United Kingdom

The Eurozone crisis and ensuing populist resentment over perceived compensation excesses have given rise to a recent wave of compensation measures and restrictions in Europe. As we explain in our memo, the measures range from a cap on financial institution bonuses (the so-called “banker bonus cap”) in the EU, binding say-on-pay votes in several European jurisdictions and even criminal sanctions for violating compensation restrictions and corporate governance requirements in Switzerland. Simon Witty, a partner in our London office, explains the key aspects of these developments.

• What is the banker bonus cap?
  
  Under CRD IV, which is slated to go into effect for credit institutions (including banks) and investment firms (such as broker-dealer or wealth management firms) in January 2014, the basic rule is that bonus payments will be capped at 100% of total fixed pay or, with shareholder approval, 200% of total fixed pay. “Shareholder approval” means approval by either 66% of shareholders owning half the shares represented or, failing that, 75% of all shares represented.  The effective bonus cap can go up by up to 25%, if the pay is in the form of long-term deferred instruments (i.e., instruments deferred for a period of at least five years).
  
  But there is a lot more to the banker bonus cap than just the cap. There are, for example, rules on how much of the bonus must be comprised of equity compensation or certain capital instruments, how much must be deferred and for how long, clawbacks, mandatory deferrals or holdbacks for discretionary pension benefits and the collection of information for individuals who are paid €1,000,000 or more in any given fiscal year.
  
  
• Who will the banker bonus cap apply to?
  
  As to which institutions, the cap will apply to all credit institutions and investment firms in the EU.  The non-EU subsidiaries of institutions headquartered in the EU will also be caught, as will the EU subsidiaries of institutions headquartered outside the EU.
  
  For example, if a financial institution is headquartered in London, all of its relevant employees (including relevant employees located in New York or Hong Kong) will be affected, and, even if a financial institution is headquartered in New York or Hong Kong, its relevant employees working for an EU subsidiary will be affected.
  
  As to which employees at those institutions, the cap will not apply to all employees of a particular entity; rather, it will only affect employees whose professional activities have a material impact on the risk profile of the relevant financial institution. Examples of these employees are senior management; risk-takers; employees engaged in control functions; and employees whose total pay takes them into the same bracket as senior risk management and risk-takers.
  
  
• Which companies will be affected by the proposed say-on-pay requirements?
  
  The EU has announced a proposed mandatory EU-wide say-on-pay initiative. The U.K. is expected to implement a binding say-on-pay vote by October 2013, plus other related requirements. Another country that has received significant press coverage is Switzerland – its “Minder Initiative” introduces a binding say-on-pay vote, together with other executive compensation measures, which will come into force by March 2014. Germany and Spain have also announced say-on-pay initiatives, which will likely be binding.
  
  Our current understanding is that these developments will just affect the companies incorporated in those jurisdictions. In contrast to the CRD IV compensation restrictions, which will apply to non-EU financial institutions (at least partially), we do not have any reason to think for now that the say-on-pay initiatives will apply to, for example, U.S. or Hong Kong companies.
  
  
• How will binding say-on-pay work?
  
  In the U.K., the jurisdiction for which there is currently the most information, a binding shareholder vote will be held at least every three years on a company’s remuneration policy report, which is prospective in that it will set out the company’s future policy regarding the compensation (including “loss of office” payments) of directors, including executive directors. A company will continue to have an advisory shareholder vote each year on its remuneration implementation report, which is retrospective in that it will set out how the company’s compensation policy was implemented in the past fiscal year.

We are pleased to announce the publication of Getting The Deal Through – Corporate Governance 2012. Davis Polk lawyers Arthur Golden, Thomas Reid and Sapna Dutta authored the “Global Overview” chapter. 

We note this year that, as the wave of post-financial crisis corporate governance reform continues across the globe, the impact of the significant burdens on the regulators that are responsible for implementing these reforms is becoming increasingly visible. That said, we are also seeing a subtle divergence in the nature of these regulatory efforts in different parts of the world.  In the United States, regulatory efforts have focused primarily on implementation of the Dodd-Frank Act, which continues to require significant time and has resulted in delays in the rulemaking schedule. In contrast, Europe has seen more in the way of new initiatives, including the publication of the European Commission’s Green Paper on a future EU-wide corporate governance framework and the U.K. government’s significant proposals intended to curb executive compensation.

As the year goes on, we expect that U.S. and European companies will continue to experience intense pressure from regulators and shareholder advocacy groups in respect of their corporate governance practices on a number of fronts. It is inevitable that the reaction to the financial crisis of 2008 and the ongoing Eurozone crisis should provoke such severe and prolonged reaction.  What remains to be seen, if, as and when global economic conditions stabilize, is whether or not these ongoing governance reforms ultimately do anything to improve the competitiveness or actual governance of individual companies or the North American or Western European economies, or whether they are simply a series of responses – ranging in nature from remedy to retribution – that may be understandable, but perhaps not efficient in the long term. 

Read the “Global Overview” chapter >

Following closely on the heels of its announcement of a package of proposals  intended to curb executive remuneration, the U.K. Government recently published a consultation paper focusing on the content of remuneration reports of UK-incorporated quoted companies that would disclose the compensation of directors, including executive directors.  While much of the consultation paper simply echoes the announcement, which we summarized in our memo, it is fairly detailed and merits a close read.  Here are selected highlights:

• Remuneration reports would have two parts:
  • A policy report setting out all elements of a company’s remuneration policy and key factors that were taken into account in setting the policy. This part of the report will only be required when there is a shareholder vote on the policy.
  • An implementation report on how the policy was implemented in the past financial year, setting out actual payments to directors and details on the link between company performance and pay.

• The policy report would cover the following six elements:
  • Tabular disclosure of the key elements of pay and supporting information, including how each supports the achievement of the company’s strategy, the maximum potential value and performance metrics (the consultation paper helpfully provides an example in an annex at the end). This table would be accompanied by a narrative explanation of whether the remuneration policy for directors differs from the policy for other employees and, if so, an explanation of why.
  • Information on employment contracts.
  • Scenarios for what directors would get paid for performance that is above, on or below target, presented in graphical form.
  • Information on the percentage change in profits, dividends and overall spending on pay.
  • The principles on which exit payments would be made, including how they would be calculated, whether the company would distinguish between different kinds of departures or the circumstances of any exits and how performance would be taken into account.
  • Material factors that have been taken into account when setting the pay policy, specifically employee pay and shareholder views.
    • While the U.K. Government did consider requiring the disclosure of a CEO-median employee pay ratio, it concluded that this information would not be meaningful and, instead, proposed that the policy report set out information including the percentage increase in pay of the workforce and the percentage increase in pay of the CEO.
    • The policy report would also set out how shareholder views were taken into account in setting remuneration policy.

• The implementation report would cover the following nine elements:
  • Single total figure of remuneration for each director, presented in a specific tabular format disclosing: salary, benefits, pension, bonus, long-term incentives and total.
  • Performance against metrics for long-term incentives, including the following details:
    • What the performance conditions were and the relative importance of each.
    • Within each performance condition, the targets originally set and the potential level of award achievable.
    • For each performance condition, how the company performed against the targets set for that condition.
    • Where the remuneration committee had discretion, how it exercised that discretion.
    • The resulting level of award.

For those elements of pay that were awarded in relation to the financial period being reported on and were subject to deferral, the implementation report would also set out the percentage deferred and whether it was deferred in cash or shares.

• Total pension entitlements (for defined benefit plans).
• Exit payments made in the previous year, with further detail including:
  • The level of compensation received broken down into the key elements.
  • An explanation of how each element was calculated.
  • An explanation of how the decisions made relate to the policy on exit payments.
• Variable pay awarded in the previous year, including the following details for awards made in the current year under long-term incentive plans:
  • Scheme – the type of long-term award (e.g., shares, matching shares, options).
  • Basis of award – calculation of face value (e.g., X times base salary).
  • Face value.
  • Vesting maximum if above face value.
  • Percentage of the award that would vest at threshold performance.
  • Date performance period ends.
  • Summary of performance criteria if not set out elsewhere.
• Total shareholdings of directors.
• Chart comparing company performance and CEO pay.
• Information about who has advised the remuneration committee.
• Shareholder context, meaning:
  • How shareholders voted on both the binding vote and the advisory vote at the previous year’s annual shareholders meeting, set out as a percentage of votes cast.
  • Percentage of shareholder base that abstained.
  • Reasons for significant dissent where known.
  • Action taken by the remuneration committee in response.

• In addition, specified sections of the remuneration report, including the single total figure for remuneration, would be required to be audited.

• The remuneration report would be prefaced by a statement to the shareholders from the Chairman of the Remuneration Committee summarizing the key messages on remuneration and the context in which decisions have been taken.  The proposal declined to prescribe a form for this letter.

• Consistent with the current regime, the proposal would apply to all UK-incorporated quoted companies and would apply to the remuneration of all directors, with the intent that it would be most relevant for executive directors.  The U.K. Government intends to work with the UK Listing Authority to consider whether the requirements of the Listing Rules need to be reviewed.

• The consultation closes on September 26, 2012 and the proposed provisions would take effect for companies whose reporting years end after October 2013.

• These proposed regulations would replace, and not supplement, the existing disclosure requirements of remuneration reports.  Specifically, they would revoke and replace Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (S.I. 2008/410).

Yesterday marked an active day on the corporate governance front. First, the U.K. Government announced “a far reaching package of reform to strengthen the hand of shareholders to challenge excessive pay.” The hallmark of this package is a binding shareholder vote on prospective compensation and exit payments. Other elements include a continued shareholder advisory say-on-pay vote, as well as enhanced disclosure regarding actual amounts of remuneration paid during the prior year.

Second, the SEC finalized its rule requiring listing standards for compensation committees and their advisers, as required by the Dodd-Frank Act. The final rules largely adopt the SEC’s proposed approach, which in turn closely follows the original statutory language. However, there are a few changes, such as narrowing the disclosure requirement regarding compensation consultants, which many had complained as overly extensive. In any event, there is much more to come, as the exchanges must now propose listing standards on several key elements within 90 days of the SEC rule’s publication in the Federal Register, and it is conceivable that they may expand beyond the limited statutory language. There may also be practical implications for companies in terms of possible committee charter amendments and procedures for the committee to consider adviser independence and consultant conflicts.

We will be summarizing both developments in further detail, but wanted to alert our readers in the interest of time.

The U.K.’s implementation of “say on pay” in 2002 is widely considered the harbinger of mandatory “say on pay” in the United States. So far, in both countries, the shareholder advisory vote on executive compensation has been non-binding on companies and their boards. Now, the U.K. appears to be moving toward a binding regime. Earlier this spring, the U.K. government’s Department of Business Innovation & Skills (BIS) published a consultation paper setting out a range of measures, including:

• An annual binding vote on future remuneration policy;
  
  
• An increase in the level of support required on votes on future remuneration policy (up to 75% of votes cast);
  
  
• An annual advisory vote on how the company’s pay policy was implemented in the previous year (same as the status quo); and
  
  
• A binding vote on “exit payments” of more than one year’s salary – with “exit payments” including not only cash severance payments, but also the vesting of equity compensation, continuation of benefits, etc.

How This Differs from Current Practice

Currently, the U.K.’s “say on pay” vote is limited to a shareholder advisory vote on the compensation of the executive directors (by approving the directors’ remuneration report). The vote is retrospective in that it relates to the prior year’s compensation.  Under the proposal, the retrospective vote would remain advisory; however, there would also be a binding vote on future pay, where an affirmative vote would require a supermajority. Companies would be required to propose, at the start of the year, a pay policy for the upcoming year, including potential payouts and the performance measures that would be used. This proposal would then be put before shareholders. If, for some reason, the binding vote were lost, the company would be required to fall back to the last policy to be approved or hold another shareholders meeting so that shareholders could vote on a revised proposal.

To facilitate this binding vote on future remuneration, the U.K. government intends to publish draft regulations later this year, which will prescribe the content of remuneration reports. The regulations are likely to state that the section of the report that discloses the company’s future remuneration should include the following elements:

• The composition and potential level of pay for each individual executive director;
  
  
• How proposed pay structures reflect and support company strategy and key performance indicators;
  
  
• What the performance criteria are, how performance will be assessed and how this will translate into total level of reward for each individual under different scenarios (e.g., on-target and stretch performance);
  
  
• How and why the company has used benchmarks and other comparison data to inform pay levels and structures;
  
  
• How employee pay and views have been taken into account; and
  
  
• How shareholders’ views have been sought and taken into account, including the results of the previous year’s votes on remuneration.

In addition, there would also be a binding vote related to any severance arrangements for an executive director exceeding the equivalent of one year’s base salary. A company proposing to pay a higher amount would be required to provide detailed information explaining the proposed amount, how it was calculated and why it is deserved. This proposal would then be put to shareholders. If the vote were lost, the company would not be able to pay the exiting executive more than the basic limit. Existing arrangements would be required to be amended prior to legislative effectiveness (as noted below, currently slated for October 1, 2013).

What to Expect Next

Already, this spring has been a tumultuous one for U.K. public companies. Three major companies – including, most recently, Aviva, Britain’s largest insurer – have witnessed the departures or imminent departures of their CEOs, in connection with compensation arrangements that drew shareholder ire. And, just before their annual shareholders meeting, Barclays announced that a portion of the bonuses for the CEO and Finance Director would be subject to performance criteria. An unanswered question is whether these developments will serve to embolden shareholder activists, or whether they are Exhibit A that shareholders already have the ability to exert their will in compensatory matters.

As a formal matter, the consultation period closed on April 27, 2012, and our understanding is that a number of market players, including trade and business organizations, have commented on the proposals. The consultation paper notes that the government will consider the comments received and confirm the exact measures it proposes to take forward in primary legislation later this year, subject to parliamentary time being available. 

Subject to the parliamentary process, the government expects legislation on new shareholder voting rights and revised reporting requirements to come into force in spring 2013. These provisions would take effect for companies whose reporting years end after October 1, 2013, and for executive directors whose contracts are terminated after that date; thus, this would impact shareholders meetings held after October 1, 2013.

It is contemplated that, in the first instance, these changes will be adopted via amendments to the U.K. Companies Act (analogous to the general corporation law of many U.S. states). Thus, they would apply to all U.K. public companies (the consultation paper notes that there are over 1,000 U.K.-incorporated companies listed on the London Stock Exchange’s Main Market as of January 31, 2012, plus another 100 or so U.K.-incorporated companies listed on the NYSE, Nasdaq or in a European Economic Area state).

However, given the perceived anti-competitive effect that this could have on U.K.-incorporated companies (who might even seek to redomicile elsewhere), it remains to be seen if any changes along these lines will be implemented more broadly through other means, such as through the requirements of the UK Listing Authority or the index inclusion rules.