Executive briefing – September 2022

New UK Prime Minister – our view on the potential impact upon Executive Remuneration

The result of the Conservative leadership election has been announced today and the UK will soon have a new Prime Minister. The election of Liz Truss will have many policy implications, but we wanted to take a moment to cover the potential impact on executive remuneration in the UK. Our briefing considers the current ‘state of play’ of UK government policy and identifies some of the policy areas that may develop as a result of new political leadership.   

Audit and corporate governance reform

Earlier this year, a paper was published by BEIS (the UK government department responsible for business) titled “Restoring trust in audit and corporate governance”. The paper sets out the Government’s plan for action in relation to reform of corporate audit processes, as well as new corporate governance and reporting requirements. The paper was itself a response to several independent reviews and an earlier consultation paper issued by the Government in March 2021. Although principally focussed on reform of the audit market (following various recent UK business scandals such as BHS, Carillion and Patisserie Valerie), the paper also includes some potentially significant changes that may impact UK corporate governance generally and executive remuneration specifically. The full BEIS paper can be viewed here.

The main proposals to note in the paper regarding executive remuneration are:

• Establishment of a “strong, independent regulator”, the Audit, Reporting and Governance Authority (ARGA), which will replace the existing regulator, the Financial Reporting Council (FRC).
• Extension of the scope of review by the regulator to include all of the annual report, including directors’ remuneration reporting (and any voluntary elements such as the CEO’s or Chair’s reports).
• ARGA to be given powers to direct changes to UK company reports and accounts (this currently requires a court order).
• Extended scope of ‘public interest entities’ (PIEs) to include companies / LLPs with 750 or more employees (globally) and annual turnover of £750 million or more. This new definition will include AIM companies and is likely to extend the level of scrutiny applied to companies caught by the new definition.
• ARGA will also have extended enforcement powers against PIE company directors in respect of their statutory duties.
• FRC invited to consult on how the existing malus and clawback provisions in the Code “can be developed to deliver greater transparency and to encourage consideration and adoption of a broader range of conditions in which executive remuneration could be withheld or recovered, beyond that of ‘gross misconduct’ or ‘material misstatements’”.

Some of the most significant aspects of the proposals contained in the paper (including establishing ARGA) will require legislation by Parliament. However, the draft ‘Audit Reform Bill’ was not tabled for consideration during the 2022/23 Parliamentary session. It remains to be seen when the detail of the draft bill will be published, whether the substance of the existing proposals (which were developed under the Johnson Government) will be honoured, and whether some or all of the proposals are still considered a legislative priority by the new Prime Minister.

FRC next steps

The new regulator, ARGA, cannot be established until the mooted ‘Audit Reform Bill’ is considered and approved by Parliament. In the meantime, the FRC is starting to take forward the substance of the Government’s proposals, as far as its existing mandate will allow it to.

In July the FRC issued a position paper (which can be read here), setting out how it will support the Government’s proposals. This includes an intention to consult upon and publish an updated version of the UK Corporate Governance Code that currently applies to premium listed companies (including the supporting guidance). In particular, the FRC intends to update the Code to ensure that it covers the Government’s goal of “strengthening reporting on malus and clawback arrangements”.

The FRC’s current intention is to consult on the substance of the new Code in early 2023 for application to periods beginning on or after 1 January 2024. This means that UK companies with a December year end should have sufficient time to prepare for any changes contained in the new version of the Code.

Listing Rules and regulatory review

There are also further potential changes on the horizon regarding the Listing Rules and broader financial services reform.

The first relates to a review by the Financial Conduct Authority (FCA) of the UK Listing Rules. The stated purpose of the review is to consider how the rules could be made “more effective, easier to understand and more competitive”. One of the models set out in the discussion paper (and highlighted in the accompanying FCA press release) is to drop the existing two segment approach (premium or standard) and move to a single segment model. Under this new model, “all listed companies would need to meet one set of criteria and could then choose to opt into a further set of obligations”. Comments on the FCA proposals closed during the summer and we now await feedback on those responses and the next steps proposed by the FCA.

Moreover, during the summer, the current Chancellor of the Exchequer (Nadhim Zahawi) announced the publication of the ‘Financial Services and Markets Bill’. This bill potentially gives the Government wide powers to update the UK regulatory regime by revoking existing onshored EU regulation and delegating rule-making powers to the PRA and FCA. As a result, amendments to legacy EU regulations, including FS regimes such as Solvency II, MIFID and CRD V, could be on the agenda for the new Prime Minister.

It is reasonable to assume that the new Prime Minister and Chancellor of the Exchequer (widely tipped to be Kwasi Kwarteng, the current Secretary of State for Business, Energy and Industrial Strategy) will be keen to build on each of these initiatives and improve the attractiveness of London as a venue for business, relative to the Europe and the US markets. This is therefore an area that is potentially ripe for action by the Truss Government.  

UK taxation

This time last year, Boris Johnson and Rishi Sunak were in the processing of announcing increases in personal taxation to help enable significant funding increases for UK health and social care (see our previous briefing here). In order to deliver those proposed increases, the introduction of a new UK-wide 1.25% ‘Health and Social Care Levy’ was announced. Part of the levy was implemented via a temporary increase in National Insurance contributions (NICs) and a stand-alone HSC levy is currently due to take effect from April 2023.

During her campaign to become Prime Minister, Liz Truss has been vocal in her criticism of the increases in NICs/ HSC levy and has pledged to reverse those increases, as well as halting proposed increases in UK corporation tax. It remains to be seen when and to what the extent of any ‘reverses’ might be implemented. The ‘cost of living crisis’ is putting significant pressure on the Government, so it is reasonable to expect an early announcement regarding this, possibly by the new Chancellor of the Exchequer at an ‘emergency budget’ in the coming weeks.

Any changes to personal tax rates are likely to have a material impact upon UK employers, especially if those changes alter the net-of-tax pay for executives and UK employees more generally. Moreover, continuing inflationary pressures mean that remuneration committees will have to carefully consider appropriate salary increases for senior executives. UK inflation recently increased to 10.1% in July and some economists believe it may materially increase further in the coming months. In response, some companies are either bringing their 2023 pay reviews forward or carrying out a second interim pay review for 2022. An alternative or supplementary strategy being utilised by some businesses is to offer a one-off payment to recognise the challenges faced by their workforce, especially for lower paid workers. Companies will continue to receive close scrutiny of any increases to executive pay, especially if it exceeds the general increases for workforce pay.

Remuneration committees may also need to consider potential changes to UK corporate tax rates and the impact that may result on incentive schemes. Some companies calibrate performance metrics on a pre-tax basis and therefore will not be directly by movements in headline CT rates. However, where measures are defined post-tax and targets have been set based on rates that are no longer accurate, committees will need to consider what action (if any) to take. This will require care as the view of executives and investors are rarely the same on this issue.  

FIT Comment: Liz Truss and her supporters have been vocal in their criticism of existing “stale economic orthodoxy” (as personified by the former Chancellor of the Exchequer). It remains to be seen whether this was simply part of campaign rhetoric or potentially signals significant changes to Government policy, including on taxation and economic regulation.

What seems likely is that previous tax rises under the Johnson regime will be reversed at least for the short term, as part of a Government response to inflationary ‘cost of living’ pressures on UK citizens.

The process of consulting on and adopting a new Code by the FRC is not dependent upon Government or parliamentary action, so the current working assumption is that development of a new version of the Code will proceed on the published timetable, for application from 1 January 2024. Companies with a policy renewal in 2024 should bear this in mind as they prepare during 2023.  

It will also be interesting to see what policy changes the Truss-led Government will prioritise in the coming months. Reform to audit and corporate governance regulations have not been a priority in recent years, but that may change, depending upon the new occupants in the Treasury and BEIS.   

We will continue to monitor events and provide regular briefings as circumstances unfold.

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or call us on 020 7034 1111 or email us at Info@fit-rem.com. 

This paper is intended to be a summary of key issues but is not comprehensive and does not constitute advice. No legal responsibility is accepted as a result of reliance on the contents of this paper.

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