From Shareholder Stewardship to Shareholder Duties: Is the Time Ripe?

Our paper “From Shareholder Stewardship to Shareholder Duties: Is the Time Ripe?” (available here) examines the development of the law of shareholder stewardship from the soft UK Stewardship Code to the proposed amendments to the Shareholder Rights Directive, and argues that the proposed Directive is a tentative step towards a hardening of stewardship standards at a pan-European level.

With the increasing institutionalisation of global equity, the role of institutional investors, especially the active ones, has attracted the attention of media, policy makers and academics. Many commentators argue that institutional investors could bridge the monitoring gap between beneficial owners and corporate managers. Others are more concerned with the ability of institutional investors to influence companies for their own benefit. At the same time, there is broad agreement that institutional investors, and especially activist hedge funds, often undertake a short-termist outlook which needs to be addressed.

Within this background the notion of “stewardship” has been articulated via the UK Stewardship Code to encourage institutional shareholders to move away from apathy and to engage constructively with investee companies. The Code is a “soft law” measure of best practices for institutions and asset managers. Although commentators criticised the Code for being national in character and unlikely to appeal to foreign investors who own the bulk of UK corporate equity, the Code has since inspired international developments in the institution of Stewardship Codes in many other countries.

At the EU level the proposed amendments to the Shareholder Rights Directive further affirms the UK Stewardship Code’s influence, especially in relation to Article 3f which requires institutional investors and asset managers to develop an engagement policy. Besides the development of an engagement policy on the part of institutional investors and asset managers, the proposed Shareholder Rights Directive instils a form of disclosure-based regulation which aims to increase the transparency of the investment chain (Articles 3g-3h).

We argue that the engagement provisions of the Shareholder Rights Directive are a step towards forging shareholder stewardship norms into hard law within the contours of well-known debates concerning the need for constructive engagement by institutional investors for the purposes of supporting a long-term wealth-creating corporate sector and mitigating short-termism, and the need to define the terms of engagement in order to rein in opportunistic activist behaviour. Although an institution can clearly reject an engagement strategy and instead explain the irrelevance of shareholder engagement in its policy, the proposed Directive is not far short of imposing a duty to demonstrate engagement, as there is a duty to publicly disclose the implementation and achievement of such engagement under Article 3g. Arguably, the disclosure-based regulation requires that certain engagement conduct be carried out in order for there to be sufficient matters to report, and moves away from treating shareholder engagement as a voluntary practice, as is the case under the UK Stewardship Code, to which voluntary signatories adhere. This is a step towards hardening stewardship norms into an engagement behaviour that is transparent and accountable, balancing a range of interests which are long-termist in nature.

Our paper concludes by considering the likely re-regulation of soft corporate governance standards through securities and financial regulation and its implications for the hardening of the law of shareholder stewardship. The proposed Shareholder Rights Directive is not a result of catering to bottom-up forces and market demand for corporate governance norms. Rather, it appears to be a re-regulatory measure rooted in public interest concerns over short-termism among institutions and the financial health of the corporate sector and is part of a wider move to re-bundle corporate governance rules from soft law into securities and financial regulation in recent years. This suggests that the increasing prescription towards shareholder behaviour addresses other public interest concerns beyond the private law dynamics of dispute resolution with respect to shareholder behaviour. Although the proposed Shareholder Rights Directive is tentative on completely hardening the soft law of shareholder stewardship, we are of the view that the time is ripe and such normative transformation of the emerging law of shareholder stewardship may be on the horizon. However, policy-makers need to be more honest and open about the regulatory objectives and premises underlying such legalisation of institutional shareholder duties.

Dionysia Katelouzou is Lecturer in Law at King's College London. Iris H-Y Chiu is a Reader at the UCL Faculty of Law.