Institutional Investors' Non-Financial Reporting: Should the EU Regulatory Framework Be Updated?

In my recent paper ‘Institutional Investors’ Non-Financial Reporting: Should the EU Regulatory Framework Be Updated?’, I argue that, if the dissemination of material non-financial information is a desirable policy objective, the EU framework should be amended to require, at least on a comply-or-explain basis, institutional investors to disclose any contents of their private engagements on environmental and social (‘E & S’) issues that they conduct with portfolio companies. My argument is not that a mandatory disclosure regime is good per se; rather, that, if European policy-makers care—as they seem to be doing—about disseminating material non-financial information on the markets, then the current framework is unsuitable to achieve the objective.

Background and empirical evidence

Shareholder-board dialogue is gaining traction in the EU and is increasingly receiving academic attention (see, eg the OBLB series on Board-Shareholder Dialogue). My paper offers an analysis of the trends in the EU as regards the exercise of shareholder voice on E & S matters. I do so by studying shareholder voice on E & S issues conducted by BlackRock, Vanguard, and State Street Global Advisors in 2020 in 83 sample companies, with which BlackRock conducted private engagements in 2020.

The empirical analysis indicates that E & S issues have been discussed overwhelmingly through private engagements, while they have never been raised through the submission of shareholder proposals or, more surprisingly, by voting on other shareholders’ E & S proposals. Does the EU regulatory framework mandating the disclosure of some non-financial information adequately reflect such empirical evidence? The short answer is ‘no’.

The importance of non-financial disclosure in the EU

EU policy-makers have recognized the central role that both corporate governance devices and investors can play in mobilizing capital towards more sustainable economic business models and projects, and have emphasized the importance of disseminating E & S information in the markets. The EU framework mandating non-financial disclosure to large investors is grounded on two pillars: the pre-contractual information regime set forth in the Sustainable Finance Disclosure Regulation (‘SFDR’) and the disclosure regime on institutional investors’ engagement policies and voting behavior of the Shareholder Rights Directive II (‘SHRD II’). The SFDR focuses almost exclusively on pre-contractual information. The SHRD II requires, on a comply-or-explain basis, institutional investors, and asset managers (i) to develop and disclose an engagement policy, explaining, in particular, how they monitor investee companies on non-financial performance and risk; and (ii) to disclose how they implemented such engagement policy, including a general description of voting behavior and an explanation of the most significant votes.

Testing the adequacy of the legal framework against empirical evidence

This framework—and, more specifically, the SHRD II—largely neglects private engagements and, in doing so, seems premised on the misconception that the EU market is characterized by traditional shareholder activism, where shareholders put forward many proposals, including on E & S issues, and voice is conducted through the most typical tool: voting. The regulatory environment is almost paradoxical: it requires disclosure for the stewardship tool (voting) that is virtually never used to address the environmental and social dimensions of investments, but it completely ignores the tool (private engagements) that, as the empirical evidence collected in this work shows, is frequently used.

The disclosure of the actual content of private engagements is instead left to the complete discretion of the institutional investors (and, potentially, to that of the portfolio companies), and this can have particularly important consequences. First, investors in the funds cannot know whether and how the stewardship principles advertised by the asset managers are being implemented. Second, and perhaps most importantly, since the details of what is being discussed through private engagements remain largely unknown, there is a risk that a large fraction of material E & S information is not being disseminated on the markets.

A mandatory disclosure regime for private engagements?

One policy solution could then be to amend the European framework to impose an obligation on institutional investors to disclose the contents of the private engagements on E & S issues they conduct with portfolio companies, similarly to what was proposed, although not with a specific focus on E & S issues, in the United States (see Bebchuk & Hirst, 2019). The measure could be introduced in the EU at least on a comply-or-explain basis. In the paper I also outline a non-exhaustive proposal that could inspire a possible reform in this direction, identify some of the possible objections to the introduction of such mandatory disclosure regime—namely, that the measure would be unnecessary, not proportionate, and that it would discourage private engagements—and offer some arguments as to why they should not prevent EU regulators from implementing the proposal.

Raffaele Felicetti is an S.J.D. Candidate at Harvard Law School and a Post-Doc Fellow in Corporate Law at LUISS Guido Carli University.

Readers who would like to receive a digital copy of the article are encouraged to reach out to the author at: Rfelicetti@sjd.law.harvard.edu.