Ellason lens on… CMIT’s letter on corporate governance reform

Wed 22, November

Last week, the Capital Markets Industry Taskforce (CMIT) published an open letter on corporate governance reform. The letter, which was supported by representatives from corporate boards and the investment community, advocates changes to corporate governance and the approach to executive pay in the UK. We summarise below the key points raised in the letter:

UK corporate governance and the interaction between corporate boards and shareholders

The FRC’s decision not to take forward the majority of proposals in its recent UK Corporate Governance Code consultation is supported by CMIT. The letter encourages the FRC to exercise proportionality over any future changes; looking at where rules and guidance no longer serve their original purpose and can either be removed or streamlined. The letter also advocates that UK-listed companies should not be subject to requirements that companies listed in other high-quality markets are not subject to, unless such incremental requirements are justified.

The letter calls for increased collaboration and the presumption of trust between investors and issuer boards; CMIT feels that too often the current regime is set up by default to be antagonistic to demonstrate challenge and such a regime cultivates mistrust. Good stewardship should revolve around committed long-term shareholdings, and consistent and balanced conversations, not gauged by the number of letters written or number of votes cast against board resolutions. They call for a new “investor and issuer forum” to facilitate more effective ongoing engagement between boards and their shareholders, and indicate that the Investor Forum is willing to take on this expanded role.

CMIT suggests the governance and fund management functions within an investor should be fully integrated, with primacy given to the accountable portfolio managers. Investors should be consistent in their approach for UK-listed companies and international peers; if the approach for UK-listed companies differs, it should be made clear why. Investors are encouraged to engage in meaningful dialogue, without which voting against should be resisted.

CMIT calls for the requirement to respond to 20% or more votes against a board resolution to be removed and the IA’s Public Register discontinued. CMIT also suggests that sufficient votes being cast to pass a resolution should be all that is required.

The ‘comply or explain’ approach in the UK Corporate Governance Code should be changed to ‘apply or explain’ to clarify that explanation of a departure from the Code should be viewed as a form of compliance.

Executive remuneration

There should be a balanced and constructive dialogue on executive pay. This does not mean an endless rise to global reward levels, but UK-listed companies should be able to enjoy a level playing field with regards to the remuneration frameworks accepted for listed and private market peers in Europe and the US.

The question of reward quantum should be separate from reward structure. It should be a matter for Boards to justify their decision-making to shareholders in the context of their company’s own particular circumstances, with benchmarking appropriate to the relevant competitive environment when determining quantum. On structure, the aim should be to encourage simple remuneration structures that clearly align the interests of management and shareholders, with simple reporting that is easy for investors to digest and less time-consuming for companies to produce.

The 5% and 10% in 10 year dilution limits on new issue shares (or the re-issue of treasury shares) in the Investment Association’s Principles of Remuneration should be raised materially or removed, with judgement handed to boards to decide how best to structure their compensation as part of the board’s wider strategic approach.

The provision in the Investment Association’s Principles of Remuneration that encourages a 50% discount rate when moving from long-term incentive plans to restricted share awards should also be removed.

Ellason commentary: It is clear from recent conversations with both boards and shareholders that a review of the UK corporate governance regime and – in particular, the UK executive pay landscape – is urgently needed. We welcome CMIT’s contribution to this important debate. In particular, the current perception of failure if a remuneration vote receives less than 80% support (even though it requires only 50% support to pass) can act as a barrier for companies to adopt remuneration structures which effectively reinforce commercial priorities. We support CMIT’s suggestions for reform in this area.

Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.