One of private equity’s hallmarks is active engagement with portfolio companies. The nature and extent of that engagement may vary from firm to firm – indeed, from company to company – but oversight of management and involvement in strategic planning are usually minimum requirements. Almost by definition, venture capital and private equity fund managers are not passive investors.
In the public markets, of course, investors often lack the wherewithal and the financial incentives to take a similar approach with their investments – and policy-makers see that as a problem. In Europe, the so-called “ownerless corporation” has been the target of various voluntary and mandatory initiatives aimed at institutional investors. Until now, perhaps the most ambitious has been the UK’s Stewardship Code (which, as we previously reported, could have some implications for private equity fund managers in its most recent iteration).
But the latest initiative – this one mandatory, and effective from last month – emanates from the European Union. And this second iteration of the Shareholder Rights Directive (SRD II) also has some implications for private equity fund managers: it applies to regulated investors across the EU, including – in relation to any investments they hold in listed companies – full-scope alternative investment fund managers (AIFMs) and firms regulated by the Markets in Financial Instruments Directive (MiFID) to undertake portfolio management. (SRD II does not apply to MiFID-regulated “adviser-arrangers”.)
While the EU’s original Shareholder Rights Directive addressed corporate governance in European listed companies by ensuring equal treatment of shareholders, SRD II turns the spotlight on the conduct of EU-regulated financial institutions that are shareholders in European listed companies. It takes aim at perceived problems with their excessive focus on short-term performance and, in some cases, lack of engagement. SRD II requires affected investors to develop a policy for engaging with their investee companies in the longer term.
That policy, which must be published on the manager’s website, should include information on (among other things) how the manager monitors an investee company’s financial and non-financial performance, its governance and its social and environmental impact, how (or whether) the manager has a dialogue with investee companies and the manner in which the manager exercises its voting rights. Managers in scope must also publicly disclose each year how they have implemented the engagement policy, and describe their voting behaviour, highlighting the most significant votes.
Although the rules apply on a “comply or explain” basis, asset managers that are active on public markets are unlikely to explain complete non-compliance, unless (perhaps) they are deliberately short-term investors who do not have the ability or incentives to engage with investee companies.
As the scope of SRD II is limited to investments in European companies whose shares are admitted to trading on an EU-regulated market (and, as implemented in some member states, comparable markets outside Europe), the impact on private equity is limited. However, private equity firms that hold stakes in publicly-traded companies, including those retained following an IPO, will need to have regard to the new rules – although they are clearly in-step with the way private equity firms already approach their ongoing responsibilities and are unlikely to catalyse any behavioural changes.
So there is some limited direct impact on private equity firms that will need to be managed. But perhaps the less obvious effect of an ongoing regulatory focus on shareholder engagement and stewardship will be to private equity’s advantage. Other European initiatives are pointing in a similar direction and – notwithstanding the claims of some of its critics – private equity’s approach to stewardship stands up well under scrutiny. Investors who are focused on these issues, whether for commercial or regulatory reasons, may be increasingly attracted to the asset class.