- July 29, 2019
Government response to BEIS Select Committee
The Business, Energy and Industrial Strategy Committee of the House of Commons (the BEIS Select Committee) published on 26 March a further report on Executive Rewards. It contained 16 recommendations to Government.
The Government’s response to the report (HC2306) was published on 13 June
The Select Committee comprises six Labour MPs (including the Committee Chair, Rachel Reeves) five Tory MPS and one SNP MP. Not surprisingly, the Committee’s conclusions and recommendations on executive pay and corporate governance reflect the political balance of its membership. It starts with an acceptance that executive pay is disproportionate and not linked to performance and that differentials are growing; it looks for measures to control and reduce executive pay, particularly using new powers to be given to the new Regulator due to replace the FRC.
The Government’s response is measured and, whilst it “welcomes” the Committee input, it accepts practically none of the recommendations. Its position is that a lot of corporate governance changes have been introduced in the past 18 months: a revised UK Code, a new set of corporate governance disclosures including the pay ratio publications; most recently changes to the Directors’ Reporting Regulations to comply with the requirements of the Shareholder Rights Directive II. In parallel the IA “name and shame” register has been introduced as have the Wates principles for private companies. It wishes to allow these measures to bed down and be appraised before introducing any new measures. It also takes the view that the requirements of companies and shareholders vary widely and changes are principally a matter for shareholders, not government prescription.
MM&K believes this is a sensible response.
Particular recommendations and responses include the following:
Further recommendations for change (e.g. on pension contribution alignment and revisions to the Stewardship Code) appear to be already under way.
For further information, contact Damien Knight.
- July 29, 2019
2019 Global Trends in Corporate Governance– progress update
GECN is a group of independent firms, specialising in advising corporate clients on executive compensation and good governance. GECN member firms have offices in London, Geneva, Zurich, Kiev, Singapore, Melbourne, Sydney, Los Angeles and New York. MM&K has been the UK member firm since 2015
For a few years now, GECN has conducted annual research on trends in corporate governance and published reports on its findings.
Our reports address such topics as executive compensation, board structure and composition, and shareholder rights and give a truly global outlook on the trends in corporate governance. The 2018 Report covered 19 countries across six continents and we are aiming just as high this year.
The 2019 Report will focus on investor perspectives about executive compensation and corporate governance, and on where investors will be directing their attention in 2019 and beyond. GECN member firms have already completed 25 in-depth interviews with leading institutional investors, proxy advisers and investment funds to identify current investor concerns and trends for the future.
We are preparing the first draft of the 2019 Report and aim to publish the 2019 Global Trends in Corporate Governance Report by the end of August or early September.
To request a copy of previous Global Trends in Corporate Governance Reports or for further information please contact Margarita Skripina.
- July 25, 2019
Green Finance Strategy will increase companies’ disclosure requirements
On 2 July 2019, the UK Government published its Green Finance Strategy: Transforming Finance for a Greener Future, which is intended to ensure that “our financial system is robust and agile enough to respond to the profound challenges that climate change and the transition to a clean and resilient economy bring with them”. The paper includes proposals which will increase the requirements for listed companies and pension funds to disclose climate-related risks.
Climate change presents companies with far-reaching financial risks from physical factors, such as extreme weather events, and transition risks that arise from the adjustment to a low-carbon economy. There are also great opportunities: the expected transition is estimated to require around $1 trillion of investments a year for the foreseeable future.
There are already requirements for companies to disclose these risks and opportunities:
• The UK Corporate Governance Code 2018 requires that a company’s annual report should include a description of its principal risks, what procedures are in place to identify emerging risks, and an explanation of how these are being managed or mitigated.
• The FRC’s Guidance on the Strategic Report states “an entity should consider the risks and opportunities arising from factors such as climate change and the environment, and where material, discuss in its Strategic Report the effect of these trends on the entity’s future business model and strategy”.
However, the Task Force on Climate-related Financial Disclosures (TCFD), in its Final Report (June 2017), found that there were inconsistencies in companies’ disclosure practices and warned that inadequate information about risks can lead to a mispricing of assets and misallocation of capital. The report recommended a new framework for disclosing:
• The organisation’s governance around climate-related risks and opportunities.
• The actual and potential impacts of climate-related risks and opportunities on the organization’s businesses, strategy, and financial planning.
• The processes used by the organization to identify, assess, and manage climate-related risks.
• The metrics and targets used to assess and manage relevant climate-related risks and opportunities.
Action against climate change has become more urgent following the publication in October 2018 by the Intergovernmental Panel on Climate Change (IPCC) of its Special Report: Global Warming of 1.5 ºC, which highlighted the potential catastrophic impacts of global warming if it exceeds 1.5°C above pre-industrial levels. Following considerable political pressure, the UK Government recently legislated to reduce carbon emissions to net zero by 2050.
In the Green Finance Strategy, the Government set out its expectation for all listed companies and large asset owners to disclose in line with the TCFD recommendations by 2022. It has established a joint taskforce with UK regulators to “examine the most effective way to approach disclosure, including the appropriateness of mandatory reporting”.
In addition, from October 2019, occupational pension schemes will be required to publish their policy on financially material considerations, including those arising from climate change.
Companies will therefore need to demonstrate not only that they have a good understanding of how the risks and opportunities arising from climate change will affect them but also that they have integrated their response to these in their business strategies and governance procedures. The Government has promised further guidance on these issues. In the meantime, some companies will find it helpful to participate in initiatives such as CDP (formerly the Carbon Disclosure Project), the Transition Pathway Initiative (TPI) and Science-Based Targets.
Once companies have fully integrated their plans to deal with climate change and the transition to a low carbon economy within their business strategies, they must ensure that their performance targets for executive incentive arrangements are aligned with them. The Investment Association’s Principles of Remuneration state that “Remuneration committees may consider including non-financial performance criteria in variable remuneration, for example relating to environmental, social and governance (ESG) objectives, or to particular operational or strategic objectives. ESG measures should be material to the business and quantifiable”.
The Shell Sustainability Report 2018 demonstrates how Royal Dutch Shell has already included climate change targets as part of its executive incentives.
For further information contact Michael Landon.
- July 22, 2019
Competition for Talent in the UK Private Equity Industry is as keen as ever
There is no doubt that the Private Equity and Venture Capital landscape is becoming even more crowded, with new funds successfully being raised and an almost unbelievable level of “dry powder” available to be invested worldwide. Apparently, the global figure has recently reached $2.5trn.
Geographically, the majority of dry powder is still targeting North America, although that proportion has been declining in recent years. However, a steadily increasing proportion of available capital is focused on Asia. Europe-focused dry powder, meanwhile, has remained consistent, accounting for around a quarter of total available capital. Nonetheless, the amount available in Europe is at a staggeringly high level. There seems little doubt that the big corporate investors are more attracted to the private ownership model than the listed one in today’s heavily bureaucratic environment.
From MM&K’s own direct experience, we have seen a healthy number of new clients in London, who are choosing to deploy some of their capital into UK and Continental European markets. This has involved them deciding to set up brand new offices in London and they are now looking to recruit whole new investment and back office teams from the London market place.
MM&K conducted a pulse survey earlier this year, seeking to identify what the latest trends were in UK PE and VC compensation levels. The results indicated that the typical level of increase in salary for investment professionals below Partner level at the most recent pay round (i.e. mainly January 2019) was above 10%. We see this as an amazingly high figure.
PE firms that are looking to invest large amounts of money into European deals need to ensure they have a happy and committed workforce, particularly in their front offices. The last thing they need is to be worrying about investment staff being tempted to look elsewhere by large new salary and bonus offers.
We are currently marketing our 2019 PE and VC Compensation Survey and are pleased with the high levels of interest we are seeing from participating houses this year. We have no doubt that firms are recognising the need to know what is happening to PE pay levels right now.
There seems little doubt that the PE, VC, Infrastructure and Real Estate sectors are entering into a new boom time period in the UK. A small part of this may be to do with the low value of the £ at the moment making investing in the UK even more attractive, counteracting the uncertainty being caused by the debacle of the Brexit process. But we are sure the larger part is just simply to do with the wall of money out there just waiting to be invested. Retaining and keeping motivated the best talent among one’s investment professionals has probably never been quite so important as it is today.
- July 20, 2019
Loans from EBT – recent HMRC developments on disguised remuneration schemes
Disguised remuneration schemes include tax avoidance arrangements that seek to avoid Income Tax and National Insurance contributions (NICs) by paying scheme users their income in the form of loans. Typically, the loans will have come from a “third party” such as an Employee Benefit Trust (“EBT”). In the view of HMRC, the loans were never intended to be repaid and so they are no different to normal income and are taxable.
These plans became popular in the mid-2000s but have been the subject of HMRC review for a number of years – with settlement terms being issued in November 2017.
As part of the continued developments in respect of those who have not settled with HMRC a “charge” on any outstanding loans was introduced as from 5 April 2019. This applies to all loans made since 6 April 1999.
Importantly, the loans are effectively deemed to be taxable income and will be subject to income tax and NICs.
Whilst it is likely that any organisation which has made these loans, now or historically, is already dealing with them, anyone who is unsure whether the loans connected to their EBT will be liable for the charge should ensure that it is compliant with the regulations.
For further information or to discuss any questions you may have, contact Stuart James.
- July 19, 2019
All change at the FRC – or is it?
The Financial Reporting Council (FRC) is embarking on a transition programme to morph into the Audit, Reporting and Governance Authority (“ARGA”) accountable to Parliament, after coming under heavy fire from the Kingman Review and others, including a report by the Competition and Markets Authority (CMA) on competition in the audit sector, which prompted BEIS to launch its own review of audit quality.
Kingman was scathing, calling the FRC a “ramshackle house, cobbled together with all sorts”. Key planks in its transition plan are diversity, culture and audit reform, with the last of these attracting much of the attention in light of recent corporate scandals. Also, the CMA has proposed that accounting firms should split their audit and advisory divisions and that FTSE 100 and 250 audits should be carried out by two firms, one of which is not in the “Big 4”.
Whilst Kingman called for the FRC to have statutory recognition and funding, it remains dependent in part on contributions from audit firms. Not surprisingly, perhaps, responses from some of those firms focus on and raise a number of questions about the FRC’s increased budget proposals for 2019/20.
The FRC’s transition plan includes the recruitment of 80 additional staff. What will they do? Some of them will be needed to resource the planned increase in the number of corporate reviews it plans to carry out. However, questions have been raised about the FRC’s ability to recruit in large numbers in a period of change and uncertainty. Scottish accountancy body, ICAS, has made the thoughtful observation that FRC has struggled to recruit at senior level and, to operate optimally, needs to address any perceived skills gaps. It should consider whether “existing resources need to be recalibrated”. In other words, does the FRC have the right people? Is it fit-for-purpose?
Kingman picked-up on the FRC’s methods of recruiting top staff, observing that it did not often employ open advertising or use headhunters and sometimes relied on the alumni networks of the largest audit firms. When the FRC transforms into ARGA, Kingman recommends that there should be limited overlap in senior management. Time will tell if this comes to pass. The FRC has committed to promote transparency, integrity and diversity in business and to reverse a loss of confidence in audit. Success in achieving those noble goals will depend, in part, on there being no perception of double standards for regulator and regulated.
Whilst audit has grabbed the headlines, the FRC (ARGA in future) also sets the UK corporate governance and stewardship codes. One of the consequences of the transition to ARGA is that the new regulator will have enhanced powers. There is a strong implication that the new regulator will be tougher than the old.
High standards of corporate governance are essential for a sustainable and successful business community and the UK leads the way. The case for change at the FRC is strong. The adoption of Kingman’s recommendations is evidence of that. Few (neutrals) are likely to disagree that everything practicable should be done to ensure that recent audit scandals are not repeated or that examples of excessive executive pay are not checked. However, care is needed to ensure that the freedom of the majority is not restricted and the burden on them is not increased unnecessarily, through the behaviour of the minority. Political intervention in executive pay, for example, has increased. The risk that this might increase further when the regulator, ARGA, is accountable to Parliament should be resisted strongly insofar as the UK continues to operate a free market society. Quis custodiet ipsos custodes?
For further information contact Paul Norris.
- June 27, 2019
PE/VC Fund Manager Compensation Survey
MM&K has been running its PE / VC compensation survey for more than 20 years now. Our survey is not just about the numbers, although it does cover that very well. It also provides invaluable insights into trends and direction of travel in the Private Equity / Venture Capital industry. Not only do we analyse compensation trends, we look at headcount, revenues, the structure of management fees, carried interest plans and GP commitment levels.
In terms of some recent remuneration trends, MM&K’s Pulse Report conducted in April showed an average 10% increase in Base Salary across all investment professionals in the latest pay rounds. This is a staggeringly high figure!
The PE and VC world in the UK and Europe seems to be growing larger and larger. The competition for talent is increasing all the time as new houses are coming to and opening up in the UK with big chequebooks willing to pay handsomely to recruit the best talent.
Our PE/VC Compensation Report is only available to participants, so don’t miss out on the opportunity to participate in our 2019 PE/VC Compensation Survey. Our submission deadline is coming soon, so please do contact us now to find out more.
- June 27, 2019
Independent board evaluation: ICSA consultation
The UK Corporate Governance Code requires, for listed companies, annual evaluation of the performance of the board. The chair should consider having a regular externally facilitated board evaluation. In FTSE 350 companies this should happen at least every three years.
The Government Department for Business, Energy and Industrial Strategy (BEIS) received responses on its Insolvency and Corporate Governance consultation paper suggesting that the standards of independent board evaluations vary considerably. BEIS invited ICSA, the Governance Institute, to convene a group of representatives from investors, governance institutions and corporations to identify ways of improving the quality of board evaluations including the development of a code of practice.
The group issued a report for consultation in May 2019 and consultation responses are required by Friday 5th July.
The report begins with defining the purpose of board evaluation. It then reviews company practice in the FTSE 350. Finally, it offers, for consultation, a draft code for external evaluation providers and a draft set of principles for companies employing them. Following the consultation, the group will publish a report with recommendations and a revised draft of the code and principles.
On receipt of the report, BEIS will decide whether and how to act.
Purpose of board evaluation
The report defines the purpose as a process of self-improvement by boards rather than providing an assessment of board effectiveness for quality assurance. The group believes this is more realistic. It will also demonstrate to shareholders and other stakeholders the board’s commitment to achieving high standards for themselves and the company.
Analysis of current practice
The report provides an analysis of current practice in the FTSE 350, using data from 2018. In that year alone, 35% of FTSE100 and 32% of FTSE 250 companies had an externally facilitated board evaluation. Over a three-year period nearly all companies are compliant with the UK Corporate Governance Code provision. This figure is contrasted with only 37.5% of companies in Continental Europe over a three-year period.
In 2018 FTSE 350 companies received evaluation services from 32 individuals or firms, a consolidation down from 51 in 2012. Just four organisations undertook 65% of the work.
There was limited data on the process of selection, although anecdotally it appeared to be getting more rigorous, with less reliance on mates of the chair. Many boards had self-imposed limits on the number of times they would work with a reviewer (usually two or three times).
In 2018 only 41% of FTSE 350 companies provided a good explanation of how the evaluation was carried out. This percentage should improve with the new provisions of the 2018 Corporate Governance Code. The same applies to a description of the outcomes and actions resulting from the evaluation. In 2018 only 47% of companies provided this.
The report emphasises the need for a share responsibility between the company board and the external evaluator. The evaluator must be prepared to challenge the board’s perception of its own performance; the board in turn must be willing to allow the reviewer to do so.
The three proposed measures from the report are:
• A voluntary code of practice for providers of independent board evaluation, who would sign up to the code, in the same way that remuneration consultants (including MM&K) sign up to the Remuneration Consulting Code. An open question for the consultation is whether the code should be underpinned by an accreditation process or a process of oversight.
• A set of voluntary principles for companies to apply in managing their board evaluation.
• Guidance to companies on disclosure of the evaluation process and outcomes, to supplement the guidance issued by the FRC to support the 2018 Corporate Governance Code.
The report includes a proposed draft for each measure and invites comments on the draft. It leaves open whether application of the code of practice should be mandated. It also raises the possibility of including shareholders in the process for appointing the evaluator.
The code for reviewers
There are three elements:
• Competency and capacity – it provides a disclosure framework of activities and attributes against which code signatories have to demonstrate their experience and capability. The group invites view on how prescriptive this framework should be. It also wants advice on establishing processes for accreditation, oversight and monitoring that are rigorous but do no set excessive entry barriers to service provision. Should the oversight body comprise mainly code signatories or be mainly independent? What should its role be in:
• Monitoring compliance
• Operating a client complaints procedure
• Reviewing the operating of the code and revising it where necessary?
• Independence and integrity – the code is more prescriptive in this area – eg in dealing with conflicts of interest. The group is particularly interested in receiving advice on how to deal with conflicts of interest.
• Client engagement – again the code is prescriptive eg in setting the terms of engagement.
Voluntary principles for listed companies
• Appointment of the evaluator will be the collective decision of the full board or the nomination committee – not the decision of a single board member.
• The company will not appoint external reviewers with which it has other current commercial relationships or that have carried out more than two previous evaluations.
• Terms of engagement will be agreed before the review commences, specifying the objectives and scope of the evaluation and the process to be followed.
• The company will provide the reviewer with direct access to the board collectively and individually, and to all board and committee papers and to management and other stakeholders as necessary to meet the agreed objectives.
• The company will provide the reviewer with an opportunity to present their findings to the full board.
• The company will identify a contact with whom the reviewer can discuss in confidence any concerns about the management of the process (usually on of the independent board members).
• In the annual report, the company will state whether it has followed these principles and whether the board reviewer is a signatory to the code. The report advises against making it mandatory for companies to employ a code signatory as the reviewer.
• The reviewer will be asked to confirm the accuracy of the description of the findings and findings in the annual report.
Draft disclosure guidance for listed companies
The report also includes what is in effect an elaboration of the guidance provided with the 2018 Corporate Governance Code plus a description of the appointment and terms of reference of the independent reviewer. It suggests:
• How the evaluation has been conducted – objectives, scope, who involved, processes.
• The evaluator, selection process, previous involvement, whether a signatory to the code, whether monitoring implementation of recommendations.
• The outcomes and actions taken- the guidance recognises the commercial sensitivity of this, but encourages disclosure as far as possible to build trust.
• How conclusions will affect board composition.
For further information, contact Damien Knight
- June 25, 2019
Could negative bonuses be the future of variable pay for executives?
Have a discussion about pay, and in particular executive pay, and invariably someone will raise the idea of “negative bonuses”.
The concept is simple, if bonuses are meant to be a reward for delivering a performance that is above and beyond what is expected, then surely it is only ‘proper’ that an executive should have to pay something back to the company if results are shown to be below what was forecast.
Tempting as it may be to apply such simple logic, the protection afforded to all employees (including directors) under UK employment law means that such a position would be impossible to introduce without the explicit agreement of the individual (and even then there would probably be cause for constructive dismissal given the relative bargaining powers of the parties).
However, the core concept of “upside and downside” on bonuses is valid and there are at least two ways in which these might be successfully applied.
Firstly, there should be nothing stopping a company from introducing this as part of a new package for a new appointment into a role. From a practical perspective, this could be achieved through an adjustment to a mixture of salary levels and the levels at which bonuses are paid. The commercial effect would be for someone to be paid less than a predecessor if performance was below agreed target levels.
The second way in which bonuses could be adjusted downwards would be by using a fractional multiplier on the bonus itself. There are a number of ways this could be done. A method we have seen that is gaining popularity is to use performance management scores – where poor performance translates into a lowering of the bonus amount.
For further information or to discuss any questions you may have, please do contact Stuart James.
Please note that this concept of negative bonuses is different from the malus and clawback provisions discussed in a separate article in this newsletter.
- June 25, 2019
Annual Returns for Share Schemes – deadline 6 July 2019
For the tax year 2018/19, the deadline for filing the share schemes annual returns is 6 July 2019. The filing obligation applies in relation to any new share schemes implemented as well as existing share schemes.
HMRC do not send out any reminders. As there are automatic penalties for late-compliance, we recommend filing your online annual return without further delay.
Please note that new share schemes will need to be registered with HMRC first before returns can be filed. The registration process may take a week or two and therefore it is imperative that the registration process is completed before the 6 July deadline.
What needs to be done?
Filings of the annual returns are done using HMRC’s Employment Related Securities (ERS) Online Services which can be accessed through the Employer’s PAYE online account. This can be carried out by the company directly or by any agent authorised to act on its behalf.
Each employee share scheme requires a separate annual return. For group companies, only one company within the group needs to submit a return, irrespective of other participating group members.
What needs to be reported?
Each and every ‘reportable event’ that has occurred in the tax year 2018/19 must be notified to HMRC on the annual return. This includes:
• the grant of a new option to an employee
• the exercise of an option by an employee
• the acquisition of shares (or interest in shares) by an employee
• adjustment of options
• the assignment or surrender of options by an employee for consideration
• changes to the restrictions on shares and disqualifying events
• any other events which give rise to a tax charge in relation to employment related securities
If in any doubt as to whether to report a particular event, further advice should be sought.
For tax-advantaged share schemes, namely, EMI, CSOP, SAYE and SIP schemes, each relevant event also needs to be reported to HMRC. However, each of these schemes has its own form of online annual return which should be filed separately.
If there has not been any activity in the previous tax year, a ‘nil return’ should be submitted.
For more information about filing of annual returns, click here.
For further information contact Michael Landon.