Essential Corporate News – Week ending November 23, 2018

Welcome to Essential Corporate News, our weekly news service covering the latest developments in the UK corporate world.

On November 22, 2018 the Investment Association published its updated Principles of Remuneration (Principles) as a guide to shareholder expectations and good practice and in the belief that if these are followed, engagement on remuneration will be efficient and effective.

Key changes to the 2017 Principles of Remuneration include the following:

• Executive shareholding requirements: The Principles make it clear that unvested shares not subject to a further performance condition can count towards the shareholding requirement set by the company on a net of tax basis, as can vested shares subject to a holding period and/or clawback (for example, deferred shares awarded under an annual bonus schemes or shares vested from a long-term incentive award which are still in the holding period).
• Post-employment holding periods: These should apply for at least two years at a level equal to the lower of the shareholding requirement immediately prior to departure or the actual shareholding on departure. Structures to maintain post-employment shareholdings (such as nominee accounts or employee ownership trusts) should be stated and these requirements should apply to all new executive directors and for existing executive directors at the earliest opportunity (and by the next remuneration policy vote at a minimum).
• Malus and clawback: Remuneration committees need to establish a substantial list of specific circumstances in which malus and clawback can be used (beyond gross misconduct or misstatement of results) and the Principles set out investors’ expectations of the enforcement processes companies should have in place to implement malus and clawback.
• Use of discretion: The remuneration committee is tasked with ensuring it has sufficient power and processes to enable it to exercise discretion and if discretion is not exercised in a particular year, the remuneration committee chair’s report should confirm this.
• Shareholder consultation: While this needs to focus on major strategic remuneration issues, the final proposals should not contain any surprises for investors, who need the complete picture and sufficient information to make an informed voting decision.
• Base pay: The reasons for any increase in base pay should be fully disclosed, justified and appropriate against awards to the wider workforce.
• Pensions: In meeting the 2018 UK Corporate Governance code requirement for executive directors’ pension provision to be in line with the general approach to the employees as a whole, investors will expect this to be the rate given to the majority of the workforce. New executive directors and directors changing role should receive that rate and the contribution rate for incumbent executive directors should be reduced over time to the level of the contribution given to the majority of the workforce. Compensation should not be awarded for this change.
• Annual bonus: Where financial metrics do not warrant a bonus, investors will scrutinise any payment and its rationale to ensure it is warranted, and dividends accrued on deferred shares should be paid in shares.
• Long-term incentives: Generally the payment of long-term incentive schemes in cash or cash equivalents should only be to settle tax, and dividends accruing on vested shares should be paid in shares.
• Restricted shares: In assessing proposed restricted share schemes, investors will consider the context of the company and the strategic rationale. The Principles set out the views of investors in relation to discretion and underpin, holding period/vesting, the company’s previous approach to remuneration and discounts when assessing restricted share scheme proposals.
• Leaver provisions: Those not meeting the “good leaver” criteria should be treated as “bad leavers”. Deferred bonus and long-term incentive awards should be settled in shares and subject to appropriate performance and holding periods. If an individual is expected to retire (and so be a good leaver), the remuneration committee should have appropriate mitigation clauses in case the director takes on another executive role.

(Investment Association: Principles of Remuneration 2018, 22.11.18)

On November 22, 2018 the Investment Association wrote to all FTSE 350 remuneration committee chairs outlining key changes in the 2018 Principles of remuneration and highlighting items that investors will focus on at 2019 AGMs.

Issues for 2019 AGMs include the following:

• Investor and remuneration committee relations: Investors are concerned that some remuneration committees do not respond to their concerns or are overly considerate of management’s perspective, at the expense of shareholders’ views. In 2018 there were more votes than in previous years against remuneration committee chairs or members where the remuneration committee’s decisions did not met investors’ expectations. Remuneration committees should consider the wider employee pay context when taking executive remuneration decisions.
• Shareholder engagement: Companies should be satisfied they have been sufficiently transparent in their shareholder consultations so that final proposals do not contain surprises and give the full remuneration picture.
• New reporting requirements: While the reporting requirements in the Companies (Miscellaneous Reporting) Regulations 2018 do not come into force until January 1, 2019 so most reporting against them will start in 2020, companies are encouraged to report their CEO pay ratios in 2019 and to use Option A as this method of calculation is considered the most statistically robust.
• Levels of remuneration: Investors will look closely at how increases in remuneration to executive directors are justified and will expect remuneration committees to show restraint in relation to overall quantum.
• Pay for performance: To justify support for remuneration pay-outs, there should be robust transparency on financial and non-financial targets so that the link between pay and performance can be clearly seen.

(Investment Association: Letter to FTSE 350 remuneration committee chairs, 22.11.18)

On November 19, 2018, Institutional Shareholder Services (ISS) published updates to its UK Proxy Voting Guidelines (ISS Guidelines) for 2019. The updated ISS Guidelines will generally be applied for shareholder meetings held on or after February 1, 2019.

The updates include the following:

• Appointment of external auditors: An additional exception has been added to the general policy of ratifying the appointment of the external auditors where the lead audit partner(s) has been linked with a significant auditing controversy. In such a situation, where that lead audit partner(s) is engaged in the audit for other public companies, this track record will be raised by ISS for investor attention, even if no issues of concern have been identified at the subject company.
• Director elections: In listing the extraordinary circumstances where ISS will consider recommending a vote against individual directors, the ISS Guidelines have added the circumstance of egregious actions related to a director’s service on other boards that raise substantial doubt about that individual’s ability to effectively oversee management and to serve the best interests of shareholders at any company. In addition, ISS may now recommend a vote against the re-election of a director if there have been repeated absences (less than 75 per cent attendance) at board and committee meetings that have not been suitably explained and this will apply to all directors, not just those with multiple outside directorships.
• Remuneration policy: Target bonuses should typically be set at no more than 50 per cent of the maximum bonus potential and share awards should be subject to a total vesting and holding period of five years or more in line with the recommendations of the 2018 UK Corporate Governance Code.
• Remuneration report: When there has been a material decline in a company’s share price, the ISS Guidelines recommend that remuneration committees should consider reducing the size of long-term incentive plan awards at the time of grant. In addition, fees payable to non-executive directors should not be excessive relative to similarly sized companies in the same sector.
• Authorisation of issue of equity with and without pre-emptive rights: The current ISS Guidelines state that if a company receives approval to disapply pre-emption rights up to 10 per cent and then is considered to have abused the authority during the year in a manner not in line with the Pre-Emption Group’s Principles, then ISS is likely to recommend a negative vote on share issuance authorities at the following AGM. In the revised ISS Guidelines, the restrictive language “during the year” has been removed so that the company’s practice over multiple years can be considered and it is made clear that an against recommendation could potentially be applied to all share issuance authorities, not only those relating to a disapplication of pre-emption rights.
• Social and environmental issues: It is made explicit that significant controversies, fines, penalties or litigation are considered when ISS evaluates social and environmental shareholder proposals.

(ISS: 2019 Proxy Voting Guidelines updates and process, 19.11.18)

On November 14, 2018, Glass Lewis published its updated 2019 Proxy Paper Guidelines (Glass Lewis Guidelines).

The changes to the 2018 Glass Lewis Guidelines include the following:

• Board and committee responsiveness: Where appropriate, Glass Lewis may hold chairs and members of the relevant committees accountable via a recommendation against their re-election where it is felt that the response to shareholder concerns has fallen below a qualitative threshold.
• Board skills: In analysing election and re-election proposals at FTSE 100 companies, Glass Lewis assess disclosure of directors’ skills. FTSE 100 companies are expected to provide a robust, meaningful assessment of the board’s profile in terms of diversity and skills in line with developing best practice standards.
• Board diversity: Glass Lewis make it clear that they will take into account disclosed gender paygap data and the composition of the executive pipeline when assessing diversity concerns at board level in relation to FTSE 350 companies.
• Environmental and social risk oversight: Glass Lewis have codified their approach to reviewing how boards are overseeing environmental and social issues. They believe that inattention to material environmental and social issues can harm shareholder interests and so should be carefully monitored and managed by companies. For large companies, and in instances where Glass Lewis identify material oversight issues, they will review a company’s overall governance practices and identify which directors or board-level committees have been charged with oversight of environmental and/or social issues. They will also note instances where such oversight has not been clearly defined by companies in their governance documents. They may consider recommending that shareholders vote against members of the board who are responsible for oversight of environmental and social risks in certain circumstances or, in the absence of explicit board oversight of environmental and social issues, Glass Lewis may recommend that shareholders vote against members of the audit and/or risk committee responsible for overseeing risk exposure.
• CEO pay ratio: Glass Lewis note that while they believe the new CEO pay ratio reporting requirement has the potential to provide additional insight when assessing a company’s pay practices, they will not base voting recommendations solely on such ratios in and of themselves.
• Executive remuneration: Glass Lewis make it clear that they will specifically assess the realised pay received by a company’s top executives over at least three years when evaluating the link between pay and company performance.

(Glass Lewis: 2019 UK Proxy Paper Guidelines, 14.11.18)

On November 21, 2018 HM Treasury published explanatory information on the draft Official Listing of Securities, Prospectus and Transparency (Amendment) (EU Exit) Regulations 2019. The draft Regulations are still in development and will be published in the due course. Their aim will be to address deficiencies in the Prospectus Directive and Transparency Directive as a result of Brexit, and they form part of planning for a no-deal scenario. As a result, the changes in the draft Regulations will not take effect if there is an implementation period after March 29, 2019.

The draft Regulations will maintain, as far as possible, the current effects of the prospectus regime, the transparency rules and the listing rules but make a number of changes, including the following:

• Issuers wishing to access the UK’s capital markets for offers to the public or admissions to trading on a UK regulated market will have to have their prospectus approved by the Financial Conduct Authority (FCA), irrespective of whether the prospectus has already been approved by a national competent authority of an EEA member state. This means EEA states and EEA issuers will be treated in the same way as other third countries and their issuers with regard to approving prospectuses. Prospectuses passported into the UK before exit day may be used in the UK until their validity expires. Prospectuses that have expired already will not be eligible for use in the UK.
• Current exemptions from the requirement to produce a prospectus which apply to EEA member state public sector bodies will be extended to certain third country public sector bodies and international bodies of which a state is a member;
• Technical assessments of the prospectus regimes of third country jurisdictions will be undertaken by the FCA and equivalence decisions in respect of those jurisdictions will be made by HM Treasury.
• In a no-deal scenario, HM Treasury will issue an equivalence decision before exit day determining that EU-adopted IFRS can continue to be used to prepare financial statements for Transparency Directive requirements and for preparing a prospectus under the Prospectus Directive. This will enable issuers registered in EEA states with securities admitted to trading on a regulated market in the UK or making an offer of securities in the UK to continue to use EU-adopted IFRS when preparing consolidated accounts. Issuers will also be able to prepare financial accounts under EU-adopted IFRS for financial years beginning before exit day but the UK will keep this decision under review.
• Provisions in UK legislation which make reference to co-operation and information sharing with EU authorities will be removed. Instead, information sharing with EU authorities will occur on a discretionary basis under the existing UK framework for information sharing with third countries.

The explanatory information also notes the Government’s intention to domesticate the remaining provisions of the Prospectus Regulation which apply from July 2019.

(HM Treasury: draft Official Listing of Securities, Prospectus and Transparency (Amendment) (EU Exit) Regulations 2019 explanatory information, 21.11.18)

On November 21, 2018 HM Treasury published explanatory information on the draft Market Abuse (Amendment) (EU Exit) Regulations 2018. The draft Regulations are still in development and will be published in the due course. They are intended to address deficiencies in retained EU law relating to market abuse to ensure that it continues to operate effectively following the UK’s exit from the EU and they form part of planning for a no-deal scenario. As a result, the changes in the draft Regulations will not take effect if there is an implementation period after March 29, 2019.

The deficiencies addressed include the following:

• UK MAR will capture conduct related to instruments admitted to trading or traded on both UK and EU trading venues.
• UK MAR will retain EU MAR’s notification requirements for issuers to report certain information to the relevant national competent authorities. UK MAR will also retain the requirement that firms and venues located in the UK provide suspicious transaction and order reports to the Financial Conduct Authority (FCA).
• Under UK MAR, the European Securities and Markets Authority’s powers and functions will be transferred to the FCA to enable it to enforce MAR to the extent necessary for a functional UK regime.
• Provisions which make reference to cooperation and information sharing will be removed. It is stated, however, that this will not prevent UK supervisors from sharing information with EU authorities where necessary, as the existing domestic framework for cooperation and information sharing with countries outside the UK allows for this on a discretionary basis.

(HM Treasury: draft Market Abuse (Amendment) (EU Exit) Regulations 2018 explanatory information, 21.11.18)

On November 20, 2018 the Financial Reporting Council (FRC) published a call for feedback to support its review of the 2016 changes to ethical and auditing standards to implement the EU’s Audit Regulation and Directive. The FRC is consulting with stakeholders to determine how effective the changes have been in delivering high quality audit, and whether further steps are now needed to strengthen auditor independence, reduce conflicts, improve quality and preserve trust in independent audits. Among others, the FRC are seeking views in relation to the following matters:

• Are the ethical principles and supporting specific requirements sufficiently clear and are the ethical principles and supporting specific requirements sufficiently proportionate for public interest entities and non-public interest entities?
• What difficulties have been faced in complying with the ethical principles and supporting specific requirements?
• Would user confidence be strengthened if the FRC required the application of the independence requirements of the FRC Ethical Standard to all components of a group audit?
• Are current restrictions on non-audit services sufficient to address threats to independence, objectivity, integrity and audit quality, and address stakeholder expectations?
• Should there be further restrictions, or an outright prohibition, on non-audit services, and should the current derogation allowing for the provision of certain non-audit services where these have no direct effect or an inconsequential effect (where indirect) on the financial statements be maintained?
• Should further steps be taken to increase the value of extended auditor reporting to users of financial statements, and if so, what additional material should be included in auditor’s reports?
• Are auditor’s responsibilities in respect of other information sufficient and should auditors undertake additional work?

The FRC requests comments by February 15, 2019.

(FRC: Call for feedback on 2016 audit standards changes to implement the Audit Regulation and Directive, 20.11.18)

(FRC: Call for feedback on 2016 audit standards changes to implement the Audit Regulation and Directive press release, 20.11.18)