The European Union (EU) has long sought to harmonize shareholders' rights and long-term shareholder engagement as part of completing its Single Market for financial services and thus capital. As part of the EU's Capital Markets Union (CMU), Directive (EU) 2017/828 (SRD II) amending Directive 2007/36/EC was published on May 20, 2017. EU Member States were required to transpose SRD II into their respective national laws and Germany implemented the relevant SRD II changes into German law through an implementation act (ARUG II), which took effect on January 1, 2020.
This Client Alert highlights some of the changes introduced by ARUG II and some of the issues that affected companies and shareholders, including institutional investors, may want to consider as this new law takes effect in Germany and as SRD II is implemented in other EU jurisdictions. While the SRD II's impact is limited to EU companies and thus ARUG II's provisions are limited to German companies listed on a "regulated market", i.e. a stock exchange, a range of institutions may be affected. Also, a number of domestic institutional investors and asset managers, but also non-German and non-EU domiciled proxy advisors, may need to comply with or may otherwise wish to avail of the SRD II and thus ARUG II's provisions – some of which may be different to principles they may be familiar with.
So what does ARUG II change?
ARUG II introduces various changes to German law, in particular to the German Stock Corporation Act (AktG). The rules on director remuneration have been adapted to the two-tier board system in Germany, consisting of the Management Board and the Supervisory Board. ARUG II does not contain material goldplating provisions compared to SRD II, although it should be noted that other EU Member States may have introduced national specificities into "their" jurisdiction. The four main areas of change are set out below.
1. Remuneration policy for the Management and Supervisory Board ("say on pay")
2020 marks the year and the proxy season during which there will be the first binding votes pursuant to ARUG II on companies' remuneration policies. The first remuneration reports based on these policies will have to be prepared for the fiscal year 2021 and will have to be put through the shareholder voting process in 2022 by the latest. For German stock corporations, it is the shareholders who determine the remuneration of the Supervisory Board members at a shareholder meeting and in turn it is the Supervisory Board which determines the remuneration of the Management Board.
- Remuneration policy for the Management Board
The new provisions require the Supervisory Board (Aufsichtsrat) of a company, which has its registered office in Germany and whose shares are listed on a regulated market, to adopt a remuneration policy for members of the Management Board (Vorstand). The law contains a list of descriptive requirements for the elements that a remuneration policy must contain, including a fixed cap on remuneration for the members of the Management Board.
In the Annual General Meeting (Hauptversammlung) of a listed company, the shareholders must vote at least once every four years, or when there are material changes, to adopt the remuneration policy proposed by the Supervisory Board. If the shareholders do not approve the remuneration policy, the Supervisory Board is obliged to submit a revised remuneration policy for adoption no later than at the next Annual General Meeting . However, this resolution does not establish any rights or obligations, but rather has the character of an advisory vote. Shareholders cannot bring a legal challenge against the vote following the Annual General Meeting.
The Annual General Meeting may reduce the maximum remuneration for the Management Board that was determined by the Supervisory Board by a vote that is binding both on the Management and the Supervisory Board. In order for the Annual General Meeting to decide on the reduction of the maximum remuneration, a motion to supplement the agenda of the Annual General Meeting in accordance with section 122 (2) sentence 1 AktG must be submitted by shareholders representing at least 5% or €500,000 of the share capital.
In principle, the Supervisory Board may set the Management Board's remuneration only in accordance with the above mentioned remuneration policy that was submitted to the Annual General Meeting for approval.
- Remuneration policy for the Supervisory Board
A remuneration policy must also be adopted for members of the Supervisory Board of a listed company and the same requirements that apply to the Management Board (as detailed above) apply to the Supervisory Board. With respect to Supervisory Board remuneration, the German legislator now requires that listed companies adopt a resolution at least once every four years, even if the Supervisory Board remuneration does not change.
- Remuneration report for the Management and the Supervisory Board
ARUG II requires companies having their registered office in Germany and whose shares are listed on a regulated market to publish a remuneration report. A single report will cover the remuneration of both the Management Board and the Supervisory Board. In accordance with the requirements of the SRD II, the remuneration report also contains information on the ratio of the average remuneration for directors to the average remuneration for the company's full-time employees over the past five years. In this regard, it is up to the company to decide how to determine a suitable comparative group for calculating average remuneration. The company has to explain in the remuneration report how it determined the comparative group.
The Annual General Meeting of a listed company has to approve the remuneration report each year. The resolution has the character of an advisory vote. Shareholders cannot bring a legal challenge against the vote in the aftermath of the Annual General Meeting.
2. Approval for related party transactions
SRD II aims to ensure that company and shareholder interests are adequately protected in cases involving related party transactions. In order to achieve this objective, ARUG II specifies that related party transactions are subject to the Supervisory Board's approval if the economic value of the transaction exceeds 1.5% of the total of the company's (or of the group's, if the company is the group parent company) fixed and current assets as stated in its most recently approved annual financial statements.
- Related party transactions
The definition of a related party transaction is based on International Accounting Standards (IAS) and is to be understood broadly from a functional standpoint. It covers both contractual and in rem transactions. The term "related party" likewise is consistent with the IAS definition (in particular, IAS 24). It comprises both natural persons as well as legal entities and partnerships. In evaluating whether a party is a related party, the formal legal structure of the relationship is not the sole determining factor. Rather, its economic substance is also to be taken into account.
- Exempt transactions
Transactions do not qualify as related party transactions for purposes of ARUG II if they were executed in the ordinary course of business and on an arm's length basis. In addition, ARUG II contains a list of other exemptions for certain types of transactions for which, owing to specific circumstances, special protection of shareholders is not required or is already ensured by other means, or the transactions serve an overriding objective. These include, for example, transactions with subsidiaries that are wholly owned by the company, either directly or indirectly, or in which no related party holds a stake. Transactions that require the approval of or authorization by the Annual General Meeting or are undertaken in execution of such an approval or authorization are likewise exempted. By expressly referring to corporate agreements, the German legislator also takes into account the complex protective mechanisms contained in German law governing corporate groups formed by contract, which already satisfy the protective standard expected to be introduced under SRD II.
- Approval procedure
Related party transactions covered by the new provisions are subject to the Supervisory Board's approval prior to being concluded. Members of the Supervisory Board that are subject to an actual or perceived conflict of interest may not take part in the vote in such cases.
If the Supervisory Board refuses to approve a related party transaction, the Management Board may request that the Annual General Meeting vote to approve the conclusion of the transaction. Related parties involved in the transaction may not vote on such a resolution in the Annual General Meeting.
Listed companies must publicly disclose related party transactions requiring approval without undue delay. This does not apply if the transaction was already published as an ad hoc disclosure pursuant to Article 17 of the EU's Market Abuse Regulation.
3. Disclosure obligations for institutional investors, asset managers and proxy advisors
Institutional investors, asset managers and proxy advisors are subject to extensive new disclosure obligations under the AURG II rules. In terms of applicability, ARUG II refers to the rules set out in SRD II. The German rules apply:
- to institutional investors whose home member state is Germany and to the extent that they invest directly or indirectly in shares traded on a regulated market;
- to asset managers whose home member state is Germany and to the extent that they invest in shares traded on a regulated market on behalf of investors; and
- to proxy advisors:
- who have their registered office in Germany; or in case they do not have a registered office in the European Economic Area (EEA), have their head office in Germany; or in case they have neither a registered office nor a head office in the EEA, have an establishment in Germany; and
- to the extent they provide services to shareholders with respect to shares of companies which have their registered office in the EEA and whose shares are listed on a regulated market situated in the EEA.
- Institutional investors and asset managers
For instance, institutional investors and asset managers must publish an engagement policy in accordance with detailed requirements. The law follows the "comply or explain" logic, i.e. institutional investors and asset managers must publish their engagement policy and their voting behavior or explain why they failed to satisfy one or more of these statutory requirements.
In addition, institutional investors must disclose how the main elements of their investment strategy are consistent with the profile and the duration of their liabilities and how they contribute to the medium- to long-term performance of their assets. Liabilities, within this context, mean the contractual and fiduciary relationship with the investor/ultimate beneficiary. This information must be made publicly available on the websites of institutional investors or asset managers for at least three years from date of publication and must be updated at least once a year.
Asset managers, who act on behalf of institutional investors, shall report annually to the investor on how their investment strategy and its implementation are consistent with the agreement between asset manager and investor and how they contribute to the medium- to long-term performance of the assets. A public disclosure by the asset manager of such information is not mandatory.
- Proxy advisors
Proxy advisors must explain on a yearly basis whether they have complied with the requirements of a particular code of conduct, such as for example the Best Practice Principles for Shareholders Voting Research put together by an industry group at the request of the European Securities and Markets Authority (ESMA). In case they have not complied with part of the requirements of the code of conduct, they must also explain which measures they have taken instead. If proxy advisors do not comply with a code of conduct at all, they must explain why they have not done so.
Proxy advisors also have to publish information regarding inter alia their methods and main sources of information, their quality assurance, qualifications and voting policies. All information must be made publicly available on the website of the proxy advisor for at least three years from date of publication and must be updated at least once a year. In addition, they must promptly notify their clients about conflicts of interests and relevant countermeasures.
4. Arrangements concerning improved shareholder identification and information ("know your shareholder")
- Identification of shareholders and intermediaries
A company that has its registered office in Germany or another member state of the EEA and whose shares are listed on a regulated market has the right to request from any intermediary, who is safekeeping shares of the company, information on the identity of the shareholder. If applicable, such a right also exists vis-à-vis the next intermediary in the chain of intermediaries. The request shall be transmitted between intermediaries up the holding chain and the intermediary holding the requested information regarding the shareholder's identity shall transmit such information directly to the company without undue delay, unless the company requests the transmission from another intermediary in the chain. In this case, intermediaries shall forward the information without undue delay to the intermediary who received the company's request or to the next intermediary in the chain.
- Transfer of information from the company to shareholders
In order to ensure a better flow of information from a company which has its registered office in Germany and whose shares are listed on a regulated market to its shareholders, such a company is required to either pass on information on corporate events to the shareholders recorded in the share register in case of registered shares, or otherwise to pass such information on to the intermediary. Corporate events in this meaning is any action initiated by the company or a third party that involves the exercise of the rights flowing from the shares and which may or may not affect the underlying shares, such as the distribution of profits or a general meeting. In case an additional intermediary exists, the first intermediary has to forward the information without undue delay to such an intermediary. The last intermediary in a chain of intermediaries has to forward the information to the shareholder.
- Facilitating the exercise of shareholder rights
The last intermediary in the chain shall forward information regarding the exercise of a shareholder's rights to the listed company either directly or along the chain of intermediaries. For exercise of shareholder rights at an Annual General Meeting, the last intermediary also has to provide proof of the shareholdings without undue delay to either the shareholder or the company at the shareholder's request. The listed company will have to confirm the electronic exercise of voting rights either directly or through the chain of intermediaries.
Entry into force and transitional provisions
ARUG II entered into force on January 1, 2020, following promulgation in the German Federal Law Gazette in December 2019. While the provisions on related party transactions and on disclosure obligations for institutional investors, asset managers and proxy advisors entered into force without transitional arrangement on January 1, 2020, the following transitional arrangements are in place:
- Remuneration policy for the Management and Supervisory boards ("say on pay")
The new requirements on remuneration policies have to be implemented by the respective companies prior to the end of the first Annual General Meeting of that listed company held after December 31, 2020. Therefore, for most listed companies having a fiscal year coinciding with the calendar year, this will be between March and June 2021. The Supervisory Board has to set the Management Board's remuneration within two months following the Annual General Meeting that approves the remuneration policy. The remuneration report has to be published for the first time for the fiscal year starting after December 31, 2020.
- Arrangements concerning improved shareholder identification and information ("know your shareholder")
The rules concerning improved shareholder identification and information will only be applicable from September 3, 2020. The rules will apply to Annual General Meetings convened after September 3, 2020. The German rules are thus aligned with the applicability of the EU implementing regulation (EU) 2018/1212 on shareholder identification, the transmission of information and the facilitation of the exercise of shareholders rights.
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