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The FRC’s proposed changes to the Remuneration section of the UK Corporate Governance Code: What you need to know

The current UK Corporate Governance Code (“Code”) has been in force since July 2018 and in May this year, the FRC announced a consultation on its proposed changes to the Code. When the consultation closed in September 2023, we thought that the proposed changes would be implemented by the end of 2023. However, as a result of the Government’s focus on reducing so-called “red tape” burdens on companies and of the FRC’s new objective to support economic growth and competitiveness, the FRC has dropped over half of the original proposals. The additional reporting requirements including resilience statements, will therefore not go ahead at this time, but the updated Code is still expected to be published in January 2024, applying to all premium-listed companies with an accounting period starting on or after 1 January 2025.  

It is anticipated that the structure of the Code will remain the same. Section 5 deals with remuneration and the changes which had been proposed showed a desire to create a strong link between pay and longer-term strategy. The proposal included a revised fundamental principle of executive remuneration, namely that remuneration decisions must be clearly aligned to “performance, purpose and values”.
 
The Government had originally tasked the FRC with introducing new provisions to the Code to increase mandatory disclosures by companies into malus and clawback arrangements they have in place, to make them more transparent to investors. Clearly this would also have been of keen interest to executives who could stand to have part of their earned remuneration withheld or clawed back! Currently the Investment Association’s Principles of Remuneration state that “shareholders expect that the Remuneration Committee will set out in the annual report how they intend to enforce malus or clawback, in the event that the mechanism is needed.” Under the new proposals, companies were to be required to describe the malus and clawback provisions in the annual report, covering the minimum circumstances in which the provisions could be used and the minimum period and why the chosen period is best suited for the particular company. On a practical level, full disclosure was to be required of whether the provisions had  been used in the last reporting period and in the last 5 years.
 
However, on 7 November, following the King’s Speech which indicated the focus of the present Government’s priorities for legislation, the FRC made a press release announcing a significant change in its own focus, by way of a wide-ranging policy update. In changing the Code, the FRC is clear that its focus now will be on changes that support and do not hinder the UK’s economic growth and international competitiveness. As a result, most of the changes originally intended have been dropped and will not be developed further. These include modifications to existing provisions around diversity, which may be disappointing to some.
 
The press release did not specifically mention the original proposals to modify and update section 5 on Remuneration, principally to increase reporting obligations on malus and clawback, as set out briefly above, but given the core theme of the announcement, it seems likely that these have been dropped.
 
Nonetheless, we are starting to see more express clauses in directors’ service agreements dealing with malus and clawback, as well as in LTIPs and other documents covering director remuneration and we consider that eventually these will become standard in executive service agreements. There are many points to consider in this context. Some examples we have seen already relate to whether gross or net amounts can be clawed back, the period which can be reviewed (for example, before or  after the accounts have been audited), whether an executive in a high- performing part of the business can suffer clawback if another part of the business, with which they are unconnected, suffers a loss and whether any amounts due from the executive can be clawed back from other unconnected amounts due to the executive, such as cash bonuses.
 
The FRC’s original expressed intention was to implement certain proposals in the UK Government’s paper entitled “restoring trust in audit and corporate governance.” In moving away from that to explicitly support the Government’s latest ambition “to make the UK the best place in the world to start, invest in and grow a business,” what should executives be concerned about?
 
Every time a business fails, or an executive is forced to resign, their exit package comes under scrutiny, including from the investors who supported their leadership. At such times, it will be important for them to know in what circumstances malus and clawback can be exercised to affect their entitlement. The fact that the new UKCGC may not be amended to force companies to report more fully on these issues, should not distract executives from having a razor-sharp focus on such provisions when negotiating their terms.
 
It is expected that the revised Corporate Governance Code (and Guidance on the Revised Governance Code) will be issued in January 2024 and will apply to premium listed companies with an accounting period commencing on or after 1 January 2025. We will provide an update at that time on changes to the Remuneration section.

If you would like to discuss Executive remuneration further or have any questions arising from this article, please contact Partner Merrill April and Trainee Solicitor Mitchell Blythe.

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