RECENT UPDATES TO REMUNERATION GUIDELINES

Investment Association (IA) Principles of Remuneration

The IA has this week published its annual letter to Remuneration Committee Chairs as well as its updated Principles of Remuneration (commonly referred to as the “IA Guidelines”). The Principles have been updated to provide additional clarity on the IA’s position on the following areas:

• pensions: pension contributions for executives should be aligned with those available to the rest of the workforce by the end of 2022. In addition, the IA’s letter to Remuneration Committee Chairs states that the level of contributions for executives at which IVIS will red top the remuneration report if there is no credible action plan to align contributions by the end of 2022 will reduce from 25% to 15%;
• post-employment holding periods: the IA expects Remuneration Committees to provide additional clarity on how shareholding requirements will be enforced once executives have left employment;
• personal and ESG performance measures: whilst the IA continues to expect the majority of annual bonus performance measures to be financial, where personal and ESG performance measures are used they must be quantifiable and clearly linked to a company’s strategy and long term value creation. In addition, the achievements which justify payments as a result of personal or strategic measures should be disclosed;
• bonus deferral: where bonus opportunity exceeds 100% of salary, a portion of the entire bonus should be deferred into shares (not just a portion of the excess); and
• leaver provisions: the IA has added a statement that it expects ‘bad leavers’ not to receive annual bonus payments.

Institutional Shareholder Services

ISS has also published updates to its UK proxy voting guidelines for 2021. Updates to the ISS guidelines also include a particular focus on the extent to which pension contributions are aligned with those available to the wider workforce and whether there is an appropriate post-employment shareholding requirement in place.

Updated IA guidance on the impact of COVID-19 on executive remuneration

The IA has also updated its separate guidance on the IA’s expectations on how UK listed companies should reflect the impact of COVID-19 on executive pay. Particular areas of focus in the updated guidance are:

• annual bonuses: where companies have raised additional capital from shareholders or have taken advantage of Government support schemes, the IA would not expect payment of any annual bonuses for FY2020 or FY2020/21, unless there are exceptional circumstances. The IA has repeated its expectation that bonuses should be reduced where dividends were reduced or cancelled for FY2019 or FY2019/20;
• LTIPs: the IA would not expect outstanding LTIP awards to be cancelled and replaced or for executives to be compensated with higher variable remuneration in 2021 as a result of lower remuneration received in 2020 due to the effects of COVID-19. Remuneration Committees should be prepared to explain how they have considered the potential for windfall gains when determining grant levels;
• performance measures: the IA has reaffirmed that it does not expect performance measures to be adjusted as a result of the impact of COVID-19 and requests that there is a confirmation in the Remuneration Committee Chair’s statement that no such adjustments have been made. Targets should remain sufficiently stretching and Remuneration Committees should be prepared to disclose how they have been set. The guidance relating to delaying the setting of performance targets for up to six months has been removed;
• enhanced disclosure expectations: the IA expects Remuneration Committees to provide additional disclosure on how COVID-19 has been taken into account in determining remuneration outcomes, with a particular focus on how factors such as cancelled dividend payments and the receipt of Government support have been addressed (for example, where financial performance has been bolstered by Business Rate relief). The rationale and outcomes of any exercise of discretion should be clearly disclosed;
• new policies and alternative remuneration structures: the IA has reiterated its guidance that the inability to set meaningful performance targets is not in itself a justification for moving to alternative remuneration structures such as the use of restricted shares and continues to suggest that it may be inappropriate for a company to introduce substantial changes to its remuneration policy if it has been significantly impacted by COVID-19.

HSF Comment

Levels of executive pension contributions and post-employment shareholding requirements continue to be “hot topics” for the IA and look set to be increasingly so for other proxy advisors. Despite already being on the agenda, Remuneration Committees are being pushed harder to comply with the expectation that pension contributions for incumbent executive directors are aligned with those available to the wider workforce by the end of 2022, despite the contractual difficulties. This is evidenced by the reduction in the level of executive pension contributions, from 25% to 15%, at which IVIS will red top remuneration reports if there is no credible alignment strategy in place. Pensions and post-employment shareholding requirements are likely to remain an area of significant focus, especially as companies who have not dealt with these issues will need to disclose against the Corporate Governance Code in this regard.

The IA’s comments on personal and ESG performance measures and in relation to setting performance targets in the context of COVID-19 demonstrate that its emphasis remains on awards being subject to stretching financial performance targets, with non-financial targets having to be both quantifiable and linked to the company’s strategic goals.

The updated guidance on COVID-19 highlights that Remuneration Committees will need to continue to be mindful of the wider context when balancing the competing pressures in relation to executive remuneration which continue to arise from the impact of COVID-19. The IA’s increased emphasis on disclosure in its updated guidance suggests that shareholders will want to see clear evidence that remuneration outcomes can be justified in the context of COVID-19 and that executives continue to “share in the pain”. Remuneration Committees should be mindful of this in their decision making processes.

The removal of the suggestion of delaying incentive grants and/or the setting of performance targets until there is more market certainty suggests that it will now be difficult for Remuneration Committees to use the impact of COVID-19 as an exceptional circumstance to justify their future actions, and highlights that where a Remuneration Committee considers it appropriate to grant long term incentives it will also need to be comfortable that it is able to set performance measures which will remain appropriate for the entirety of the performance period.

Remuneration Committees will also need to be aware that there is likely to be significant focus on long term incentive vestings in the next three to four years. Particular focus will be on how the Remuneration Committee has, or has not, exercised discretions in the incentive plans to override the formulaic performance condition outcomes so as to avoid any windfall gains, and the Remuneration Committee will need to be prepared to justify those vesting outcomes particularly where a reduction in the grant level was not in evidence.