UK: Walker Review - The Final Report's Recommendations On Remuneration

Last Updated: 1 December 2009
Article by Nicholas Stretch and Anthony Fincham

On 26 November 2009, Sir David Walker released his final report on his review of corporate governance in the UK financial services sector, which includes a number of remuneration-related recommendations.

There have been a number of further remuneration developments since the publication of the draft version of the report in July 2009. These include the issue of the FSA's Remuneration Code in August, publication of the G20 remuneration standards in September, various banks publicly adhering to the FSA's Remuneration Code and the G20 standards this autumn, and more recently the publication of the Financial Services Bill.

Generally, Sir David's final recommendations generally repeat those set out in the draft report, an analysis of which was provided in our previous Law-Now and can be accessed here. However, his final report makes a few changes to the initial recommendations and sets out more detail on how affected companies need to report pay in bands for relevant employees.

To view the article in full, please see below:



Full Article

On 26 November 2009, Sir David Walker released his final report on his review of corporate governance in the UK financial services sector, which includes a number of remuneration-related recommendations.

There have been a number of further remuneration developments since the publication of the draft version of the report in July 2009. These include the issue of the FSA's Remuneration Code in August, publication of the G20 remuneration standards in September, various banks publicly adhering to the FSA's Remuneration Code and the G20 standards this autumn, and more recently the publication of the Financial Services Bill.

Generally, Sir David's final recommendations generally repeat those set out in the draft report, an analysis of which was provided in our previous Law-Now and can be accessed here. However, his final report makes a few changes to the initial recommendations and sets out more detail on how affected companies need to report pay in bands for relevant employees.

The changes, a brief summary of the relevant provisions of the Financial Services Bill and discussion of where the position is likely to go from here are included in the enclosed article.

Changes to Walker review recommendation on remuneration Who are "high end" employees?

Although Sir David recommended that the remuneration committee should have oversight of all remuneration arrangements within a company covered by his report, he also wanted the remuneration committee to approve the detail of the packages for not just main board directors (the remuneration committee's original focus) but also "high end" employees. The financial crisis had brought to public attention that banks often contained a significant number of employees with remuneration packages more generous than those offered to board members and Sir David also concluded that these needed to be monitored by the remuneration committee for risk-effectiveness.

In his draft report, Sir David said that "high end" employees should be defined as those who earned more than the median Board director. However, individuals whose packages are subject to the Remuneration Code are those individuals who perform a "significant influence function" at the company, or whose activities have, or could have, a "material impact on the risk profile of the entity".

Sir David concluded that there was no good reason for his definition not to dovetail with the one used in the Remuneration Code. Although using the Remuneration Code definition is likely to cover far more individuals than the original group proposed by the Walker report, this is at least a logical change which reflects where the Remuneration Code has now in effect superseded the Walker review.

Disclosure by bands

Disclosure of individual remuneration had been sought by some and feared by many.

Fortunately, Sir David still does not recommend this. However, he continues to recommend disclosure of pay by bands. The draft report left open what those bands would be. There will now be an obligation to disclose the number of "high end" employees whose remuneration falls into bands of £1 million to £2.5 million, £2.5 million to £5 million, and finally £5 million and above. This part of the recommendations will be applicable for UK listed banks (who will still have to disclose individual director pay), who should include broad details of the main elements of salary, cash bonus, deferred shares, and pension contributions and how this balance is earned. FSA-authorised banks that are UK-domiciled subsidiaries of non-resident entities will also have to comply with this obligation.

These disclosures will not be made in the private remuneration report which is made to the FSA. They will have to be made in a separate report under the Financial Services Bill, which will be publicly available (see below) and where the Government has confirmed that Sir David's recommendations on pay disclosure will be implemented by legislation.

These changes will apply at the earliest for remuneration payable in 2011 by reference to performance in 2010.

Structure of remuneration arrangements

One of the most fiercely contested proposals in the draft report had been that the requirement for at least one-half of variable remuneration to be in the form of a long term incentive with vesting subject to a performance condition, with deferral of half of the award for a minimum of three years and the remainder after five years. Short-term variable compensation (i.e. an annual bonus) should be released over three years after the bonus is earned.

These recommendations remain but they are proposed to be given effect by inserting them in the FSA's Remuneration Code giving companies a "comply or explain" choice when reporting on them. In short, this is undoubtedly a dilution of the strength of the original recommendation, but this is perhaps inevitable given that they have not received universal acceptance in the UK or more importantly internationally, and it is therefore premature to promote these vigorously.

These changes will apply at the earliest for remuneration payable in 2011 by reference to performance in 2010.

Financial Services Bill

The Financial Services Bill, (the "Bill") was introduced in the House of Commons on 19 November 2009. Among other things, the Bill is intended to make banking remuneration more appropriate and transparent, with a better link between remuneration and effective risk management.

  • The Bill contains little primary legislation which has an immediate impact on remuneration, as regulations will provide all the detail and these have not yet been published.
  • However, the Bill provides further statutory support for the FSA's Remuneration Code and allows the Remuneration Code to take into account non-risk related matters by allowing implementation of G20 standards.
  • In addition, it provides for regulations to be implemented so that pay packages which breach the Code are not just in breach of the Code but are "void" and for amounts payable under them to be repayable. Here, guaranteed bonuses must be in sight, and this provision gives rise to interesting questions about whether employees will be able to sue under contacts which are affected. However, despite public comment on this point, there are no explicit provisions on clawback for under-performance (and nor is there any assurance that packages already in place will be sacrosanct).
  • In addition, the Bill also provides for disclosure of pay by bands and reporting of remuneration in other ways (see above).
  • The Bill is very wide-ranging and allows regulations to be adopted which affect all authorised persons. Currently, however, there are only plans to use the pay reporting requirements for UK listed banks and subsidiaries of non-UK banks (oddly, the legislation does not seem directed at branches) but there is clearly the potential for extension of these provisions and for political input into these arrangements as they proceed through Parliament with enactment not likely until just before the General Election.

For further details of other aspects of the Financial Services Bill, please click here.

Conclusion

Earlier this year, one would have hoped that by November 2009, the pay jigsaw for financial services would be complete.

However, various pieces are still to be produced. The FSA has still to announce whether and if so how it will require companies outside the largest 26 banks and broker-dealers to adhere to a remuneration code of some sort. In addition, the banks own bonus proposals in early 2010 and continuing media and political pressure are also likely to lead to some further changes, and the FSA and the UK generally are ahead of the game internationally and there is still to emerge a consensus on whether there should be prescription (for example) exactly on how much pay should be deferred and for how long. Various sub-sectors of the industry may indeed emerge with different proposals – remuneration proposals have, for example, recently feature in the latest draft of the Alternative Investment Funds Directive.

While most of the key changes in relation to remuneration are now being included either in the Remuneration Code or the Financial Services Bill, there is also the wider question about how many changes which are to be made to the Combined Code by the Financial Reporting Council will actually become changes made for all companies. One particular candidate here must be the Walker recommendation on greater openness on the ability to make discretionary increases in pension and other provision for directors on termination employment, where there seems very little reason for this to be limited to the financial services sector.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 26/11/2009.

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