Latest Guidance On Remuneration From The FSA And ABI

Remuneration, in particular in relation those in the financial services sector, has remained a hot topic since the first banking crisis in 2007 and has attracted much attention from politicians and newspaper editors alike.

Recently the spotlight has been expanding, and in addition to the financial services sector, executive remuneration in companies has very much been the focus for 2011.

Companies are not short of guidance as they begin to prepare for this year’s bonus round! The Association of British Insurers (ABI) published its new guidance on executive pay on 29 September 2011, shortly followed by the Financial Services Authority’s (FSA) revised “Dear CEO” letters providing guidance on issues relating to remuneration. The Department for Business, Innovation and Skills (BIS) published a discussion paper on executive remuneration in September.

 A few of the headline points that you might like to think about when considering the bonus round this year are outlined below.

Quantum

Perhaps as a result of press attention, the ABI has focussed more than ever on the quantum of executive pay. Some key points are as follows:

• Both the Government and the ABI have acknowledged that they support generous rewards for exceptional performance. However, there must be a clear link between those rewards and corporate performance. In particular the long term success of the business;
• ABI guidance echoes the FSA message that a key factor in considering remuneration policies should be the promotion of sound risk management and that the Remuneration Committee should be considering remuneration in the context of the finances of the company, its profits and its investment and capital needs;
• Of particular note in relation to the quantum of remuneration in today’s climate of low share prices is that companies should take measures to ensure that, where share or option grants are expressed as multiples of salary, they are managing the risk of windfall gains in circumstances where the share price of the company recovers dramatically prior to vesting;
• When making remuneration decisions, the ABI have branded as “crude” the common practice of justifying salary or bonus increases simple to match the “median” in simple benchmarking exercises against peer companies. Instead the ABI advise companies to use these benchmarks as a point of reference to determine the appropriate remuneration for a specific job, and to be mindful of the principle of paying no more than is necessary;
• Companies should bear in mind the remuneration of other members of staff when considering executive remuneration; and excessive remuneration and “reward for failure” should be avoided.

Performance Measures

Bonuses should be clearly linked to business targets. Performance targets:

• Should be set at the start of the bonus year;
• Should be quantifiable; and
• Can be financial and non-financial.

In relation to the long-term incentives, the ABI and the Government have emphasised the need for careful tailoring when using performance measures such as total shareholder return (TSR) relative to an index or peer group. The Government also suggested that shareholders welcome measures directly linked to company strategy used in addition to TSR and/or earnings per share (EPS).

The ABI emphasised that the practice of “retesting” performance conditions (most common in relation to long-term incentives) was unacceptable. However, if the business has suffered an exceptional negative event, payment of annual bonuses is discouraged by the ABI even if some specific targets have been met.

Remuneration Structure

• Keep it simple where possible.
• To promote a long-term focus remuneration structures should:
• Contain a high degree of deferral and measurement of performance over the long-term; and
• Contain a careful balance of fixed and variable pay.
• The FSA and ABI both emphasise the importance of personal shareholding or holdings of share linked or capital instruments in aligning the interests of executives with shareholders and stakeholders. The FSA Remuneration Code sets out that for some institutions this must be a minimum of 50% of variable remuneration for staff to whom the Code applies.
• The ABI advises that remuneration structures should not be used to compensate individuals for changes in their personal tax status. Any schemes designed to increase tax efficiency should not result in additional cost to the company.

Clawbacks and “malus”

Clawback is a key focus of the FSA and ABI, clawback provisions seek to avoid executives receiving “undeserved” remuneration.

“Malus” means the use of “downside” adjustments to adequately balance “upside” incentives. Malus must be built into Long Term Incentive Plan (LTIP) rules in order for LTIPs to be included in the FSA Code’s 50% deferral threshold required in relation to variable remuneration. The ABI has now also called for malus to be built into incentive schemes and executives contracts.

“Malus” can be achieved by:

• Making awards subject to risk adjustments;
• Performance conditions which allow the realistic possibility of a zero payout; and
• Specific provision for performance adjustments, for example where:
• There is reasonable evidence of employee misbehaviour or material error; or
• The firm or the relevant business unit suffers a material downturn in its financial performance; or
• The firm or the relevant business unit suffers a material failure of risk management.

Summary

The key messages coming from the ABI and FSA have remained consistent. Remuneration decisions should be focussed on appropriate remuneration and the aligning the interests of executives with those of company stakeholders.