UK: ABI Guidelines 2005: What´s New?

Last Updated: 17 January 2006
Article by Rory Cray

The ABI has made available on its website (www.abi.org.uk) its revised 2005 guidelines: ‘Principles and Guidelines on Remuneration’. The revised guidelines were approved by the ABI's Investment Committee on 14 December 2005. We have set out below a summary of the main changes to the guidelines. This year several of these changes were flagged in a paper published by the ABI in July 2005 - ‘Developments in Remuneration’.

Overall, the changes do not indicate any major new developments in institutional investors' thinking on remuneration issues, but they do demonstrate:-

institutional investors' continuing ‘drill-down’ on detail, particularly in relation to the performance conditions applied to incentive plans; and

the continuing emphasis on Remuneration Committees to consider the appropriateness and the application of performance conditions.

This is perhaps not unexpected given recent trends towards greater proportions of total remuneration being paid via annual cash bonus or ‘free share’ incentive plans (Performance Share Plans/Share Matching Plans). In these plans, the performance conditions are the primary determinants in delivery of value, whereas with traditional share options, there is an underlying requirement for share price growth in order to create value.

Remuneration Committees (‘RemCos’)

  • RemCos and Performance Conditions

Changes to the guidelines re-emphasise the RemCo's role in setting and monitoring performance conditions for incentive plans:-

    • Where companies review incentive plans, the guidelines now provide that RemCos:

    ‘should bring independent thought and scrutiny to the review process together with an understanding of the drivers of the business which contribute to shareholder value’

    This appears to be a steer towards RemCos giving particular consideration to performance conditions in any new proposals, and to consider how the proposed performance conditions balance the interests of shareholders with the requirements of executives to have a ‘clear line of sight’ to targets that they consider relevant.

    • The guidelines also stress the need for RemCos to be involved in monitoring the outcome of performance conditions. A new guideline makes clear that RemCos are responsible for monitoring fulfilment of annual bonus performance metrics (liaising with the Audit Committee where appropriate). Similarly, a further new guideline recommends that on the vesting of share awards, RemCos should satisfy themselves that the vesting achieved accords with the initial objectives of having performance conditions that are robust, demanding and linked to the achievement of enhanced shareholder value.

  • RemCos - Further requested disclosures

The new guidelines contain three requests for further or expanded Remuneration Report disclosures.

    • On annual bonus plans, the previous version of the guidelines included a request for Remuneration Reports to contain an explanation of the performance metrics that will be applied to the current year's bonus plan, and also an analysis of achievement against the performance metrics for the year just ended if a bonus has been paid. The new guidelines repeat this request, but also clarify that the disclosures in respect of the current year's bonus should explain what are the corporate and personal measures that apply.

We expect that there will continue to be sensitivity concerning annual bonus disclosures, particularly in relation to disclosure of personal objectives and also disclosure of performance against past years' targets that are often based on business plan budgets.

    • In relation to share plans, RemCos are asked to give a statement as to whether the operation of share plans has been reviewed in the past year, with particular emphasis on how discretions have been exercised and whether grant levels and performance conditions are considered to remain appropriate.

    • A new principle makes it clear that where RemCos depart from their published policy in respect of exceptional ‘recruitment or retention arrangements’, a full explanation including the details of the arrangements and the rationale must be given to shareholders.

It is already a Listing Rules requirement that where a company establishes a ‘Long-Term Incentive Plan’ without express shareholder approval in these contexts, the next Remuneration Report should give details comparable to those that would be given in a shareholders' circular for a general meeting. However, clearly the ABI and its members are giving all such special recruitment and retention arrangements more focus, even where they may be annual bonus based, and outside the scope of the Listing Rules requirements.

Pensions

The revised guidelines do not significantly expand on the ABI's previously expressed position on pensions:-

  • the ABI's clear position is that companies should not seek to compensate executives for the imminent tax changes to the pensions regime from ‘A-day’;
  • companies should consider whether performance based remuneration may be more appropriate than pension benefits given the relatively high costs of pension provision and the lack of specific performance linkage; and
  • changes in pension provisions should be fully explained and justified.

However, in the introduction to the new guidelines, the ABI makes clear that:

  • it expects companies to be addressing any appropriate structural changes to remuneration packages as a consequence of ‘A-day’; and
  • policy intentions in this respect should be disclosed in Remuneration Reports.

Share Plans

  • Share Appreciation Rights
    • The new guidelines make it clear that the ABI expects companies to apply the guidelines to all share-based plans, including cash-based ‘phantom’ plans and plans that provide rewards by delivering a number of shares for nil cost that have a market value equal to any option gain (‘share-settled share appreciation rights’).

    • The new guidelines also make clear that where a company grants share-settled share appreciation rights and will issue new shares to satisfy these, at the point of grant the normal 10% and 5% dilution limits will apply to the full number of shares by reference to which the option gain is to be calculated. However, there may still be scope to count only those shares actually issued at exercise of the award towards the dilution limits, adding back in the remainder.
  • Performance Conditions

The largest number of changes in the new guidelines are in relation to performance conditions that apply to share incentive schemes:

    • There is a recommendation that the level of awards vesting at threshold performance should not be significant ‘by comparison to annual base salary’. Clearly, the size of awards actually made will impact on this recommendation. For example, if awards are made at, say, a 50% of salary level it might be considered acceptable to have a higher percentage of an award vesting at threshold performance than would be considered acceptable if the initial award is made at levels above, say, 100% of salary.

    • The new guidelines emphasise the ABI's preference for performance conditions to incorporate a ‘sliding scale’ of targets, with a threshold level target for initial vesting, but with full vesting being available only on attainment of ‘significantly greater value creation’.

    • In relation to TSR targets, new guidelines:-

      1. caution RemCos that particular care is needed with small comparator groups. The ABI's concern is that ‘comparative performance will not result in arbitrary outcomes’. What the ABI appears to have in mind here are TSR calculation methods that always set vesting levels by reference to the mid-point between ranked comparator companies, rather than considering how close a company's performance has been to the higher or lower ranked comparator. Within small groups, the vesting range between two comparator companies could be significant.
      2. recommend that, for consistency, TSR calculations for international comparator groups are made in a common currency.

    • In relation to earnings per share targets or other financial measures:-
      1. there is a new guideline focusing on how companies define these measures. RemCos are asked to consider such definitions carefully, to ensure that these will ‘reflect performance of the business on a consistent basis’;
      2. RemCos are also asked to explain (presumably within Remuneration Reports) how a consistent approach to performance measurement is being achieved. This is because the transition to international accounting standards may mean there are changes to reported earnings which do not reflect changes to underlying business performance.
  • The guidelines on ‘leavers’ rights’ have been expanded and reflect what has been ‘state of play’ for the last 12-18 months. In summary:-

    • ‘voluntary’ leavers awards should normally lapse; and

    • if ‘involuntary’ leavers' awards are to vest, the vesting should normally be on a time pro-rata basis and performance conditions should apply.

  • Interestingly, the long-standing prohibition on grants made within a period before retirement has been altered as a consequence of the impending Age Discrimination legislation. Instead, the new guidelines suggest that RemCos continue to consider the extent to which executives could contribute to performance for awards made within 3 years of anticipated retirement when setting grant levels. Also, on an actual retirement, the guidelines recommend pro-rating of awards as well as applying the performance conditions over the original performance period - a ‘wait and see’ approach.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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