EU’s SRD: Reworking Proxy Services

Custodian bank operations managers should start planning to get their hands a lot dirtier in the proxy plumbing process.

The new version of the European Shareholder Rights Directive (SRD) calls for them to respond to European issuer requests for identifying investors who hold more than 0.5 percent of a company’s stock, to forward proxy information to investors in a standardized electronic format, and to deliver their votes promptly.

Although the pan-European regulatory body European Securities and Markets Authority (ESMA) has yet to publish technical recommendations, the current text provides some inkling of the extra efforts custodians are facing come June 2019. That’s the final deadline for the European Union member states to pass the SRD into national law.

Topping the list of challenges for custodians could be adapting to ISO 20022-compliant messages for proxy distribution and voting. Although SWIFT, the La Hulpe, Belgium-headquartered global messaging network provider, did release ISO 20022-compliant messages for proxy distribution and voting as early as 2008, one year after the adoption of the first version of the SRD, legacy ISO 15022-compliant message formats are still the norm.

So far, SWIFT has allowed users of its network to rely on both ISO 15022 and ISO 20022-based message types for other functions to accommodate financial firms who can’t afford either the time or expense necessary to convert to the XML-based ISO 20022 messages. Switching from ISO 15022 could involve an overhaul of middle and back-office systems, so many financial firms are relying on third-party software which “translates” between ISO 15022 and ISO 20022 messages.

“International standards, such as ISO 20022, will pave the way for the transmission of information and the collection and tracking of shareholder votes in a standardized way at the global level,” predicts Cecile Dessambre, a market manager in SWIFT’s securities team. She says that SWIFT’s ISO 20022 message types for proxy distribution and voting already meet the SRD’s requirements, which are designed to promote investor participation in corporate governance.

Informing Investors

European regulators are concerned that investors are not getting sufficient and consistent information on corporate agendas, particularly when it comes to the compensation for board members. They also want investors to understand how much they might be paying for the right to vote. The European Commission’s solution: put some of the administrative onus on custodians as “financial intermediaries” who must also inform asset owners of what they are being charged for proxy services. The directive is not explicit about what a custodian should do if the fund manager doesn’t want to sign up for its proxy service. Presumably the custodian must offer a proxy service.

Global custodians are starting to feel the heat. “There could be more administrative work required without additional compensation,” speculates the proxy operations manager at a US-based global custodian. The SRD calls for financial intermediaries to charge investors “non-discriminatory and proportionate fees.” That means fees proportionate to the cost of offering the service. European member countries can also prohibit intermediaries from charging any fees for the “cost of changes related to disclosures.”

The current “omnibus” method for account ownership and recordkeeping makes it easy for companies and investors to lose sight of each other. Companies typically don’t know who their shareholders are unless the investors are registered on the books of their registrars in their own names. If they hold shares in the names of their banks or broker-dealers, their holdings will be reflected on the books of registrars as being owned by the financial intermediary.

Custodian banks typically forward information on corporate agendas to their fund manager and other clients. If the bank also offers a proxy voting service, it will allow the fund manager to cast its vote through the custodian bank which will either forward it directly to the issuer, issuer’s agent or another custodian — a subcustodian– located in the same market as the issuer. The local custodian bank or subcustodian will pass the vote along to the issuer or its agent.

Given that the proxy distribution and voting process is so cumbersome to manage — and not a profit-making initiative — more than 40 global custodian banks have decided to outsource their work to Broadridge Financial Solutions, which distributes the proxy information to fund managers and transmits their votes on their behalf. Manifest, a London-based proxy services firm, distributes proxy material to pension plans and casts their votes. However, that service is only available in the UK.

The directive suggests that once companies are told who their underlying investors are, they will be able to forward information directly to all of their investors, including the ones who hold shares in the name of their financial intermediary. Companies won’t have to rely on financial intermediaries — such as custodian banks — to forward the information or use Broadridge Financial. Instead, corporate registrars could do so. Those registrars could also offer voting services. However, it remains to be seen how many companies will want to take on the challenge of handling proxy distribution and voting for institutional investors on their own.

Faster Standardized Messages

“We don’t believe the directive will change our proxy operations [model] globally,” says Elizabeth Maiellano, vice president of Broadridge’s investor communications unit. However, she acknowledges that Broadridge and subcustodian banks might have to make some changes to the frequency of their administrative work depending on the final language of the SRD. It will all come down to how quickly votes must be relayed to issuers.

Broadridge may be required to forward votes to subcustodians and issuer agents on a continual daily basis rather than in one batch before the cutoff time for vote receipt for a corporate meeting. Broadrige would continue to reconcile account ownership and share positions on its books daily with data provided by custodian banks because the eligibility of shareholders to vote changes daily. However, subcustodians might have to reconcile their records of the number of votes that are eligible to be cast with the number actually received on a daily basis, rather than at one time before the corporate meeting.

Although the SRD did not specify which message formats should be used in the proxy distribution and voting process, the increase in message frequency and volume as well as the need for standardized information delivery could prompt Broadridge and custodian banks to more fully embrace the ISO 20022 protocol. Broadridge acknowledges that the bulk of its voting transmissions still occur through secure file transfers and ISO 15022 messages to accommodate the needs of subcustodians. SWIFT’s Dessambre also says that central securities depositories are showing the most interest in ISO 20022 messages for proxy distribution and voting with the most popular being those for “notification and cancellation of general assembly.”

ISO 20022 message formats could become more popular for proxy voting should distributed ledger technology, or blockchain, now under development, become implemented. Last month, a group of central securities depositories, including Russia, South Africa and Switzerland’s, announced that they had worked with SWIFT to develop requirements for proxy voting on a DLT platform using ISO 20022 message types.

Regardless of how much or little the European SRD shakes up the current European proxy landscape, one thing is certain. Fund managers and their buy-side customers will at least be better informed about just how much they are paying. Fund manager operations managers tell FinOps that global custodians will have to unbundle proxy distribution and voting fees from other services if they don’t do so already.

Operations managers at several global custodian banks tell FinOps they are concerned about whether they will be able to pass on the potential higher costs of their proxy services to fund manager investors. Even if they can, they will need to keep a detailed audit trail to substantiate just how much those costs are. Still, the SRD’s current language provides them with some inkling of hope. Apparently, a previous version of the revamped SRD suggested that custodians couldn’t charge fund managers and other clients any fees for proxy related services.