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Shareholders Rights Directive requires institutional investors and asset managers to develop engagement strategies in the name of greater transparency

Shareholders Rights Directive requires institutional investors and asset managers to develop engagement strategies in the name of greater transparency
  • United Kingdom
  • Financial services and markets regulation
  • Financial services



The EU’s amended Shareholder Rights Directive (“SRD II”), which had to be transposed into Member States’ domestic rules by 10 June 2019, builds on the original Shareholder Rights Directive (“SRD”). SRD II seeks to address investors’ short-termism and shortcomings in corporate governance of listed companies that were exposed by the financial crisis.

In this briefing, we consider the new transparency rules which apply to institutional investors and asset managers. SRD II also includes provisions which apply to listed European companies and intermediaries who sit between those companies and their shareholders which we do not consider in in this briefing.

The FCA began grappling with the SRD II requirements in January of this year, publishing a consultation paper (CP19/7) on proposals to improve shareholder engagement on 30 January 2019. The Financial Reporting Council (“FRC”) simultaneously consulted on proposed amendments to the UK Stewardship Code. In an encouraging indication of the willingness of the FCA and FRC to collaborate on governance topics, the FCA and FRC have also subsequently issued a joint discussion paper on building a regulatory framework for effective stewardship.

The FCA’s final rules were published in PS 19/13. As expected, the final rules reflect the draft rules set out in CP 19/7. The FCA has demonstrated pragmatism in how it has implemented SRD II, generally taking an “intelligent copy-out approach” and permitting firms a grace period in order to ensure that they have sufficient time to implement SRD II effectively.

One important element of “gold plating” has, however, come into force with PS 19/13. Whilst SRD II only applies to shares listed on a regulated EU exchange, the FCA has extended the scope of this to apply to any shares traded globally on any market comparable to an EU regulated market where the shares are of comparable quality to those listed on UK regulated markets. The FCA considers that, given the importance of the policy imperatives behind the SRD II and the global nature of firms’ businesses, there is no reason why the SRD II requirements should be limited to shares listed on EU exchanges only.

To read SRD II, click here.

To read SRD, click here.

To read CP19/7, click here.

To read the FRC consultation, click here.

To read the FCA and FRC discussion paper, click here.

To read PS 19/13, click here.

Who is in scope?

Among other things, SRD II applies new transparency provisions to institutional investors and asset managers.

For this purpose, “institutional investors” are:

• life assurance companies authorised under the EU’s Solvency II Directive

• occupational pension schemes falling within the scope of the EU’s Directive on Institutions for Occupational Retirement Provision

“Asset managers” are defined as:

• MiFID investment firms that provide portfolio management services

• alternative investment fund managers (AIFMs), apart from small AIFMs

• UCITS management companies

• UCITS funds which do not have an external management company

What are the requirements?

The requirements affecting firms are set out in a new Chapter 1b of SRD. Among other things, they cover the following requirements:

• to have an engagement policy

• for institutional investors to disclose their investment strategy and requirements about institutional investors’ arrangements with asset managers

• asset manager transparency

Engagement policy

Under new Article 3g of SRD, firms must develop and publicly disclose an engagement policy which describes how they integrate shareholder involvement in their investment strategy or, if they do not, publicly disclose a clear and reasoned explanation about why they have chosen not to do so.

The engagement policy required by Article 3g must describe how the firm monitors investee companies on relevant matters including strategy, financial and non-financial performance and risk, capital structure, social and environmental impact and social governance; conducts dialogues with investee companies, exercises voting rights and other rights attached to shares; cooperates with other shareholders; communicates with relevant stakeholders of investee companies; and manages actual and potential conflicts of interest in relation to their engagement.

In addition to the requirement to develop and disclose an engagement policy, firms must also publicly disclose, on an annual basis, how their engagement policy has been implemented. This disclosure should include a general description of voting behaviour, an explanation of the most significant votes and the use made of the services of proxy advisers. The disclosure should state how the relevant institutional investor or asset manager has cast votes in the general meetings of companies in which they hold shares unless the votes are insignificant because of the subject matter of the vote or the size of the holding in the company concerned. There is so far no industry or regulatory consensus as to what would be considered “insignificant” (although note that the SRD II recitals give some examples) and managers can therefore apply thresholds which seem to them appropriate in the context of their business.

The engagement policy of a firm and the annual disclosure about how the policy has been implemented must be available free of charge on the website of the firm. Where the engagement policy, including voting, of an institutional investor is implemented by an asset manager on the institutional investor’s behalf, the institutional investor must provide a reference to where the asset manager has published such voting information.

Article 3g(3) provides that conflicts of interests rules which apply to firms (including under the EU’s AIFM Directive, UCITS Directive and MiFID II) also apply with regard to engagement activities.

Investment strategy and arrangements with asset managers

New Article 3h sets out requirements in relation to investment strategy and arrangements between institutional investors and asset managers.

Institutional investors must publicly disclose how the main elements of their equity investment strategy are consistent with their liability profile and duration (and, in particular, their long-term liabilities) and how they contribute to the medium to long-term performance of their assets.

Where an asset manager invests on behalf of an institutional investor (either on a segregated mandate basis or through a collective investment undertaking), the institutional investor must publicly disclose information about its arrangement with the asset manager, including:

• how the arrangement incentivises the manager to align its investment strategy and decisions with the profile and duration of the institutional investor’s liabilities (and, in particular, its long-term liabilities)

• how the arrangement incentivises the manager to make investment decisions based on assessments about the medium and long-term performance of the investee company and to engage with investee companies in order to improve their medium to long-term performance

• how the method and time horizon for assessing the manager’s performance and remuneration for its services are in line with the profile and duration of the institutional investor’s liabilities (and, in particular, its long-term liabilities) and take absolute long-term performance into account

• how the institutional investor monitors portfolio turnover costs incurred by the manager and how it defines and monitors a targeted portfolio turnover or turnover range

• the duration of the arrangement between the institutional investor and the asset manager

Where the arrangement between the institutional investor and the asset manager does not contain any of the elements set out above, the institutional investor must give a clear and reasoned explanation for this.

As with the information about engagement policies, information about the arrangement between an institutional investor and an asset manager must be made available on the institutional investor’s website on a free-of-charge basis, although life insurers regulated by the EU’s Solvency II Directive may include this information in their report on solvency and financial condition. The information must also be updated on an annual basis unless there is no material change.

Asset manager transparency

Where asset managers have entered into arrangements with institutional investors, they must disclose to the institutional investor on an annual basis how their investment strategy and its implementation complies with the arrangement they have entered into and contributes to the medium to long-performance of the assets of the institutional investor or of the fund. This disclosure should include a report on:

• the key material medium to long-term risks associated with the investments

• portfolio composition

• turnover and turnover costs

• the use of proxy advisers for the purpose of engagement activities

• the manager’s policy on securities lending and how it is applied to fulfil its engagement activities, if applicable (and, particularly, at the time of shareholder meetings of investee companies)

The annual disclosure made by an asset manager to an institutional investors with which it has entered into an arrangement must also include information on whether (and, if so, how):

• the manager makes investment decisions based on evaluation of medium to long-term performance of the investee company, including non-financial performance

• which conflicts of interest have arisen in connection with engagement activities and how the asset manager has dealt with these

There is no requirement for the asset manager to provide the information directly to the institutional investor where the information is already publicly available.

Member States can provide for the information required to be disclosed to be included in the annual reports of an investment fund required under the AIFM or UCITS Directives or in the periodic client communications required under MiFID II.

SRD II provides that Member States may require that information provided to institutional investors in collective investment undertakings should also be provided to other (non-institutional) investors on request. In CP19/7, the FCA indicated that it did not propose to impose this requirement on asset managers but was interested to hear whether there would be demand for this from other investors.

Implications for firms

Asset managers and institutional investors will need to consider what changes they may need to make to their policies and procedures in order to comply with the new requirements:

• review existing policy, whether it complies with the new rules and make appropriate changes where this is not the case

• if firms do not have an engagement policy, they will need to develop one or decide whether they will instead publicly disclose a clear and reasoned explanation about why they have chosen not to do so. At the moment, there is no industry or regulatory guidance as to what kind of explanations or business models will be able to genuinely benefit from the “comply or explain” option without the risk of challenge from the FCA. Firms focusing on certain strategies – such as passive, or largely-synthetic strategies – will understandably be keen to understand how the FCA would view an “explain” approach in those circumstances. Firms will need to be mindful of the “spirit” of the requirements and the FCA have been clear that overly “technical” arguments will not be looked on favourably. The FCA will likely review the impact of the requirements once they have bedded down in the market and have indicated that further future action may be required if the policy objectives are not, in their opinion, being achieved under the new requirements

• consider at what level to disclose their investment policy. The FCA appears to envisage that this could encompass disclosure of a firm’s overall approach to engagement or that of a wider group to which the firm belongs or, alternatively, could set out the approach on a product-specific basis

• if not yet fully compliant, the FCA has indicated a firm can comply in the short term with the relevant rule by explaining what it is doing to develop an engagement policy (including a statement that it is in the process of developing an engagement policy or whether to have one). Any such explanation should have been added to a relevant webpage by 10 June

In industry discussions, the FCA has indicated that it does not expect firms to implement the requirements in PS 19/13 in a “check box” fashion and expects firms to implement in a thoughtful and tailored way which contributes to achieving the policy imperatives behind the SRD II. Our view is that firms which do not have a compliant policy should be aiming to be compliant by the end of this year as a reasonably achievable deadline for compliance:

• institutional investors will need to consider the arrangements which they have in place with asset managers and whether the arrangement contains the elements specified by Article 3h and if not why not. The new requirements will, therefore, lead to institutional investors seeking to revisit the arrangements they have in place with asset managers who manage their investments

• AIFMs and UCITS ManCos will need to be able to respond to requests from institutional managers for details about their arrangements and implement mechanisms to continue to provide such information on an annual basis until they are told that the institutional investor no longer holds an investment in the fund. Asset managers will also wish to consider whether, for practical ease, they make such information publicly available because the FCA has indicated that in such a case there would be no need to provide it directly to individual institutional investors

Some key questions to consider

There are multiple issues which arise for firms in considering how best to comply. We have set out a selection of the issues we see arise most frequently below.

• How should firms operating passive or synthetic strategies approach compliance?

• How can firms operating multiple different strategies approach their policies?

• How can firms track shareholder engagement?

• In what circumstances will the “explain” option in “comply or explain” be available to firms?

• How do firms establish thresholds for what counts as “significant” or “insignificant” votes?

• How should “host” operators or managers who delegate investment management functions comply?

• Are there issues with confidential or sensitive disclosure – should firms be looking at additional safeguards to protect their business?

• The UK regime is wider than that under SRD II – are there additional workstreams needed to engage with non-EU investee companies?

• How should firms approach compliance when several managers are engaged on one fund or mandate?

How Eversheds Sutherland can help

Eversheds Sutherland’s Financial Institutions Group is an adviser to both asset managers and institutional investors and we would be pleased to discuss how the rules might affect you.