New EU legislation to promote sustainable and transparent companies for the long-term

The Directive aims to promote long-term shareholder engagement, as well as to improve the sustainability, transparency and governance of EU companies listed on a stock exchange. The rationale behind the Commission’s proposal was to address certain corporate governance shortcomings in European listed companies identified after the financial crisis and to promote more long-term oriented and active engagement by shareholders.

The text introduces the following changes:
 
Executive pay – Companies will be required to hold a binding vote on executive remuneration policy at least every four years (unless Member States decide that the vote is advisory). The remuneration policy is expected to contribute to the company’s strategy and long-term interests and sustainability. Where variable pay is awarded, the policy is expected to set clear, comprehensive and varied criteria for bonuses. The policy should also indicate the financial and non-financial performance criteria including, where appropriate, criteria related to ESG factors. This is important to incentivise directors to consider the best long-term interests of the company and its environmental and social impacts.

The pay policy must explain how the pay and employment conditions of employees were taken into account. The pay report must include the average pay of full-time equivalent workers. An earlier proposal for an advisory employee vote was removed during negotiations.

Transparency requirements for institutional investors and asset managers – Institutional investors will be expected to develop and publish their engagement policy on a comply-or-explain basis, in particular on monitoring strategy, financial and non-financial performance, as well as environmental, social and governance (ESG) factors. Annual reports should be published disclosing how the engagement policy was implemented, explanations of the most important votes, and the use of proxy advisory services.

The negotiations were unusually protracted, the Commission issued its initial proposal in April 2014 and agreement was only reached in December 2016. The Legal Affairs Committee in the European Parliament introduced a tax transparency amendment in the revised text, which would require large companies to provide country-by-country reporting (CBCR) on their business activities. This was removed from the final version after the Commission issued a separate proposal on tax transparency.

 

The current corporate governance model puts strong incentives and constraints on publicly listed companies to maximize short-term value creation and to increase the payout ratio to shareholders. Partly as a result, award compensation packages for executive managers tend to be heavily weighted towards stock options. Shareholders in many cases support managers' excessive short-term risk taking, which contributed to the financial crisis. The rationale for the revision of the Directive was to address these misaligned incentives and promote optimal monitoring of investee companies by institutional investors and asset managers to promote the long-term performance of companies, not short-term share price increases.

Identification of shareholders – Member States will be required to allow companies to identify their shareholders above a threshold set by the Member State (maximum threshold of 0.5%).

Transactions with related parties – Related party transactions will be subject to vote by the shareholders or the board of directors, in order to increase transparency and protection of (minority) shareholders.

The Directive was already approved after trilogue negotiations between the three EU institutions. The Council will now be required to formally approve the text, which is likely to occur before summer. Member States will then have two years to transpose it into national law.