Investment Association Principles of Remuneration for 2025

The Investment Association (the "IA") has now published the long-awaited update to its Principles of Remuneration (the "Principles").

The update follows on from the letter sent by the IA to Remuneration Committee Chairs in February 2024 trailing that a more significant review of the Principles than in previous years was being undertaken (the "February Letter").

The revised Principles have been substantially rewritten and there are several important changes that UK-listed companies should be aware of, particularly as we move into annual reporting season.

The Principles are significantly less prescriptive than before, and their publication provides an opportunity for companies to take stock of whether their existing incentive arrangements continue to remain fit for purpose. The new Principles open up the possibility of more diverse approaches to the quantum and form of executive pay which companies should consider. There is also greater flexibility in how a company can mechanically choose to settle share awards and so it would be a good time to review hedging strategies.

Remuneration Policies

The revised Principles will be particularly important for those companies who are due to put forward a new directors' remuneration policy at their next AGM. We expect that shareholders and other stakeholders will soon want to understand what changes such companies intend to make to pay structures, if any, in light of the publication. This year's round of remuneration policies may also see additional investor and press scrutiny given the opportunity for companies to reconsider their approach to pay.

Overview

The amendments that the IA have made are geared towards reducing restrictions on executive pay structures.

The IA acknowledges that the Principles are intended to reflect investor sentiment regarding pay, rather than setting market practice, and that previous iterations of the Principles may have prompted companies to fall into a "one size fits all" approach to executive remuneration. The new Principles are intended to provide companies with greater scope to introduce more tailored arrangements, provided that they can justify to stakeholders why this is appropriate.

The changes reflect the broader discussion regarding the UK listing environment and whether the current approach to remuneration impedes UK companies' ability to compete in the global market for talent.

5% Dilution Limit

The IA has removed the 5% dilution limit applicable for discretionary share schemes that capped the use of new issue or treasury shares over rolling 10 year periods. The 10% limit that captures both discretionary and all-employee schemes is now therefore the only limit suggested by the IA. The IA further acknowledge that in exceptional cases newly listed high growth companies may feel that an even higher limit is appropriate on a temporary basis.

The move helps to bring the UK market more closely into line with practice elsewhere, in particular in the US where much higher levels of dilution often appear to be tolerated by investors. The 5% limit is referred to in other influential investor guidelines, for example LGIM's executive pay principles, however we expect that other institutions will follow the IA's approach on this topic.

Removing the limit will give companies more flexibility about how they choose to settle executive awards, particularly for those with limited headroom under the existing limits. Share plan rules should be reviewed to confirm whether a shareholder-approved amendment would be required to take advantage of this change. Hedging strategies should also be reviewed.

Bonus Deferral

The new Principles state that shareholders expect companies to have a deferral policy in place but that where an executive director has already met their shareholding guideline, a company may be able to justify reducing deferral levels, provided that it can demonstrate that adequate malus and clawback protections are still in place. The explicit expectation for deferral where bonus opportunity exceeds 100% of salary has been deleted.

Companies with long-standing executive directors who have accumulated significant shareholdings could consider whether a reduced level of deferral is appropriate. Such directors may be keen on such a change if a significant portion of their net worth is tied up in a single asset. Any reduction would however increase the upfront cash cost of satisfying bonuses. Any change in deferral levels would need to be discussed with shareholders and may necessitate a new remuneration policy.

Hybrid Schemes

As trailed in the February Letter, the Principles acknowledge that a "hybrid scheme", under which executives receive a combination of performance-based and service-based share awards may be appropriate for some companies. Such arrangements are more common in the US and allow a balance to be struck between stretching performance targets and providing employees with certainty that at least a portion of their awards should vest.

Discounts on award quantums should be applied if service-based awards will be offered. The Principles continue to suggest a 50% discount, however in a further relaxation this is implied to be a starting point only, with remuneration committees encouraged to explain the rationale and methodology for determining the discount rate ultimately selected.

Companies may wish to review their incentive schemes to confirm whether they already include the flexibility to offer a combination of different award types, and gauge shareholder views on these structures.

Changes of Control

The specific section on treatment of share awards on a change of control has been deleted in the new Principles. The previous guidance was prescriptive, mandating that time pro-rating should be applied. Deletion reflects market practice in recent years; the norm now is ordinarily for time pro-rating to be waived on a change of control, or for a replacement award to be granted with equal value to the portion of an LTIP award lost due to time pro-rating, often without any further performance conditions.

Performance conditions should continue to be assessed on a change of control, and the Principles state that if a Remuneration Committee is considering changes to performance conditions (or the assessment thereof) in connection with a corporate event, it should engage with shareholders. Committees will need to move quickly to canvas shareholder views in these circumstances, given that, if competition concerns do not arise, a takeover can occur on a short timetable.

The new Principles no longer forbid the use of transaction bonuses for directors, albeit that these are unlikely to become common in practice given limitations under remuneration policies and the Takeover Code.

Shareholding Guidelines

The IA has clarified that it considers one times the annual LTIP award to be an appropriate benchmark for the minimum shareholding requirement. Whilst not explicitly stated in the Principles, where a company uses a service-based restricted share plan, and discounts awards levels accordingly, we expect that the IA would consider that the shareholding guidelines should be proportionately increased.

The IA has also given some examples of the type of consequence shareholders may expect to see where directors do not meet the shareholding guidelines within the required timeframe which include deferral of bonuses and reducing LTIP awards.

Other Changes to the Principles

The Principles are generally less prescriptive than the previous edition, with much greater emphasis on companies having the ability to engage with shareholders to justify why they consider their incentive arrangements are appropriate. These changes flow through both the substantive aspects of the Principles and disclosure expectations.

The tone of the Principles has been softened throughout. For example, the guidance on discretion now explicitly references that upwards discretion can be exercised where performance outcomes do not fairly reflect achievement/contributions, whereas the previous edition only explicitly referred to downward discretion. Companies which have, until now, followed the downwards-only approach to discretion may wish to review share plan rules and remuneration policies to take advantage of this additional flexibility. The opening sentence of the section on remuneration levels previously emphasised that "undeserved and excessive remuneration sends a negative message to all stakeholders", now a more benign statement is included, that "Investors analyse levels of remuneration on a case-by-case basis, acknowledging that there is no one-size-fits-all approach."

As trailed in the February Letter, the general thrust of the changes to the Principles is towards allowing UK companies to be more competitive in the global hunt for talent. There is particular acknowledgment that more flexible incentive arrangements may be appropriate where a company has a significant US presence or revenues.

Contacts

If you have any queries on the Principles or would like to discuss them further, please contact a member of the Remuneration and Incentives team.