Comply or explain

Short definition

“Comply or explain“ is a regulatory mechanism: It says that one either has to comply with a recommendation or — if one plans not to — name reasons for one’s deviation (explain). Under SRD II, “Comply or explain” applies to requirements for asset managers as well as institutional investors regarding transparency in relation to shareholder investment.

The Comply-or-explain-principle explained

As a basic principle “Comply or explain“ describes a mechanism that is used to manage compliance with provisions that are not legally binding. The addressed party can decide for itself whether it accepts and complies with a proposed best practice or not. If it decides not to do so, but gives and openly publishes an explanation for its deviation, there are no sanctions to be imposed. By contrast, “Comply or Else“ implies that there are indeed negative legal ramifications as a consequence of not following suggested practices.

“Comply or explain“ under SRD II

Since SRD II has come into force, asset managers are obliged to develop and disclose a policy that states the way voting rights are performed and how shareholders are engaged (so-called “Engagement Policy”). This policy is developed and publicised on a “Comply or explain” basis: If asset managers decide not to comply with this requirement, they must provide an explanation for their decision.

Engagement Policy – a “Comply or explain” requirement

With a view to promoting shareholder engagement, asset managers and institutional investors are now obliged to develop and disclose a shareholder engagement policy on their website, or alternatively disclose on their website why they have chosen not to do so. The engagement policy must cover how shareholder engagement is integrated into a manager or investor’s investment strategy and how it monitors the companies it invests in on matters such as strategy, financial and non-financial performance and how it exercises voting rights.

Asset managers and institutional investors must now report annually on the implementation of the engagement policy, including voting behaviour and explanations of the most significant votes taken. The report must include information on the use of the services of proxy advisors. An asset manager must additionally comply with the applicable conflicts of interest requirements in relation to its shareholder engagement activities.

The Engagement Policy in question is to be made publicly accessible on the respective asset manager’s website. Asset managers must do this free of charge. In this policy these aspects need to be addressed:

  • Monitoring of investee companies
  • Interaction and cooperation with shareholders
  • Specifications regarding the management of conflicts of interest

Aside from this policy, the annual disclosure provided by asset managers also falls under the Comply-or-explain-principle. The report in question must disclose these aspects:

  • Implementation of the Engagement Policy
  • A general description of voting behaviour
  • Whether and how proxy advisors were utilised
  • A report on how the asset manager voted in the general meetings on the listed companies he holds shares in