Luxembourg’s SRD II implementation: long-term engagement, reinforced rights and greater transparency.

On 10 July 2019, the Luxembourg Parliament adopted the bill of law 7402 (the New Law), transposing into Luxembourg domestic law the provisions of Directive (EU) 2017/828 (the SRD II), which amends the earlier Directive 2007/36/EC (the SRD I), to encourage long-term shareholder engagement in listed companies, ensure greater transparency of asset managers, institutional investors and proxy advisors. The New Law brings SRD II provisions into the Luxembourg law of 24 May 2011 on the exercise of rights of shareholders in listed companies (the Amended Shareholders’ Rights Law).

Background

The European Commission has announced various corporate governance initiatives to improve shareholders’ involvement in reaction to the risk factor which has been identified on short-term investments notably in the context of the financial crisis.

On 10 July 2019, the Luxembourg Parliament adopted the bill of law 7402 (the New Law), transposing into Luxembourg domestic law the provisions of Directive (EU) 2017/828 (the SRD II), which amends the earlier Directive 2007/36/EC (the SRD I), to encourage long-term shareholder engagement in listed companies, ensure greater transparency of asset managers, institutional investors and proxy advisors. The New Law brings SRD II provisions into the Luxembourg law of 24 May 2011 on the exercise of rights of shareholders in listed companies (the Amended Shareholders’ Rights Law).

Summary

This note summarises the main features that the New Law introduces, including requirements regarding the exercise of shareholders’ rights, attached to voting shares, beneficiary shares with voting rights (parts bénéficiaires avec droit de vote) and non-voting shares, concerning companies with a Luxembourg registered office whose shares are admitted to trading on an EU regulated market (as defined in directive 2014/65/EU of 15 May 2014 (MiFID II), or, for third-country regulated markets, through an express opt-in to these rules in the company’s articles of association (AoA).

In summary, the Amended Shareholders’ Rights Law is adding the following elements:

  • Extension of the scope: to asset managers and institutional investors
  • Directors’ Remuneration: ensure that shareholders are involved in directors’ remuneration policy
  • Transparency: create an obligation of transparency in the voting process to asset managers and institutional investors
  • Identification and communication: ensure the exercise of shareholders’ rights through the identification of shareholders, and
  • Related party transactions: Ensure shareholders’ control over transactions with related parties.

1. Extension of the scope

Before the New Law, the law of 24 May 2011 imposed obligations solely on the issuer (companies having shares in a regulated market situated or operating within, and whose registered office is in, an EU Member State (Issuer)) and its shareholders. Yet in contrast, in the pursuit of greater efficacy and transparency across the sector, the New Law extends this scope, also obliging the following market players:

  • Asset Managers - where investments are made, on behalf of investors, in shares traded on regulated markets (eg AIFM, investment firms and management companies)
  • Institutional Investors - where investments are made directly, or through an asset manager, in shares on regulated markets (eg life assurance, reinsurance and pension funds)
  • Intermediaries - where services are provided to the shareholders, or other intermediaries, of the Issuer (eg central securities depositories, investment firms and credit institutions), and
  • Proxy Advisors - where services are provided to the shareholders of the Issuer (eg a legal person that analyses, on a professional and commercial basis, among other things, the corporate disclosure of listed companies).

Importantly, however, except where the new transparency obligations apply, as outlined below, the New Law does not apply to collective investment undertakings (AIFs), as defined in Article 1(39) of the amended law of 12 July 2013 on alternative investment fund managers, and undertakings for collective investments in transferrable securities (UCITs), as defined in Article 2(2) of the amended law of 17 December 2010 on undertakings for collective investment.

2. (Executive) Remuneration

For the improved alignment of both the interests of the Issuer and its executive, administrative and managerial bodies, the New Law reinforces shareholders’ rights to have an effective “say on pay”. Shareholders are afforded two cumulative opportunities to express their views under the New Law.

2.1 Policy

The first opportunity is that the shareholders will vote ex-ante on the company’s policy, prospectively laying down a framework for remuneration which must complement the Issuer’s business strategy and long-term interests, while also detailing how this is achieved.

The Luxembourg Parliament determined this to be an advisory vote, as envisioned in the SRD II; however, the Issuer can make this vote binding through a provision in its AoA.

Each material change to the policy must be submitted to a shareholders’ vote, and otherwise reviewed in four-year intervals.

2.2 Report

The second opportunity that the New Law provides to shareholders is that, for every financial year, the Issuer must provide a remuneration report. This report details comprehensively the remuneration awarded to each director during the last fiscal year.

The shareholders have the right to hold an advisory vote, ex-post, on this report. The Issuer must then explain, in the subsequent remuneration report, how they took this shareholders’ vote into consideration.

Small and medium sized enterprises (SME) (as defined in the amended law of 19 December 2002 on the register of commerce and companies and the accounting and annual accounts of undertakings) may, however, replace this vote with a discussion by the shareholders.

Under the New Law, both remuneration policy and report are to be disclosed publicly, on the Issuer’s website, with the former remaining there for at least as long as it is applicable and the latter for a minimum of ten years.

3. Communication

Central to the New Law’s objectives is improving shareholder engagement. Again, this is often difficult where there are Intermediaries between the Issuer and its shareholders.

To facilitate the shareholders’ ability to exercise their rights when an Issuer does not communicate directly with its shareholders, it must provide the Intermediaries with all the necessary information for shareholders to exercise their rights, and the latter must then pass this on to the shareholders (or further up the chain of Intermediaries) without delay, then return responses to the Issuer. This information must be in a standardised form, according to the Commission Implementing Regulation (EU) 2018/1212 of 03 September 2018.

The facilitation of exercising the shareholders’ rights, by Intermediaries, includes the right to participate and vote in general meetings, and the intermediary must make the necessary arrangements to enable this to take place. Either they can opt for the shareholder (or their nominated proxy) to exercise the rights themselves, or the intermediary can exercise the rights flowing from the shares, with explicit authority from the shareholder, and solely for the shareholder’s benefit.

The New Law also details specific measures to protect shareholders when voting electronically and obliges Intermediaries to publicly disclose the fees they charge in connection with their previously mentioned obligations. Any such fees must be non-discriminatory and proportionate to the actual costs incurred for delivering the services. Furthermore, differing charges levied for services in relation to a cross-border exercise of rights must be disclosed and duly justified.

4. Identification

Under the New Law, the Issuer has the right to know the identity of its shareholders. It is often rather difficult for the Issuer to identify its shareholders, especially where there are complex chains of intermediaries and cross-border structures.

The New Law obliges Intermediaries to provide identifying information for shareholders without delay if the Issuer requests it or, where there are several Intermediaries in a chain, these must ensure that the request is transmitted between them without delay.

The SRD II also includes the option for setting a minimum threshold of 0.5% shares (or voting rights) before the Issuer can request such information about the shareholder. The New Law opted not to implement this provision (however, the Issuer may still provide for this in their AoA).

5. Greater transparency

5.1 Related party transactions

Transactions between the Issuer and related parties (as so defined in Regulation (EU) 1606/2002 of the European Parliament and of the Council of 19 July 2002 on the application of international accounting standards) have the potential to adversely affect the Issuer and its shareholders while placing its directors in positions of conflicting interests.

Thus, “material transactions” (defined in the New Law as transactions entered into with a related party whose publication and disclosure could materially impact the shareholders’ economic decisions, and that may create a risk for the Issuer or and non-related parties, including minority shareholders) must be announced publicly, no later than at the time of the transaction’s conclusion.

Such an announcement should contain all necessary information to assess whether the transaction is fair and reasonable from the perspective of the Issuer and its shareholders, including minority shareholders. However, the New Law does not require the option provided for in the SRD II, to produce a fairness report to accompany the announcement, since this would lengthen the procedure and increase costs.

There are, however, numerous exemptions to this regime, including transactions entered into in the ordinary course of business and concluded on typical market terms.

5.2 Other obligations

There are also increased transparency obligations for Institutional Investors, Asset Managers and Proxy Advisors under the New Law.

Firstly, Asset Managers and Institutional Investors must develop, and publicly disclose on their websites, an engagement policy that describes how they integrate shareholder engagement into their investment strategy. They must also annually publish a report detailing the implementation of their policy. They are also not obliged to comply with the related party transaction requirements above, provided they publicly disclose a clear, reasoned explanation why they have chosen not to do so.

Secondly, the New Law requires Institutional Investors to publicly disclose how the main components of their equity investment strategy are consistent with the profile and duration of their liabilities, particularly long-term liabilities, and how they contribute to the performance of their assets, medium to long-term.

Moreover, where Asset Managers invest on behalf of institutional investors, the latter is obligated to disclose this arrangement publicly; including how the arrangement incentivises the former and aligns its strategy with the profile and duration of the latter’s liabilities, particularly long-term liabilities, and to make decisions based on the financial and non-financial performance of the investee, medium to long-term, while actively engaging to improve this performance.

Lastly, Proxy Advisors must disclose, on an annual basis, vital information concerning the preparation of their recommendations, in the pursuit of increased reliability. Under the New Law, Proxy Advisors under must also prepare a code of conduct and a report of how this code is applied in practice.

Timing

The New Law will come into force on the first day of the second month following its publication in the Luxembourg Official Journal (presumably on 01 October 2019).

Importantly, the provisions of Commission Implementing Regulation (EU) 2018/1212, which becomes applicable from 03 September 2020, will complement and refine the regime set out by the New Law. In particular, this regulation aims to improve communication between the Issuer and its shareholders, including introducing standardised formats for data transmissions.

Penalties

All obligated entities must abide by the New Law’s regime since directors are jointly and severally liable for any damages resulting from a breach of such obligations.

Conclusion

Simmons & Simmons LLP can assist issuers, and other obligated entities or legal organisations, to become compliant with their new obligations.

Our corporate team will provide solutions tailored to your specific needs and requirements.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.