Revised UK Corporate Governance Code - Remuneration aspects

The Financial Reporting Council (FRC) yesterday published a draft updated Corporate Governance Code (the Code) for public consultation.

This Law-Now just concentrates on the key remuneration aspects. A Law-Now on the remaining aspects of the proposed new Code, including on how “employee” views will be gauged and taken into account by companies, will be issued shortly.

Background

The FRC has consulted on changes to the Code regularly over the last few years, usually every other year. This year it had previously announced that it wanted to shorten the Code to give it greater impact but it was also tasked with considering some of the recommendations from the Government’s own corporate governance consultation, which contained a number of remuneration recommendations.

Corporate governance developments on pay now occur through so many bodies and codes – the Investment Association’s “ABI Guidelines”, changes to company law (where draft legislation is promised before the end of the year on ceo/employee pay ratios and more detail on remuneration outcomes of share awards) and then individual fund managers and industry sectors also have their own requirements - that many of these codes overlap. However, the Code’s remuneration requirements are still important for companies, because listed companies are required to state in their annual report either that they have complied with them or explain why not.

In some cases, the various codes exceed shareholder expectations and are intended to drive up standards – in others, they lag behind. In all cases, however, companies’ different profiles, shareholder bases, remuneration circumstances and pay scales mean that this will still be an area where there will continue to be the need for some judgment in negotiating between the various sets of provisions.

Changes

Although the revised Code has been substantially recast/simplified, most of the remuneration material remains the same.

Key proposals to note are:

• Considerations of wider employee pay. Remuneration committees should now consider wider employee pay, not just those of executive directors and senior management. Wider employee pay is to be considered not just to judge any disparity between the executive and all-employee pay scene, but for general supervision too in terms of adequacy and other factors. This will be a major change for many remuneration committees who have traditionally focused and been advised only on executive pay.
• Rem com chairman to have served at least a year as a member of a remuneration committee. The Government’s corporate governance consultation was behind this proposal, though it is interesting that this proposal merely requires prior service of at least 12 months on any remuneration committee (presumably quoted or unquoted) and not necessarily the company’s own remuneration committee. It remains odd that this restriction just applies to remuneration committee chairman, and not to (for example) a company chairman or audit committee chairman.
• No options for NEDs. The Code has allowed non-executive directors to be awarded options or other variable remuneration, so long as shareholder approval had been received and any shares obtained from the exercise of the options are retained for at least a year after ceasing to be a director. However, the new Code proposal is that non-executive directors will not be able to receive variable remuneration at all. Where non-executive directors hold any options or other variable pay awards, the company will therefore be non-compliant and have to explain why it has permitted this. Received corporate governance wisdom has been against NEDs receiving options in any event for some time now, though some companies will probably continue to allow NEDs of smaller companies who were granted options pre-float to retain those. Granting options to NEDs once a floated company may present more of a challenge now though.
• No shares from long-term incentives to be sold within 5 years of award. Again, this was another recommendation from the Government’s corporate governance consultation. The proposed wording says that this should apply “in normal circumstances …”, which presumably still allows earlier receipt in good leaver and change of control situations, and shares to be sold to meet exercise price and tax commitments. Market practice has been moving in this direction anyway.
• Rem coms should have discretion to override formulaic outcomes. Remuneration committees should not be tied by the mathematical result of conditions set at award and should always have the discretion to change (by which is presumably meant reduce) vesting levels.
• Greater explanation. Following the general trend, much greater disclosure of how decisions have been met is required. Clarity, transparency and alignment should be demonstrated as well as a description of the remuneration committee’s work within the year.
• Policy on executive directors taking up NED positions in other companies is no longer required to be reported. The Code has traditionally contained a provision stating that companies should disclose whether they allow executive directors who serve as NEDs at other companies to keep that remuneration (invariably they can) and, if so, what the remuneration is. This provision is being deleted. Given that it is not reportable remuneration for Directors’ remuneration reporting purposes, it may be that reporting of these directorships’ remuneration falls away – although the directorships themselves would still need to be reported.

One aspect of the new Code which is not exclusively remuneration-related is the proposal to create a framework for what should happen when significant shareholder opposition to a proposed resolution is received. Many of these resolutions have, however, been remuneration-related including where there has been a large vote against a director because of a share scheme proposal. "Significant" in this context is proposed to be 20% of votes cast against. In addition to publishing an immediate response as to what actions are being taken to consult with shareholders to understand the reasons behind the vote, there is a proposed Provision setting out the need for an update six months later rather than just next giving an update in the annual report. The Investment Association’s website would host these explanations.

The FRC gives little justification for any of the changes, but none of the above changes are particular surprises or dramatic changes although companies will no doubt have a range of responses to the proposals, including whether some of them are necessary or proportionate.

As provisions in the Code, rather than principles, companies are of course free not to comply with the above proposals, but have to explain why not, and no doubt be prepared to accept criticism or volunteer how they intended to comply in the future.

The consultation on the proposed new Code is open until 28 February 2018, with a final version of the Code due in early Summer 2018. It is intended that the revised Code will take effect for accounting periods beginning on or after 1 January 2019.

(For those interested in the detail, remuneration aspects of the Code have been included in Section D of the Code, with a list of relevant factors to take into account when considering remuneration awards being contained in Schedule A. As part of the revised Code, the detail of Schedule A is now mostly removed from the Code, and Section D has been simplified (and is now Section 4) although the opportunity has also been taken to update the Code as above. As part of the general framework of the new Code, Supporting Principles have disappeared and there will only be Principles (which companies have to explain how they comply with) and Provisions (where companies are (theoretically at least) free either to comply with them or explain how they do not comply). There is also a new annex to the Code: the Guidance on Board Effectiveness, which does not have the status of a Principle or Provision in its own right, but which gives guidance as to how they might be applied.)

Click here to see the FRC’s announcement.

Click here and here to read other recent Law-Nows on this subject.