By Claudia Morante Belgrano – Head of Corporate Governance at Georgeson for Spain
Several months ago, Georgeson decided to address a challenging and complex issue: to consider the role of the proprietary director – who, in some cases, could be considered an independent director, despite the fact that under Spanish law they cannot be defined as such.
A proprietary director is someone who is nominated by shareholders based on the extent of their shareholding. This situation, the causes of which are explained below, is creating difficulties for Spanish companies in several aspects related to the configuration of the board of directors’ structure and functioning of its committees. It also has an impact on their own shareholders, especially foreign investors, who, on occasion penalise these type of investors at the general meetings. For all, puts Spanish companies at a disadvantage when compared with other comparable jurisdictions.
Recent legislation in Spain has meant that any director with a significant shareholding (normally considered three per cent or more) cannot be considered independent. However, in Spanish companies there is a phenomenon that we have coined ‘micro-dominicales directors’, that is, directors with a three to 10 per cent shareholding, that also comply with the main criteria for being considered an independent director. These micro-dominicales directors are the focus of this article.
In Spain, advances in corporate governance matters have intensified in recent years, including several measures in the Spanish legal system, the last of which was the passing of the Spanish Companies Act in December 2014. This included, among other reforms, improvements to general shareholders’ meetings, powers of board of directors, mandate terms, mandatory existence of certain committees (such as the appointments and remuneration committee), as well as responsibilities of the board secretary.
As part of these reforms, and for the first time, different categories of company directors, which until now had been merely recommended, were enshrined and defined in law as ‘executive’, ‘proprietary’, ‘independent’ or ‘other external’. The problem arises with the definition of two of these types of directors, proprietary and independent.
- Under the new Act, the law does not distinguish between proprietary directors who represent controlling or reference shareholders and proprietary directors who represent significant minority shareholders (i.e that represent between three and 10 per cent)
- Meanwhile, according to current Spanish law, an ‘independent director’ can not be considered independent if he or she has a significant shareholding. In most cases this means having issued share capital of three per cent.
In other words, the current law defines directors with a three per cent or more shareholding as not being independent. These definitions mean that:
- Spanish companies have greater difficulties when it comes to setting up their boards of directors and cannot benefit from a uniform and adequate level playing field with comparable environments in other jurisdictions
- Moreover, the legal definition of ‘proprietary director’ prevents directors that represent shareholders who do not have a controlling share from being classified as independent directors. This is despite the fact many of them could be classified as such under other regulations and/or voting policies of institutional investors and also by some proxy advisors
This has led to proprietary directors submitted for approval at general meetings being voted against in cases where the company does not meet the minimum threshold of independence. This situation is especially critical because many such proprietary directors who are penalised are really micro-proprietary directors and who, for practical purposes, could be considered independent from a foreign investor’s point of view.
Growth in the weighting of foreign institutional investors in the share capital of Spanish listed companies suggests that a new, practical approach – that incorporates improvements using evidence-based analysis – is required in order to make the figure of proprietary director more flexible.
Georgeson recognise that the role of the proprietary director could be more flexible
to help Spanish companies, but only through the development of regulatory mechanisms and adjustments that would, in turn, allow greater flexibility when compared with other companies around the world.
We joined forces with law firms Uría Menéndez and Davis Polk & Wardwell to investigate this area, the first empirical analysis of this issue in Spain, in order to understand the singularity of the Spanish experience and propose such a change to the issue of micro-dominicales using the experience and knowledge of the investment community.
Researchers conducted two analyses:
- To understand what the market demanded in terms of proprietary directors and independence; an analysis of the main proxy advisors’ guidelines (ISS, Glass Lewis and ECGS); and the voting policies of the top 100 foreign institutional investors of Spanish listed companies. Such analysis focussed on the share capital limit that would mean a director could be considered independent
They concluded there was consensus among proxy advisors and institutional investors that, in order for a director to be considered independent, the maximum limit in terms of issued share capital, was 10 per cent (see table, below)
As the table shows, proxy advisors, except ECGS, have a limit of 10 per cent. In the
case of institutional investors, of the 66 per cent that publish this information, a large proportion (48 per cent) establish a threshold of 10 per cent or more, while 11 per cent have a policy based on local criteria. It therefore follows that this percentage could even add up to 59 per cent, if the regulations change.
- 130 Spanish listed companies belonging to the Ibex-35 and Continuous Market also analysed to identify listed Spanish companies that had board members with directors that could be affected. In other words, researchers wanted to identify those companies with board directors that generally comply with the different requirements of independence and do not have, or represent, any controlling shareholder, but are linked to a shareholder that owns a significant participation (more than three per cent, but less than 10 per cent of capital).
To complete the analysis, researchers also examined the most frequent variables that could affect the independence of a director. These included:
- Directors with less than 10 per cent of the issued share capital (direct and indirect shares)
- Directors without related party transactions
- Directors who have been on the board less than 12 years, which is the maximum time period a director can be classified as independent according to Spanish regulations
- Non-overboarded directors – micro-proprietary directors should not hold too many directorships in order not to compromise their effective dedication
- Directors that comply with a minimum cooling off period (i.e. a proprietary director needs to be completely disassociated from and have no relationship with the company for five years)
Following the analysis of 35 companies in the Ibex-35 and 95 belonging to the Continuous Market, it was possible to conclude that just over a quarter (25.5 per cent) of the companies that have proprietary directors on their boards were in this situation; that is, 35 directors at 28 companies fulfilled all the most relevant requirements to be considered independent (see graphic, below).
- Although the research gave only a snapshot of the situation, the fact that more than 25 per cent of Spanish listed companies are affected by it is concerning. Accepting that this analysis has been undertaken in a specific period of time and new directors will be appointed, while others will leave suggests that the problem is well and truly alive and could affect more companies
- From the regulator’s point of view, it is noteworthy that the National Securities Market Commission (CNMV) has stated several times that it is looking at the difference between micro-proprietary directors and independent ones, and that it could be possible to ‘open the door’ so that such directors can even chair appointments and remuneration committees
- In November, the CNMV submitted a technical guide on appointments and remuneration committees for public consultation, with the aim of providing best practice recommendations to enable such committees to improve the performance of their duties. In the guide, the concept of ‘micro-proprietary’ is already introduced, thereby establishing in the recommendations that among the composition of such committees ‘… it is considered desirable that, in case[s]…[where]…there are proprietary directors among its members, these are preferably ‘micro-proprietary’.
When it comes to publicly-traded companies, we believe that appointments and remunerations committees face new challenges, specifically;
- In order to successfully carry out their duties, they should address the competencies and skills their boards should have: one of the very issues for institutional investors during the recent proxy season in Spain
- In this context, it is the duty of appointments and remunerations committees to oversee the existence of a ‘board skill matrix’, based on board of directors’ criteria regarding profile needs. Some institutional investors are increasingly interested in this process and also in how these committees provide the necessary mechanisms to ensure that boards have the required skills and structures to meet the challenges they face. For example, a key area most recently highlighted anecdotally by investors is the level of knowledge and ability of boards to deal with cyber breaches
While the CNMV completes its efforts to articulate the position of micro-proprietary directors, appointments and remuneration committees should strive to engage with investors in order that such directors should be considered, at least initially, within the parameters of current thinking on market independence. This is especially relevant for those boards with this type of director. It will be interesting to see what the CNMV concludes.
About the Author:
After holding a Bachelor degree in Business Administration from Universidad de Lima (Perú), Claudia Morante Belgrano began her professional career in the financial sector, as a stock market analyst at the Interbank Group Stock Exchange (Lima-Peru). She also holds a master degree in Business Consultancy for CEU University (Madrid-Spain). Since 2003 and for more than 12 years, Claudia developed her career in the field of business advisory at KPMG and PwC. She joined Georgeson in 2016 were she is the Head of Corporate Governance. Claudia has an extensive experience in advising companies in Corporate Governance matters, mostly in the Ibex-35 companies, were she developed annual Board Assessments, corporate governance GAP analysis, Risk maps, Proxy Solicitation, corporate governance roadshows, etc. Claudia is co-author of several publications regarding the development of corporate governance practice in Spanish listed companies and participates in specialized forums within corporate governance issues. She is member of ICGN (International Corporate Governance Network).
1.Ley 31/2014, of 3 December, where the Spanish Companies Act (Ley de Sociedades de Capital) was modified to improve corporate governance.
2.However, ISS states in its policy that local criteria will be applied if it is more restrictive. Glass Lewis has adapted its policy for the case of Spain, reducing this threshold to the provisions of local regulations: three per cent.
3.Excluding those that are not domiciled in Spain or that have been delisted.
4.It has been considered the total participation of the shareholder, which must be less than 10 per cent of the capital, regardless of whether it can be represented by several proprietary Directors with less than 10 per cent of the capital each. Likewise, the total number of shares held (or represented) by the proprietary director has been considered: direct and indirect actions.
5.Related party transactions are those established by the company throughout the Annual Corporate Governance Report (IAGC), with special emphasis on the sections related to ‘Related Transactions and Intragroup Operations’.
6.The number of boards that proprietary directors can occupy which have been taken into consideration are: – if it is a non-executive director in other companies: five boards in total (non-executive member), if it’s an executive director in another company: two more boards (non-executive member), if it’s a non-executive chairman in another company: three more boards (non-executive member)