Gem Briefing Note 19/4

FCA Policy Statement PS 19/13: Information on the FCA’s requirements for implementing the provisions of the amended Shareholder Rights Directive (SRD II).

July 2019

Purpose of this Briefing Note   
This briefing note summarises the Financial Conduct Authority’s (FCA) changes to rules relevant to asset managers, to reflect the implementation of the SRD II. The SRD II was required to be transposed by all EU member states, including the UK, by 10 June 2019. This means that asset managers had to publish their engagement policy, or explain why they have not done so, by 10 June 2019. 

The FCA previously consulted on its proposed changes (CP19/7) in January 2019), with the final rules to be reflected in the FCA Handbook, which have now been set out in policy statement PS19/13 released on 31 May 2019. Although the rules are intended to cover both life insurers and asset managers, this briefing note will only focus on the latter.

SRD II requires asset owners (institutional investors) and asset managers to make disclosures about their long term investment strategies, their arrangements with each other and their engagement with the companies they invest in. The new rules seek to improve transparency by enhancing the flow of information across the institutional investment community, and by promoting common stewardship objectives between institutional investors and asset managers.

The Directive also recognises that certain persons (related parties) may have an influence on companies they invest in, and that the nature of transactions with related parties (RPTs) may affect shareholders’ assessment of company valuation. The requirements build on the accounting framework set under International Financial Reporting Standards. SRD II requires companies with shares admitted to trading on regulated markets to disclose and have other safeguards in place for material transactions with related parties.

As such, the FCA is amending its COBS 2.2 rules to implement SRD II for the asset managers it regulates, with the key rule changes at COBS 2.2B as follows: 

·      New requirements regarding the public disclosure of their shareholder engagement policies, and periodic public disclosure of the implementation of such policies. 
·      New requirements regarding the disclosure to asset owners of the manager's shareholder engagement activities. 
·      For UK companies with shares admitted on a regulated market, requirements regarding the disclosure and approvals required for related party transactions.

The transparency requirements apply to asset managers, including MIFID investment firms, alternative investment fund managers (AIFMs) (excluding small AIFMs), UCITS management companies, self-managed UCITS funds and FCA-regulated insurers. Whilst this may not cover the full universe of institutional investor, the SRD II changes should be considered alongside the Financial Reporting Council’s revisions to its Stewardship Code (discussed below). 

Engagement policy
Asset managers are required to develop, and publicly disclose on their website, their policy on shareholder engagement. The engagement policy should include the ways the firm: 

·      integrates shareholder engagement in its investment strategy; 
·      monitors investee companies, including their (i) strategy, (ii) financial and non-financial performance and risk, (iii) capital structure, (iv) social and environmental impact, and (v) corporate governance; 
·      conducts dialogue with investee companies; 
·      exercises voting rights and other rights attached to shares; 
·      cooperates with other shareholders; 
·      communicates with relevant stakeholders of the investee companies; and 
·      manages actual and potential conflicts of interest in relation to the firm’s engagement. 

The requirement will apply on a ‘comply or explain’ basis, so if a firm does not comply with one or more requirements, it must publicly disclose with a clear and reasoned explanation why they have chosen not to do so. The FCA has recognised however that the rules have come into effect relatively quickly after publication, and so for an initial period, a firm can comply with the relevant rule by explaining what it is doing to develop an engagement policy. This may include, for example, simply explaining that it is developing one, or considering whether or not to have one.

Asset managers will also be required to publicly disclose on their website how their engagement policy has been implemented, including: 

·      a general description of voting behaviour; 
·      an explanation of the most significant votes they have participated in; 
·      an explanation of their use of proxy advisors; and 
·      how they have cast votes at the general meetings of companies in which they hold shares (subject to an exception for “insignificant votes”). 

The FCA has indicated that a vote may be insignificant either due to the subject matter of the vote or the size of the holding of the company.  

Transparency of Asset Managers
To help asset owners evaluate whether asset managers act in their best long term interests, asset managers will be required to disclose to certain types of institutional investor various information on at least an annual basis. That information must include: 

·      how their investment strategy and their implementation thereof contributes to the medium to long-term performance of the assets of the institutional investor or the fund; 
·      certain key information, including (i) key material medium to long term risks associated with the investments, (ii) portfolio composition, (iii) turnover, (iv) turnover costs, (v) the use of proxy advisors for the purpose of engagement activities, (vi) the firm’s policy on securities lending and how it is applied to fulfil its engagement activities if applicable; 
·      whether, and if so how, the asset manager makes investment decisions based on evaluation of medium to long term performance of the investee company including non-financial performance; and 
·      whether any conflicts of interest have arisen in connection with their engagement, and if so, how the asset manager has dealt with these conflicts. 

The FCA does not prescribe how these disclosures should be provided, but does indicate that where the information is available publicly, the asset manager is not also required to provide the information directly to institutional investors. 

Related party transactions 
Issuers who are within scope of the new regime for related party transactions, and rest of world issuers to whom the extension applies via the Listing Rules (LR), will be required to comply with the new requirements from the start of their first financial year post the new rules coming into force on 10 June 2019.

SRD II requires Member States to set requirements about the disclosure and approval of transactions between issuers (who have voting shares admitted to trading on a regulated market) and their related parties. The Directive specifies that issuers should comply with the rules on RPTs that have been implemented in the jurisdiction in which they have their registered office. Under SRD II, the requirements apply with respect to investee companies whose shares are admitted to trading on a regulated market in the European Economic Area (EEA), which the FCA regards as including overseas companies with a secondary listing in the EEA. In addition, the FCA is extending the requirements to investee companies whose shares are listed on a comparable market outside the EEA. 

The FCA will implement the minimum standards from the Directive through the Disclosure Guidance and Transparency Rules sourcebook (DTR), and retain the more stringent existing requirements for premium listing in the LRs. Certain transaction types will be exempt however, including UK Companies Act-compliant transactions for directors’ remuneration. 

The FCA has decided that materiality should not depend on the issuer’s listing category and that a better approach would be to apply the same materiality threshold for all RPTs. Therefore, the materiality threshold is being reduced to 5% for all RPTs. There will however, remain a distinction between premium listing and the DTRs rules in what is required of issuers in terms of approvals and associated shareholder rights. Under the rules on RPTs, only the existing premium LRs will require shareholder approval and a third-party report. Under the revised DTRs, only board approval will be required in addition to the disclosure requirements.

Stewardship Code
Alongside the FCA’s original consultation paper on SRD II, the Financial Reporting Council (FRC) published its own consultation paper regarding revisions to the UK Stewardship Code. This resulted in a joint FRC/FCA discussion paper entitled “Building a regulatory framework for effective stewardship” that seeks to encourage institutional investors to engage more actively with the companies in which they invest to promote sustainable long-term value creation. 

With respect to the interaction between the SRD II and the Stewardship Code, the FCA has said that the implementation of SRD II sets an important baseline in a continuum of measures to drive effective stewardship. The revised Stewardship Code is intended to encourage higher standards beyond that baseline. Institutional investors will be expected to enquire regarding an asset manager’s compliance with the FRC Stewardship Code.

Next steps
The changes implemented by the SRD II are not a fundamental step change from what firms should already have in place with respect to shareholder engagement and transparency arrangements. Therefore asset managers should give consideration to the rules in COBS 2.2B, DTR and LR, and the Stewardship Code to ensure any apparent gaps are closed. This may entail: 

·      updating shareholder engagement policies. 
·      making any consequential changes to shareholder engagement practices. 
·      making arrangements to collate and publish the information needed for annual reporting requirements.
·      ensuring that RPT transactions meet DTR and LR requirements going forward
·      ensuring that adherence to the Stewardship Code can be demonstrated as necessary 
Please contact us at Gem Compliance if you wish advice or assistance with any aspect of this process.

This newsletter contains generic information and has been generated for professional clients and associates of Gem Compliance Consulting Limited only and should not be regarded as advice. We will not be liable for loss, however caused by parties acting on the information contained herein.

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