The IA’s updated remuneration principles that will impact Oz companies

The UK Investment Association (IA), has 250 members that manage over £8.5 trillion for clients across the globe. IA recently published its annual update to Principles of Remuneration for 2021 with a covering letter to FTSE remuneration committee chairs.

The IA was the forerunner in establishing “say on pay” and other governance guidelines and will continue to have a major influence on governance standards in the UK and other parts of the world, including continental Europe and Australia.

The principles that are, or may become, most relevant for Australian-listed companies include post-employment shareholding requirements, use of ESG or other non-financial performance measures, and issues to consider in relation restricted share plans.

Post-employment shareholding policies

Post-employment shareholding requirements is a significant practice in the UK, as it is in the US. It features in the UK Corporate Governance Code. We note that post-employment holding requirements are gaining traction also in Europe.

We suspect it is only a matter of time before it investors will lobby for it in Australia.

The IA considers that the post-employment shareholding requirement 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.

Whilst this principle has featured in the IA’s previous versions, it has now been clarified that the remuneration committee should state the structures or processes it has in place to ensure that post-employment shareholding policies are enforced after a director has left the company.

Use of non-financial performance measures

This is a new principle, and whilst the IA are clear that they do not seek to prescribe or recommend any particular approach to variable remuneration, it may still influence remuneration committees’ thinking going forward.

The IA’s principles state that remuneration committees should consider including strategic or 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. In each case, the link to strategy and method of performance measurement should be clearly explained.

To an extent, the IA is reflecting what is already a significant market practice. Our forthcoming GECN Group research report may surprise as to the extent non-financial incentive measures are applied globally, and how Australia fares.

This is in line with our own checklist for ESG measures published recently, see HERE.

Restricted shares

No change from previous principles, but still relevant for Australian companies which consider using restricted shares for more effective ownership alignment.

With several listed companies in UK having moved from LTIPs to restricted shares in recent years, the IA’s principles point out the following tissues that are important for remuneration committees to consider:

  • Strategic rationale: Investors assess proposed restricted share schemes on a case-by-case basis, paying particular attention to the context of the company and the rationale articulated when deciding on the appropriateness for a particular company. For example, the impact of commodity pricing or a cyclical business model could make restricted shares appropriate.
  • Discretion and underpin: It is important for remuneration committees to have the ability to exercise discretion on vesting outcomes. This will allow the remuneration committee to guard against payment for failure. committees should confirm they have reviewed the vesting outcomes and should provide an explanation as to why a level of pay-out is appropriate, and how such a decision was reached. Some shareholders have expressed a preference for a quantitative underpin to be achieved prior to any award vesting. This should be resisted, as it makes such grants much more like an LTI, and moves away from an ownership principle.
  • Vesting and holding periods: Investors are largely agreed that the preferred vesting period for restricted share schemes is at least five years. In addition, the company’s shareholding requirement should be significant and require a post-retirement shareholding requirement of at least two years.
  • Previous approach to remuneration: In deciding on whether to support the introduction of a restricted share scheme, investors will factor in a company’s previous approach to remuneration. In particular, they will compare the previous pay-out levels to historic company performance and reflect on the level of trust they have with the remuneration committee when assessing any proposals.
  • Discount: If a company is moving from an LTIP to a restricted share model, the remuneration committee should consider the appropriate discount to award levels. This is to reflect that restricted shares have more certain outcomes. Members believe that the discount rate for moving from the LTIP to restricted share awards should be at least 50% and grant levels should be held at this level in future and not gradually increase over time.

Our recent experience in Australia suggests that all of the above issues are relevant also for local institutional investors and proxy advisors if they are to support a restricted share scheme.

The IA’s updated principles can be found HERE.

© Guerdon Associates 2024
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