ABI Releases New "Principles of Remuneration"
29 September 2011
Background
Today the ABI published new "guidelines" on executive remuneration (re-branded "Principles of Remuneration").
The ABI is the trade body for UK insurance companies who represent around 15% of the UK Stock Market in their capacity as institutional shareholders. The ABI has been the traditional thought leader for executive remuneration guidance, with guidelines on share plans and remuneration being in existence since the early 1970s. Recently their direct influence has waned as foreign institutional investors have begun to dominate the ownership of UK listed companies. However, the guidelines still remain the principal source of guidance for UK listed companies and, as well as being adopted by ABI members, they have also been embraced by the NAPF, forming the basis for analysis through their RREV voting service.
So, overall, the ABI guidelines remain an influential force shaping the UK executive pay landscape. This update is the first since 2009, which itself changed little from the previous update in 2007. The recent practice of the ABI has been to leave guidelines unchanged, but to send periodic "position papers" to remuneration committee chairmen, often relating to particular developments in executive pay policy with which the ABI has taken issue. Recently these have included the proliferation of "value creation plans", base salary increases, retention awards and guidance on shareholder consultation.
We met up with the ABI prior to the publication of these principles to discuss their content and practical application.
The sub-committee of the ABI that has developed this guidance comprises a broader church of members than has been the case in previous years, including fund managers (with no governance role), with the guidelines then reviewed by the ABI Board (made up of senior UK based executives sourced from different ABI members). This change of approach is evident through a greater focus on remuneration costs - particularly the cost breakdown between remuneration, interest and capital needs and dividends to shareholders - as well as a reduced focus on the detail.
What has changed?
In essence this document is a consolidation of previous guidelines and the position papers. Presentationally there has been a move away from separate sections covering specific issues, so that there is now greater emphasis on five key principles. These come under the headings of the Role of Shareholders, the Role of the Board and Directors, the Remuneration Committee, Remuneration Policies and Remuneration Structures. Further guidance is then included in separate sections, following which there is an appendix which contains much of the technical detail contained in previous guidelines (for example dilution limits, change of control and structure of performance conditions).
The ABI is moving away from a more prescriptive approach and towards providing greater focus on core principles. For example, the guidelines state that "it is not the role of shareholders to micro-manage companies" (although some of our clients believe that this is exactly the approach that has been adopted by some institutional shareholders in recent years). Instead the ABI has placed a greater onus on remuneration committees to determine the remuneration policy, but with the message that they will be held accountable where there are perceived failures of policy or practice through the new annual re-election vote of all directors for FTSE 350 companies, together with the annual vote on the Directors' Remuneration Report.
Key changes to the Guidance
Quantum
There is a new heading covering "Quantum" for the first time. Historically the ABI has not dealt with quantum per se, focussing more on the structure of performance conditions which determine quantum.
The guidelines say that "quantum of remuneration is a matter of concern to shareholders" and provides some guidance as to the appropriate reference points to determine quantum, including (i) a focus on "aggregate" remuneration and its link to overall corporate performance, (ii) the remuneration of the wider workforce and (iii) the use of a "fairly constructed" peer group without undue focus being placed on the median.
Clawback and malus
Whilst ABI guidelines have previously commented on clawback, for the first time there is a new section specifically dealing with both clawback and malus. The guidance suggests that shareholders expect to see such provisions included in remuneration arrangements. Whilst clawback has been something that an increasing number of companies have included in their annual bonus and long term incentive plans, the concept of malus is different. Clawback deals with the repayment of bonuses and other awards which have previously been paid, while malus deals with the potential reduction to the value of the deferred remuneration which has not yet been paid. Whilst malus provisions have become a feature of executive pay in FSA regulated companies recently, such provisions are very rare outside the financial services sector and could necessitate a significant re-design of deferred bonus plans. For this reason, we question how many companies will adopt malus clauses, not least because the value of deferred bonus awards paid in shares (the most common approach adopted by companies outside the financial services sector) may well fall if performance deteriorates during the deferral period.
Discretion
For the first time the ABI guidelines state that the use of general remuneration committee discretion in incentive plans can be helpful, albeit that this should be exercised diligently, within previously agreed parameters and clearly disclosed. This is a welcome development.
Executive shareholdings
Priority is given to the use of share ownership guidelines for senior executives and a desire for executives to build up significant shareholdings in companies.
Special awards and ex-gratia payments
The ABI guidelines reiterate their opposition to "off policy" payments to executives, although it can be acceptable for a new team in a turnaround situation.
The wider context
BIS consultation on executive pay
The ABI told us that it will be pushing hard in the BIS Consultation on Executive Pay for there to be material changes to the way in which remuneration is reported, as it wishes to see remuneration reports providing much better disclosure and easier comparability across companies. The ABI also mentioned to us that there is an increasing call from its members for "pay ratios" to be disclosed (i.e. between the CEO and workforce), although we question how useful/meaningful such information would be.
Approach of IVIS
We have discussed with the ABI the approach that the IVIS voting service will be taking. IVIS provides an analysis of FTSE All Share AGMs and EGMs and, in relation to executive pay, has traditionally formed a view based on compliance with ABI guidelines (albeit taking into account the views of its members in a particular situation). The IVIS team has confirmed that it will be taking a more rounded view of a company's remuneration policy, reflecting the views of its members and the specific circumstances, rather than guideline compliance determining its view (i.e. the 'colour' of a report).
Conclusion
Much of the content is a re-packaged version of previous ABI guidance and there is little new. However, the emphasis is very much on allowing remuneration committees and boards to determine remuneration in an environment where there will be greater transparency (through better remuneration report disclosures in due course) and accountability (through the annual vote on the re-election of directors). Also, a secondary key theme in the guidelines is the need to link pay policies to underlying corporate strategy (including risk profile) and that financial and non-financial targets can be used. However, for companies to be able to do this, the ABI must be willing to embrace the use of non-standard incentive structures and performance metrics where the need arises.
Key points to note
- Review linkage of pay policy to corporate strategy and risk profile.
- Any increases in quantum will require robust justification beyond peer-based benchmarks.
- More pressure on the introduction of clawback provisions (with malus also now an agenda item).
- Greater flexibility to apply discretion where the need arises to ensure a link is maintained between remuneration and performance.
Please contact your usual Hewitt New Bridge Street advisers if you would like to discuss the points raised in this briefing.
This update is intended to highlight issues and not be comprehensive, nor provide specific advice. Aon Hewitt Limited does not accept nor assume any responsibility for any consequences arising for any person as a result of them using or relying on the information contained in this update.
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