The UK Government’s Consultation on restoring trust in audit and corporate governance (which can be found here) has implications for executive remuneration policies in the UK. The Consultation is open to everyone but will be of particular interest to large privately-owned companies, FTSE350 companies, users and preparers of accounts, and regulated firms. The Consultation was published on 18 March 2021 by the Department for Business, Energy & Industrial Strategy (“BEIS”) and will close on 8 July 2021.
Overview of the Consultation
The Consultation follows the high-profile failure of a number of companies, including Carillion and BHS. While its primary focus is on the audit profession and plans to break up the dominance of the Big Four audit firms, the Chief Executive of Accountants at the ACAEW, Michael Izza, has said that the Consultation is “as much about corporate governance reform as it is of the audit profession”.
The Consultation’s key proposals include:
New reporting and attestation requirements covering internal controls, dividends and capital maintenance decisions and resilience planning, designed to sharpen directors’ accountability within the largest companies;
Creation of a new, stand-alone audit profession, overseen by a new regulator and underpinned by a common purpose and principles, with a reach across all forms of corporate reporting. This is alongside new regulatory measures to increase competition and reduce the potential for conflicts of interest, by providing new opportunities for challenger audit firms and new requirements for audit firms to separate their audit and non-audit practices;
Companies to be required to set out their approach to audit through publication of an Audit and Assurance Policy on which there would be an advisory shareholder vote, with shareholders also able to propose to the Audit Committee areas of emphasis to be considered within the auditor’s annual audit plan; and
New statutory objectives and functions for the new audit regulator, including a new statutory levy to replace the existing voluntary levy, competition and reporting powers to enforce the corporate reporting duties of directors, and responsibility for deciding which individuals and firms should be approved to audit Public Interest Entities (“PIEs”).
Impact of the Consultation on Executive Remuneration
Strengthening clawback and malus provisions in directors’ remuneration arrangements
The Consultation proposes enhanced powers for Remuneration Committees, as well as administrators or liquidators, to recover remuneration already paid to directors (clawback) or to withhold pending awards (malus). Currently, there are no mandatory clawback provisions for UK companies, except for firms regulated by the Financial Conduct Authority (“FCA”) or Prudential Regulation Authority. The UK Corporate Governance Code does however recommend that directors’ remuneration policies include clawback and malus provisions and specify when such tools should be used.
The BEIS committee previously noted challenges relating to the enforceability of these provisions as, if they are too broad, they are difficult to enforce and, if too narrow, they can exclude action being taken even where it would seem self-evident that action is necessary. The Consultation further identifies that although around 90% of FTSE 350 companies have malus and clawback provisions in place at present, the provisions tend to be triggered by misstatements or errors only, and so are limited in scope. The Consultation therefore recommends that the following minimum ‘trigger points’ for clawback provisions are included in the UK Corporate Governance Code and adopted by companies:
Material misstatement of results or an error in performance calculations;
Material failure of risk management and internal controls;
Conduct leading to financial loss;
Reputational damage; and
Unreasonable failure to protect the interests of employees and customers.
The Consultation also recommends that, following a review, there may be a need to extend these triggers to all listed companies through amendments to the FCA Listing Rules.
The Consultation invites responses on whether other conditions should be added to the proposed minimum list above and what considerations should be taken into account to ensure that these conditions can be enforced in practice.
Audit of Alternative Performance Measures (“APMs”) and Key Performance Indicators (“KPIs”) linked to executive remuneration
The Consultation identifies that APMs and KPIs linked to executive remuneration were areas where there has previously been support for extending the scope of statutory audit. The Annual Directors’ Remuneration Report (“DRR”) already required for quoted companies must include details of performance measures used to determine executive pay and is within the scope of statutory audits, but there is no equivalent for companies that are not quoted.
To address this, the Consultation recommends introducing an Audit and Assurance Policy process which will allow investors to ask companies to obtain specific assurance on APMs and KPIs linked to remuneration.
The Consultation also notes that companies may wish to engage a different firm to provide specific assurance on APMs or KPIs linked to remuneration, which furthers the Consultation’s aim of increasing competition in the audit industry. In particular, specialist audit services should be sought for assurances relating to non-financial KPIs, such as employee satisfaction metrics, carbon emissions or oil reserves. Companies should explain in their Audit and Assurance Policies the rationale for proposing to engage a particular audit firm and invite shareholders’ views as appropriate.
Impact of the Consultation on Executive Remuneration in Regulated Financial Services firms
The Consultation states that “the Government is committed to avoiding overlap or duplication between the role of [the FRC’s successor body, the Audit, Reporting and Governance Authority] and the existing scope or powers of the FCA wherever possible”. We can anticipate that the FCA, FRC and UK Government will work together to ensure that such overlap is avoided.
In practice, it is unlikely that any new malus and clawback provisions will have a significant impact on many regulated firms, in particular larger and more complex firms, due to the rules that are already in place. However, firms that are not currently subject to the existing malus and clawback rules may ultimately be in scope of rules introduced following the Consultation.
On the other hand, the proposed Audit and Assurance Policy process with respect to APMs and KPIs appears to go further than current requirements and will therefore represent something new for regulated firms that are not quoted.
Even though the Consultation primarily addresses the audit industry, it contains proposals on governance and executive remuneration that have potential to impact a large number of private and public UK companies and as a result, should be of much wider interest. The intention is for the responses to this Consultation to inform draft legislation that the Government will introduce to Parliament. Those measures not requiring legislation will be taken forward by the FRC.
 Financial Times, UK directors face new liability demands under major audit reform, 4 February 2021.
 UK Parliament, Committee calls for measures to help avoid next corporate collapse, 4 November 2019.