Europe’s Next Big Step
ESMA is calling for an EU-wide stewardship code to hone and standardise investors’ engagement efforts and disclosures.
The sustainable finance landscape in the EU has rapidly expanded in recent years, largely thanks to a slew of legislation delivered in line with the European Green Deal.
This includes now-familiar acronyms such as CSRD, SFDR and CSDDD.
With most of the key officials responsible for shaping EU legislation over the next few years now in place, it’s time for lawmakers to consider solidifying the existing landscape to ensure investors can support the bloc’s climate and sustainability goals.
According to the European Securities and Markets Authority (ESMA), the current framework needs to mature further to facilitate their sustainable investment journey.
Last month, ESMA outlined recommendations for the European Commission. A key suggestion – which was confined to a single paragraph within the 21-page document – was to implement an EU stewardship code that would apply to institutional investors and other market players.
A voluntary code would provide more active support for the implementation of the EU framework across member states, ESMA argued.
“The future of responsible investment must combine managing ESG risks and identifying and acting on sustainability outcomes,” says Elliot Sutcliffe, EU Policy Specialist at the UN-convened Principles for Responsible Investment (PRI). “Given systemic risks cannot be diversified away, investors must be active owners to manage [the] transition to a sustainable economy that operates within planetary boundaries and protects human rights.”
As such, clearer and more supportive legislation on stewardship and fiduciary duties is needed, Sutcliffe argues.
Piecemeal
Although EU-based investors have demonstrated plenty of sustainability-related ambition, their adoption of stewardship principles remains patchy.
A 2023 ShareAction report assessing asset managers’ voting activities found European investors had voted in favour of 88% of shareholder proposals on average, compared to 25% for US investors and 64% for UK investors.
Separate research has shown that European investors are generally more vocal than their US peers when communicating concerns over specific portfolio companies – thereby exhibiting a more active approach to stewardship.
“Many EU-based investors use stewardship as a key lever to meet their fiduciary duties, improve risk-return, and contribute to long-term sustainability goals,” says Sutcliffe.
Existing approaches to stewardship are generally informed by industry groups like Deutsche Vereinigung für Finanzanalyse und Asset Management (the Association of Investment Professionals in Germany) or the International Corporate Governance Network, as well as through national codes and laws – such as Germany’s ARUG II – and investors’ in-house strategies.
There’s also the stewardship code introduced by the European Fund and Asset Management Association (EFAMA), which was first adopted in 2011. It contains six principles, including ensuring asset managers have a publicly available engagement policy, monitor portfolio companies in line with it, and establish clear guidelines on when and how to escalate engagements.
Yet EFAMA’s code doesn’t quite deliver for its members as it downplays disclosures on conflicts of interest, explains Paul Lee, Head of Stewardship and Sustainable Investment Strategy at investment consultancy Redington.
“That feels like quite the omission, frankly,” he says. “Perhaps it’s a sign of the fund management industry not being quite as attuned to the need to address conflicts as it ought to be.”
With encouragement from the commission, some member states such as Denmark and Spain have developed their own stewardship codes – but most of the bloc has not followed suit.
“The Netherlands and Italy are the most developed [on stewardship], followed by Germany, France and the Nordic markets,” argues Alexander Juschus, CEO of the Association of Stewardship Professionals (StePs) – a non-profit dedicated to the advancement of the investment stewardship profession. “There is considerable room for improvement in all other markets.”
Strong foundation?
That’s not to say that EU lawmakers haven’t issued rules on stewardship, however.
The Shareholder Rights Directive II (SRD II), for instance, outlines disclosure rules on themes such as the remuneration of directors, ultimately increasing transparency requirements for investors. Similarly to a stewardship code, it demands that asset managers annually report on their engagement and investment strategy.
“SRD II recognises that involving shareholders in corporate governance is a lever that can help improve the performance of companies – yet [it] does not require meaningful stewardship action or outcomes,” says Sutcliffe.
It also centres on listed equity, which limits stewardship practices in other asset classes, such as fixed income and private equity, he adds.
“Arguably, current EU policies are insufficient at promoting consistent and strong stewardship practice,” he continues.
The PRI would support the introduction of stewardship omnibus legislation that sets out expectations for investors’ related practices in a much broader sense – clarifying their rights and responsibilities and reducing the barriers they face in engagement activities and investee monitoring, Sutcliffe argues.
An EU-wide code would “make life easier for investors” agrees Juschus. “Reporting will become standardised and more easily comparable, and collaborative engagement would become easier, too. ‘Free-riding’ will also become more difficult [and] it could help less developed markets take the next step.”
However, a diluted stewardship code with weak requirements would be counterproductive, Juschus warns.
In its 2021 sustainable finance strategy, the European Commission included an action point to revise SRD II to better reflect impact considerations and global best practices in its stewardship guidelines.
Across the Channel
If the EU did need some inspiration on what its stewardship could look like, it should look no further than the UK Stewardship Code.
Lee argues the “best stewardship reporting globally” is done against the UK code, which was last updated in 2020 and currently requires signatories to identify and respond to market-wide systemic risks to promote a “well-functioning” financial system.
“When we [Redington] assess asset managers on their stewardship reporting, we look for their UK code-aligned disclosures,” says Lee. “Not because we’re parochial, but because this gives us the best insights into what they are actually delivering.”
Beyond the UK’s borders, the code is also popular globally, with around 40% of the code’s near-300 signatories headquartered outside the country.
“The EU could pursue a clearer approach [to stewardship] and encourage better transparency by developing a voluntary code similar to the one pioneered by the UK,” says Antje Stobbe, Head of Stewardship at Allianz Global Investors (Allianz GI). “Alignment would be welcome [so as not to] overburden investors with reporting requirements.”
According to Juschus, around 90% of the content of all codes globally is congruent with the UK version.
“I could imagine that most [versions developed by other countries] took the UK as their basis and developed their own standards from there,” he says. “The UK code is very advanced, established and accepted – therefore, my hope is that all [its] principles would be reflected in an EU iteration.”
But, while many agree that the sensible option is to follow the well-trodden path set out by the UK, the EU should also consider its reputation as arguably the world’s most ambitious jurisdiction when it comes to sustainable finance-related legislation.
“Simply replicating the UK code would feel like a missed opportunity,” says Lee. “If you’re going to create a new code for the EU, why not be ambitious and set the bar higher?”
One area where the bloc could push further is on principle four of the UK code – which focuses on systemic risk and public policy engagement.
“This is a crucial area in which an increasing number of investors are recognising the need to think about the systemic issues that will shape markets going forward and shape investment opportunities,” Lee continues. “Climate change is the most obvious of these – inequality is another.”
The UK code is currently subject to a three-stage review. Recent changes have included removing the requirement to annually disclose all reporting expectations around stewardship ‘context’ – except for new reports or material changes – and setting clear expectations of what is considered an ‘outcome’ for stewardship purposes.
A full public consultation will be launched in the coming weeks, with the finalised UK code due to be published early next year.
Bloc-by-bloc
Of course, implementing a single stewardship code across 27 countries is easier said than done.
Among the many challenges such a feat would entail, member states have various ownership rights. For instance, in Germany, pension funds are required to have an asset manager, and are therefore not entitled to engage themselves, explains Juschus. As such, EU code would need to reflect differences across member states and provide flexible solutions.
But this may not be as high a hurdle as it appears to be.
“Stewardship codes are not a set of rules, but of principles,” Lee counters. “This might sound like a semantic difference, but actually it’s about influencing mindset and approach – inviting investors to rise to the challenge and deliver as they feel appropriate against a set of principles, rather than treating it as a rulebook that needs to be applied.”
Principles-based guidance would give asset owners and managers more flexibility in their compliance with EU-wide reporting requirements on stewardship.
“An EU code could also help with transparency on asset managers’ convictions and approach to sustainability-related engagements,” agrees Allianz GI’s Stobbe. “This would allow clients to make better choices when directing their assets towards sustainable investments.”
There is, however, concern that the existence of other widely adopted national and international stewardship codes would make implementation more challenging for the EU as a late mover on the subject.
“We recommend that a new stewardship code be designed in a way that limits duplication with existing national and non-EU codes for those organisations already reporting against them,” says Sutcliffe. “The interoperability of stewardship codes, through similar objectives, common design principles and consistent metrics, is critical to ensure a clear understanding.”
While the concept of an EU stewardship code is currently nothing more than an idea tucked away in an ESMA report, there is clear appetite for the bloc to take a more proactive approach to regulating European investors’ efforts and disclosures in this area.
Should an EU-wide code be developed, it should also be supplemented with additional measures, Sutcliffe insists – with the overall goal to clarify that investors have a duty to undertake stewardship in ways that are consistent with both financial and sustainability objectives, to serve beneficiaries’ best interests.
“[The code] should be accompanied by mandatory stewardship requirements and a wider review of the EU legislative framework – including, but not limited to, SRD II,” he says.
But additional action is also needed from legislators globally, to make stewardship more effective and to create a level playing field which clarifies the rules of the game for collaborative engagement across Europe.
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