The Investment Association (“the IA”) has written to FTSE All Share Remuneration Committee Chairs to summarise the outcome of its annual review of its Principles of Remuneration. The past year has taken place against the backdrop of the pandemic with the coming year also set to be affected by its aftermath. The IA has welcomed the response of the overwhelming majority of companies to the pandemic and has set out its areas of focus for 2022.
Letter to Remuneration Committee Chairs
The letter focused on two key themes:
Impact of the pandemic and its aftermath
- The IA’s previous guidance on responses to the pandemic remains unchanged.
- Companies must continue to factor the shareholder and stakeholder experience into their remuneration decisions and clearly communicate the approach taken.
The use of ESG metrics in executive remuneration
- As companies incorporate the management of material ESG risks and opportunities into their long-term strategies, this should also be incorporated into the performance conditions used in variable pay.
- ESG metrics should be quantifiable, clearly linked to company strategy and the rationale for choosing them should be clearly disclosed to investors.
- Where ESG risks and opportunities have been incorporated into the company’s long-term strategy but not into its variable pay structures, companies should clearly explain to shareholders how they will incorporate these in future years.
Updated Principles of Remuneration for 2022
Whilst the IA’s letter states that there have been a small number of updates, there are some significant changes of emphasis. We summarise the key changes to the principles and the accompanying guidance below.
Levels of remuneration
- Benchmarking peer groups should be specific and clearly disclosed.
- Companies should justify the level of remuneration, show restraint in relation to overall quantum and provide a clear rationale for increases.
- Committees should be mindful of the multiplier effect of salary increases on levels of total remuneration.
Performance adjustment
- Malus and clawback grounds should be broader than just gross misconduct and misstatement of results, and Remuneration Committees should set out in the remuneration report how malus and clawback will be enforced in the event that it is needed.
- Use of discretion should take account of wider stakeholders and the general market environment. Remuneration Committees should disclose how the experience of material stakeholders has been considered when exercising discretion and should ensure that they have the ability to exercise that discretion.
Variable remuneration
- Remuneration Committees should consider whether, and disclose in the remuneration report why, the level of pay-out is appropriate given the wider stakeholder experience.
- The choice of long-term incentive should be made based on consideration of the long-term strategy and not based on short-term performance or be changed regularly.
- Where companies move from LTIPs to restricted stock, the reduction in grant levels should be maintained and not gradually increased over time.
- Where the company’s share price has fallen, Remuneration Committees should scale-back LTI award levels at grant to avoid windfall gains and in all cases the Committee should review the grant level each year to determine if it is appropriate given the Company’s performance.
New guidance on Value creation plans (“VCPs”)
- Investors are generally sceptical of VCPs and these should therefore only be used if they are appropriate for the Company’s specific circumstances.
- There should be a cap on the overall value of awards and total number of shares that can be granted and Committees must be mindful of the potential additional dilution.
- Performance targets must be more stretching and robust than for a conventional LTIP.
Other changes
It is worth noting that the IA has updated the guidelines to incorporate guidance on directors contracts and termination payments that was previously contained in 2008’s ABI/NAPF Joint Statement. This includes some welcome but relatively small updates to the requirements in this area.
Updated IVIS voting policy on pensions
In a continuation of existing guidance, IVIS will red-top:
- any new remuneration policy that does not explicitly cap the pension for any new executive director in line with the majority of the workforce.
- any remuneration report where incumbent executive pension contributions are not aligned to the workforce or there is no credible plan to do so by 31 December 2022.
A&M’s view
The latest update to the IA’s Principles of Remuneration is notable in a number of respects, but none more so than that the IA has explicitly introduced a requirement to incorporate ESG metrics in incentive plans where ESG forms a part of their long-term strategy.
Also of note for companies are the requirements to disclose benchmarking peer groups. For many companies, for whom identifying specific peer groups is a challenge due to a shortage of listed companies that are genuinely comparable and who will have relied on more general groups of companies that are similar in size, what is expected is not entirely clear. The best approach may be to be more specific about their overall approach to choosing peer groups and the extent to which benchmarking informs their decision making.
This update to the guidelines also emphasises that the IA’s preferred approach to avoiding windfall gains from long-term incentives where share prices have fallen, is for awards to be scaled-back at grant rather than relying on Committees to exercise discretion to reduce vesting to remove the impact of windfall gains.
Finally, as we see more companies introducing restricted stock and value creation plans, the additional guidance from the IA is welcome.
If you would like to discuss these or any of the other developments above, please contact one of the authors using the contact information provided.