On 9 October 2024, the UK’s Investment Association (IA) published its updated Principles of Remuneration, representing the first update since 2022, having postponed the 2023 update in order to discuss specific issues with its members. The accompanying press release explained that the 2024 principles have been “simplified to reflect the evolving practices in the market and the expectations of investors”.
The update represents a substantial rewrite, although this is more reflected in a softening in the tone rather than fundamental changes to the principles themselves, with an emphasis that the new principles reflect a set of guidelines rather than a prescriptive list of market practices. Similarities can be seen with the Financial Reporting Council (FRC)’s update to the UK Corporate Governance Code in January 2024, which also removed prescriptive wording and updated its guidance on “comply or explain” reporting.
The IA’s update in context
In February 2024, the IA stated that it intended to carry out a fundamental review of its Principles of Remuneration to reflect evolving expectations of IA members and incorporate feedback from companies. In addition, it noted that it had written a letter to the remuneration committee chairs of FTSE 350 constituents, explaining that the IA had met with almost 100 FTSE companies in September 2023 to discuss its remuneration principles and seek their views on the competitiveness of UK remuneration standards more generally. The IA reported that this feedback, among other things, highlighted challenges that UK companies face in attracting executives and competing more generally in the US market, particularly for larger companies and those that have a significant US presence or US exposure. As a result, some companies sought more flexibility in the IA Principles regarding higher long-term incentive plan (LTIP) opportunities and the ability to make use of so-called hybrid LTIP schemes, which incorporate both performance and non-performance-based rewards (usually shares).
The IA’s decision to review its Principles of Remuneration should therefore be considered alongside the wider competitiveness debates in the UK. The first debate revolves around the competitiveness of UK executive remuneration and calls to ensure that UK companies can attract and retain key talent in light of the larger remuneration packages available in some other markets (particularly the US). Nonetheless, this debate is itself part of a second more holistic debate on the competitiveness of the UK market more generally, and the need to retain companies in the aftermath of a number of delistings from the London Stock Exchange and a paucity of IPOs in recent years. Indeed, the question of whether executive remuneration is a main reason for the UK’s recent competitiveness concerns, one of a myriad of factors, or merely ancillary to other, more important considerations (such as the depth of US capital markets compared to the UK) has long been discussed among the issuer and investor communities. These debates, which are discussed in more detail in A Mid-season Review of the Ongoing UK Executive Remuneration Debate, have continued to influence regulatory developments in the UK market in recent months, including the update to the Financial Conduct Authority’s Listing Rules in July 2024.
The main changes to the IA’s Principles of Remuneration
It is against this backdrop that the IA decided earlier this year to update its Principles of Remuneration, with the objective of reflecting evolving market practice. Since this initial decision, the 2024 AGM season has taken place, which saw some companies incorporate hybrid plans into their remuneration policies. These plans have long been utilised by many UK companies below the board level. However, unlike in the US, they have rarely been proposed for the remuneration structures of Executive Directors.
The IA’s Principles of Remuneration have traditionally been used as the guide to UK best market practice. Consequently, as the IA did not publish its principles until after the 2024 AGM season, much of the investment community were not able to utilise them to support their own approaches to the new hybrid plans being proposed by some companies. Some of the hybrid plans put forward in 2024 have received significant levels of shareholder dissent, including at the AGMs of Smith & Nephew, Spirent Communications and Ashtead Group.
In the foreword to its updated principles, the IA reflects on the 2024 season, which it notes saw some companies put forward remuneration proposals that differ in structure and quantum from what are seen as UK norms. However, many of these were supported by investors during the season following constructive engagements with companies.
In addition, it highlights that it believes some stakeholders had considered past versions of its principles to be formulaic. The IA therefore reiterates that its guidance “should not be read as a prescriptive set of rules but rather an approach which is commonly accepted as appropriate for the majority of companies”. This has been reflected in the changes made to the general tone of the principles. Moreover, this echoes some of the feedback received by the FRC in its own update to the UK Corporate Governance Code, with some commentators emphasising that the “comply or explain” principle – traditionally the cornerstone of UK corporate governance – had in practice devolved into a “comply or else” situation, with some investors interpreting the UK Code as a formulaic set of rules.
It is also worth noting that, in general, the principles now place more emphasis on the importance of dialogue and engagement between companies and their investors. Its language also allows companies more flexibility to diverge from UK market practice, provided that “a suitably comprehensive explanation” is given.
Outside of the general tone of the principles, one of the most notable additions is new guidance on hybrid LTIPs. The IA notes that companies should follow the same guidance as a standalone performance share plan or restricted share plan (RSP), and that the RSP element “should be discounted to reflect the lower risk and higher certainty involved”. It is also noted that, although the language surrounding the discounting of award size when a company moves from a performance-based award to an RSP has generally been softened, the IA still suggests that this discount typically remain at 50%. Finally, the IA expects the vesting period for hybrid schemes “to be at least five years, with no accelerated vesting or early release of shares”. This is at odds with some of the hybrid plans proposed during the 2024 AGM season, which allowed for staggered vesting schedules of less than three years.
Bonus deferral guidance has also been softened in line with the general trend discerned during the season that deferrals have been reduced, or even removed entirely, if Executive Directors have already met their shareholding requirements.
There are also various other deletions and amendments. For instance, in relation to total remuneration, the new principles state that they “do not seek to prescribe any particular remuneration structure or quantum”, whereas the previous 2022 principles called for “restraint in relation to overall quantum”. In addition, the updated principles do not mention the previous 5% dilution limit for discretionary awards. Nonetheless, the overall 10% limit for all share awards has been retained. However, as of yet, it is unclear whether the removal of specific elements of text is due to the IA’s decision to simplify its approach to the principles, whether it believes that these practices are already covered by other relevant guidance (e.g., the UK Code) or are no longer relevant to the UK market.
The IA’s Principles of Remuneration and the future of UK market practice
On balance, the IA’s review has resulted in a set of Principles of Remuneration that are more flexible and less prescriptive than previous iterations. The general tone has softened, which in practice will likely allow companies more room for manoeuvre in the formulation of their own remuneration structures than before. Nonetheless, many of the previous tenets of UK best practice still remain – such as the five-year combined vesting/holding schedule and Executive Director salary increases being in line with the wider workforce – albeit couched in less stringent language. As a result, it is yet to be seen if this simplification of the IA’s principles will have a material effect on how UK companies approach executive remuneration in the future.
By: Tom Inchley
