Executive remuneration is a hot topic for companies seeking to comply with UK regulation, guidance and codes, whilst still attracting the right calibre of board member; and for executives when negotiating, both on the way in and when leaving a company, to ensure that they maximise their pay out.
Increasingly, it is also a hot topic in the press and in some sectors watched closely, not just by activist shareholders, but also by politicians, as was evident in the context of the recent departure of Alison Rose from Natwest, forced out overnight, by direct political pressure from the Prime Minister and others. Questions are being asked openly in the press about her termination entitlement, pending the outcome of the ongoing independent investigation.
As a result, both companies and high-profile executives, especially in public companies, are increasingly seeking strategic, legal, regulatory, and PR advice in navigating this complex matrix.
This article also addresses the remuneration aspects to consider in the light of the new Financial Services & Markets Act 2023 which, though aimed at larger listed companies in the UK with a UK Listing, has a much farther reach, and in practice influences all companies that wish to champion good practice and drive culture change.
Whilst the language differs depending on the type of firm we are talking about and whether they are FCA, PRA, or dual regulated, the key terms apply in most contexts, including in private companies, and PE backed companies. Most executives will have a combination of fixed and variable remuneration. The key difference between these two is that fixed remuneration will normally reflect an individual’s professional experience (prior to joining) and organisational responsibility, as set out in their job description and terms of employment. It should be permanent, pre-determined, non-discretionary, non-revocable and not dependent on performance. Any terms of a proposed service agreement that weaken these characteristics, demand careful scrutiny, before signing the deed and commencing employment. Indeed, the phrase “rewarding failure” is often deployed inaccurately in this context, as an executive with 12 months’ notice, who receives full payment for that period, is not being rewarded for failure, but rather, is receiving their contractual entitlement and unless a company has grounds to dismiss summarily, it would be in breach of contract, if it were to withhold payment.
Often as valuable, if not more so, is variable remuneration, which is commonly dependent on company and individual performance and should reflect the executive’s long-term performance and performance in excess of their job description and terms of employment. When assessing performance to determine the amount of variable remuneration to be paid to an executive, financial as well as non-financial criteria should be considered. These criteria should be transparent and available at the beginning, which can create tension in a fast-moving hire situation. For example, it may be that an incoming CEO will be expected to build their board and develop these criteria (with their non-exec colleagues) and find themselves taking something of a leap of faith at the stage they sign their service agreement and resign from their current role, when the most valuable elements of their package have not been clearly defined.
These are issues which must be carefully negotiated, normally at speed, and advice can prove very valuable during this period. Examples given by the FCA of non-financial criteria include adherence to (or promotion of) a firm’s risk management and compliance policies and achieving targets relating to ESG factors and diversity and inclusion (D&I). In the current febrile climate, we are increasingly seeing calls for companies to consider what rights they have to clawback variable remuneration (including bonus payments) both on termination and in on going situations when dealing with adverse press that is affecting the confidence placed in an executive and undermining their power to lead. Scrutiny is required in such situations, considering express and implied terms. In this context, arrangements which make it clear which sums relate to which elements of performance can be fertile ground for negotiation of the size of the clawback.
Guaranteed variable remuneration sounds like a contradiction in terms and is normally only relevant at the beginning of the relationship, as a sign-on bonus or “golden handshake”. It can be used to compensate an executive where they have lost the opportunity to receive variable remuneration by leaving their previous employment during the performance period. For this reason, these awards are also sometimes referred to as “lost opportunity bonuses”. The company will expect evidence of the lost opportunity and the quality of the guarantee must be carefully considered, especially in an environment where senior level redundancies are not unheard of, even in the first two years after a strategic move. This must be handled sensitively, especially where the current employer is unaware of the potential move, which may be market-sensitive.
The other key area for careful consideration is performance adjustment or ex-post risk adjustment, which is a reference to the process and mechanisms through which a firm adjusts a founder or other executive’s variable remuneration, including the deferred portion and awards made under long–term incentive plans (LTIPs) and buy outs. The adjustments take account of the financial situation of the company/firm as a whole and the performance of the firm, the business unit and the individual concerned.
A firm may adjust variable remuneration in response to a specific crystallised risk or adverse performance outcome, including in accordance with a malus arrangement under which unvested, deferred variable remuneration is reduced or a clawback arrangement under which an executive is required to repay amounts they have received. When moving into a more senior role or into financial services for the first time from a different sector, it is important to understand what can be reduced, or even clawed back from monies or shares already received and vested.
An LTIP generally refers to an arrangement under which an employee can be awarded shares in a firm or its parent company at no cost, subject to a period of continued employment and performance. Frequently such awards are severely curtailed or lost completely on exit and are viewed therefore as part of an overall compensation package that in the most advantageous circumstances also includes an STIP, a cash bonus and a designated sum for pension or a pension contribution, depending on whether the relevant cap has been reached.
Finally, a buy-out award involves a firm compensating a new employee or “buying out” their previous contract with another employer, where the deferred variable remuneration of the executive was reduced, revoked or cancelled by the previous employer. This could be because they terminated their contract or because the employee has to pay back some money, for example where the employer has paid for a training course or qualification that was attached to a retention clause.
By contrast, a retention award is a bonus that is dependent on a senior executive remaining in a role until a defined event or for a set period. They can be used during restructurings, in wind-down or in the context of specific projects within a firm, for example. A firm may make payment of a retention award dependent on the relevant individual meeting certain performance criteria that have been defined in advance.
The role of the Remuneration Committee is key to these issues. It must ensure that the remuneration policies support the purpose, long-term strategy, and values of the company/firm, whilst also being mindful of the prevailing economic environment. In a public company it will not be possible to deviate from the published policy, including on termination, so scope for negotiation will be limited. The FCA wrote a Dear Remuneration Committee letter to the Chairs of level one banks, building societies and PRA designated investment firms this time last year to reinforce its published strategy 2022 to 2025, which sets out its focus and the outcomes it is seeking to promote through its rules and guidance.
The themes of that letter resonate more widely and are interesting to note, including a focus on driving positive cultural change, of which ESG and D&I are large components. The FCA clearly state that remuneration and incentives have a part to play in supporting diversity and recognise that to achieve a strong pipeline of diverse talent, better data will be important.
One year on, as hybrid work continues and a debate rages about getting employees back into the office, initiatives such as making bonuses dependent on a 4 day office week and other strategies that may adversely affect careers of both sexes, are trialled, it is interesting to note the FCA comment that the Chairs of the committees in these largest financial services firms, “may wish to review how remuneration policy takes into account some of the risks that an employee’s working preferences negatively influence their remuneration”.
The FSMA 2023
It seems extraordinary that the FSMA is now 23 years old! The new FSMA 2023 brings in significant reform to the UK financial services sector to address issues arising from Brexit. The broader scope of the changes brought in by FSMA 2023 is beyond the scope of this article, but sections 25 to 28, which come into force on 29 August 2023 via commencement regulations, have the ability to affect executive remuneration in financial services. These sections introduce a new growth and competitiveness secondary objective, for the PRA, which the PRA has said will affect the way it makes rules and could be significant for the direction of travel of executive pay in financial services.
In its Business Plan for 2023/24, the PRA states that it will look more broadly at the ways in which it can facilitate competitiveness and growth, taking advantage of the additional opportunities afforded by FSMA 2023 to review areas of policy that have previously been fixed in UK legislation. The PRA has plans to take action to facilitate competitiveness and growth in a range of areas, including remuneration, which it intends to develop further following its international conference in September. It will be interesting to see how this (along with the more widely canvassed review of the cap on bankers’ bonuses) develops and whether there will eventually be a wider trickledown effect to firms in other sectors.
Executive remuneration is at an interesting place in the UK, post Brexit. It bears the weight of political scrutiny, even as all parties recognise the value of the City and UK financial services to the economy as a whole. Ultimately, it is a matter for negotiation between individuals and their employers, where knowledgeable advice is indispensable, especially for those looking to innovate to attract and retain whether as an executive acting on their own behalf or as the incumbent board.