Executive remuneration: Revised regulations published

Following consultation on draft regulations concerning the reporting of executive remuneration which were set out in a consultation paper published by the Department for Business Innovation and Skills (BIS) last June, BIS has recently published a revised draft of those regulations.

The regulations set out the content requirements of the new form of directors’ remuneration report that the directors of UK incorporated companies on the Official List (and the directors of UK incorporated companies on an official list in an EEA State or whose securities are admitted to dealing on the New York Stock Exchange or Nasdaq) will need to produce. That remuneration report will comprise two distinct parts - the directors’ remuneration policy and the annual implementation report.

While the revised regulations are still in draft and are subject to change, this briefing considers the new provisions included within them. For further background information, see our earlier briefings “Executive remuneration: Reforms announced by the Government” and “Executive remuneration: Draft legislation published”.

The revised regulations include a transitional provision. This makes it clear that the new reporting requirements will apply to the directors’ remuneration report of a quoted company which is put to its AGM held in the first financial year of the company which begins on or after 1 October 2013. As a result, for a company with a 31 December year end, the remuneration report put to its AGM held in 2014 will need to comply with these regulations.

It also appears from the current drafting of the revised regulations that the implementation of the regulations could be accelerated in the case of a company which has voluntarily decided to put its remuneration policy to shareholders for approval prior to 1 October 2013. The second part of the transitional provision provides that where a quoted company has an approved remuneration policy in place prior to 1 October 2013 which the directors decide to revise, and that revised remuneration policy is put to a shareholder vote at a general meeting held after 1 October 2013 but before the company’s next AGM, then that revised remuneration policy will also need to comply with all the content requirements for a remuneration policy specified by the regulations. However, it is not clear how this will operate in practice.

The regulations require the directors’ remuneration report to contain a statement by the chair of the company’s remuneration committee. It is now made clear that the purpose of that statement is to set out the company’s key messages on remuneration, the context in which decisions have been taken and the major changes during the year.

A number of changes have been made to the regulations specifying the content of the annual implementation report that directors will need to prepare. These changes include the following:

• Single total figure: In preparing the table setting out the total remuneration figure for each director, companies can choose to produce a table for executive directors and a separate table for non-executive directors. If estimated figures are used in the table for the current financial year, the actual figure must be reported in the table produced in the following year’s implementation report. If amounts included in the table for a previous financial year are reduced or clawed back for any reason in the financial year being reported on, then the reduction or claw back can be deducted from the total remuneration figure for the current year, with a note to the table providing an explanation of the reason for the reduction or claw back and how it was calculated. Except for the first year of such a report prior year numbers should also be included and extra columns can be added to the table.
• Payments to past directors: The implementation report must contain details of money or other assets paid within the reporting year to anybody who was not a director when the award was made but who had previously been a director of the company.
• Statement of performance targets: If the company is not putting its directors’ remuneration policy to the vote at the AGM, the implementation report should include details of the performance targets for that year (unless these have already been disclosed in the previously approved remuneration policy) although information need not be disclosed if the directors believe that its disclosure would be seriously prejudicial to the company’s interests.
• Loss of office payments: In the disclosures about any loss of office payments made during that year, the implementation report should include information about the treatment of outstanding incentive awards that vest on or following termination, as well as the total amounts paid (including an explanation of each element) and, where a discretion was exercised, an explanation of how that was exercised.
• Directors’ shareholdings and interests: The information about the shareholdings of the directors should be set out in tabular form and as well as providing information about any shareholding requirements (and whether those have been met), it should include the total number of shares in the company beneficially owned by each director, details of their scheme interests and details of the shares subject to share options which they have not exercised. This is intended to capture the details of awards that were neither awarded or vested in the year being reported.
• Performance graphs: The performance graph to be included in the implementation report which plots total shareholder return on a shareholding in the company against a broad equity market index should be measured over a five year period initially, increasing to ten years. The comparison with the pay of the chief executive officer (CEO) for each financial year over the same period should be set out in a table. That table should specify the CEO’s total remuneration, the annual variable element award rates against maximum opportunity and the multiple reporting period variable element award rates against maximum opportunity (in each case, as used in the single figure calculation for the relevant year). The changes in this area reflect work carried out by the Financial Reporting Lab in its recent project report on the reporting of pay and performance.
• Increase in CEO’s remuneration and relative importance of spend on pay: Disclosures as to the percentage increase in the remuneration of the CEO against that of all employees or a comparator group and the chart showing the relative importance of the company’s expenditure on pay for directors (as compared to retained profits, profits distributed via a dividend or a share buy-back and tax paid in that financial year) have been moved from the directors’ remuneration policy report to the implementation report.
• Considerations by the directors on pay: In the disclosures as to the consideration by the directors of matters relating to directors’ remuneration, an additional disclosure will be required. The remuneration committee will have to state how it satisfied itself that advice it received from any third party adviser was objective and independent.

As with the draft regulations relating to the content of the annual implementation report, a number of changes have been made to the regulations specifying the content requirements for the directors’ remuneration policy. These include the following:

• Application of previous policy: If a new directors’ remuneration policy is put to shareholders for approval, but it is intended that certain provisions of the last approved directors’ remuneration policy should continue to apply after the approval of the new policy, then this fact needs to be made clear in the new policy and it needs to be made clear which provisions in the previous policy will continue to apply and for how long. This will enable companies to pay out long term incentives, for example, which were granted under a previously approved policy but are not included in the current policy.
• Future policy table: In the table setting out the company’s future pay policy, some changes have been made to the requirements to reflect comments in the consultation process on the approach to performance targets and measures for variable pay elements. If a new element is to be included in the remuneration package for directors, then an explanation of why that element is now to be included must be provided, together with a description of both the measure and any relevant target. The table should set out the targets for the first year in which the policy is to operate, with targets for any following years if possible. If targets in respect of following years cannot be set out as the necessary information does not yet exist, then an indication of the approach to be taken in setting those targets and how it is intended that those targets relate to the target set for the first year must be provided. However, once again, the directors will not be required to disclose information about any matter if they believe that the disclosure would be seriously prejudicial to the company’s interests.
• Approach to recruitment: A new requirement is that the directors’ remuneration policy should include a statement of the principles which the company would apply when agreeing a remuneration package for the appointment of new directors. The statement will need to set out the various elements which the company would consider for inclusion in a package, the approach of the company to each of those elements and the maximum level of salary (to be expressed as a percentage of the current highest paid director’s salary) which could be awarded.
• Service contracts: More information will be required to be disclosed about the directors’ service contracts. For example, the remuneration policy must describe any obligation on the company which is contained in any or all of the existing service contracts or which could be contained in service contracts entered into in the future which could give rise to, or impact on, remuneration or loss of office payments but which is not disclosed elsewhere in the directors’ remuneration report.
• Scenarios: More detail has been added to the requirements in relation to different scenarios, explaining what directors will get paid for performance that meets, exceeds or falls below target. Charts will need to be prepared in relation to the different scenarios and, once again, this reflects the work carried out by the Financial Reporting Lab in its project report on the reporting of pay and performance. A narrative description of the assumptions underpinning the various scenario charts will also need to be included so as to enable an understanding of the charts as they are presented.
• Loss of office payment policy: In the company’s summary and explanation of its loss of office payment policy, the approach to consideration of the circumstances under which a director leaves and how his performance during his service with the company is to be taken into account should be included.

While a number of the changes to the draft regulations are likely to be welcomed as they provide greater clarity as to what the directors’ remuneration report must include, companies are still likely to have a number of questions as to how they should implement certain of the requirements. Comments on the draft regulations are requested by BIS by 25 March 2013 and these comments will be considered before the final regulations are laid before Parliament. BIS suggests that this will be during the spring of 2013 but after the Enterprise and Regulatory Reform Bill (Bill) has received Royal Assent. BIS has also confirmed that the regulations will come into force on 1 October 2013 as was previously reported.

The Bill is in the process of being amended in a number of respects, including limiting the liability of directors who make a payment outside the approved remuneration policy, having acted honestly and reasonably and believing it to be a legitimate payment.

The GC100 is also currently working on the best practice guidance that will address the practical implications of implementing the regulations. The aim is to develop clear guidance on the level of detail and type of information that should be reported by companies under the regulations and on the engagement between companies and investors in respect of matters arising from the application of the new statutory framework. This guidance should help companies develop a better understanding of the content requirements for their directors’ remuneration report and ensure some consistency between different remuneration reports.