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IA: Principles of Remuneration 2016
On October 31, 2016 The Investment Association (IA) published its Principles of Remuneration (the Principles) for 2016 and an accompanying introductory letter which outlines the key changes to the Principles since the most recent edition published in July 2016. These changes reflect the IA’s response to the Executive Remuneration Working Group Final Report which was published in July and highlights some issues IA will be focusing on ahead of the 2017 AGM season.
2016 Review of the Principles of Remuneration
The main changes made to the Principles are:
- The Principles have been slimmed down to a set of high level issues and updated to reflect the recommendations of the Executive Remuneration Working Group.
- The Principles have also been amended to acknowledge the need for increased flexibility of remuneration structures.
- The Principles and Guidance have been updated to ensure that they do not promote a single remuneration structure.
- The Principles have been updated to ensure that the level of remuneration has appropriate focus and that companies should disclose pay ratios between the CEO and median employee, and the CEO and the Executive team, to provide the context of the remuneration provided.
- The Guidance includes a new section on the importance of improving shareholder consultation, ensuring that it is based on the strategic elements of remuneration and leads to consultation rather than affirmation of the company’s position.
- Post retirement shareholding guidelines should be maintained.
- The Principles note that the definition of any performance measurement should be clearly disclosed and add that any adjustments to reported metrics should be clearly explained and the impact on the outcome detailed. Members expect the impact of share buy backs and other capital management decisions to be taken into account when determining whether a performance measurement has been satisfied.
Issues to consider for 2017 AGMs
In particular, members of the IA have asked for the following aspects of the Principles to be re-emphasised:
- Levels of Remuneration – In particular, members believe that any salary increases or increases to variable remuneration should be justified with clear and explicit rationale. Companies must be sensitive to the prevailing mood regarding executive remuneration, and take into account the effect of executive pay levels on all stakeholders. Furthermore, Remuneration Committees should respond to a significant vote against their remuneration report or policy (more than 20% of the votes against). Companies should seek to understand the reasons for the dissent, publish their explanation of the reasons and outline what the Board and Remuneration Committee are doing to address the dissent.
- Bonus disclosure – Shareholders require the retrospective disclosure of bonus targets so that they can ensure that there is an appropriate link between pay and performance. IA members’ beneficiaries continue to seek explanations as to why the IA supports the remuneration packages of investee companies; therefore, the IA needs this information to justify supporting remuneration packages to its clients. For 2017, members expect full retrospective disclosure of the threshold, financial target and maximum performance targets, the level of performance achieved against these targets and the resulting bonus outcome and a thorough explanation as to why personal or strategic targets have been paid out, not just a description of non-financial performance indicators. Where targets are not disclosed or the company has not made a commitment to disclose the target range in future, Investment Association members have asked the Institutional Voting Information Service (IVIS) to highlight this issue on a Red Top, as without such disclosures there is insufficient information to make an informed voting decision. Where IVIS deems there to be insufficient information on non-financial targets, members have asked IVIS to Amber Top the report.
- Policy Renewals – IA members expect companies to have maximum limits on each aspect of variable remuneration. Whilst discretion is an important part of the Remuneration Policy, IA members do not expect companies to seek discretions to provide payments outside the scope of the policy.
- Use of Discretion – Discretion is an important tool to ensure that the remuneration outcomes are appropriate for the overall performance of the company, shareholder experience, and fair to executives. Members wish for companies to be clear when the Committee has exercised discretion and fully outline the circumstances, reasons and outcomes of the use of the discretion.
- Pensions – For a number of years the IA has highlighted the disparity in Executive Director pension provision compared to that provided to the general workforce. IA members are concerned with the lack of progress made on this issue. Therefore, the IA reiterates that, in instances where contribution rates for Executives and the general workforce differ, the differences should be clearly justified.
The Parker Review Committee: Report into ethnic diversity of UK boards
On November 2, 2016 the Parker Review Committee published a consultation version of a report into the ethnic diversity of UK boards. The Report highlights that ethnic minority representation in the Boardrooms across the FTSE 100 is disproportionately low, especially when looking at the number of UK citizen directors of colour and makes recommendations for increasing diversity, underpinned by strong industrial logic and the need for UK companies to be competitive in the increasingly challenging and diverse marketplace.
The recommendations of the Report are as follows:
Increase 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 all FTSE 100 and FTSE 250 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.
- Given the impact of the “Standard Voluntary Code of Conduct” for executive search firms in the context of gender-based recruitment, we recommend that the relevant principles of that code be extended on a similar basis to apply to the recruitment of minority ethnic candidates as board directors of FTSE 100 and FTSE 250 companies.
Develop Candidates for the Pipeline & Plan for Succession
- Members of the FTSE 100 and FTSE 250 should develop mechanisms to identify, develop and promote people of colour within their organisations in order to ensure over time that there is a pipeline of board capable candidates and their managerial and executive ranks appropriately reflect the importance of diversity to their organisation.
- Led by board Chairs, existing board directors of the FTSE 100 and FTSE 250 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 (e.g., educational trusts, charities and other not-for-profit roles). These opportunities will give experience and develop oversight, leadership and stewardship skills.
Enhance Transparency & Disclosure
- A description of the board’s policy on diversity be set out in a company’s 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 appendices to the report contain a set of questions for directors and a resource toolkit which were developed to help boards deliver on the report's recommendations. The questions have been drafted to be consistent with the key considerations that directors need to make in the satisfaction of their statutory duties under the Companies Act 2006 and in a manner that is consistent with the UK Corporate Governance Code.
Comments on the consultation version of the Report are requested by February 28, 2017.
ISS: Benchmark policy 2017 – Consultation
On October 27, 2016 Institutional Shareholder Services Inc. (ISS) announced the launch of its 2017 benchmark voting policy consultation period. ISS is consulting on changes to its policy on executive remuneration, its policy on audit and remuneration committee composition, and its policies on European pay for performance methodology.
Policy on Executive Remuneration
ISS is consulting on changes to the ISS UK & Ireland policy to clarify that when forming a view on new remuneration arrangements, ISS will pay particular attention to the following points:
- how far the proposals are consistent with the good practice principles set out in ISS voting guidelines;
- the linkage between the proposals and the company's strategic objectives;
- whether or not the proposals have an appropriate long-term focus;
- the extent to which the proposals help simplify executive pay; and
- the impact on the overall level of potential pay.
Furthermore, ISS is considering recommending a vote against the re-election of the chair of the remuneration committee (or, where relevant, another member of the remuneration committee) in cases where a serious breach of good practice is identified, and typically where issues have been raised over a number of years.
ISS also requests comment on whether, if serious concerns have been raised with pay practices over a number of years but the remuneration committee chair position is being rotated, respondents support the view that the longest serving member of the Remuneration Committee should be held accountable.
Policy on Audit and Remuneration Committee Composition for smaller companies
The change under consideration is that ISS' voting guidelines for audit and remuneration committee composition at AIM companies should reflect the Quoted Companies Alliance (QCA) position, namely that these committees should comprise independent non-executive directors only. ISS is consulting on recommending voting against non-independent non-executives being members of such committees.
Policies on European Pay for Performance Methodology
ISS is proposing to formalise the existing process on assessing pay performance by including a formal reference to the European pay-for-performance methodology in the UK/Ireland (UKI) and Continental European voting guidelines. The reference to the methodology will be as part of the current policy principles. The envisaged change would furthermore include the definition of the methodology, which reads as follows:
"ISS annually conducts a pay-for-performance analysis to measure the alignment between pay and performance over a sustained period. With respect to companies in the European Main Indices, this analysis considers the following:
Peer Group Alignment:
- The degree of alignment between the company's annualised total shareholder return (TSR) rank and the CEO's annualised total pay rank within a peer group, each measured over a three-year period.
- The multiple of the CEO's total pay relative to the peer group median.
Absolute Alignment – the absolute alignment between the trend in CEO pay and company TSR over the prior five fiscal years – i.e., the difference between the trend in annual pay changes and the trend in annualised TSR during the period."
The ISS requests comments by November 10, 2016 and plans to publish its final 2017 policies in the week of November 14, 2016. The revised policies will be applied to shareholder meetings taking place on or after February 1, 2017.
FRC: Corporate reporting thematic review on tax disclosures
On October 31, 2016 the Financial Reporting Council (FRC) published a corporate reporting thematic review on tax disclosures. This report shares the FRC’s findings from the targeted review of certain aspects of companies’ tax reporting, against which companies can assess and enhance their own disclosures to ensure they provide high quality information to investors in their annual reports and accounts.
In December 2015, the FRC wrote to 33 FTSE 350 companies informing them that the tax disclosures in their next annual report and accounts would be reviewed by the FRC’s Corporate Reporting Review (CRR) on behalf of the FRC’s Conduct Committee. The objective of the review was to encourage more transparent reporting of the relationship between tax charges and accounting profit and the factors that could affect that relationship in the future, in accordance with existing requirements.
Overall, the FRC evidenced improvements in the transparency of tax disclosures included in companies’ strategic reports and saw examples of good practice in the following areas:
- Tax in strategic reports.
- Effective tax rate (ETR) reconciliation disclosures.
- Uncertainties relating to tax liabilities and assets.
The FRC did note that there is scope for companies to articulate better how they account for tax uncertainties by explaining the bases for recognition and measurement and will continue to challenge companies who do not disclose the amount of uncertain tax provisions when these are subject to risk of material change in the following year. The audit of uncertain tax provisions is an area of particular focus of the FRC’s audit monitoring activities for 2016/2017.
Additionally, the FRC encourages companies to:
- Consider carefully whether there are significant judgements and estimation uncertainties relating to tax. Where estimation uncertainties are repeated unchanged year on year, the FRC will question whether the disclosure of quantified risk specifically relating to the next year is clear.
- Appraise what specific information about judgements and estimation uncertainties would be most helpful to users of the accounts. In its project “Accounting policies and integration of related financial information” the FRC’s Financial Reporting Lab found that investors value an understanding of the judgements made and estimations applied by management, including where that judgement sits within a range of possible or acceptable outcomes.
Financial Reporting Lab: Report on business model reporting
On October 27, 2016 the Financial Reporting Lab published a lab project report on business model reporting, which is the first in a series of projects announced in July 2015.
Findings in the report include:
- Investors are unanimous that business model information is fundamental to their analysis and understanding of a company and its performance, position and prospects, both at the initial investment stage and for their ongoing monitoring and stewardship responsibilities.
- There are a number of advantages to companies for providing comprehensive business model disclosure that meets investor needs, including (i) making the company’s clear and comprehensive definition of their business model the primary source of business model information for investors, thereby avoiding the risk that others less close to the business develop their own definition of the business model; (ii) demonstrating the board’s clear understanding of their business and its key drivers engenders investor trust; and (iii) developing and sharing the business model definition can strengthen alignment of understanding within the company.
- Practice by companies is varied, with business model disclosures ranging from very high level to quite detailed, and covering different information sets.
- Investors are concerned when companies fail to articulate their business model well, and comment that many annual report business model disclosures do not yet fully meet their needs.
- Investors need more detail than is currently provided by most companies. Investors ask companies to assume the reader knows nothing about the company and provide disclosure that stands alone in describing the business model – something as fundamental as stating what the company does is often omitted from the disclosure as it is described elsewhere in the annual report or is assumed knowledge.
- In particular, investors find disclosures are often lacking information that answers questions such as what the key revenue and profit drivers are and how profits convert to cash, whether there are any key asset and liability items that support the business model, and what the competitive advantage is.
- Investors note improvement is needed in linkage and consistency between the business model and other information in the annual report.
- Where a company operates more than one distinct business model, investors believe each significant business model should be disclosed, together with the rationale for having the different businesses within one company.
- Nearly all investors believe the business model should be presented near the front of the annual report, with some wanting it presented as the first section, as it provides context to the remainder of the information.
- Investors want the business model description to be written in plain, clear, concise, and factual language.
- Most investors believe business models are best communicated through a combination of infographic and detailed narrative.
- Once the business model disclosure has been clearly defined and meets investor needs, investors expect that companies will only modify the disclosure to reflect changes to the model. Changes in the year, and forthcoming changes, should be clearly identified, including their rationale.
- Business model disclosures tend to be developed for the annual report alone, and not used elsewhere. Sometimes there is a different, or more detailed depiction of the business model provided in investor presentations or online. Investors prefer one high quality disclosure to be provided consistently across the communication channels, as it provides confidence that the business model presented represents the real business model.
CLLS: Updated Q&A on MAR
On October 28, 2016 the City of London Law Society (CLLS) and Law Society Company Law Committees' Joint Working Parties on Market Abuse, Share Plans and Takeovers Code published an updated version of its Q&A on the Market Abuse Regulation (MAR), which combines the Q&A published in July and August.
The answer regarding what exchange rate should be used for calculating the EUR 5,000 threshold in Article 19(8) of MAR has been updated to reflect the position in European Securities and Markets Authority’s (ESMA) Q&A on MAR, which states that, for transactions carried out under Article 19(1) MAR in a currency which is not the Euro, the exchange rate to be used to determine if the threshold set in Article 19(8) MAR is reached is the official daily spot foreign exchange rate which is applicable at the end of the business day when the transaction is conducted. Where available, the daily euro foreign exchange reference rate published by the European Central Bank on its website should be used.
European Commission: Commission Implementing Decision on equivalence of reporting requirements of certain third countries on payments to governments to the requirements in the Accounting Directive published in the Official Journal
On October 29, 2016 Commission Implementing Decision (EU) 2016/1910 of 28 October 2016 on the equivalence of the reporting requirements of certain third countries on payments to governments to the requirements of Chapter 10 of the Accounting Directive (Directive 2013/34/EU) was published in the Official Journal.
Chapter 10 requires large undertakings and all public-interest entities active in the extractive industry or the logging of primary forests to prepare and make public a report on payments made to governments on an annual basis. EU companies may choose to prepare their reports in compliance with the reporting requirements of a third country that have been assessed in accordance with Article 47 as equivalent to the requirements of Chapter 10.
This Commission Implementing Decision provides that, since adopting reporting requirements on payments to governments that deliver substantive outcomes equivalent to the provisions contained in Chapter 10, the reporting requirements of Canada should be considered as equivalent to requirements of Chapter 10 of the Accounting Directive on payments to governments regarding their activities in the extractive industry.
(European Commission, Official Journal of the European Union: Commission Implementing Decision (EU) 2016/1910 of 28 October 2016 on the equivalence of the reporting requirements of certain third countries on payments to governments to the requirements of Chapter 10 of Directive 2013/34/EU of the European Parliament and of the Council, 29.10.16)
How will latest changes to Volcker Rule affect non-US banks?
Kathleen A. Scott discusses the final Volcker Rule, focusing on some of the issues raised by non-US banks in their comments.