Changes to the UK's Corporate Governance Code put focus on executive remuneration

The Financial Reporting Council (FRC) has now published the 2018 Corporate Governance Code. Although the new Code looks very different in its "shorter and sharper" form, the remuneration provisions are, as expected, largely unchanged in substance.

The FRC highlights two particular points as being a response to public concern over executive remuneration. The first of these is a requirement on remuneration committees to take into account workforce remuneration and related policies when setting directors' pay. The second is an insistence that remuneration committees should retain discretion to override formulaic calculations of performance-related pay, where the formula outcome is not justified. Companies will need to review their existing share plans, performance conditions and remuneration policies and consider the extent to which they should be amended to add performance underpins and potentially the ability to use discretion in the opposite direction. The Code is of course still a "comply or explain" regime, but it could be difficult to explain a decision not to increase the remuneration committee's discretion in this way.

Other points to note include the following:

• The new Code introduces a requirement that to be qualified to chair a remuneration committee a director must have served on a remuneration committee for at least 12 months. The FRC has clarified that it need not necessarily be the same remuneration committee.
• In terms of plan design, the Code remains neutral as between performance based LTIP awards and restricted shares, although one of the factors which the Code states that remuneration committees should take into account when determining remuneration policy is simplicity.
• However the Code clarifies that the minimum expectation in terms of time period is five years, comprising the vesting period and where necessary, a subsequent holding period. It also states that share awards should be released for sale on a phased basis. It is not completely clear how that should be interpreted. While there is already a market expectation that new plans will include a five year period, remuneration committees will need to consider whether existing plans should be amended to include a holding period.
• The new Code does not impose a rule requiring executives who leave the company to retain some or all of their shares for a period after their departure. However it does require companies to have a formal policy on the point. That will be an obvious immediate action point for remuneration committees. It will be interesting to see what practice develops.
• The new Code contains a requirement to include in the company's annual report a description of the work of the remuneration committee. This will overlay the existing Companies Act requirements. The detailed requirements include:
  • an explanation of the strategic rationale for executive directors’ remuneration policies, structures and any performance metrics;
  • reasons why the remuneration is appropriate using internal and external measures, including pay ratios and pay gaps;
  • a description, with examples, of how the remuneration committee has addressed the factors which the Code tells it to take account of when setting remuneration policy (clarity, simplicity, risk, predictability of return, proportionality and alignment with culture);
  • whether the remuneration policy operates as intended in terms of company performance and quantum, and, if not, what changes are necessary;
  • what engagement has taken place with shareholders and the impact this has had on remuneration policy and outcomes;
  • what engagement with the workforce has taken place to explain how executive remuneration aligns with wider company pay policy (backing up the requirement mentioned above to take into account workforce remuneration); and
  • what discretion has been applied to remuneration outcomes and the reasons why.
• Rather oddly, the provision in the previous Code requiring new LTIPs to be approved by shareholders has been removed. Although many companies will be required to obtain shareholder approval under the listing rules or the Companies Act this means that AIM listed companies who choose to follow the Code will not be subject to this requirement.

Although the new Code only applies to accounting periods beginning on or after 1 January 2019, remuneration committees will clearly need to take it into account now when considering changes to remuneration policies.