The agency cost is considered by many as a timeless concept. Indeed, the information asymmetry that exists between shareholders and the Chief Executive Officer is generally held to be a classic example.
In this context, the first Shareholder Right Directive (SRD) has been adopted by the European Parliament in 2007 in order to ensure a better protection of the exercise of shareholders rights in listed European companies, by implementing rules around transparency, proxy voting rights and the ability to vote in general meetings via electronic means.
Nevertheless, in the aftermath of the financial crisis in 2008, the European Union outlined numerous flaws with this Directive:
Among those deficiencies, we can point out the engagement and control by long-term shareholders, active managers and institutional investors. The shareholders often supported managers excessive short-term risk taking, with definitely too much focus on short-term returns. They also lacked the means to effectively monitor the companies in which they invested. It has been felt that some directors remuneration was so excessive and not justified by their company’s performance. In addition, exercising shareholder rights was often complicated and costly, especially in cross-border situation where intermediaries are located in different jurisdictions.
In response to this, the revised Shareholder Rights Directive was introduced in 2017 and is scheduled to take effect during Q2 2019. This amended version focuses on long-term shareholder engagement by enhancing transparency at all levels (identification, voting decisions, investment policy) and improving issuer-investor dialogue.
Which stakeholders would be affected by this directive?
It’s simple, the investors and the shareholders will be highly impacted, but that’s not all:
- Issuers and listed companies will be able to obtain shareholders identification;
- Custodians and other intermediaries will have to cooperate in the identification process and proxy advisors will be subject to increased transparency obligations.
What will be the future impacts of this Directive? Those, should be significant. Indeed, the issuers will have the right to obtain shareholders identification with the objective of engaging directly with the investors. For their part, proxy advisors should establish accurate and reliable voting recommendations as they will have to publish a report on their compliance with the code of conduct of proxy advisors; Institutional investors, such as asset managers, pension funds or insurance companies should establish an investment strategy and publish associated reports in due course. Another big change, the “say on pay” which will give shareholders the right to vote during the general meeting on the directors remuneration policy, as well as the remuneration report that details individual directors’ remuneration in the previous financial right. Finally, the new requirement which will affect intermediaries relate to the organization of general meetings and corporate events, in an effort to enhance the efficiency of the chain of intermediaries and improve the transmission of information along it. For instance, the last intermediaries in the chain must confirm to the shareholders their entitlement to exercise their shareholder rights in a general meeting. Intermediaries will be required to also transmit to the issuer updated notices of shareholder participation in the general meeting, while the last intermediary must ensure the information regarding the number voted is consistent with the entitled position. The information to be provided on corporate events gives intermediaries strict deadlines regarding corporate actions and shareholders identification processes. In addition, any transmission between intermediaries will need to be made in electronic and machine readable ISO format.
The implementation of the Directive has many benefits:
Investors and shareholders will have increased rights in General Meetings, as well as access to investment strategy information (when they are institutional investors) and have far better visibility into proxy advisors and how they establish voting instructions II, through encouraging more effective investor stewardship, provides an opportunity for positive change in corporate governance with benefits for many stakeholders, and should be embraced. The revised directive also provides an opportunity to improve the governance of companies for the benefit of all key stakeholders. Increased transparency could facilitate more dialogue between issuers and their shareholders. When combined with other initiatives targeting long-term engagement and funding source diversification for issuers, the SRD II could lead to longer-term engagement and investment in issuing companies.
However, this emphasis on immediate information is challenging both technologically and practically. The state-of-the-art technology can be an option. Thus, we can ask ourselves:
Could the Blockchain technology be an alternative for the implementation of SRD II?
We noted that the advantages of the blockchain are numerous:
First off, the blockchain technology allows for verification without having to be dependent on third-parties. The data structure in a blockchain is append-only. So, the data cannot be altered or deleted thanks to “Hashing, hash code” and Merkle Tree. More precisely, all blocks are interconnected via a mechanism which consists to put in the header of each block the hash code of this block as well as the hash code of the previous block.
Furthermore, it uses protected cryptography to secure the data ledgers. Also, the current ledger is dependent on its adjacent completed block to complete the cryptography process. This is called “Merkle Tree”, also known as a binary hash tree, which is mainly used for efficiently summarizing and verifying the integrity of large sets of data. The ledger is distributed across every single node in the blockchain who are the participants. So, it is distributed. Additionally, there is no possibility that the data if lost cannot be recovered. The origin of any ledger can be tracked along the chain to its point of origin. Since various consensus protocols would be needed to validate the entry, it removes the risk of duplicate entry or fraud.
On top of that, we can also note that recent regulatory and initiatives have shown that blockchain technology is feasible, particularly for the stock exchanges who are using this technology: As examples, we can notice that the Australian Securities Exchange ASX in collaboration with Digital Assets Holding is replacing its current clearing and settlement system with blockchain technology. It will also allow to provide proxy voting for all relevant issuer meetings. In addition, in 2016, the German Central Bank together with the Deutsche Börse announced the development of a prototype for securities settlements by using the Hyperledger Fabric of the Linus Foundation Blockchain technology.
Therefore, in the context of SRD II, we can imagine that the Blockchain technology can harmonize shareholders engagement opportunities by offering a common discussion platform for shareholders and board member. It may offer the required scope and appropriate platform for improvement: all questions from shareholders may be included in the blockchain, and thus become transparent, verifiable and immutable, and so do the answers of corporate board. Blockchain technology may actually enhance the forum of the AGM for shareholders and solve problems relating to amending resolutions during the AGM itself where shareholders that have remotely cast their votes are not present. The information on shareholder ownership stakes and identification is also stored in the blockchain and the issuer may directly be able to identify its shareholders as required in the Directive.
To resume, the blockchain technology can fulfill the following requirements: the transmission of information and the handling of electronic voting instructions from shareholders to the issuers; uniform, automated and the smooth application of the issuer’s right to know its shareholders; the standardization of the confirmation of entitlement to participate in the AGM; the swift processing of transmissions and ensuring that information reaches shareholders cross-border; and the secure transmission of confidential data.
However, it will require standardization and cooperation between regulators, issuers, shareholders and auditors in order to enable a financial consumer-friendly IT architectural system. In addition, small shareholders and institutional investors may still be skeptical about the use of blockchain to conduct a “virtual-only” meeting. Despite this, the Regulation of the SRD II seems to hint at this type of modern technology. The involvement of a party facilitating the switch in the market to this state-of-the-art technology is key, but also the European Union can play a pivotal role in guiding the transition towards swift and resilient institutional blockchain shareholder ownership and engagement framework.
Chloé Bouttevile is graduated with a master’s degree in Management and Corporate Strategy. She has gained experience in the distribution fund industry as Associate for almost 2,5 years. She has also gained advanced knowledge in the fund industry through their experiences in an insurance life company (control of NAVs, AML, KYC) and in a major bank based in Luxembourg.