This article is the fourth in the series What’s Next in Post-trade Regulation?, a guest column from Citi which will take a look at some of the major regulatory transformations currently underway in Europe’s capital markets. All articles in the series can be found here.

SRD II – Ironing out the creases

Marcello Topa, Director, Market Policy and Strategy, Direct Custody and Clearing, Citi

Adopted by the EU Parliament in 2017 and live across the European Union (EU) since September 2020, the Shareholder Rights Directive II (SRD II) is a piece of legislation aimed at enhancing shareholder rights. In order to encourage investors to engage with companies, regulators have stipulated that intermediaries in the custody chain ( central securities depositories, global custodians, sub-custodians and other relevant intermediaries) must transmit – without delay – information between issuers and investors, and facilitate the exercise of shareholder rights. While this Directive will usher in a number of positive changes, there are some lingering uncertainties which require urgent clarification.

Driving reform Inside the EU

SRD II is playing a vital role in strengthening investor rights and corporate governance standards inside the EU, not least because it requires institutional investors and asset managers to publicly disclose how they engage with EU listed companies and exercise their shareholder rights accordingly. Experts argue this is promoting greater transparency and incentivising long-term investment behaviour. SRD II is also helping to support harmonisation and closer integration within the EU through the imposition of common standards, making it easier for investors to engage with companies on a pan-EU basis. On the intermediary side, the rules require market participants to disseminate data across the custody chain on a near real-time basis, which is forcing providers to automate legacy systems and upgrade their technology infrastructure. Such digitalisation is a step in the right direction, as is the industry’s adoption of the ISO 20022 messaging format, which is enabling for a more streamlined and comprehensive SRD II communication process.

The time for clarity and improvement is now 

Although the underlying principles behind SRD II are sensible, the Directive is posing serious challenges for intermediaries which need resolving. Firstly, SRD II is not a regulation but a Directive, which means it is subject to different interpretations across member states. As a result, SRD II’s pan-EU implementation has not been fully harmonised, which is creating confusion for investors, issuers, and intermediaries. For example, the actual definition of what constitutes a shareholder is not unanimous across the EU, owing to differences in the underlying legal concepts in different jurisdictions. This poses a residual risk for intermediaries, as it could result in them either over or under disclosing details about shareholders depending on which market(s) they are operating in. It is critical that local regulators articulate which party in the chain should be disclosed as the shareholder if this risk is to be avoided.

The rules have also created unintended operational problems for intermediaries elsewhere. Legacy national laws underpinning shareholder engagement and disclosure continue to be enforced despite the introduction of SRD II. In many instances, the volume of non-SRD II-compliant requests exceeds that of compliant requests. This is problematic because many of the legacy requests require manual processing, in contrast to the automation expected for SRD II requests. As a result, industry experts have urged that all requests adhere to SRD II requirements moving forward. Simultaneously, intermediaries are also fielding a number of requests in the ISO 15022 format or via email, both of which require manual intervention as they do not respect the SRD II provision that all requests be sent in an ISO 20022 format. Other difficulties arise from the information about general meetings or disclosure requests being incomplete or incorrect. In some cases, this information contains a wrong sequence of relevant dates for the processing of the event or is drafted in the local language. In extremis, these ongoing deficiencies may even result in providers refusing to process requests altogether unless they are received in the correct format and contain all of the required information. Again, these are issues which EU regulators and stakeholders must resolve collaboratively.

Citi is actively engaged with various industry groups to provide feedback to the EU authorities as they evaluate the impacts of SRD II and consider developing legislative changes to the current rules. A key priority will be to focus on introducing a single EU definition of “shareholder” and on promoting the definition of common standards and practices that will provide for a smooth processing of these information flows.

Getting it right

SRD II has the potential to drive material improvements and further inflows into the EU’s capital markets. Not only does it introduce a common framework for shareholder disclosure, but it is also forcing intermediaries to embrace digitalisation, thereby augmenting the investment process. If SRD II is to succeed however, regulators need to achieve greater consistency in how it is interpreted and transposed across the different EU markets. On their side, market stakeholders also need to stamp out some of the inconsistent industry practices pertaining to information requests which have persisted despite the passage of SRD II. Once these problems are fixed, SRD II will have a positive impact on the functioning of the EU’s capital markets and the attractiveness of investments in European securities.

This is the fourth article from the series and here you can find the rest of the published ones, starting from the most recent one:

• The fifth article Moving with the times: Updating the SFD discusses how the Settlement Finality Directive (SFD) has been instrumental in strengthening capital markets and mitigating systemic risk by harmonising - across member states - the legal protections for market infrastructures and their participants. By Marcello Topa.
• The third article Enabling Digitalisation in Europe discusses the major digitalisation process and adopting new innovative technologies, as it looks to improve client experiences and support emerging asset classes. By Marcello Topa and Ryan Marsh.
• The second article in the series is CSDR: The saga continues, by Marcello Topa.
• The series began with Post-trade in Europe – a 20 year harmonization journey, by Marcello Topa.