Government consults on new requirements for Directors' Remuneration Report

Transcription

1 Update July 2012 Executive Remuneration Government consults on new requirements for Directors' Remuneration Report The UK Government has published draft regulations setting out what UK quoted companies must disclose in remuneration reports within the annual accounts, for financial periods ending after October The new rules will replace the current requirements for the content of remuneration reports and are intended to streamline disclosures, with increased focus on the link between pay and performance, and to encourage long-term shareholder engagement. The new regulations are part of the package for the reform of governance of directors' pay announced by Vince Cable on 20 June, and will support the proposed new shareholder voting regime for directors' pay, outlined in our June update. Background In January 2012, following responses to consultations on the reporting, regulation and structure of executive pay, the Government announced a package of measures which it would be taking forward to tackle the key issues around executive pay. See our January update for further details. On 20 June, following a further consultation on shareholder voting rights in March, Vince Cable announced the Government's package of proposals to introduce a new framework for executive pay, including a new shareholder voting regime, and revised disclosure requirements. See our June update. The new regime is due to take effect for financial periods ending after 1 October 2013, by way of amendments to the Enterprise and Regulatory Reform Bill and revised regulations setting out what companies must report on directors' pay. Latest developments draft legislation and regulations now available The draft regulations setting out the requirements in relation to remuneration disclosure within the new overall framework for executive pay (the "New Regulations") were published by the Department for Business, Innovation and Skills (BIS) in a consultation paper (the "Consultation Paper") on 27 June. In particular, the New Regulations, which will replace the current regulations dealing with the content of directors' remuneration reports, will provide for the directors' remuneration report to be in two distinct parts: the Policy Report, on which shareholders will have a binding vote; and the Implementation Report, which will be subject to an advisory shareholder vote. It is also proposed there should be a Chairman's statement to shareholders as a preface to the remuneration report, which summarises the key messages on remuneration and the context in which relevant decisions have been made. In addition, Government amendments to the Enterprise and Regulatory Reform Bill ("ERRB") have also now been tabled to enable the full package of Government proposals on executive pay to be implemented. The ERRB will introduce new clauses into Companies Act 2006 relating to the new requirements for directors' remuneration policy, the binding shareholder vote on future policy and the implications for making payments which don't comply with the applicable policy. As is the case with the current regime, "directors" will include both executive and non-executive directors. However, for the new provisions relating to directors' remuneration policy, the ERRB also specifically includes shadow directors (but consistent with existing provisions of the Companies Act 2006, references to loss of office will not include loss of status as a shadow director.) The Policy Report binding shareholder vote Under the new shareholder voting regime, companies will be required to set out proposed pay policy for a shareholder vote. Policy will be put to shareholders annually or, if it remains unchanged, at least every three years. Once the pay policy has been approved by shareholders, companies will be restricted to acting, in relation to directors' pay, within the scope of that policy until such time as a revised policy is approved. To facilitate the binding vote, the New Regulations provide that the policy part of the Directors' Remuneration Report will set out the company's forward-looking policy on remuneration and potential payments. This part of the report will only be required in years when a binding vote on policy is proposed and would contain the following information:

2 A table setting out the key elements of pay and supporting information, including how each supports the achievement of the company s strategy, the maximum potential value and performance metrics. Information on employment contracts. Scenarios for what directors will get paid for performance that is above, on and below target. Information on the percentage change in profit, dividends and the overall spend on pay. The principles on which exit payments will be made, including how they will be calculated; whether the company will distinguish between types of leaver or the circumstances of exit and how performance will be taken into account. Material factors that have been taken into account when setting the pay policy, specifically employee pay and shareholder views. The Government intends, through the New Regulations, to address issues both as to the type of information included, and how it is presented. It is proposed that the report should include a table, including all elements of pay (for example, base salary, benefits, annual bonus, long-tem incentives and pension), for each current or potential director (including nonexecutive directors), and setting out how that pay is structured and the policy for each element of the pay package (the "Pay Table"). With a view to maintaining a balance between the provision of clear and specific information to investors, and the ability for companies to retain sufficient flexibility to design and implement appropriate pay policies, the Government does not propose to prescribe the nature of the disclosures for each element of pay. The Consultation Paper contains an example of the level and type of disclosure that the Government would expect to see, which it says should be similar to the type of disclosures which companies adopting "best practice" are making under the existing regime. The key elements of remuneration to be captured in the Pay Table would fall under the following headings: Purpose how it supports the company's short and long term strategic objectives Operation summary of how each element of pay operates including whether clawback and malus are possible Opportunity maximum potential value Performance metrics - a summary of the performance metrics, the relative weighting of each, and the time period over which they are measured Changes to policy what decisions the committee has made about that element of pay for the future period and why The Pay Table will provide a framework for disclosure, and the Government also proposes that it will be supplemented by clear guidance on the level of detail and type of information that should be reported. The intention is that this guidance should be agreed between the business and investor communities and be in place prior to the New Regulations taking effect from 1 October Further elements in the Policy Report will include: Service contracts it is proposed that the Policy Report should contain a statement setting out all provisions relating to remuneration which are contained in directors' service contracts. In future, any contractual obligations as to remuneration will need to take account of the policy on remuneration as approved by shareholders. In many cases, directors' service contracts would not in any case contain any firm provisions as to whether, and to what extent, any award of variable pay would be made. However, in some circumstances, contractual entitlement will need to be considered in this wider context. Potential performance outcomes the Consultation Paper gives an example of how directors' anticipated potential entitlements at threshold, maximum and below-threshold performance might be set out in graphical form, setting out total amounts and proportions of different elements of pay. It is expected that the requirement to set out this information would build on current best practice reporting. Spend on pay the Government proposes that overall expenditure on pay in the relevant reporting period should be set out alongside information as to the percentage change in profit and dividends. This would be a new requirement and is intended to give shareholders the ability to assess the remuneration cost in the context of company performance. Employee context previous proposals to introduce disclosure of the ratio between CEO and median employee pay have not been pursued. However the Government does want more specific disclosures in relation to the pay policy for the wider organisation, beyond the simple statement required under the current regime. The proposal is that companies should disclose: whether comparison metrics were taken into account and how the information was used; the percentage increase in pay of the workforce and of the CEO; whether and how a company sought employee views on remuneration policy. The Government also proposes that companies should give further context to the disclosures in the Pay Table, by explaining if remuneration policy for directors differs from that for employees and if so, why. Shareholder context it is proposed there should also be a statement as to how shareholder views were taken into account in setting remuneration policy.

3 Any obligation to make a payment which does not comply with the relevant shareholder-approved remuneration policy will have no effect. If a non-compliant payment is actually made, it will be held in trust by the recipient and there will be indemnity obligations on the directors who authorised such payments to the extent that the company suffers any loss. However, these provisions will not apply to any payment made or obligation arising prior to the Government's announcement of the new regime on 27 June 2012, unless it is modified or renewed on or after that date, and will also not apply until the first remuneration policy of the relevant has been approved under the new provisions (or the end of the company's first financial year following enactment of the provisions, if earlier). Implementation Report advisory shareholder vote Once a pay policy has been approved by shareholders, they will then have the ability to signal their views in relation to its implementation through an annual advisory vote. Companies will be required to set out the following information in the Implementation Report: Single total figure of remuneration for each director Detail of performance against metrics for long term incentives Total pension entitlements (for defined benefit schemes) Exit payments made in year Detail on variable pay awarded in year Total shareholdings of directors Chart comparing company performance and CEO pay Information about who has advised the remuneration committee Shareholder context The single figure for remuneration is intended as a simple method for presenting to shareholders the total amount paid to each director, and also to provide a mechanism to achieve consistent reporting and to facilitate comparisons, both yearon-year, and between companies. The proposals in the Consultation Paper build on the outcome of work by the Financial Reporting Lab which obtained views from nine companies and twelve investor bodies in relation to the pay components which should be included in the single figure and the basis for measurement of each. For further comments on this, see our June update. The single figure is intended to reflect actual pay earned, rather than potential pay awarded. However, as we understand it, the single figures will often include amounts the director has not in fact yet received and which may never be received. For variable elements of pay, the figure will include the amount of remuneration receivable as a result of performance measured for the reporting year in question or the last year of the performance period if longer than one year. So for annual bonus, the full amount awarded in the reporting year will be included, even if a certain proportion is deferred. For LTIP awards, the value of the amount vesting in the reporting year, or an estimate of that value, will be included, irrespective of whether the award has been exercised, or the shares delivered. The single figures will also include all pension-related benefits - it is proposed that the benefit an individual receives under a defined benefit pension scheme should be calculated using an agreed HMRC methodology using an annual multiplier of 20. Additional disclosures are proposed in relation to bonuses and LTIPs to explain: What performance conditions were, and the relative importance of each The targets originally set and the potential level of award achievable Levels of performance against targets How the committee exercised any applicable discretion The resulting level of award (and indicating the proportion, if any, subject to deferral) The Government is aware that there have been differing views on how the single figure should be calculated and the Consultation Paper contains several questions as to whether the proposals represent a practical and informative approach, and whether they give effect to Government's intentions. There is also a question around how an appropriate degree of flexibility can be achieved where publication of full details of performance against metrics would involve commercially sensitive information. Further elements in the Implementation Report will include: Exit payments the new regime will include a binding vote on the policy for exit payments as part of the new binding vote on remuneration policy, and the existing Listing Rules requirement for shareholder approval of most new employee share schemes and long-term incentive plans. Companies will be required to make a statement "immediately" in relation to the calculation of any exit payment, and it is also proposed that the details be restated in the Implementation Report. This will need to explain the termination payments in the context of the shareholder-approved policy in place at the time the payment was made. Variable pay awarded in the reporting year the proposal is for the disclosure of the face value of awards made under long-term incentive plans. Although recognising the risk of "over-valuing" awards which may not pay out in full, or at all, the Government considers that this can be overcome by supplementary disclosures, including as to the percentage vesting at threshold performance.

4 Comparison of overall company performance and pay the Government proposes a graph which plots total shareholder return against CEO pay. This is intended to provide an "at a glance" view of how pay compares with performance, using TSR rather than actual company performance which could itself be the sole measure for performance related pay. The Consultation Paper asks for views as to whether the graph would be useful, and whether there may be more appropriate measures for comparison. Directors' shareholdings the disclosure requirements for total shareholdings of directors will be simplified, and will focus on information which is not available elsewhere in the remuneration report under the revised disclosure regime. This disclosure will bring together information on actual shareholdings and any share ownership requirements, and also contingent shares, share options and deferred share awards under incentive plans. Provision of advice disclosures in relation to the provision of advice on remuneration will be strengthened, and will include detail on how consultants were selected, by whom they were appointed, other services they have provided and the total cost of remuneration advice and basis for payment. Shareholder context increased engagement between companies and shareholders has been a key theme in the consultation process leading up to this point. Details of how shareholders have voted on the previous year's remuneration report, and action taken by the committee in response, will be set out in the Implementation Report. PM comment There is a lot to absorb in the Government's proposals, both in terms of the detailed provisions of the draft New Regulations, and the interplay of disclosure with the new regime for binding and advisory shareholder votes. Although the proposals are not due for implementation until October 2013, companies will need to factor in the changes to their medium- and long-term remuneration planning. In some cases, the requirements of the New Regulations will be similar in substance to "best practice" disclosures under the current regime for example in relation to potential performance outcomes. However, it is likely that companies will wish to revisit presentation of this information to tie-in with other new requirements for disclosure. There is an increased focus on transparency and ease of access to information for shareholders and presentation will be an important consideration. Other requirements are new most notably, the single figure for remuneration in the Implementation Report. A number of issues have been raised in relation to this by companies and investors alike. One such concern is that, without appropriate education, the media and other users of the reports may reach inappropriate conclusions by looking solely at the single figure - whereas the accompanying disclosures will be just as important as the numbers themselves and will provide further detail and context which is key to understanding how pay is being awarded and levels of pay which are actually received. A further concern is whether these supplementary disclosures will in fact cut-across the increased transparency which it is intended that the single figure approach should achieve. What should companies do now? Consider responding to the consultation the draft New Regulations are subject to consultation, with the period for responses closing on 26 September Companies may consider whether they wish to respond directly, or through an appropriate advisor or representative body and we would be happy to assist in this process. Plan ahead although the New Regulations are still in draft, and there is still over a year until implementation (so for most companies, it will be AGM 2014 for which compliance with the new regime first becomes compulsory), there is lots of change coming through and it will take a certain investment in time and resource to bring all those involved in developing and agreeing pay policy up to speed with the new disclosure requirements and wider remuneration framework. Companies need to factor this into relevant timetabling for example the first remuneration report in the new format will potentially take a lot more preparation than has been needed in previous years where the requirements have become familiar. Suitable processes will need to be put in place to ensure than relevant information and data is available in a format which can easily be used to compile the various disclosures. Consider early implementation once we have a response to the consultation, some companies may wish to consider whether there is merit in addressing some or all of the new requirements at their 2013 AGM, identifying and tackling any particular transitional issues or difficulties and engaging with shareholders on them, in advance of the full implementation in Think carefully about what steps are taken now companies need to be aware of the commencement and transitional provisions and note in particular that any amendment or renewal of a pre-27 June 2012 obligation to make a payment to a director may bring that obligation or payment within the scope of the new regime. This could cause difficulties if the payment would not be compliant with the pay policy which the company subsequently adopts and which may apply when the payment is made at a future point in time. Companies entering into new arrangements now will need to consider how future pay policy may look when creating new obligations after 27 June 2012 where payments will be made once the new regime is in force.

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