of listed companies and lost potential for cross-border investment.
A range of options, including no policy change, have been considered to address each of the presented problems. In light of the careful assessment of these policy options, it appeared that the following preferred option would best fulfil the objectives without imposing disproportionate burdens:
1) Mandatory transparency of institutional investors and asset managers on their voting and engagement and certain aspects of asset management arrangements;
2) Disclosure of the remuneration policy and individual remunerations, combined with a shareholder vote;
3) Additional transparency and an independent opinion on more important related party transactions and submission of the most substantial transactions to shareholder approval;
4) Binding disclosure requirements on the methodology and conflicts of interests of proxy advisors;
5) Creating a framework to allow listed companies to identify their shareholders and requiring intermediaries to rapidly transmit information related to shareholders and to facilitate the exercise of shareholder rights.
Following an initial negative opinion, the Impact Assessment Board adopted a positive opinion on the revised Impact Assessment on 22 November 2013. It should be noted that the part of the impact assessment on shareholder identification, transmission of information and facilitation of the exercise of shareholder rights was initially dealt with in a separate impact assessment that was cleared by the IAB and was integrated only in the final impact assessment report at a later stage.
The proposal is based on Article 50(2) (g) and 114 of the Treaty on the Functioning of the European Union (TFEU) which is the legal basis for Directive 2007/36/EC. Article 50(2)(g) provides for the EU competence to act in the area of corporate governance. It provides in particular for coordination measures concerning the protection of interests of companies’ members and other stakeholders, such as creditors, with a view to making such protection equivalent throughout the Union. Article 114 is the legal basis for the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market.
According to the principle of subsidiarity the EU should act only where it can provide better results than intervention at Member State level and action should be limited to what is necessary and proportionate in order to attain the objectives of the policy pursued. As regards this aspect it is important to note that there is strong evidence that the EU equity market has to a very large extent become a European/international market.
In view of the international nature of activities of institutional investors, asset managers and proxy advisors the objectives relating to engagement of these investors and the reliability of the advice of proxy advisors cannot be sufficiently achieved by Member States. Action from Member States would only cover some of the institutions concerned and would most likely lead to different requirements, which could lead to an uneven level playing field on the internal market.
On the objectives to ensure sufficient transparency and shareholder oversight on directors’ remuneration and related party transactions, the existing Member State rules in these areas are very different and as a result, they provide an uneven level of transparency and protection for investors. In both cases, the result of the divergence of rules is that investors are, in particular in case of cross-border investments, subject to difficulties and costs when they want to monitor companies and engage with them, and have no effective tools to protect their investments.
Without EU norms, rules and their application would be different from Member State to Member State, which could be detrimental to the EU level playing field. Without action at EU level the problems are likely to persist and only partial and fragmented remedies are likely to be proposed at national level. It therefore results that the objectives of this amendment are such that they cannot be fulfilled by unilateral action at the level of the Member States.
Targeted further development of the EU legal framework for corporate governance would create a better framework for shareholder engagement. EU rules ensure that the same transparency obligations will apply across the EU, which guarantees an EU level playing field and facilitate cross-border investment. As one of the key underlying problems is information asymmetry, this can only be dealt with through uniform transparency measures.
Harmonisation of disclosure requirements at EU level would be a remedy to asymmetry of information which is detrimental to shareholders and, therefore, plays a key role for minimising agency costs. It would be beneficial for cross-border investment, since it would facilitate comparison of information and make engagement easier and thus less costly. Moreover, it would make companies more accountable to other stakeholders like employees. Common standards at EU level are necessary to promote a well-functioning internal market and avoid the development of different rules and practices in the Member States.
Nevertheless, Member States should have a degree of flexibility as far as the transparency and information required in this proposal are concerned, in particular in order to allow the norms to adequately fit into the distinct corporate governance frameworks. To allow for such flexibility only some basic principles regarding shareholder identification, transmission of information by intermediaries and facilitation of the exercise of rights should be ensured. Moreover, institutional investors and asset managers should comply with certain of the obligations only on a comply or explain basis, for remuneration of directors the provisions only ensure the necessary transparency and a shareholders vote, while leaving the structure and level of remuneration to companies, while proxy advisors will only be subject to some basic principles to ensure accuracy and reliability of their recommendations.
To this end, an amendment to the Shareholders Right Directive is the most appropriate legal instrument as it allows a certain flexibility for Member States, while at the same time providing the needed level of harmonization. Amending the Directive also ensures that the content and form of the proposed EU action does not go beyond what is necessary and proportionate in order to achieve the regulatory objective.
Identification of shareholders has an impact on fundamental rights recognised in particular in the Treaty on the Functioning of the European Union (TFEU) and in the Charter of Fundamental Rights of the European Union (Charter), notably the right to the protection of personal data recognized in Article 16 TFEU and in Article 8 of the Charter. In view of this and of Directive 95/46/EC of the European Parliament and of the Council of 24 October 1995[13]it is necessary to strike a balance between the facilitation of the exercise of shareholders' rights and the right to privacy and the protection of personal data. The identification information on shareholders is limited to the name and contact details of the corresponding shareholders and can only be used for facilitation of the exercise of shareholder rights.
Improving engagement of institutional investors and asset managers
Articles 3f until 3h will increase the transparency of institutional investors and asset managers. They will be required by these articles to develop a policy on shareholder engagement, which should contribute to managing actual or potential conflicts of interests with regard to shareholder engagement. They should in principle disclose to the public their engagement policy, how it has been implemented and the results thereof.Where institutional investors or asset managers decide not to develop an engagement policy and/or decide not to disclose the implementation and results thereof, they shall give a clear and reasoned explanation as to why this is the case.
Institutional investors will be required to disclose to the public how their equity investment strategy is aligned with the profile and duration of their liabilities and it contributes to the medium to long-term performance of their assets. Where they make use of an asset manager the institutional investor will have to disclose to the public the main elements of the arrangement with the asset manager with regard to a number of important elements listed in the article 3g. Where the arrangement with the asset manager does not contain such elements the institutional investor shall give a clear and reasoned explanation as to why this is the case.
Asset managers will be required to disclose on a half-yearly basis to institutional investors how their investment strategy and implementation thereof is in accordance with the arrangement and how the investment strategy and decisions contributes to medium to long-term performance of the assets of the institutional investor. They should moreover disclose to the institutional investor on a half-yearly basis a number of important elements related to the execution of the arrangement with the institutional investor.
The proposal aims at creating more transparency on remuneration policy and the actual remuneration awarded to directors and creating a better link between pay and performance of directors by improving shareholder oversight of directors’ remuneration. The proposal does not regulate the level of remuneration and leaves decisions on this to companies and their shareholders.
Articles 9a and 9b will require listed companies to publish detailed and user-friendly information on the remuneration policy and on the individual remuneration of directors, and Article 9b empowers the Commission to provide for a standardized presentation of some of this information in an implementing act. As is clarified in Article 9a paragraph 3 and 9b paragraph 1 all benefits of directors in whatever form will be included in the remuneration policy and report. The Articles give shareholders the right to approve the remuneration policy and to vote on the remuneration report, which describes how the remuneration policy has been applied in the last year. Therefore, such report facilitates the exercise of shareholder rights and ensures accountability of directors.
Board structures vary significantly between Member States. In Member States with a two tier system the supervisory board plays a very important role and is responsible for the remuneration for the members of the management board. This proposal would not affect the key role of the supervisory board in two tier systems. It would still be the supervisory board that would develop the remuneration policy to be submitted to shareholders for confirmation. Most importantly, it would still be for the board, on the basis of the policy, to decide on the actual remuneration to be paid. The requirement of a shareholder vote will, in line with the general objectives of the proposal, increase the engagement that the board will seek with its shareholders.
The new article 9c will require listed companies that related party transactions representing more than 5% of the companies’ assets or transactions which can have a significant impact on profits or turnover to submit these transactions to the approval of shareholders and may not unconditionally conclude it without their approval. For smaller related party transactions that represent more than 1% of their assets, listed companies shall publicly announce such transactions at the time of the conclusion of the transaction, and accompany the announcement by a report from an independent third party assessing whether the transaction is on market terms and confirming whether it is fair and reasonable from the perspective of the shareholders. In order to target only transactions that could be most disadvantageous for minority shareholders and to keep administrative burden limited Member States should be allowed to exclude transactions entered into between the company and members of its group that are fully owned by the listed company. For the same reason, Member States should also be able to allow companies to request the advance approval by shareholders for certain clearly defined types of recurrent transactions above 5 percent of the assets, and to request from shareholders an advance exemption from the obligation to produce an independent third party report for recurrent transactions above 1 percent of the assets, under certain conditions. According to the Impact assessment, the most significant costs would be linked to the fairness opinion by an independent advisor. However, depending on the complexity of the transaction, an experienced advisor should be able to assess the fairness of the given transaction within between approximately 5 and 10 hours. This could result in a cost of maximum 2,500-5,000 € in case the opinion is made by an auditor.
Article 3i will require proxy advisors to adopt and implement adequate measures to guarantee that their voting recommendations are accurate and reliable, based on a thorough analysis of all the information that is available to them and are not affected by any existing or potential conflict of interest or business relationship. Proxy advisors are required by this article to publicly disclose certain key information related to the preparation of their voting recommendations and, to their clients and the listed companies concerned information on any actual or potential conflict of interest or business relationships that may influence the preparation of the voting recommendations.
Articles 3a of the proposal requires Member States to ensure that intermediaries offer to listed companies the possibility to have their shareholders identified. Intermediaries should, on the request of such a company communicate without undue delay the name and contact details of the shareholders. Where there is more than one intermediary in a holding chain, the request of the company and the identity and contact details of the shareholders shall be transmitted between intermediaries without undue delay. For legal identities also their unique identifier, where available, should be should be transmitted. Such identifier allows a legal person to be identified by a number that is unique at EU level. On international level the Legal Entity Identifier has been proposed by the Financial Stability Board (FSB) and endorsed by the G20, to ensure consistent and comparable data. This is a necessary component of this project making it easier to track companies in cross-border situations through centralised searches by electronic systems. The Regulation on improving securities settlement in the European Union and on central securities depositories (CSDs) and amending Directive 98/26/EC will ensure that the shares of listed companies shall be represented in book-entry form. In order to protect as much as possible the personal data of shareholders, intermediaries shall inform them that their name and contact details may be transmitted for the purpose of identification, while the information may not use this information for any other purpose than the facilitation of the exercise of the rights of the shareholder. Moreover, shareholders will be able to rectify or erase any incomplete or inaccurate data and the information should not be conserved for longer than 24 months.
Article 3b provides that if a listed company chooses not to directly communicate with its shareholders, the relevant information shall be transmitted to them by the intermediary. Listed companies are required to provide and deliver the information to the intermediary related to the exercise of rights flowing from shares in a standardised and timely manner. Where there is more than one intermediary in a holding chain, information referred to in paragraphs 1 and 3 shall be transmitted between intermediaries without undue delay.
Article 3c requires that intermediaries facilitate the exercise of the rights by the shareholder, including the right to participate and vote in general meetings and requires companies to confirm the votes cast in general meetings by or on behalf of shareholders. In case the intermediary casts the vote, it shall transmit the voting confirmation to the shareholder. Articles 3a until 3c empower the Commission to adopt implementing acts to ensure an efficient and effective system of shareholder identification, transmission of information and facilitation of exercise of shareholder rights.
The proposal has no implications for the Union budget.
According to the Joint Political Declaration of 28 September 2011, the Commission should only request explanatory documents if it can "justify on a case by case basis […] the need for, and the proportionality of, providing such documents, taking into account, in particular and respectively, the complexity of the directive and of its transposition, as well as the possible administrative burden".
The Commission considers that in this particular case it is justified to ask Member States to provide explanatory documents to the Commission due to the implementation challenges that will arise in the context of this proposal. The proposal aims to regulate a number of aspects of corporate governance and would cover a number of different players in that area, such as listed companies, institutional investors and asset managers, proxy advisors and intermediaries. Therefore it is likely that the provisions of his Directive will be transposed into several acts at national level.
In this context, the notification of transposition measures will be essential to clarify the relationship between the provisions of this Directive and national transposition measures, and therefore to assess the conformity of national legislation with the Directive.
The simple notification of individual transposition measures would not be self-explanatory and would not allow the Commission to ensure that all the EU legal provisions were faithfully and fully implemented. The explanatory documents are necessary to obtain a clear and comprehensive picture of the transposition. Member States are encouraged to present the explanatory documents in the form of easily readable conformity tables.
Given the above, the following recital is included in the proposed Directive: 'In accordance with the Joint Political Declaration of Member States and the Commission on explanatory documents of 28 September 2011, Member States have undertaken to accompany, in justified cases, the notification of their transposition measures with one or more documents explaining the relationship between the components of a directive and the corresponding parts of national transposition instruments. With regard to this Directive, the legislator considers the transmission of such documents to be justified.'