Ellason lens on… FRC consultation on the UK Corporate Governance Code

The FRC has launched a public consultation on revisions to the UK Corporate Governance Code (‘the Code’). Although the majority of the proposals relate to expanding the responsibilities of audit committees and enhancing reporting on risk management and internal control systems, in this Lens we review the key remuneration-related revisions on which the FRC is consulting.

The consultation is open until 13 September 2023, with the revised Code expected to apply to financial years commencing on or after 1 January 2025.

Malus and clawback

The proposed Code includes a new Provision to strengthen reporting expectations relating to malus and clawback. Remuneration reports will be expected to disclose:

• the minimum circumstances in which malus and clawback provisions could be used;
• a description of the minimum recovery period and why this is best suited to the organisation; and
• whether the provisions have been used in the last reporting period. If provisions have been used, a clear explanation of the reason should be provided in the annual report.

Companies will also be expected to set out the use of recovery provisions in the last five years.

Ellason commentary: Many companies already operate comprehensive recovery provisions, and disclose voluntarily some of the key features thereof. As such, this requirement should not be particularly onerous. The FRC has opted against defining a specific list of minimum trigger events for malus and clawback, instead leaving this to companies to determine in the context of their circumstances.

ESG

The principles prefacing the Remuneration section of the Code have been updated to strengthen the link between remuneration policies, practices and outcomes, and performance in the round (as well as corporate purpose and values, this also explicitly calls out delivery of ESG objectives).

Ellason commentary: Remuneration-related references in the Code to ESG reflect the recent market trend for a growing prevalence of the inclusion of ESG measures in incentive scorecards. However, companies that have not introduced ESG to incentives may come under growing pressure to do so – or explain why they choose not to.

Provisions 40 and 41

Provision 40 of the current Code requires companies to disclose how the remuneration policy and pay practices address six factors: clarity, simplicity, risk, predictability, proportionality and alignment to culture. However, In response to concerns that this requirement has resulted in boilerplate disclosure, this Provision is being replaced by a requirement for the remuneration policy to be clear, identify and mitigate risks associated with remuneration, and ensure outcomes are proportionate and do not reward poor performance.

Existing Provision 41 has been updated to strengthen the expectation for companies to explain how executive director remuneration policy, structures and performance measure selection support ESG objectives. The expectation that companies frame director remuneration by the context of pay gaps and pay ratios has also been dropped, and replaced by a requirement to explain in the annual report the company’s approach to investing in and rewarding its workforce.

Ellason commentary: The FRC acknowledges that Provision 40 has not resulted in improved disclosure since being introduced in 2018. It is hoped that, by dropping this Provision, greater flexibility will yield better quality (i.e. tailored) disclosures explaining how arrangements support company strategy and circumstances. Changes to Provision 41 seek to streamline disclosure, while further sharpening the focus on how executive remuneration aligns with broader employee reward strategy and decision-making (a key theme of the 2018 Code).

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