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Changes to Directors’ Remuneration and GC100 Guidance

On 1 October 2013 a new legislative regime came into effect which significantly changed the way in which quoted UK companies report on executive remuneration to shareholders and create their remuneration policy.

For the first time the regime provides shareholders with the power to vote to approve or reject a company’s executive remuneration policy and in doing so enables shareholders to "promote a stronger, clear link between pay and performance”.

Summary of the new regime

The new regime is being implemented by way of amendments to Companies Act 2006 (“CA 2006”) by the Enterprise and Regulatory Reform Act 2013 and the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013. It will apply to all main market listed UK companies but not AIM or non-UK incorporated companies.

Under the new regime there will be:

  • a new obligation to publish the company’s future remuneration policy for its directors (the “Directors’ Remuneration Policy” or “DRP”)
  • a new obligation to publish an annual implementation report on how the remuneration policy was implemented in the previous financial year (the “Directors’ Annual Report on Remuneration” or “DARR”)
  • a new binding shareholder vote on the DRP at least once every three years
  • an annual advisory shareholder vote on the DARR, and
  • a new obligation to publish directors’ exit payment details promptly.

Directors’ Remuneration Policy

The DRP is a forward-looking policy that sets out the parameters for the company’s future remuneration policy and potential payments to directors. The proposed policy is subject to a binding shareholder vote, determined by way of an ordinary resolution, at least once every three years.

Once the DRP has been approved, the company will only be able to make a remuneration payment or a payment for loss of office which is in accordance with the policy, unless separate shareholder approval has been obtained for the payment. If a payment is made in breach of the approved DRP, the payment will be held by the recipient in trust for the company or other person making the payment.

In addition, the directors who authorised the payment will be jointly and severally liable to indemnify the paying company for any loss resulting from it unless it can be proved that they acted honestly and reasonably.

Do existing remuneration payments and payments for loss of office have to comply with the new legislation?

A remuneration payment or payment for loss of office which is required to be made pursuant to an agreement that was entered into before 27 June 2012 does not have to comply with the approved DRP. Such agreements however may be caught by the new legislation if they were “modified or renewed” on or after 27 June 2012.

Care should be taken to identify any such modifications or renewals as in these circumstances, the agreement will no longer benefit from these grandfathering provisions and will instead by subject to the parameters of the DRP.

What are the deadlines for compliance?

The DRP should be put to a shareholder resolution at the AGM held in the first financial year to begin on or after 1 October 2013. Companies with a 30 September year-end will therefore be the first to comply with the new regime.

If the DRP is not approved at this AGM, the company must have their policy approved by the start of the second financial year to begin on or after 1 October 2013. After approval, the DRP must be put to a shareholder vote every three years beginning with the first financial year after the last meeting at which the DRP was put to shareholders.

GC100 Guidance on DRP

A best practice guidance (the “Guidance”) has been published by the GC100 and Investor Group1 (the “Group”) to promote effective engagement on remuneration between companies and their investors. In addition, it aims to assist UK quoted companies to understand the practical aspects of implementing the new reporting requirements and provides advice on how to prepare the DRP.

The Group emphasise that remuneration policies should be drafted in such a way that they have the ability to “stand the test of time”. As a result, it should only be necessary to put remuneration policies in the normal course to a vote once every three years rather than on an annual basis.

How important is flexibility in DRP?

The Guidance highlights that the inter-play of flexibility, discretion and judgment are crucial for the successful design and implementation of the remuneration policy. Consideration should be taken to enable the provision of sufficient operational flexibility over pay in the DRP to enable the policy to reflect future changes in both the company and the marketplace without the need for amendments.

One way the Group advises to achieve such flexibility is to set out various discretions for the committee to use when implementing any payments – including levels of variable remuneration which may be awarded depending on performance of an individual and the company.

As discussed in a previous PLC update on 1 June 2012, one area of particular concern is the regime’s potential to make the recruitment of new top level executives more difficult by having a fixed scope for remuneration.

Cementing the scope will undoubtedly preclude the company’s ability to offer bespoke deals to new directors in return for securing their employment unless these comply with the company’s existing DRP.

Given the fact that a company will no longer have the ability to make any payments outside the scope of the policy without shareholder approval, it is therefore of paramount importance when determining the scope for there to be some flexibility for payments to new recruits.

Without this flexibility, a company will undoubtedly limit its ability to attract new directors. To ensure flexibility, care should be taken to clearly set out in sufficient detail the principles that the remuneration committee will use to approve a remuneration package for new directors, what this package will contain and the extent of the flexibilities set out in the DRP.

This will enable investors to more easily evaluate whether such a payment is within the remuneration policy.

In essence, in order to benefit from the successful design and implementation of a DRP, there needs to be the right balance between providing sufficient flexibility for a company to attract new directors and for investors to have sufficient information to evaluate and vote on the scope of the policy.

How important is the exercise of discretion in the implementation of DRP?

The requirement for flexibility in the DRP should be coupled with the remuneration committee’s ability to exercise their discretion and judgment in order to ensure that the outcome of the implementation of the policy is fair to both the directors and the shareholders, whilst taking into account the overall performance of the company.

If such discretion has been exercised, there should be an explanation of how it was exercised and why the use of this discretion is in the best interests of the company. The Group believes that such an explanation should not come as a surprise to investors provided the remuneration committee has remained within the parameters of the DRP. An approved DRP with clearly defined parameters and discretions will therefore promote healthy company-investor relations as both parties will be aware of what constitutes a compliant and non-compliant payment under the policy.

Directors’ Annual Report on Remuneration

Under the new regime shareholders will continue to have an annual advisory vote on whether they approve the payments made to directors in the previous financial year. Under the new rules however this vote will now have greater authority. Before the new regime took effect, a company could ignore a failure by the shareholders to pass the advisory vote (although in practice this might risk damaging shareholder relations).

Now, however, such a failure will activate an obligation on the company to re-submit a DRP to the shareholders in the following year for re-approval in a binding vote. This new obligation is expected to mark a change in future payments to directors as the board will now be held accountable to the shareholders for unapproved payments.

Are there going to be changes to the Listing Rules on reporting requirements where duplication exists?

On 28 August 2013 the Financial Conduct Authority (“FCA”) published a consultation paper on changes to the Listing Rules that relate to directors’ remuneration where the new remuneration legislation has the same outcome.

The proposal includes the deletion of Rule 9.8.8R(8) relating to disclosure of service contracts in order to avoid duplication with the new regime. Rule 9.8.8R(9) will however be retained as this provision also applies to premium listed overseas issuers who are not caught by the new regulations.

Responses to the consultation were requested by 9 October 2013 and the FCA has confirmed that it intends to implement the changes to the rules on 1 January 2014.

Any UK incorporated quoted company with a financial year ending on or after 30 September 2013 must comply with both the new reporting requirements and the current listing rules, while the revised listing rules will apply to premium listed companies with a year ending on or after 1 January 2014.

Will there be changes to the Corporate Governance Code?

The Financial Reporting Council (“FRC”) is currently consulting on whether changes should be made to the UK Corporate Governance Code (the “Code”) in light of the new remuneration regime. It is seeking feedback on whether or not the Code should be amended to:

  • extend the clawback provisions
  • deter the appointment of non-executives to the remuneration committee who are also executive directors in other companies
  • specify the action that companies should take when an advisory vote is passed but a significant minority dissent (the new reporting regime already requires an explanation to be given in the DARR in such circumstances)
  • ensure compatibility with the new remuneration reporting and voting regime, and
  • remove any redundant Code provisions.

The deadline for responding to the consultation is 6 December 2013. The FRC has not yet decided whether changes to the Code are required but any such changes will be subject to consultation in the first quarter of 2014. Accordingly, the revised Code will apply to financial years beginning on or after 1 October 2014.

For more information please contact Mark Howard on +44 (0)20 7203 8902 or at mark.howard@crsblaw.com