MM&K News

Revised Stewardship Code sharpens the focus on ESG factors

The UK Stewardship Code forms part of the FRC’s mission to promote transparency and integrity in business. The 2020 version of the Code was published by the FRC earlier this month. Under the Code, it is incumbent on asset owners and asset managers to disclose how they have prioritised ESG factors when assessing investments.

The introduction to the 2020 Code recognises that, in addition to governance, environmental and social factors have become material issues for investors to consider when making investment decisions and carrying out their stewardship role. The revised Code sets out 12 principles for asset owners and managers. Principle 7 requires asset owners and managers to explain in their Stewardship Reports, which will be public documents, either:

• how integration of stewardship and investment has differed for funds, asset classes and territories and the way they have ensured that tenders have included material ESG factors as part of a requirement to integrate stewardship and investment, or

• the processes used to integrate stewardship and investment, including material ESG issues, to align with the investment time horizons of clients and beneficiaries and to ensure service providers have received clear and actionable criteria to support integration of stewardship and investment, including ESG factors.

The Stewardship Code is not the only set of principles urging corporates and investors to concentrate on sustainability and ESG factors. The Sustainable Development Goals and Principles of Responsible Investment, published under the auspices of the UN, have a similar purpose. Corporates are under increasing pressure to incorporate ESG factors into their executive remuneration policy and practice. And there is evidence that corporates are taking positive action. Interestingly, however (and, perhaps, counter-intuitively) whilst many ESG factors are long term in nature, research indicates that those corporates which have included ESG metrics in their remuneration policies have done so in connection with their short-term incentives.

Whilst corporates have been required to address a range of Governance issues for some time, under various corporate governance codes, now they are paying closer attention to Environmental and Social factors. One of the difficulties is that ESG is likely to mean different things to different companies. For example, research indicates that oil & gas companies place greater emphasis on employment conditions, safety and physical damage to the environment, whilst financial services companies are more likely to be concerned about customer service.

Larger companies have established ESG/Sustainability teams or departments and committees. One of the first questions to consider is: what does ESG mean for us? Other important initial questions are: what are we going to do about it? and who is accountable? For a multi-national company, what it is going to do about ESG may well differ for each of the territories in which it operates.

Not all companies will have the resources to establish a department dedicated to ESG. However, there can be a positive financial advantage for corporates that have developed a coherent ESG policy, as increasingly lenders offer finer rates to corporates with a clear ESG policy.

To comply with the Stewardship Code, asset owners and managers must ask themselves and address questions similar to those asked of the Boards of the corporates in which they invest. In addition, they must understand the action corporates have taken (or intend to take) to address ESG factors and the reasons for taking such action. That understanding can only be achieved through constructive engagement, as encouraged by the Stewardship Code and a willingness on all sides to listen and to be clear and open. Corporates and their investors will need to start on their respective sides of the bridge and walk to the centre. That will require a good deal of co-operation and commitment (both of time and thought) and flexibility. If the Stewardship Code, adherence to which is voluntary, can help to bring that about, it will have made a stride towards breaking down the antipathy, which has sometimes existed between corporate Boards and their investors, for the benefit of all stakeholders globally.

For further information about the issues raised in this article or to discuss any questions you may have, please contact Paul Norris.

2020 MM&K / GECN Global Research

In 2019 MM&K, together with our partners in the GECN Group (Global Governance and Executive Compensation Group) researched the Global Trends in Corporate Governance – investors perspective. The outcomes of this research are present in the Executive Summary (click here to request a copy).

25 global investors were interviewed to understand the key issues for them and to identify upcoming trends in Corporate Governance around the world. Board effectiveness appears to be a key issue for investors from Australia and Asia. To the EU, UK and US investors the ESG (environmental, social, and governance) is the main concern.

The G – Governance is currently one of the most regulated aspects of ESG in the UK. There are two codes published, that companies could adopt:

• 2018 UK Corporate Governance Code (applies to accounting periods beginning on or after 1 January 2019);

• 2018 QCA Corporate Governance Code (update of the 2013 QCA Corporate Governance Code).

The E and S – Environmental and Social aspects are less defined at the moment. The 2020 UK Stewardship Code is addressing the whole ESG issue. However, the 2020 Code does not define Environmental and Social measures, only mentioning the climate change issue.

Based on the interviews conducted,  climate change is in the lead for the majority of respondents. Some respondents suggest that there will be no material change unless the relevant metrics are incorporated into pay structures.

However, for companies to successfully tackle the whole of the ESG issue, they will need to defining the E and S aspects beyond climate change – “What does ESG mean for us?”. To help our clients and to find out what is the current practice around the world, we will focus our 2020 Research on the ESG being addressed around the world.

For further information contact Margarita Skripina.

The FRC’s annual review of reporting, following 2018 changes to the UK Corporate Governance Code shows the quality of reporting has been mixed.

In this article we analyse key elements of the FRC review

The 2018 UK Corporate Governance Code that applies to accounting periods beginning on or after 1 January 2019, is designed to build on the relationships between companies, shareholders and stakeholders and make them key to long-term sustainable growth of the UK economy.

The new Code focusses on the application of the Principles and reporting on outcomes achieved. For the Code’s Provisions, companies should disclose how they have complied with these or provide an explanation appropriate to their individual circumstances.

Key elements of 2018 UK Corporate Governance Code and summary of the Annual Review of Corporate Governance by FRC are provided in the table below:

To conclude, the new Code applies to premium listed companies for accounting years beginning on or after 1 January 2019. Therefore, reporting will be part of the annual reports published in 2020. However, many listed companies noted in their annual reports published in 2019 the actions that they were planning to take in preparation for full reporting.

In relation to early adoption of the 2018 Code, according to Annual Review of Corporate Governance the quality of reporting has been mixed. Corporate culture and workforce engagement were the most frequently discussed areas. Also, many companies would be proposing new remuneration policies to their 2020 AGMs.  Therefore, the 2018 Code changes to remuneration committee oversight will become evident in this year’s reports.

For further information about the issues raised in this article or to discuss any questions you may have, please contact Natalie Cherkas.

What insights into effective business practices are coming out of the QCA review of Good Governance on AIM?

MM&K are members of the Quoted Companies Alliance (“QCA”) and sit on both the Corporate Governance and Share Schemes experts group.  Here are four insights coming out of the recently published AIM Good Governance Review.

1) There is an increasing trend for more disclosure in the year-end financial reports of AIM companies.  This trend towards more detailed reporting, which we think is likely to continue, is expected to create a situation where low levels of reporting and the use of “boiler plate responses” – even perhaps in private companies – will start to be commented on unfavourably by shareholders and proxy agents.

2) There is still a low level of reported engagement with employees as a distinct “stakeholder” group.  It is surprising that companies are not taking the opportunity to self-regulate in this area and show more openness on this point.  We suspect that, if this does not show improvement during 2020, this may be an area for fresh intervention from the government.

3) Board Experience and Evaluation is seen as an increasingly key issue for investors – although some of the attitudes highlighted remain very “traditional” in that sector expertise in Non-Executives is seemingly prized above ability to challenge and develop the business.

However, as work with our partner organisations in the Board Evaluation space is beginning to show more and more, the effectiveness of Boards is less about industry knowledge and more about having all the right skills in the Boardroom.

4) Succession planning is starting to get the attention it deserves.  The review showed that companies which included a statement on succession planning had increased from 20% to 48%.  However, it does still look like many of the statements made are generic in nature.  Good succession planning can act as an effective antidote to the pressure of bringing in new Directors in the future on high remuneration packages.

For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.

European PE Activity in 2019

It appears that 2019 was another very good year for the European Private Equity Industry.  The year set a new annual record for European PE fundraising with €86bn raised across 89 fund entities.

The year was also a good year for PE deal activity which in value terms was the second highest on record.  However, the number of deals was some way down on previous years.  One consequence of this was the fact that the median PE deal size in 2019 was the largest ever (by some margin), just exceeding €30m.

The whole thrust of what we are seeing in this sector seems to be that it is becoming more mainstream and more accepted as mainstream.  Those investors who once shied away from the asset class cannot afford to do so anymore.  It is particularly interesting to observe that a not insignificant number of PE investors who used to rely on the GP community or the fund of funds community to manage their PE allocation, have started to invest directly themselves.  Good examples of these are family offices, pension funds and sovereign wealth funds.

This has meant that the competition for deals has become greater as has the competition for talent.

One area that has not performed so well is exits.  The value of PE exits in 2019 was well down on 2018 and 2017 and was in fact the lowest it has been since 2013.  When looking at the exit routes used, secondary buyouts still account for a significant proportion of them although trade buyers were also pretty active.  The IPO markets however were not a happy hunting ground for exits.  2019 saw only 29 companies exit to public markets, registering the lowest IPO value and volume figures since 2012.

We have referred in the past to the seemingly ever-increasing demand for talent in this sector which shows no signs of abating.  This can only push up the salaries and the packages generally of the investment professionals, particularly at the senior associate and investment director levels.  Our 2019 survey indicated that salary and bonus levels were again on the rise, particularly for the middle and more junior ranking professionals and the expectations were that this would be happening again come 2020.

But one other area that PE fund managers may need to be looking at is the way that their long-term incentive plans are structured.  There does seem to be evidence that the industry is moving towards a longer typical holding period for their portfolio investments than used to be the case.  This is particularly true for those pension funds, sovereign wealth funds and family offices who have chosen to become direct investors in their own right.  These types of investors tend not to be so concerned about internal rates of return (“IRR”), but more about cash on cash money multiples and in some cases yield as well.

We have heard about some, and seen one or two first hand, carried interest plans that have been adopted recently, that have set their hurdle as a money multiple hurdle rather than an IRR hurdle.  This type of hurdle we believe is better suited to a PE investing business where the expectation is for longer term hold investments.  There are other attractions to this type of hurdle in a carried interest plan.  The methodology of calculating the hurdle and its likelihood of being achieved is more transparent and easier to communicate to participants.  The way the catch up mechanism works is also much more straightforward with this structure of hurdle.   We are envisaging that more and more carried interest plans will have this type of hurdle going forward.

For further information contact Nigel Mills.

Annual Conference sees the GECN emerging as a stronger independent global compensation and governance adviser

The sixth Annual Conference of the Global Governance and Executive Compensation Group (GECN) took place in Zurich from 6 to 8 January, hosted by Swiss-based group member, HCM International.

The GECN is a group of five independent advisory firms specialising in executive compensation and corporate governance. It comprises 95 professionals operating from nine offices globally (www.gecn.com). GECN member firms have offices in Los Angeles, New York, London, Kiev, Geneva, Zurich, Singapore, Melbourne and Sidney. MM&K represents the GECN in the UK.

Key topics discussed were how to co-ordinate and optimise leverage of the wealth of knowledge and consulting experience that resides within the GECN to add value to clients globally. Good progress has been made over the past year, as evidenced by the increasing number of global projects won by GECN member firms working together.

The GECN adds value globally through objective, tailored advice and implementation provided by high-quality independent professional firms. The advice provided by GECN is supported by the Group’s data collection, research and analysis facilities.

In 2019, GECN interviewed 25 institutional investors and their advisors globally to gather information about the areas of corporate governance behaviours which are of most concern to them. Perhaps not surprisingly, ESG factors appear high on the list. The report of this research is available from Margarita  Skripina

This year, GECN will look at the ways in which corporates globally have been tackling the issues raised by investors.

For more information, please contact: Paul Norris or Margarita  Skripina.

With the majority of parties now having published their manifestos, what clues do they contain as to the future direction of corporate governance and executive pay in the UK?

This article is strictly apolitical – as countless polls have shown, it is impossible to predict how an election will be decided. However, irrespective of who wins (or perhaps which parties form a coalition) it is undoubtedly true that policies from one party can influence decisions of other parties.

Even more crucially, when, as in the 2017 General Election, there was general consensus over an issue (such as pay ratios or increasing worker representation) changes followed within a year.

So, what messages might we be getting from the manifestos?

In terms of the Conservative party, unlike 2017, when actions around reward and pay were specific and targeted, the current manifesto raises only one point regarding executive pay:

• “We will improve incentives to attack the problem of excessive executive pay and rewards for failure.”

No explanation is given as to what “improving incentives” means in the context of ’rewarding failure’ or as to where those incentives are aimed and it seems a strange turn of phrase given that Remuneration Committee’s receive a flat fee in respect of their work on executive pay. NEDs are not supposed to participate in incentive pay plans but could this be a veiled recognition that whilst the remit of remuneration committees has expanded, their fees have not followed suit?

Given the absence of anything more definitive, it is worth considering the Labour and Liberal Democrat manifestos.

The main point of agreement in both documents is an extension of the requirement for large UK companies (i.e. those with 250+ employees) to report more “gaps in pay”. Both parties support an extension to record Black, Asian and Minority Ethnic (BAME) pay gaps. In addition, the Labour party would extend this to include gaps based on disability reporting and the Liberal Democrats to LGBT+ reporting.

It is interesting to note that, in terms of gender pay reporting, Labour are proposing to extend the influence of government through the requirement that all large companies (listed or otherwise) will have to get government certification regarding their approach and level to gender equality.

In terms of other common policy points, both Labour and the Liberal Democrats have indicated support for a proportion of a large listed company’s shares to be held in trust for employees. We assume such measures would be settled by an issue of new shares, thus diluting existing shareholders.

The amount to be put into trust would be mandated at 10% by Labour (as previously indicated by Shadow Chancellor, John McDonnell) and, to avoid executives taking the largest share, the maximum payment receivable would be £500 per person per year.

In comparison, the Liberal Democrats are only proposing a right for workers in large companies to request that a trust is created for employees.

The other area of common interest in both manifestos is in respect of worker representation on Boards, with the Liberal Democrats suggesting that there should be one such person and Labour indicating that 1/3rd of the Board should be elected “worker-directors”.

Only once things have settled after the Election will we have a better idea of what might occur in the short term.

In terms of likely outcomes, the current Conservative government has expressed support already for BAME reporting and, therefore, it is strongly possible that this particular measure will be actively introduced within the next year.

It is more difficult to tell with the other matters. However, given the general direction of travel, it is likely that issues of pay and corporate governance will be areas in which all parties (should they need to) are likely to feel that concessions could be made.

For further information about the issues raised in this article or to discuss any questions you may have, please contact Stuart James.

MM&K and its partner firm in the US, Holt Private Equity Consultants, have published their 2019 Survey Reports on Compensation in the UK and North American Private Equity and Venture Capital Fund Management industries.

Nigel Mills reflects on some of the key findings in the Reports with regard to pay levels on both sides of the pond, and the levels of Management fees and Performance fees (or Carry).

In October MM&K and Holt Private Equity Consultants published their 2019 European and North American Private Equity and Venture Capital Compensation Reports. The Reports are derived from Surveys that were conducted in the year into pay and incentive practices in the European and North American PE and VC fund management industries.

Some of the key findings from the surveys and commentary thereon are set out below.

The headline takeaway is that the market for top-quality talent in the sector remains extremely competitive. We see that the sector generally is booming with a large number of firms recruiting both in the US and in Europe, either with a view to simply increasing their headcount to deal with the strength of the business pipeline or in some cases to move into the sector for the first time.

The stats from both North America and Europe showed significant increases in total cash compensation for non-partner investment professionals across all strategies. And, as in Europe, the North American VC data showed that the VC strategy, in particular, is doing particularly well in the United States.

As most observers will know, the ability to reward and incentivise key talent in this industry is very dependent on the revenues that the firms make from management and performance fees (or carry). It is interesting to observe the slightly differing fee structures as between the European and North American Houses. In both territories, the standard fee structure remains 2% Management fee and 20% Carry (two and twenty). These still represent the median numbers for all participating houses both in Europe and North America. However, when one delves a little deeper, one sees that whilst this is still the standard for the Buy-out and growth capital houses, the numbers look a little different for the VC houses and for the fund-of-fund entities.

In Europe, the median annual management fee for VC funds is 2.3%, whilst in North America it is 2.4%, perhaps unsurprisingly quite a bit higher than for the Buy-out houses. In sharp contrast to this, for fund-of-funds managers, the typical annual management fee is 1%, both in Europe and in North America, and for larger funds it is actually some way below this.

20% carry is still the norm for the large majority of independent direct investing fund managers, although one does still see quite a number of 25% carry plans in VC houses in the United States. In fact, the upper quartile figure for VC Carry in North America is 25%, whilst in Europe it is 21%. This would suggest that over 25% of VC funds in the United States have a carry percentage of 25% or greater.

Interestingly (and in our view rather surprisingly) we have not seen much movement in these figures over the last ten years or so. However, the one area where we are starting to see some movement is in the hurdle rates of return applying to carry plans. In the European Report, 18% of carried interest plans now have a hurdle rate of less than 8%. A few years ago, there would not be any plans (in the UK at least) with hurdle rates below 8%.

One last interesting statistic relating to differences we are seeing between European Houses and North American firms is to do with how widespread the Carry is among the members of the firm. In North America it seems that over 80% of the carry is spread among the partners and only c 18% goes to non-partners. In Europe, we are seeing carry being spread more widely among the more junior investment professionals with only c 68% of the carry being allocated to the partners. It may well be that in the UK, in particular, there is a greater recognition of the need to incentivise and retain the more junior investment professionals in a very competitive market place. Offering them a small slice of the carry can help to do this.

Readers wishing to obtain more information on this survey should contact Nigel Mills or Margarita Skripina.

Revised and Strengthened UK Stewardship Code sets new world-leading benchmark

Nigel Mills summarises some of the changes in the new Code and the impact it will have. One key change is that signatories now have to explain their Stewardship approach in their alternative investments such as PE and Infrastructure.

The Financial Reporting Council (the FRC) launched a significant and ambitious revision to the UK Stewardship Code at the end of October 2019. The Code was last updated in September 2012.

The Code was originally introduced to enhance the quality of engagement between investors and companies to help improve long-term risk-adjusted returns to shareholders.

The new Code (the UK Stewardship Code 2020) substantially raises expectations regarding how money is invested on behalf of UK savers and pensioners.

The new Code focuses on protecting the interests of UK Savers and pensioners by seeking to ensure that their money is managed (and invested) responsibly with a new emphasis on creating long-term value and while doing so, considering sustainable benefits for the economy, the environment and society.

The FRC’s Chief Executive, Sir Jon Thompson said “I encourage institutional investors, asset managers and their service providers to sign up to the new Code and demonstrate that they are operating across their businesses to these high standards of Stewardship.”

The new Code contains 12 principles for asset owners and asset managers and six separate principles for service providers. Each principle is supported by reporting expectations which indicate the information which a signatory to the Code should include in its Stewardship Report. The structure is different from that adopted by the UK Corporate Governance Code (which relies on principles and supporting provisions).

The new Code makes it clear that: Environmental, particularly climate change, and social factors, in addition to governance, have become material issues for investors to consider when making investment decisions and undertaking stewardship.

Signatories are now expected to explain how they have exercised stewardship across asset classes beyond just listed equity, such as private equity and infrastructure and in investments made outside the UK.

The Code is voluntary and operates on a comply-or-explain basis. The Financial Reporting Council monitors compliance with the Code.

Whilst the Code is voluntary, there is no doubt that the pressure is on for all UK asset managers to sign up to it, whether it be in connection with their listed investments or their unlisted ones. Asset managers are required under the FCA COBS to disclose the nature of their commitment to the Code or, where they do not commit to the Code, their alternative investment strategy.

It does appear that the very large majority of the traditional UK fund management community have already signed up to the Code. This includes many UK hedge fund managers.
However, there seems to be a large number of PE fund managers that have not yet signed up. We would suggest that those businesses will need to consider doing so.

For further information contact Nigel Mills.

“Does making the rich poorer make the poor richer?” – a new concept or just a misuse of Sir Winston Churchill’s quote “You don’t make the poor richer by making the rich poorer”.

This month, the High Pay Centre (HPC) held an event to talk about pay and the increasing gap in incomes between those at the top and those at the bottom. In recent years, executive remuneration has attracted a lot of attention and is being thoroughly scrutinised by the media. So, can the Robin Hood effect be achieved without sending the economy into a turmoil?

A panel consisting of representatives from the HPC, the Institute for Fiscal Studies, the GMB union and an independent writer/researcher, presented their thoughts on the topic. In this presentation only one side of the coin was discussed – how to make the rich poorer. The panel promoted the idea of wealth re-distribution but failed to identify how this is to be achieved. They also failed to mention the potentially negative effect of government intervention in the economy.

This event has yet again highlighted, that while the HPC was set up to be an independent organisation it is nonetheless politically orientated.

Robert Joyce, Deputy Director of the Institute for Fiscal Studies (one of the speakers) – used the latest available data from HMRC (2014-2015), to produce a report entitled: “The characteristics and incomes of the top 1%”. According to this report, across all income tax payers in the UK, the median tax payer has an income of about £22,000 per year, while at the 99th percentile, taxable income is £162,000. The top 0.1% earn a taxable income of about £650,000 and above.

It is important to understand that the study includes the self-employed, entrepreneurs, business owners, partners and investors. So, the comparison is between salaries in some cases and total income in others. This is a skewed statistic which compares apples with pears and is used as a weapon to back a particular view rather than to offer objective comment on the topic.

Robert Joyce also highlighted, that the dramatic income gap appeared in the period from 1980 to 1990. Since then, the top 1% of earners have continuously pulled away from the rest.

So, could we attribute this gap in incomes between top and bottom to the reduction in income tax rates from 83% in 1979 to 40% in 1989 (for the top rate)? And if so, could the rapid growth in the country’s GDP in that period and subsequently be the result of tax reform and top earners being rewarded for top performance?

The graph below represents the figures for GDP according to the Office of National Statistics:

Sir Winston Churchill said: “For a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”.

In the current general election, campaign wealth re-distribution and change in tax rates are subjects both major parties are addressing. It remains to be seen what the majority of population think.

For more insights on the executive pay please contact Margarita Skripina.