Corporate governance review
BEIS Committee: Government responds to corporate governance report
In September 2017, the Business, Energy and Industrial Strategy Committee (BEIS Committee) published the Government's response to the BEIS Committee’s report on corporate governance which was published in April 2017. Since then, the Government, in August 2017, published its own response to its Green Paper consultation on corporate governance, which supports a number of the BEIS Committee’s recommendations.
The Government’s response to a number of BEIS Committee’s recommendations is as follows:
Promoting good corporate governance
- Recommendation 1 – The Government agrees with the BEIS Committee that all companies of significant size (private as well as public) should explain how their directors have had regard to their employee and other non-shareholder interests set out in section 172 Companies Act 2006, and intends to make this form of reporting a legal requirement by introducing secondary legislation. The Government will publish a draft statutory instrument setting out details later this year.
- Recommendation 2 – The Government believes that a formal annual rating exercise risks undermining the current valuable and legitimate flexibility of the UK’s ‘comply or explain’ approach to corporate governance.
- Recommendation 3 – The Government does not, at this stage, believe that the Financial Reporting Council (FRC) should receive extra powers to engage and hold directors to account for their duties. However, it notes the steps it has set out in its own response to the Green Paper in this area.
- Recommendation 4 – The Government supports further development of the role of the Investor Forum and notes that the Investment Association and other representative bodies offer additional means to facilitate dialogue between investors and boards.
- Recommendation 5 – The Government agrees that companies should be required to explain how they are engaging with stakeholders and notes that further details will be set out in a draft statutory instrument to be published later this year.
- Recommendation 6 – The Government agrees that institutional investors have a vital stewardship role in relation to the companies in which they are invested and welcomes ideas for strengthening this role.
- Recommendation 7 – The Government agrees that companies’ use of advisers should be subject to appropriate transparency and accountability but does not plan to introduce any further requirements on private companies at present, though notes that this might be an area for consideration by the group developing corporate governance principles for large private companies. The Government will also consider some of the points raised as part of transposing the Shareholder Rights Directive in the UK.
The Government shares the BEIS Committee’s view that good corporate governance is relevant to all companies, not just those with a public listing, and notes the steps it has taken in the response to the Green Paper for the development of an appropriate code or set of principles for large private companies.
The Government believes that companies should continue to have the flexibility to choose the long-term share remuneration policies and models that they put to investors for approval. At the same time, companies and shareholders should aim to be more open to alternatives to the currently dominant LTIP model. The Government notes the proposals it set out in its response to the Green Paper in this area. This includes steps taken by companies that receive significant shareholder dissent on executive pay, the position of chair of remuneration committees, the broader responsibilities of the remuneration committee in overseeing pay and reward across the company, and the requirement to publish the pay ratio between the CEO and average employee pay, as will be required by secondary legislation.
Composition of boards
In response to the BEIS Committee’s report, the Government is not preparing to mandate that, from May 2020, at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women as it believes the Hampton-Alexander Review targets of 33 per cent women on FTSE 350 boards and 33 per cent women on executive committees and their direct reports by 2020 should be met first in terms of diverse workforces. The Government also continues to believe that a non-legislative solution is the right approach for now, rather than legislation requiring FTSE 100 companies to publish their workforce data, broken down by ethnicity and by pay band. The Government also does not intend to guarantee the FRC an increased role in overseeing the rigour of the board evaluation process by the external facilitator.
BEIS: Government response to Green Paper consultation on corporate governance reform
The Department for Business, Energy & Industrial Strategy (BEIS) published the Government’s response to its Green Paper on corporate governance reform (Green Paper) in August 2017. The response document identifies nine proposals for reform which the Government intends to take forward. It also includes a summary of the responses to the Green Paper.
Background to the Green Paper
The Green Paper was published in November 2016 and its purpose was to consider changes that might be appropriate to the UK’s corporate governance regime to help improve business performance and ensure that the economy works for all. The Government consulted on three specific aspects of corporate governance, namely executive pay, strengthening the employee, customer and supplier voice and corporate governance in large privately-held businesses. The nine proposals for reform relate to these aspects of corporate governance.
The Government is to invite the Financial Reporting Council (FRC) to revise the UK’s Corporate Governance Code:
- To be more specific about the steps that premium listed companies should take when they encounter significant shareholder opposition to executive pay policies and awards (and other matters). The FRC will need to consult on the new measures in the UK Corporate Governance Code and the Government notes that the new provisions could include, for example, provisions for companies to respond publicly to dissent within a certain time period, or to verify that dissent has been sufficiently addressed by putting the company’s existing or revised remuneration policy to a shareholder vote at the next annual general meeting. Stakeholders will also be able to comment on whether the new measures should apply to all premium listed companies or only to those in the FTSE 350. The Government notes in the response document that it will monitor the impact of these measures carefully once they are in place and will consider further action at a future point unless there is clear evidence that companies are taking active and effective steps to respond to significant shareholder concerns about executive pay outcomes.
- To give remuneration committees a broader responsibility for overseeing pay and incentives across their company and require them to engage with the wider workforce to explain how executive remuneration aligns with wider company pay policy (using pay ratios to help explain the approach where appropriate). This will involve the FRC consulting on revisions to the UK Corporate Governance Code and its supporting guidance and the Government notes that this consultation will provide an opportunity to seek best practice examples from those remuneration committees that already proactively engage with the wider workforce while enabling current work in this area by a number of prominent think-tanks to be taken into account. The Government also proposes to ask the FRC to include in its consultation a proposed new provision that chairs of remuneration committees should have served for at least 12 months on a remuneration committee, unless there is a clear and valid explanation why this may not be appropriate in a particular case.
- To extend the recommended minimum vesting and post-vesting holding period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes in setting share based remuneration. The Government notes that lengthening the holding period in this way would bring the rules for executive remuneration closer to those introduced in 2015 for the banking sector which lengthened deferral periods for variable pay to seven years.
The Government is to introduce secondary legislation to require quoted companies:
- To report annually the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year and setting the ratio in the context of pay and conditions across the wider workforce. The Government notes that the new pay ratio reporting requirement should, for reasons of consistency and simplicity, cover UK employees only. However, multinational companies could publish a broader ratio alongside, covering all employees in their group. Currently the Government proposes that the ratio should be calculated based on the CEO’s total annual remuneration relative to the average total remuneration of the company’s UK workforce. This will enable the new reporting requirement to be based in most cases on existing payroll data. Further details will be set out in a draft statutory instrument to be published later in the year.
- To provide a clearer explanation in remuneration policies of a range of potential outcomes from complex, share-based incentive schemes. This proposal reflects the arguments of a number of investors and other respondents that companies’ executive remuneration policies should be required to set out more clearly the potential remuneration outcomes of long-term incentive plans under a range of scenarios, including significant share price growth. The new requirement will build on the existing requirements governing the content of remuneration policies set out in Schedule 8 of the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended). The Government will also invite the FRC to seek stakeholder views during its consultation on changes to the UK Corporate Governance Code on whether and how new principles or detailed guidance on share-based remuneration could be included there.
The Government intends to invite the Investment Association to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20 per cent or more, along with a record of what these companies say they are doing to address shareholder concerns.
Other issues in relation to executive pay
The Government notes in the response paper that it will commission an examination of the use of share buybacks to ensure that they cannot be used artificially to hit performance targets and inflate executive pay. The review will also consider concerns that share buybacks may be crowding out the allocation of surplus capital to productive investment and the Government will announce more details shortly.
In terms of other options included in the Green Paper in relation to executive pay, the Government will not be taking these forward at the moment. These are as follows:
- The possibility of establishing a Shareholder Committee to oversee executive pay, directors’ nominations and strategy at every quoted company;
- Mandatory disclosure of investor voting records;
- Increasing retail investor voting through industry-led action or legislative change; and
- Adding further regulation to the existing disclosure framework for directors’ bonus targets.
Strengthening the employee, customer and wider stakeholder voice
The Government intends to introduce secondary legislation to require all companies of significant size (private as well as public) to explain how their directors comply with the requirements of section 172 Companies Act 2006 to have regard to employee and other interests. The Government notes that the operation of this new reporting requirement will be subject to further consideration. It envisages that it would include a requirement to explain how the company has identified and sought the views of key stakeholders, why the mechanisms adopted were appropriate and how this information has influenced decision-making in the boardroom. Such disclosures might have to be included on the company’s website as well as in its annual strategic report.
In terms of determining which companies should be subject to the new reporting requirement, the Government’s initial view is that a threshold based on employee numbers would be reasonable and its initial view is that a threshold of 1000 employees should be used. However, this will be subject to further consideration.
The Government will invite the FRC to consult on the development of a new UK Corporate Governance Code principle establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level as an important component of running a sustainable business. As part of this, the Government will ask the FRC to consider and consult on a specific provision requiring premium listed companies to adopt, on a “comply or explain” basis, one of three employee engagement mechanisms:
- A designated non-executive director;
- A formal employee advisory council; or
- A director from the workforce.
The Government notes that many companies already have mechanisms in place to ensure that employee and other stakeholder voices are heard and taken into account in boardroom decision-making but it wants to ensure that good practice is adopted more widely and more consistently, including potentially to larger private companies.
The Government intends to encourage industry-led solutions by asking the Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders. This is something that they are already developing. The Government will also invite the GC100 to complete and publish new advice and guidance on the practical interpretation of directors’ duties in section 172 Companies Act 2006. The Government notes that it has no plans to amend section 172 but it does consider that it would be useful to have more guidance for companies of all sizes on how the “enlightened shareholder value” model enshrined in section 172 should work in practice. It notes the recommendations in relation to employee voice made by Matthew Taylor in his Review of Modern Working Practices published in July 2017 and the Government will consider these and respond to the whole report later in 2017.
Corporate governance in large privately-held businesses
The Government is to invite the FRC to work with the Institute of Directors, the CBI, the Institute for Family Businesses, the British Venture Capital Association and others to develop a voluntary set of corporate governance principles for large private companies under the chairmanship of a business figure with relevant experience. In making application of these principles voluntary, the Government notes that private companies would be able to continue to use other industry-developed codes and guidance if they are considered more appropriate. Companies will also be able to adopt, or to continue to use their own preferred approaches.
Secondary legislation will be introduced to require companies of a significant size to disclose their corporate governance arrangements in their directors’ report and on their website, including whether they follow any formal code. This requirement will apply to all companies of a significant size unless they are subject to an existing corporate governance reporting requirement. The Government will also consider extending a similar requirement to limited liability partnerships of equivalent scale. Further consideration is to be given to the size of company that would be covered by the new reporting requirement, but the Government’s initial view is that it should apply to companies with over 2000 employees. It will apply to privately-owned and public companies but there will be an exemption for premium listed companies required to report against the UK Corporate Governance Code or companies required by the Disclosure Guidance and Transparency Rules to issue a corporate governance statement. The disclosure will include details of any UK Corporate Governance Code or other formal set of corporate governance principles that the company has adopted. Where a company departs from any of the provisions in the adopted code or principles, it should explain which parts these are and the reasons for the departure. If a company has decided not to adopt a formal code or set of principles, it will be required to explain the reasons.
Other issues relating to strengthening the UK’s corporate governance framework
The Government notes that consultation on the Green Paper revealed questions over whether the FRC has the powers, resources and status to undertake its functions effectively. To address this, the Government is to ask the FRC, the Financial Conduct Authority and the Insolvency Service to conclude new, or in some cases revised letters of understanding with each other before the end of 2017 to ensure the most effective use of their existing powers to sanction directors and ensure the integrity of corporate governance reporting. In light of this work, the Government will then consider whether further action is required.
The Government notes that the FRC intends to consult on amendments to the UK Corporate Governance Code in the late Autumn. The Government intends to lay before Parliament draft secondary legislation, where required, before March 2018. The work on developing voluntary corporate governance principles for large private companies will commence in the Autumn.
The current intention is to bring the reforms into effect by June 2018 to apply to company reporting years commencing on or after that date.
The Government notes that many of the recommendations set out in the House of Commons Business, Energy and Industrial Strategy Committee’s report on Corporate Governance published April 2017 are concerned with potential amendments and enhancements to the UK Corporate Governance Code and guidance. While the Government supports many of these recommendations, it notes that they are ultimately matters for the FRC to consider and states that many will be addressed in the consultation on the UK Corporate Governance Code that the FRC intends to undertake in the Autumn.
The Government also notes that the reforms set out in the response document will complement wider work that the Government and others such as Mathew Taylor, Sir Philip Hampton, Sir John Parker and Baroness McGregor-Smith have done and are leading in relation to matters such as increasing gender and ethnic diversity in the boardroom and the workforce.
Developments in relation to dialogue between shareholders and listed companies
ISS: Consultation on changes to UK/Ireland policy on virtual/hybrid shareholder meeting proposals
In October 2017, the Institutional Shareholder Services (ISS) published its 2018 benchmark policy consultation, seeking views on changes to certain of its voting policies for 2018. In relation to its UK/Ireland policy and its European policy, ISS is considering adding a new policy on virtual/hybrid shareholder meetings. While ISS notes that the practice of holding virtual shareholder meetings is rare in the UK, it comments that a growing number of companies have sought shareholder approval for article amendments that allow for the possibility of hybrid or virtual shareholder meetings in the future. While in continental Europe the practice of holding virtual or hybrid shareholder meetings has not been observed, it notes that it is thought that the practice could emerge at some point if UK and US-based companies continue to adopt it.
Key changes under consideration
Under the proposed policy, ISS will generally recommend FOR proposals that allow for the convening of hybrid shareholder meetings and will generally recommend AGAINST proposals that allow for the convening of virtual-only shareholder meetings.
ISS is proposing these changes in light of investors’ views on virtual shareholder meetings. It notes that some investors are concerned about moves to completely eliminate physical shareholder meetings, arguing that virtual meetings may hinder meaningful exchanges between management and shareholders and enable management to avoid uncomfortable questions. However, investors generally support “hybrid” meetings, where companies employ technological means to allow for virtual participation as a supplement to the physical shareholder meeting.
Questions for comment
While ISS welcomes any comments on the topic, it specifically seeks feedback on the following:
- If investors would be willing to support “virtual-only” shareholder meetings if they provide the same shareholder rights as a physical meeting, what rationale or assurances would be required for investors to support changes to the articles of association allowing for “virtual-only” shareholder meetings?
- Should ISS provide additional disclosure or alter its voting policies in markets where shareholder approval is not required for companies to switch to virtual-only meetings?
ISS expects to publish its final 2018 benchmark policy changes in the second half of November 2017 and it will apply the revised policies to shareholder meetings on or after February 1, 2018.
Investment Association: FTSE companies asked to explain how they have tackled shareholder concerns
In October 2017, the Investment Association (IA) announced that it is writing to FTSE companies that are due to appear on the Public Register of shareholder votes. The letter is being sent to companies in the FTSE All-Share who received votes of 20 per cent against any resolution or withdrew a resolution in 2017.
The Government announced the setting up of the Public Register in its August 2017 response to the Green Paper on corporate governance reform. The IA is prompting companies to provide a public explanation on how they have addressed their shareholders concerns since the shareholder vote before the Public Register goes live later this year. The main aim of the Public Register is to focus attention on those companies who have received a significant vote against and to track whether and how they are responding to shareholder concerns.
The Public Register will be launched in the fourth quarter of this year and will be updated regularly. The Public Register will include:
- a description of the resolution;
- the result of the shareholder vote;
- a link to the AGM results announcement (including any statement the company has made under Provision E 2.2 of the UK Corporate Governance Code); and
- a link to any further statement the company has made on the actions they have taken since the vote.
ICSA and the Investment Association: The stakeholder voice in board decision making – Guidance
In September 2017, the Governance Institute of the Institute of Chartered Secretaries and Administrators (ICSA) and the Investment Association issued joint guidance on stakeholder engagement which is aimed at helping company boards think about how to ensure they understand and weigh up interests of their key stakeholders when taking strategic decisions (Guidance).
In the Government’s response to its Green Paper consultation on corporate governance reform published in August 2017, in the context of its proposals for strengthening the employee, customer and wider stakeholder voice, the Government said that it would be encouraging industry-led solutions in this area by asking ICSA and the Investment Association to complete the joint guidance they announced in January 2017 on practical ways on which companies can engage with their employees and other stakeholders. This is the Guidance which has now been published.
The Guidance is designed to take boards through the different elements involved in understanding and assessing the company’s impact on key stakeholders, noting that while almost all companies will have common key stakeholders such as workers and customers, for each company the list will be different depending on factors such as their size, location and the nature of their activities and business relationships. As a result, the mechanisms used by boards to gain an understanding of the views of their key stakeholders will vary and each company’s approach needs to be informed by its purpose, culture and value.
In light of this, the Guidance does not attempt to set out a comprehensive range of different approaches that should be considered but it includes a list of ten core principles that should guide the way boards approach the issue and the Guidance also contains illustrative examples of how some companies have gone about the process. In addition, the Guidance considers a potential change to the UK Corporate Governance Code, as announced by the Government in its August 2017 response document, which would require listed companies to have either a designated non-executive director, a formal employee advisory council or a director from the workforce, or to explain why they do not have one. The Guidance covers these approaches, among others, but states that companies should choose whichever approach or approaches are, in the opinion of the board, most likely to lead to effective engagement and an enhanced understanding of the impact of their decisions on their key stakeholders.
The Guidance is divided into seven sections as follows:
The Guidance notes the general statutory duties of directors set out in sections 171-181 Companies Act 2006, noting in particular the duty to promote the success of the company set out in section 172.
The Guidance points out that boards should identify and prioritise their stakeholders. They should identify the groups which have a positive or negative impact on the company’s ability to operate or are potentially impacted by the company’s activities. They could then conduct a mapping exercise to prioritise these stakeholders for the purposes of engagement by identifying the key stakeholders and/or the issues or activities with the most material impact on a range of stakeholders. The Guidance notes that once the prioritisation exercise has been completed, it should lead to a discussion of the extent to which the board needs information on and from those stakeholders, how extensively the company should engage with them, and how best to do so. It includes, as an example, a matrix developed by the Royal Bank of Scotland Group to identify the significant issues that impact on its different stakeholder groups.
The Guidance also points out that boards should consider in the identification process the types of individuals or groups that they will use as points of contact for a particular stakeholder group. The board should also have a process in place for reviewing the groups identified as key stakeholders to make sure that engagement remains appropriate for the relevant audience. It notes the manner in which Intu Properties conducted a review of its stakeholder programme in 2016.
The Guidance notes that the board’s knowledge and understanding of the interests of the company’s key stakeholders should be among the factors considered when assessing the overall composition of the balance of the board and whether there is a need to recruit new directors. In relation to the approach to acquiring expertise, it suggests that one broad approach would be to reserve one or more board positions for directors drawn from a stakeholder group, such as the workforce. Another approach would be to extend the selection criteria and search methods for non-executive directors to identify individuals with relevant experience or understanding of one or more stakeholder groups. It considers the merits of both of these approaches and points out that they need not be mutually exclusive.
Given that directors share collective responsibility for the board’s actions and have the same legal responsibilities and liabilities, the Guidance recommends that unless there are exceptional considerations, the terms of appointment for these directors should be the same as for other directors.
The Guidance looks at the selection and search procedures in relation to finding a new director and sets out a number of questions to be considered if it is decided that one or more new directors are needed to bring an understanding of particular stakeholders. It also sets out particular questions to be considered by a board if it is decided that one or more directors should be appointed to represent the views of the workforce and it suggests companies may also wish to consider whether there is a case for appointing one or more non-executive directors with specific responsibility for other key stakeholders.
Induction and training
The Guidance notes that directors will be more effective in their role if they have benefited from a well-thought-out and effective induction programme which enables them to build an understanding of the nature of the company, its business and its markets, build a link with the workforce and build an understanding of the company’s main relationships.
The Guidance looks at designing a directors’ induction programme and it suggests a non-exhaustive list of activities that could be considered to give the new director an understanding of the role and nature of the company’s principal stakeholders. The Guidance also stresses the need for ongoing director training.
The Guidance points out that having relevant expertise on the board is only of limited use if that expertise is deployed and engaging with important stakeholders is only of limited value unless the results of that engagement are used to inform the board’s decisions. It notes that many boards suffer from a shortage of time and an excess of information so it looks at the following:
- the management of the board’s agenda;
- the form and frequency of the information the board wishes to receive, including any relevant performance measures; and
- whether any board committees or individual directors should have specific responsibilities for some stakeholder-related issues.
The Guidance also looks at the approach of designating to one or more individual directors the task of understanding the views of, and impact on, key stakeholders in ensuring these are fed into the board’s discussions. It considers issues that will arise if this approach is adopted and sets out a list of points for boards to consider if they do decide to designate one or more non-executive directors.
This section of the Guidance gives some illustrative examples of approaches already being used by companies to engage with their important stakeholders, with the aim of prompting companies to review their own existing mechanisms and to consider whether there would be value in adopting alternative or additional ways of engaging with the stakeholders concerned. In assessing the overall engagement carried out by the company, the Guidance sets out a number of key questions boards should consider.
In terms of engagement mechanisms, it looks at forums and advisory panels, as well as at other engagement mechanisms such as surveys and social media. It also considers staff engagement mechanisms and includes examples in each case.
Reporting and feedback
This section of the Guidance considers both how companies should report to shareholders and to their other stakeholders. It notes that reporting to shareholders will primarily be done through the annual report and accounts and through subsequent ongoing or specific engagement, such as meetings or discussions at and before the annual general meeting. It notes that reporting should cover the following three questions:
- Who are the key stakeholders?
- How does the board hear from its key stakeholders?
- What were the outcomes of the company’s engagements with its key stakeholders, and what impact did that all have on the board’s decisions?
The Guidance notes that one approach would be for the board to disclose its key stakeholders and explain concisely the processes that the board has in place to receive input and information from stakeholders. It could then demonstrate how the directors have fulfilled their duties under section 172 by explaining how information gathered through engagement with stakeholders has informed the board’s decisions during the year.
The Guidance also considers reporting to other stakeholders and notes that companies should consider what other reporting and feedback mechanisms might be necessary. It considers publications and online resources as well as other forms of reporting and feedback. It also points out that different stakeholders may want or require reporting on different timescales so while annual reports may be appropriate for groups such as shareholders, social media and other forms of communication could be used to update other stakeholders on a more regular basis.
The Guidance notes that the Government’s intention is that the various reforms to corporate governance that it announced in August 2017 will come into effect by June 2018. ICSA and the Investment Association will update the Guidance if necessary to reflect the new reporting requirements and potential changes to the UK Corporate Governance Code. They state that in any event, they will review the Guidance in the second half of 2019 to learn from companies’ experience of applying it.
The Investment Association: FTSE 350 companies respond to shareholders’ executive remuneration concerns
In August 2017, the Investment Association (IA) published a press release containing an analysis of voting data from the 2017 AGM season.
When compared to voting data from the 2016 AGM season, the IA notes that:
- FTSE100 companies have listened to shareholders and acted on 2016 investor concerns regarding remuneration reports, with a 35 per cent decrease in 2017 remuneration resolutions that received over 20 per cent dissent (down from 14 in 2016 to nine in 2017);
- Meanwhile, FTSE250 companies witnessed a 100 per cent increase in companies getting 20 per cent or more of votes against their remuneration resolutions compared to 2016 (with 29 companies affected this year, up from 15 in 2016);
- Overall, FTSE350 companies saw a 400 per cent increase in votes against a director re-election (from four directors in 2016 to 21 directors in 2017); and
- Six FTSE350 companies withdrew resolutions on pay ahead of the company AGMs to avoid a shareholder rebellion.
Developments in institutional investor/proxy adviser matters
Best Practice Principles Group: Consultation on Shareholder Voting Research and Analysis
In October 2017, the Best Practice Principles Group (BPP Group) launched a consultation that seeks views from investors and companies on whether the Best Practice Principles for Shareholder Voting Research and Analysis (the Principles) have been effective in ensuring the integrity and efficiency of the services provided by shareholder voting analysts and advisors.
The Principles, introduced in 2014, were developed by the industry to provide a voluntary performance and reporting framework, to promote a greater understanding of its role, and to promote the integrity and efficiency of processes and controls related to the provision of these services and management of any conflicts of interest.
The BPP Group has also published a consultation questionnaire, which asks various questions including the following:
- Would it be beneficial to have a set of principles that are capable of being applied in all markets?
- Are there any other issues or activities that should also be covered by the Principles, such as intermediary vote processing and confirmation, ESG advisory services and indices or governance engagement services?
- Is the structure of the Principles, whereby each principle is accompanied by guidance which sets out practices to be followed and information to be disclosed on a "comply or explain" basis, clear and appropriate?
- Should details of any other potential sources of conflict of interest be included in the non-exhaustive list currently set out in the Principles?
- How satisfied are companies with their communication with signatories to the Principles?
- What are the views of investors in relation to many companies' belief that they should have the opportunity to comment on the analysis and recommendations in research reports before they are finalised?
The BPP Group is keen to hear from investors, companies and other providers of voting research and related services on their experience by December 15, 2017. A decision has not yet been taken on whether there will be a second consultation on draft revised Principles and reporting arrangements. This is likely to depend on the extent of any revisions proposed, and will be informed by the responses to this consultation. If it is decided that a second consultation is not necessary, then the aim would be to publish a report setting out the findings and conclusions of the review, together with the revised Principles and details of the reporting and monitoring arrangements in April 2018. If there is a second consultation, it will begin in April 2018 and the revised Principles and other documents will be published in July or August 2018.
Pre-Emption Group: No change to pre-emption thresholds for Prospectus Regulation
In July 2017, the Pre-Emption Group announced that the Investment Association and the Pensions and Lifetime Savings Association will continue to support the current overall limit of a ten per cent disapplication authority, as specified in the 2015 Statement of Principles – Disapplying Pre-Emption Rights (and the two template resolutions for the two separate five per cent authorities), despite the newly introduced exemption from the obligation to publish a prospectus for up to a 20 per cent increase in securities admitted to trading.
The provisions in the Prospectus Regulation that introduce the new threshold came into force on July 20, 2017 (although the majority of its provisions will apply 24 months thereafter and will take effect from July 2019). However, the Financial Reporting Council (FRC) notes that no change to the flexibility permitted by the Statement of Principles is expected as a consequence of the Prospectus Regulation.
Hampton-Alexander Review: Improving gender balance in FTSE leadership
In November 2017, the Hampton-Alexander Review published a “one year on” report, summarising how women’s representation is progressing on FTSE 350 boards and in the “executive pipeline”, the executive committee and those who report to members of the executive committee. This follows the targets set in November 2016 by the Hampton-Alexander Review which included a target of 33 per cent women on FTSE 350 boards and 33 per cent women in FTSE 100 leadership teams by 2020. The target of 33 per cent women in leadership teams also now applies to FTSE 250 companies.
The report includes the following:
Executive committee and direct reports
- While the number of women on the combined executive committee and direct reports of FTSE 100 companies has only increased from 25.1 per cent in 2016 to 25.2 per cent in 2017, the report notes that transparency has been much improved, with all FTSE 100 companies submitting their leadership data and an automated collection process and robust guidance.
- All but 10 FTSE 250 companies submitted data in 2017 and their combined executive committee and direct reports are 25 per cent, although women’s representation on executive committees within the FTSE 250 is 16.6 per cent, compared to 19.3 per cent for the FTSE 100.
- 55 FTSE 350 companies are at or above the 33 per cent target currently.
- The report notes that a step change is needed in pace as less than a third of FTSE 350 leadership roles went to women in 2017. It notes that almost one in two or around 40 per cent of all appointments will need to go to women over the next three years to achieve the 33 per cent target.
Women on boards
- The FTSE 100 figure has increased from 26.6 per cent in 2016 to 27.7 per cent. Over one third of the FTSE 350 are already at 33 per cent or more, or are on track to achieve this by 2020.
- In order for FTSE 100 boards to reach the 33 per cent target by the end of 2020, the report notes that they need to achieve the same rate of progress over the next three years as they did in the previous three years and similarly with a step up in appointment rates.
- There were 10 all-male boards in the FTSE 350 as at the beginning of November 2017.
- The report lists those companies which have made significant progress during the past year and also consider the drivers of progress. The two variables that drive progress are the turnover rate and the appointment rate.
- The report features some of the recent innovations and different thinking seen across a variety of industries in order to provide examples of initiatives that have had a high impact.
- The report includes a number of FTSE “board stories” providing perspectives from chairs, a company secretary and a non-executive director.
- The report includes a section on international comparators, reviewing progress being made elsewhere and summarising how other countries are tackling the gap in diverse leadership on listed company boards.
- The report includes detailed analysis of progress in appendices.
Parker Review Committee: Final report into the ethnic diversity of UK boards
In October 2017, the Parker Review Committee, led by Sir John Parker, published its final report (Report) into the ethnic diversity of UK boards. This follows the report that the Parker Review Committee published in November 2016 which summarised the findings of their review so far and was prepared for consultation purposes.
The Report notes that UK citizen directors of colour represent only about two per cent of the total director population and 51 out of the FTSE 100 companies do not have any directors of colour. The Parker Review Committee believes that it is important that FTSE 100 and FTSE 250 companies change the way they approach the issue of ethnic diversity in the boardroom and the pipeline and as well as highlighting clear business reasons for increasing ethnic diversity on UK boards, the Report includes a number of recommendations as follows:
Increasing the ethnic diversity of UK boards
- Each FTSE 100 board should have at least one director of colour by 2021 and each FTSE 250 board should have at least one director of colour by 2024.
- Nomination committees of FTSE 350 companies should require their human resources teams or search firms (as applicable) to identify and present qualified people of colour to be considered for board appointment when vacancies occur.
- Relevant principles of the Standard Voluntary Code of Conduct for executive search firms, which have been used successfully for gender-based recruitment, should be extended on a similar basis to apply to the recruitment of minority ethnic candidates as board directors of FTSE 350 companies.
Development of candidates for the pipeline and plan for succession
- FTSE 350 companies should develop mechanisms to identify, develop and promote people of colour within their organisations to ensure over time that there is a pipeline of board capable candidates in their managerial and executive ranks that appropriately reflects the importance of diversity to their organisation.
- Led by board chairs, existing board directors of FTSE 350 companies should mentor and/or sponsor people of colour within their own companies to ensure their readiness to assume senior managerial or executive positions internally or non-executive board positions externally.
- Companies should encourage and support candidates drawn from diverse backgrounds, including people of colour, to take on board roles internally (e.g. subsidiaries) where appropriate, as well as board and trustee roles with external organisations to give experience and develop oversight, leadership and stewardship skills.
Enhanced transparency and disclosure
- The board’s policy on diversity should be described in the annual report and this should include a description of the company’s efforts to increase, amongst other things, ethnic diversity within its organisation, including at board level.
- Companies that do not meet board composition recommendations by the relevant date should disclose in their annual report why they have not been able to achieve compliance.
The Report includes “Questions for Directors” in Appendix A and a “Directors Resource Toolkit” in Appendix B to help existing boards deliver on the recommendations of the Report. Appendix C sets out case studies, with organisations providing practical examples of the steps they have taken to improve diversity in their organisations and within their executive and board ranks.
The Report notes that based on the current rates of turnover amongst FTSE 100 directors, the Parker Review Committee estimates that to reach an ethnically diverse mix similar to that of the overall adult working population by 2021 (approximately 15 per cent), one in five new board appointees would need to be a person of colour. Taking into account typical board appointment cycles, they calculate that this would mean that, on average, each FTSE 100 company would need to appoint one minority director in the period to 2021.
The Parker Review Committee plans to stay intact at least through 2021 and will meet at least annually to assess efforts being made and progress in relation to the Report’s recommendations. It encourages FTSE 350 companies to adopt the recommendations on a voluntary basis but notes that if there is insufficient progress it may endorse that the recommendations (or relevant parts) become mandatory.
Investment Association: Revised Principles of Remuneration
In November 2017, the Investment Association published their updated Principles of Remuneration (Principles) which set out, through over-arching Principles and general guidance, the views of Investment Association members on the role of shareholders and directors in relation to remuneration and the manner in which it should be determined and structured. While predominantly aimed at Main List companies, the Investment Association notes that the Principles are also relevant to companies on other public markets, such as AIM, and other entities.
Key changes from the October 2016 Principles include the following:
- Discretion specific to a particular incentive scheme should be disclosed in the remuneration policy in addition to the plan rules.
- In reporting on matters such as the gender pay gap or publishing executive pay to employee pay ratios, the remuneration committee should provide numbers in the context of the company’s business and fully explain why these figures are appropriate.
- In consulting with shareholders on remuneration, details of the whole remuneration structure, not just the proposed changes, should be provided.
- Following consultation and before the remuneration report is finalised, the remuneration committee should review the proposals in light of subsequent events between the consultation and implementation of the policy, to ensure the proposals remain appropriate.
- Relocation benefits should be disclosed when an executive director is appointed. If needed, they should be for a limited period, disclosed to shareholders and each element detailed in the remuneration report.
- In relation to annual bonuses, the definition of performance measures should be clearly disclosed, any adjustments to the metrics set out in the accounts should be clearly explained and the impact of the adjustment on the outcome disclosed.
- When a bonus is paid, a full analysis of the performance relative to targets should be provided in the remuneration report and bonus targets should be disclosed no later than 12 months following payment of the bonus award.
- Deferral of a portion of the bonus into shares is expected for any bonus opportunity of greater than 100 per cent of salary.
- In looking at long-term incentives, remuneration committees should select a remuneration structure that is appropriate, efficient and cost-effective in delivering long-term strategy and its selection should be well justified to shareholders.
- If an LTIP-type structure is chosen, performance conditions should be carefully chosen so they are suitable for measurement over a long period of time, threshold vesting amounts should not be significant compared to annual base salary and full vesting should reflect exceptional performance and depend on achieving significantly greater value creation than that applicable to threshold vesting.
- In relation to restricted share awards, the discount rate for moving to these from an LTIP should be a minimum of 50 per cent. The total vesting and post-vesting holding period should be at least five years and some Investment Association members expect restricted share awards to be subject to an appropriate underpin.
Investment Association: Remuneration issues to consider for 2018 AGMs
In November 2017, the Investment Association wrote to chairs of remuneration committees outlining key changes to their updated Principles of Remuneration and highlighting items of focus for their members in the 2018 AGM season.
Issues to be considered for 2018 AGMs include the following:
- Levels of remuneration – It is hoped all companies will follow the approach of some large companies who have reduced potential variable remuneration rewards and limited overall pay in renewing their remuneration policies in 2017. Increases to variable remuneration maximums in revised remuneration policies, salary increases and “automatic” inflationary salary increases are matters of concern. Disclosure of pay ratios between the CEO and median or average employee and between the CEO and executive team are welcomed. Contribution rates to pensions for executive directors should be at the same level as for the general workforce.
- Remuneration structures – The letter notes the move by some companies to restricted shares and states that growing numbers of shareholders will support this for the right company, in the right circumstances. However, new remuneration structures should not be proposed only when the current structure is not paying out to the executive directors and remuneration committees are urged to adopt a remuneration structure which is most appropriate for the company and the implementation of its business strategy.
- Shareholder consultation – The letter notes the consultation process could be improved in some cases. Where companies withdraw resolutions prior to the AGM, they should conduct a full analysis of shareholder feedback and consult further before resubmitting their remuneration policies.
- Pay for performance – Robust transparency on targets and structures is required so that the link between remuneration and company performance can be clearly seen. Full disclosure of all performance targets is needed, either through disclosure at the time of the award or within 12 months where there is commercial sensitivity. Where adjusted metrics for executive remuneration are used, an explanation of why this is appropriate should be given and a breakdown of how the remuneration target has been adjusted from the headline key performance indicator should be provided. A thorough explanation as to why personal and strategic performance targets have paid out should be provided and IVIS will Amber Top reports where insufficient information on non-financial targets is provided.
- Accountability of remuneration committee chairs – The letter notes the different approaches investors are taking in their voting policies in relation to the re-election of directors based on decisions made by the remuneration committee.