The EU Commission s Green Paper The EU Corporate Governance Framework

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1 BVI Eschenheimer Anlage 28 D Frankfurt am Main Via to: Ms. Claire Bury Head of Unit F2 DG Internal Market and Services European Commission 1049 Brussels BELGIUM Bundesverband Investment und Asset Management e.v. Contact: Dr. Magdalena Kuper Phone: Fax: July 2011 The EU Commission s Green Paper The EU Corporate Governance Framework Dear Ms. Bury, BVI 1 gladly takes the opportunity to engage in public discussion concerning the Commission s ideas for an EU Corporate Governance Framework. General remarks The issues of corporate governance are relevant for BVI members from two different perspectives: As fund management companies, BVI members are themselves corporations and thus likely to be affected by regulatory tendencies stemming from the Green Paper at hand, even though they are usually not listed at stock exchanges. 1 BVI Bundesverband Investment und Asset Management e.v. represents the interests of the German investment fund and asset management industry. Its 85 members manage currently assets in excess of EUR 1.8 trillion both in mutual funds and mandates. BVI s ID number in the EU register of interest representatives is For more information, please visit Director General: Stefan Seip Managing Director: Thomas Richter Rudolf Siebel Eschenheimer Anlage 28 D Frankfurt am Main Postfach D Frankfurt am Main Phone: Fax: info@bvi.de

2 Page 2 of 13, Date 22 July 2011 As managers of assets for both retail and institutional investors, BVI members are major shareholders in European companies. For this reason, BVI members take great interest in the governance of their investee companies as well as in the relating possibilities of effective shareholder engagement. BVI concurs with the Commission in attaching high importance to good corporate governance in European companies. Just for that reason, we are concerned that the interrelation of the different strands of work processed by the Commission in relation to corporate governance is not clear enough which might result in the lack of consistency as regards the regulatory approaches to corporate governance. In particular, it must be ensured that corporate governance measures for financial institutions are fully compatible with the general concept of corporate governance under company and capital market law. Similarly, the role of shareholders in corporate governance should be defined in a consistent manner regardless of the background or motivation of individual shareholders and especially detached from the question whether a shareholder operates within or outside the financial industry. In our view, the legal framework for engagement in companies governance should be the same for all shareholders. Moreover, it is our understanding that any EU measures for enhancing corporate governance discussed in the consultation paper would apply on a comply or explain basis and hence encompass the possibility of being duly adapted to the specific circumstances of a company. Specific comments From the viewpoint of BVI, the focal point of the consultation is clearly Section 2 relating to the role of shareholders. Nonetheless, we deal also with other issues raised in the consultation paper insofar there is a clear opinion among the German fund industry. Q1: Should EU corporate governance measures take into account the size of listed companies? How? Should a differentiated and proportionate regime for small and medium-sized listed companies be established? If so, are there any appropriate definitions or thresholds? If so, please suggest ways of adapting them for SMEs where appropriate when answering the questions below.

3 Page 3 of 13, Date 22 July 2011 Q2: Should any corporate governance measures be taken at EU level for unlisted companies? Should the EU focus on promoting development and application of voluntary codes for non-listed companies? We do not think that EU corporate governance measures in their substance should be different depending on the size of a company. If at all, differentiation could be done gradually in the sense that implementation of some requirements could be made subject to a proportionality principle in accordance with the comply or explain approach. On the other hand, a distinction between listed and unlisted companies as regards application of EU corporate governance measures is still appropriate. Listed companies are by nature capital market oriented and often characterised by a very broad shareholder base. These features justify the requirement for specific measures in addition to those already foreseen by company law. In addition, we strongly support a clear distinction between normal (operational) listed companies and listed products such as listed investment funds, instruments issued under the Prospectus Directive and listed real estate companies. Many of the Green Paper s proposals appear not proportionate or irrelevant to the structure and operations of listed products. For instance, in case of externally managed investment funds, the role of the board of directors is very limited and incompatible e.g. with the request for stronger involvement in the risk management process. The provisions for strengthening of the board s supervisory function are also inappropriate in this case given the very limited role of the board in the investment process. Therefore, BVI strongly suggests refraining from applying the future EU corporate governance measures to listed products. 1. Boards of Directors Q3: Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided?

4 Page 4 of 13, Date 22 July 2011 In the dual system of the German company law, the functions of CEO and chairperson of the supervisory board are already clearly divided. BVI is also in favour of introducing a clear separation of functions at EU level. Q4: Should recruitment policies be more specific about the profile of directors, including the chairman, to ensure that they have the right skills and that the board is suitably diverse? If so, how could that be best achieved and at what level of governance, i.e. at national, EU or international level? Q5: Should listed companies be required to disclose whether they have a diversity policy and if so, describe its objectives and main content and regularly report on progress? Q6: Should listed companies be required to ensure a better gender balance on boards? If so, how? In BVI s view, ensuring adequate skills and diversity in the board composition is essential for the proper performance of the supervisory function. Specification of the required profiles in recruitment policies could thus help to warrant effectiveness of a company s internal control. We also agree that listed companies should strive for better diversification in their board composition. Diversity needs to be appropriate to the business activity, size and strategy of a company and should comprise many different factors. Gender should be only one of the many criteria employed by companies in order to ensure diversification at the board level. In this context, we would also like to point out that the legal framework applicable to investment management, in particular UCITS and AIFM Directives as well as MiFID, already provides for very specific requirements as regards reputation and skills of directors and persons who effectively conduct the business of management companies. These requirements are reflected in the recruitment process and strictly applied by supervisory authorities whose approval is needed for the board members appointment. Q7: Do you believe there should be a measure at EU level limiting the number of mandates a non-executive director may hold? If so, how should it be formulated? BVI is reluctant to the idea of a fix limit of mandates for all listed companies. We could imagine general guidance on this issue being provided at EU level combined with the flexibility for companies to adopt a different approach on

5 Page 5 of 13, Date 22 July 2011 the basis of specific circumstances and in line with the comply or explain principle. Such guidance could require that non-executive directors be in a position to devote adequate time and resources to each mandate held taking into account the nature, scale and complexity of a company s business activities. Q9: Should disclosure of remuneration policy, the annual remuneration report (a report on how the remuneration policy was implemented in the past year) and individual remuneration of executive and non-executive directors be mandatory? Q10: Should it be mandatory to put the remuneration policy and the remuneration report to a vote by shareholders? BVI supports the introduction of an EU-wide requirement for disclosure of remuneration policies and inclusion of related information in annual reports. As institutional investors owing fiduciary duties to their unitholders, BVI members would be interested in expanding their tools to discern and correctly assess moral hazard at the level of investee companies. It should also be noted that for investment managers, very detailed rules on remuneration have recently been introduced in the AIFMD or are about to be introduced by revision of the UCITS Directive. The AIFMD provides also for disclosure of remuneration policies and actual remuneration paid by the AIFM. Moreover, BVI is clearly of the opinion that shareholder voting upon the remuneration policy is an effective control mechanism and should be made mandatory at EU level. An advisory vote by shareholders appears sufficient as a clear dissent by the general assembly would send an unequivocal message to a company s management despite its non-binding nature. Q11: Do you agree that the board should approve and take responsibility for the company s risk appetite and report it meaningfully to shareholders? Should these disclosure arrangements also include relevant key societal risks? Q12: Do you agree that the board should ensure that the company s risk management arrangements are effective and commensurate with the company s risk profile?

6 Page 6 of 13, Date 22 July 2011 BVI shares the notion that approving and taking responsibility for the company s risk appetite is a key element of the supervisory board s duties. There should also be adequate and meaningful reporting to shareholders on the risk profile of a company. Regarding a company s risk management, in Germany the responsibility is divided between executive and supervisory board with the latter being vested with an oversight function in this regard. In its respective capacity, the executive and supervisory board must ensure that the risk management arrangements undertaken by a company are effective and commensurate with its risk profile. Similar approach should in principle apply to the one-tier board structure encountered in Europe. 2. Shareholders The section on the shareholders role in corporate governance touches directly upon the function of asset managers as agents of institutional clients. Therefore, we would like to revert to the general debate underlying the Commission s findings and to correct some misconceptions in terms of the asset management industry and the capital market in general. Lack of appropriate shareholder interest We strongly disagree with the thesis that investors are driven into equity markets by the perspective of high returns as opposed to limited losses. It is incontestable that investors in equities are exposed to the risk of losing their entire investment which can be economically devastating especially as the Commission assumes that in many cases, acquisition of shares is financed through high leverage. In addition, the risk exposure of shareholders is higher, not lower, to that of creditors: creditors losses are likewise limited to the amount of invested capital, whereas in the event of bankruptcy the claims of creditors are served first before distributing the remaining assets, if any, to the shareholders. We are convinced that the perceived lack of shareholder interest in exercising control rights in their investee companies is due to a multitude of factors such as complexity of the underlying legal structures, insufficient information about the shareholder rights in general and participation in shareholder meetings in particular.

7 Page 7 of 13, Date 22 July 2011 Generally speaking, however, it must be recognised by the Commission that investors in listed companies are free to engage in governance issues and to exploit their respective means to hold the companies management accountable, but also equally free to abstain from any activities in this regard. Certainly, such freedom does not apply to asset managers who are under the fiduciary duty to act in the best interest of their clients. Lack of appropriate shareholder engagement BVI shares the Commission s impression that institutional investors have been too reluctant in the past to engage in corporate governance issues. In order to remedy this situation in terms of asset management, BVI has taken a leading role in promoting the development of the EFAMA Code for External Governance which was presented to the public in May The EFAMA Code aims to provide a framework of high-level principles and best practice recommendation which should facilitate communication between investment management companies and investee companies as well as stronger engagement on the part of the former. BVI is actively engaged in facilitating execution of voting rights by asset managers also at national level. In 2006 BVI members decided to foster their shareholder engagement in listed companies by appointing a proxy advisor at the association level who would assist BVI in establishing the so-called BVI Corporate Governance Platform, an IT-tool providing analyses of shareholder meeting agendas for 200 biggest German and international companies. Following a beauty contest, BVI has chosen a start-up enterprise called IVOX for this project. The IVOX analyses have been performed on the basis of methodical guidelines developed by BVI members with the advice of IVOX. In 2010 it was decided that the market launch of IVOX had been successful and hence the contract with BVI was terminated, but the cooperation in terms of shareholder meeting analyses still continues at the association level as well as with individual companies. Short-termism of capital markets We disagree with the Commission s approach to draw conclusions pertaining to the asset management industry from the article by Paul Woolley Why are financial markets so inefficient and exploitative a suggested remedy. Obviously, the cited article refers to investment banking which is an entirely

8 Page 8 of 13, Date 22 July 2011 different activity with a fundamentally different business model. We cannot understand why in the Green Paper the Commission applies the report s findings to asset management without even mentioning investment banking. The business model of the asset management industry requires asset managers to act as agents who manage their clients assets on their clients behalf and in the clients name. The clients assets may be managed either through collective investment schemes or individual mandates. They are strictly segregated from the own assets of the asset manager and from other clients assets. Management of the clients assets does not directly affect the assets of the manager, but entails operational and reputational risks. The reputational risk is one of the most sensitive issues for asset managers as good reputation is essential for generating new business opportunities. The asset managers reputation derives from good performance and track record in managing clients assets in the longer term which strongly aligns the interests of asset managers and investors. Moreover, we reject the Commission s conclusion in terms of shareholding periods in asset management on the basis of the asserted turnover on the major equity exchanges. A turnover of 150% per year of aggregate market capitalisation appears quite low given that it is based upon all kinds of transactions and hence also accounts for highly speculative day trading which aims at gaining profit from the smallest price movements by buying and selling assets repeatedly, even several times within a fraction of a second. There is absolutely no evidence that the mere average of all holding periods is of any significance for the holding pattern of asset managers. Lastly, enhancement of liquidity through trading is exactly one of the reasons for which publicly traded companies seek listing of their shares on stock exchanges. Q13: Please point to any existing legal rules which, in your view, may contribute to inappropriate short-termism among investors and suggest how these rules could be changes to prevent such behaviour. In general, all rules which require regular financial reporting and preparation of financial accounts by institutional investors have the effect of shortening the terms for performance evaluation and thus contributing to shorttermism. Such rules can be found in banking and insurance regulation, in particular Solvency I and II as well as CRD. The existing approaches to risk

9 Page 9 of 13, Date 22 July 2011 management may also amplify the short-term attitude of institutional investors. Q14: Are there measures to be taken, and if so, which ones, as regards the incentive structures for and performance evaluation of asset managers managing long-term institutional investors portfolios? BVI is deeply bewildered by the Commission s statement that the agency relationship between institutional investors (asset owners) and their managers contributes to capital markets increasing short-termism and to mispricing. These conclusions are apparently drawn on the basis of the Woolley report which deals specifically with investment banking and thus cannot be deemed valid in terms of asset management (cf. supra). As regards incentive structures and performance evaluation relevant for asset managers, these elements are negotiated on a bilateral level between institutional investors and asset managers. Institutional investors are free to choose their asset managers according to their individual preferences, free to determine the investment strategy to be pursued, to set a suitable incentive structure and to specify details of the performance evaluation. While enjoying contractual liberty under civil law in these respects, institutional investors are nevertheless constrained by the regulatory requirements for reporting and accounting applicable to their business activities as mentioned above. These rules must be duly taken into account in the contractual terms underlying the relationship with asset managers. Q15: Should EU law promote more effective monitoring of asset managers by institutional investors with regard to strategies, costs, trading and the extent to which asset managers engage with the investee companies? If so, how? In BVI s view, institutional investors have already at their disposal sufficient means for the effective monitoring of their selected asset managers. Institutional investors determine the investment strategy to be applied to their portfolios and the extent to which asset managers shall engage with investee companies. Costs are negotiated on a bilateral level between asset managers and their institutional clients. Implementation of investment strategies, actual costs, trading and details of shareholder engagement are then reported by the asset manager to the client as agreed between the

10 Page 10 of 13, Date 22 July 2011 parties. Most information can be found in annual, semi-annual or quarterly reports as well as any additional reporting required by the individual client. Q16: Should EU rules require a certain independence of the asset managers governing body, for example from its parent company, or are other (legislative) measures needed to enhance disclosure and management of conflicts of interest? Asset managers are already bound by very strict rules on conflicts of interest management laid down in UCITS and AIFM Directives as well as MiFID. On this basis, they must set up and implement conflict of interest policies which cater for conflicting interests also with relation to other members of the corporate group, including the parent company. Where the risk of damage to the client interest cannot be eliminated by internal arrangements undertaken by an asset manager, the remaining conflicts must be clearly disclosed to clients. In addition, UCITS managers are under the obligation to develop measures and procedures in order to prevent or manage any conflicts of interest arising in the execution of voting rights (cf. Article 21 para. 2 c) of Directive 2010/43/EC). On balance, no further EU measures appear necessary in order to warrant proper disclosure and management of conflicts of interests. Q17: What would be the best way for the EU to facilitate shareholder cooperation? Currently, shareholder cooperation in the EU faces significant legal uncertainties. Asset managers engaging in shareholder cooperation risk being accused of acting in concert the underlying concept of which is still subject to diverging interpretation in the Member States. Harmonising the criteria for acting in concert in the EU Transparency Directive would certainly help to provide more legal clarity and hence to facilitate cooperation among shareholders. Moreover, asset managers are sometimes reluctant to approaching other shareholders in order not to obtain information which would render them insiders under the EU Market Abuse Directive. Q18: Should EU law require proxy advisors to be more transparent, e.g. about their analytical methods, conflicts of interest and their policy for managing them and/or whether they apply a code of conduct? If so, how can this best be achieved?

11 Page 11 of 13, Date 22 July 2011 Q19: Do you believe that other legislative measures are necessary, e.g. restrictions on the ability of proxy advisors to provide consulting services to investee companies? BVI would welcome EU standards for transparency to be provided by proxy advisors. Such transparency should encompass analytical guidelines and methodologies appointed by proxy advisors for preparing recommendations to shareholders as well as conflicts of interest policies followed by proxy advisors. In addition, any identified conflict of interest which might negatively impact the shareholder interests should be clearly disclosed to investors. In our view, conflicts of interest arrangements by proxy advisors must ensure full independence of their business activities. In this respect, we would also welcome a requirement for organisational separation of the two business lines consultancy and advisory services by means of Chinese walls. EU measures restricting the general ability of proxy advisors to provide consulting services to investee companies should be considered last resort and do not appear appropriate at the current stage. Q20: Do you see a need for a technical and/or legal European mechanism to help issuers identify their shareholders in order to facilitate dialogue on corporate governance issues? If so, do you believe this would also benefit cooperation between investors? Please provide details (e.g. objective(s) pursued, preferred instruments, frequency, level of detail and cost allocation). Major shareholders in listed companies are supposed to be already publicly known due to notification requirements of the EU Transparency Directive. However, divergent implementation and in particular interpretation of the EU requirements on the basis of national civil law provisions lead to a situation where companies are not always able to identify the ultimate shareholders. In many cases, they only take notice of intermediaries who hold the shares in nominee accounts. Hence, aligning the understanding of notification duties under the Transparency Directive would very much help to facilitate a reliable dialogue between companies and their investors. Q21: Do you think that minority shareholders need additional rights to represent their interests effectively in companies with controlling or dominant shareholders?

12 Page 12 of 13, Date 22 July 2011 An effective implementation of the one share one vote principle throughout the EU would help abolish privileges of dominant shareholders and thus significantly contribute to the protection of minority rights. Q22: Do you think that minority shareholders need more protection against related party transactions? If so, what measures could be taken? The EU standards in terms of related party transactions are fairly high. In many Member States related party transactions must be reviewed by auditors and are disclosed in the financial accounts. Moreover, it would be desirable if the related party was required to abstain from participation in any voting pertaining to the transaction. Q23: Are there measures to be taken, and if so, which ones, to promote at EU level employee share ownership? We do not perceive any need for EU regulatory activities in this regard. 3. The comply or explain framework monitoring and implementing corporate governance codes Q24: Do you agree that companies departing from the recommendations of corporate governance codes should be required to provide detailed explanations for such departures and describe the alternative solutions adopted? Q25: Do you agree that monitoring bodies should be authorised to check the informative quality of the explanations in the corporate governance statements and require companies to complete the explanations where necessary? If yes, what exactly should be their role? We concur with the Commission s view that companies departing from the recommendations of a corporate governance code should be obliged to provide detailed explanations for the reasons underlying such conduct and to describe any alternative solution adopted. Giving more flesh to the comply or explain statements would certainly help investors to assess the quality of corporate governance measures undertaken by listed companies.

13 Page 13 of 13, Date 22 July 2011 In terms of monitoring, enhancing the board s responsibility for the adequacy of information under the comply or explain approach would seem a sensible measure. We could also envisage private law bodies such as auditors, stock exchanges, industry bodies or associations being entrusted with the task of checking the informative quality of the explanations. On the other hand, imposing control requirements by public authorities appears disproportionate at this stage. We hope that our views will help the EU Commission to adopt a sound and commensurate approach to the EU corporate governance framework while avoiding any excessive regulatory tendencies in this respect. Please do not hesitate to contact us with any requests for further clarification or discussion. Yours sincerely Marcus Mecklenburg Dr. Magdalena Kuper