Introduction
The Government has now published draft legislation to implement proposed reforms on directors’ pay together with a consultation paper seeking views on the draft regulations which will specify the content of directors’ remuneration reports. The proposed legislation and regulations will introduce new and far reaching requirements relating to shareholder approval for, and the disclosure of, directors’ remuneration and termination payments.
The key issues arising from the proposed changes are as follows:
- shareholders will need to approve the company’s policy for all aspects of directors' pay (including fixed, short and long-term variable pay, pensions contributions and potential termination payments);
- companies will need to put in place a directors’ remuneration and termination payment policy which is both comprehensive but also flexible;
- remuneration and termination payments outside of the approved policy will not be permitted without shareholders’ approval;
- the proposed transitional provisions are unclear and so companies should consider any new arrangements for directors being put in place now very carefully since these may need to be included in the first policy which is put to shareholders for approval; and
- companies are likely to want to begin the process of shareholder consultation on their pay policy early so that shareholders approve the first pay policy that is put to them and it does not become a contentious issue.
In summary, the proposed legislation and regulations will require:
- a two part structure to the directors’ remuneration report comprising a forward looking statement relating to the company’s pay policy (the Policy Statement) and an implementation report disclosing pay received or earned and termination payments made with respect to the reported financial year (the Implementation Report);
- a binding shareholder vote on the Policy Statement, every three years or sooner if there are changes made to it; and
- a non-binding annual shareholder vote on the Implementation Report.
We set out below the answers to some of the questions you may have about the application and impact of the proposed new regulations and legislation. If you have any other questions please feel free to contact us.
For further information on the background to the draft regulations and the debate on shareholders’ “say on pay”, please see our June 2012 briefing “Executive Remuneration: Reforms announced by the Government”.
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Impact and implementation
Which companies will be affected?
As is currently the case, only UK incorporated companies on the Official List, or on any official list in an EEA State, or whose securities are admitted to dealing on either the New York Stock Exchange or Nasdaq (i.e. “quoted” companies for the purpose of the Companies Act 2006) will be required to produce a directors’ remuneration report and seek the proposed shareholder approvals. Companies whose securities are admitted to trading on AIM and non-UK incorporated companies on the Official List will not need to comply with the new legislation and the directors’ remuneration report regulations: UK incorporated companies which are not quoted companies will continue to be subject to the Companies Act 2006 requirements in relation to payments for loss of office.
How should the directors’ remuneration report be structured?
The proposed regulations provide for a two-part framework for the remuneration report:
- the Implementation Report - this part is the equivalent of the current annual reporting requirements for directors’ fixed and variable earnings. Elements of this part of the remuneration report will be subject to audit; and
- the Policy Statement - in this part the company sets out its arrangements and policies for directors’ remuneration and loss of office payments for the current financial year and/or future years.
In addition, it is also proposed that the directors’ remuneration report should be prefaced by a statement to shareholders from the chairman of the company’s remuneration committee summarising the contents of the report, including the key messages on remuneration and the context in which decisions have been taken.
When will the new regulations apply?
It is currently intended that the new regulations will apply to the directors’ remuneration report put to shareholders in the first financial year beginning after the date on which the new legislation comes into force (currently anticipated to be in October 2013). Accordingly, a company with a 31 December year end will have to apply the new rules in relation to its remuneration report prepared in respect of the financial year ended 31 December 2013 and put the required resolutions to shareholders at its AGM in spring 2014, whereas a company with a 30 June year end will put its first directors’ remuneration report in respect of the financial year ending 30 June 2014 to its shareholders with the necessary resolutions at its AGM in autumn 2014.
What period should the Policy Statement apply to?
The Policy Statement relates to the company’s future pay structure and the directors will need to determine whether it is to be operated in respect of the financial year in which the AGM or general meeting to approve it is held or whether it is to have a different commencement date specified in the Policy Statement, which could, for example, be from the start of the following financial year. Difficulties may arise for companies whose shareholders do not approve a Policy Statement which the company intends to apply from the beginning of the financial year in which the meeting to approve it is held. In these circumstances the company would be obliged to revert to its previously approved Policy Statement and accordingly may need to revise any awards it has made during that year.
The implications of shareholders not approving a Policy Statement are discussed further under “Shareholder Approval” below.
Do the new remuneration report content requirements replace or add to existing company law requirements?
The new regulations will replace the reporting requirements set out in Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 which currently specify the content of the directors’ remuneration report. As a result, the disclosures set out in the draft regulations are instead of, rather than additional to, the existing disclosure requirements.
However, the new requirements are more far-reaching than the current reporting requirements since companies will have to set out and comply with the forward-looking Policy Statement covering all elements of directors’ pay and termination payments, and will not be permitted to make payments outside the limits of that Policy Statement unless specific shareholder approval of these payments is sought.
How does the new regime fit with the Listing Rule requirements in relation to share schemes and long-term incentives?
The Listing Rules require shareholder approval for any employee share scheme which uses newly issued shares and for any long-term incentive arrangements in which directors may participate, whether or not such arrangements operate over new or existing shares. It would seem that these Listing Rule provisions will operate in addition to the shareholder approval required for the directors’ Policy Statement, although the Government has stated that it will be consulting with the UK Listing Authority in this respect as there are clear overlaps and conflicts between the Listing Rules and the proposed new regime.
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The Policy Statement
What must the Policy Statement cover?
The Policy Statement must set out information on directors’ total compensation arrangements, potential exit payments and the considerations made by the company in determining its directors’ remuneration. The regulations specify areas to be covered (as set out below) but do not prescribe the specific detailed disclosures to be made which means that companies can design their own Policy Statement to suit their business model and strategy.
One of the key concerns companies will have in drafting their Policy Statements will be the degree of flexibility built into the Policy particularly with regard to dealing with exceptional circumstances and the exercise of discretions.
The regulations provide specifically that the Policy Statement must include information under the following heads:
| Pay Policy: | Each element of directors’ pay and supporting information in the form of a table (the Pay Policy Table). |
| Service Contracts: | All existing contractual provisions that relate to directors’ remuneration. |
| Scenarios: | A graph setting out what directors will be paid for threshold, maximum and below threshold performance. |
| Spend on Pay: | The percentage change in profit, dividends and overall expenditure on pay in the reporting period compared to the previous period. |
| Exit Payment Policy: | A framework for how the company will calculate directors’ termination payments. |
| Consideration of Group Employee Conditions: | A statement, amongst other things, about how the pay and employment conditions of other employees were taken into account in setting directors’ pay. |
| Consideration of Shareholder Views: | A statement about whether and how shareholder views were taken into account in formulating the pay policy. |
Does the Policy Statement have to be included in the remuneration report every year?
Companies must put their Policy Statement to the shareholder vote at their AGM (or at a general meeting) by way of an ordinary resolution at least every three years. This means that for a company with a 31 December year end, if the first Policy Statement is approved by shareholders in spring 2014, it must be put again to shareholders at the AGM in spring 2017.
There are other circumstances which may require the company to submit its Policy Statement for approval sooner than every three years and these are discussed further under the heading “Shareholder Approval” below. However, companies may still wish to include their Policy Statement in the remuneration report each year even if shareholders are not being asked to vote on that part of the remuneration report. Alternatively, companies may opt to incorporate it by reference to the links on their website where it can be found.
What should the Pay Policy Table include?
All elements of directors’ pay (both fixed and variable) must be included separately in the table and typically this will comprise base salary, annual bonus, deferred awards, long-term share incentives and pension.
The detailed information to be included in the table is not prescribed. However, for each element of pay the table must set out information under the following heads:
| Strategy: | How that particular element supports the short and long-term objectives of the business. |
| Operation: | The key features and terms of the arrangements, including whether there will be provisions for withholding or clawback by reference to performance or behaviour. |
| Opportunity: | The maximum potential value. |
| Performance Metrics: | Applicable conditions (if any), their relative weighting and measurement period. |
| Changes: | Whether the pay element in question was included in the previous Policy Statement, whether there are any changes to that element and the reasons for any changes. |
The consultation paper includes an example Pay Policy Table and it is clear from this, together with the accompanying commentary, that the Pay Policy Table is intended to set out a high level overview. It must be accompanied by notes which explain the differences in remuneration policy for directors compared with other employees and the reasons why performance conditions in respect of long-term variable incentive awards were chosen or why any such long-term awards are not subject to performance.
What should the exit payment policy within the Policy Statement cover?
The company’s exit payment policy must summarise and explain the duration of directors’ service contracts, notice periods and contractual termination rights under such contracts. The Policy Statement must set out the company’s policy on how termination payments will be made and include for each element of directors’ pay:
- how each element of pay will be calculated on termination;
- whether the company will distinguish between types of leaver or the circumstances under which a director left; and
- whether and how performance will be taken into account.
In addition, this section must disclose any contractual arrangement made prior to the coming into effect of the regulations that could impact on the quantum of directors’ termination payments.
Other than in respect of long-term incentives, it is unusual for companies to pre-determine good leaver/bad leaver scenarios since it may be difficult for companies to foresee every eventuality. This may prompt companies to adopt a broad and generic exit payment policy to retain flexibility in dealing with difficult or unusual circumstances.
What are the employee conditions to be taken into account?
This section of the Policy Statement requires specific statements and information relating to pay and employment conditions of other employees in the group and how these relate to directors’ pay. It must include the following:
- a statement about how the pay and employment conditions of other employees have been taken into account in determining the directors’ pay policy;
- a statement on whether and, if so, how the company consulted with employees in drawing up its directors’ pay policy;
- whether and, if so, how any comparison metrics were taken into account; and
- information on the percentage increase in pay of the chief executive officer and all other employees or an appropriate comparator group of employees.
Is there a legal obligation to consult with shareholders?
There is no legal obligation, but the Policy Statement must state whether and, if so, how views expressed by shareholders at the previous AGM or during the reported financial year have been taken into account. In relation to any changes to the directors’ remuneration policy, most companies will wish to engage in a shareholder consultation process before such changes are disclosed in the Policy Statement.
The Implementation Report may also need to set out information on shareholders’ views where there has been any substantial dissent (see further comments under “What must the Implementation Report cover” below).
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The Implementation Report
What must the Implementation Report cover?
This part of the directors’ remuneration report explains how the directors’ pay policy as set out in the Policy Statement has been implemented in the relevant reporting year and should include the following:
| A Single Total Remuneration Figure: | A table (the Remuneration Table) setting out for each director serving in the reported year a series of single aggregate figures relating to each pay element. |
| Variable Pay Awards: | The Remuneration Table must includes notes setting out information on the performance conditions for variable pay. |
| Total Pension Entitlements: | Details of pension schemes in operation, beneficiaries under them, information on the accrued value of the pension of each director were they to retire at the end of the year and assuming a normal retirement date and the value of any additional benefit receivable if a director were to retire early. |
| Loss of Office Payments: | For any person who has served as a director during the year, information on any termination payments, whether made or receivable. |
| Variable Pay Awards: | Information about awards made in the current year under LTIPs, if their value is to be determined in the future. |
| Comparison of Overall Performance and Pay: | A graph comparing company performance with the chief executive officer’s pay, with total shareholder return being used as a proxy for company performance. |
| Directors’ Shareholdings: | Total shareholdings of directors, including share ownership requirements and whether they have been met, and the total numbers of shares and share options that each director owns outright, subject to deferral and subject to performance conditions. |
The information set out under the headings above will be subject to audit.
The Implementation Report must also include:
- certain information about the members of the remuneration committee and their independent advisers; and
- information as to how shareholders voted on both the binding vote on the Policy Statement and the advisory vote on the Implementation Report at the last AGM, set out as a percentage of votes cast, the percentage of the shareholder base that abstained, the reasons for significant dissent where known and action taken by the directors in response.
What does the Remuneration Table need to cover?
There is a requirement to provide, for each director, a series of single figures relating to the separate elements of his or her pay together with an aggregate total as follows:
| Salary and Fees | In respect of his/her “qualifying service” as a director. |
| Taxable Benefits | This includes benefits-in-kind and any other miscellaneous receipts not otherwise covered such as cash dividends received in respect of any unvested LTIP awards. |
| Pension Related Benefits | (i) The contributions to or additional value achieved in the year from participation in money purchase and/or defined benefit schemes and (ii) any cash received in lieu of pension. |
| Money or other assets received | This covers short-term variable pay in the reporting period due to achievement of performance conditions that relate to that period, such as annual bonus received during the year. |
| Awards under long-term schemes | This covers (i) long-term awards which have vested as a result of achievement of performance for any period ending in the reported year and (ii) awards granted in the year if not subject to performance. |
| Total | |
Is any other information required to be included in Remuneration Table?
The last two columns in the table relate to annual and long-term variable pay received or earned in the reported year, and in respect of these interests, the notes to the table must include:
- any performance conditions and their weighting;
- targets set within each performance condition and the proportion of the award achievable against such targets and how the company performed against the targets;
- if and when any discretions were exercised with respect to the award;
- the resulting level of the award achieved; and
- the percentage deferrals of any short-term award and whether deferred in cash or shares.
What details should be included with regard to exit payments actually made?
The Implementation Report should set out the level of compensation received, broken down into the key elements, an explanation of how each element was calculated and an explanation of how any discretions allowed within the Policy Statement in relation to exit payments were exercised.
In addition, the Government proposes that an announcement must be made promptly by the company after a director has left with details of the payment received.
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Shareholder approval
What resolutions have to be passed and how often?
As is the case now, the company will need to put its Implementation Report to the vote at each AGM. Shareholders must be asked to approve it by way of ordinary resolution.
The Policy Statement must be approved by shareholders by way of an ordinary resolution passed at least once every three years or earlier if the Implementation Report was not approved at the previous AGM, the Policy Statement was not voted on at that AGM and has not been voted on since, or if the company proposes any revisions to the Policy Statement.
What happens if the Policy Statement is not approved?
There is currently no proposed obligation on directors to revise the company’s Policy Statement if shareholder concerns lead to it being voted down.
However, the remuneration arrangements for directors cannot be inconsistent with the last approved Policy Statement and so, in these circumstances, the company would have to revert to its previously approved Policy Statement. This will produce a somewhat odd result if the policy set out in the rejected Policy Statement has not, as a matter of fact, changed from the policy in the previously approved Policy Statement.
What happens if the Implementation Report is not approved?
A company will need to put an ordinary resolution approving its Policy Statement to the next AGM if the annual vote on the Implementation Report was not passed at the previous AGM, if the Policy Statement was not voted on at that AGM and has not been voted on since that AGM.
What are the consequences of making payments which are inconsistent with the Policy Statement?
An obligation to make a payment which is inconsistent with the approved directors’ Policy Statement and which has not been approved by a separate shareholder resolution has no effect. Moreover, if a payment is made in breach of the provisions, it is to be held by the recipient on trust for the company or the person who made the payment and, if the payment was made by the company, any director who authorised the payment will be jointly and severally liable to indemnify the company for any loss resulting from it.
What if a company wants to change its Policy Statement during a financial year?
Since a company cannot operate outside its approved Policy Statement, it would need to put a revised Policy Statement to its shareholders at a general meeting convened specifically to approve the revised Policy Statement. Alternatively, it may be more practical to make conditional provisional arrangements but ensure that these are genuinely subject to subsequent shareholder approval.
What about arrangements made before the first Policy Statement is approved?
The proposed legislation (which will amend the Companies Act 2006) provides for transitional provisions in relation to certain payments and ongoing contractual obligations which, in some circumstances, are carved-out from the requirements that they should otherwise fall within the parameters of the approved Policy Statement or be the subject of separate shareholder approval.
Remuneration payments and payments for loss of office made before the earlier of (i) the end of the first financial year beginning after October 2013 (the coming into force of the legislation), and (ii) the date from which the first approved Policy Statement takes effect (as specified by the directors in the Policy Statement itself) are not caught by the new restrictions. This means that for a company with a financial year ended 31 December (which must put its first Policy Statement to shareholders at its Spring 2014 AGM), if the Policy Statement is expressed to apply to remuneration and termination payments in respect of the current financial year (i.e. the year commencing 1 January 2014), the carve-out applies only to payments made up to 1 January 2014 and not thereafter. This could put the company in difficulties with respect to remuneration or termination payments it needs to make between 1 January 2014 and spring 2014 when it will seek shareholder approval of the Policy Statement at its AGM if those payments are outside the parameters set out in the proposed Policy Statement. However, if the company was to provide that its Policy Statement applies from the beginning of the following financial year (i.e. the year commencing 1 January 2015), the carve-out would apply to all payments made up to 31 December 2014. Therefore, by specifying that the Policy Statement will apply to the financial year following the 2014 AGM, a company should avoid the difficulty of requiring retrospective approval for payments already made.
In addition, payments made at any time in respect of agreements or obligations entered into before 27 June 2012 will also not be affected by the proposed new restrictions. However, this carve-out is limited since many companies will be granting long-term awards after 27 June 2012 but prior to the approval and commencement of their Policy Statements. These awards will not benefit from the payment carve-out set out above since they are not being made under an agreement or obligation entered into before 27 June 2012 and in the normal course will paid out considerably after the last date for the payment set out in the paragraph above. Again, using the example of a company with a 31 December year end, its next annual LTIP grants would normally be made following the announcement of its results in 2013 and again in early 2014, prior to its obligation to put its first Policy Statement to its shareholders at the 2014 AGM. It is not clear how these awards will be brought within the authority of the shareholder approval of the Policy Statement unless the Policy Statement is expressed to apply retrospectively and, in the case of the 2013 awards, even to the financial year preceding the year of the relevant AGM.
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Next steps
Responding to the consultation
The consultation on the draft regulations is open until 26 September 2012. The regulations are expected to come into force from October 2013, alongside the provisions in the Enterprise and Regulatory Reform Bill which will amend the Companies Act 2006 and set out the shareholder voting requirements. The aim is that the regulations provide a framework within which companies and shareholders can set, agree and implement the company’s pay policy. They will need to be supplemented by clear guidance on the level of detail and type of information that should be reported. The Government plans to work on this guidance with business and investor groups so that it can be in place before the regulations come into effect.
Consulting with shareholders
The Government has stated that the proposed regulations and legislation are designed to encourage greater shareholder consultation. As a result of the consequences of a failed vote on the Implementation Report and the new voting requirement on the Policy Statement, it is very likely that companies will want to consult their shareholders in advance of the first AGM at which the resolutions on both will have to be proposed and may well choose to operate a regular ongoing consultation exercise. Some companies may wish to send their key investors a draft of their proposed Policy Statement, particularly if this sets out any key changes to existing practice.
Drafting the Policy Statement
Careful consideration will need to be given to the Policy Statement. Whilst this is supposed to provide “parameters”, companies will wish to consider to what extent it is appropriate to take the authority to exercise discretions and introduce exceptions for particular circumstances.
Where can I find the proposed regulations and ancillary legislation?
The draft regulations setting out the required content of the remuneration report are set out in a BIS consultation document “Directors’ Pay - Consultation on revised remuneration reporting regulations” published in June 2012. The provisions relating to voting on the remuneration report are included in the Enterprise and Regulatory Reform Bill which is currently at the Committee stage in Parliament and amendments will be made to the Companies Act 2006 in due course.
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How we can help
We will be producing a response to the consultation in due course and are happy to discuss with you any issues you may have concerns about.
We will be sending out supplemental briefings identifying the particular practical issues the regulations present for variable pay and director appointments and termination payments.
When the legislation is finalised we will be happy to provide you with a remuneration report checklist and guidance you may need on the detailed form of the disclosures and the policies to ensure they comply with your arrangements.
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