Ellason lens on… LGIM’s updated UK Principles of Executive Pay and revised approach to consultation

LGIM has recently issued an updated version of its UK Principles of Executive Pay, to guide companies as they make pay decisions ahead of the 2022 AGM season. The key tenets of the Principles remain similar to previous years, but there are some noticeable changes to certain aspects as the governance team have sought to simplify the guidance and clarify expectations.

Key areas of change to the Principles include:

ESG metrics in incentive plans

The updated Principles confirm that where companies are exposed to high levels of environmental, social or governance (ESG) risk, this should be incorporated into the strategy of the business and, where relevant, reflected in incentive arrangements.

Where ESG metrics are used in incentives, they should have a modest weighting, for example not more than one-third of the LTIP. Any ESG metrics used should be meaningful, measurable, aligned to the company’s strategy and subject to third party verification. Such metrics could include environmental or social measures, depending on the criticality of ESG to the strategy and the company’s business activities. This is a change from previous guidance, which encouraged the use of ESG modifiers rather than standalone metrics.

In the case of health and safety, LGIM continues to advocate the use of a modifier (i.e. the ability of the committee to exercise downwards discretion). The updated Principles also confirm that, in the event of a workplace fatality, LGIM expects this to be reflected in incentive outcomes (normally the annual bonus) through a reduction to the formulaic pay-out of at least 20%.

Shareholding guidelines

LGIM’s earlier guidance featured ‘aspirational’ shareholding guidelines for FTSE100 companies of 400%-500% of salary. This has been removed from the latest Principles and replaced with a minimum expectation that the shareholding guideline should be equivalent to the annual performance share award opportunity (or three times the restricted share award opportunity). LGIM continues to expect 100% of vested LTIP and deferred bonus shares (except those sold for tax purposes) to be retained until the shareholding requirement has been achieved.

Consistent with LGIM’s previous guidance, the post-exit shareholding requirement should reflect a significant proportion of the prevailing in-post requirement (at least 80%), and remain in place for two years following termination of employment. However, the latest update confirms that where the in-post holding is set at a higher level than LGIM’s minimum expectations, LGIM will support a proportionally lower post-exit shareholding requirement providing that it remains at least 80% of LGIM’s minimum shareholding expectation (e.g. 160% of salary for a company typically granting LTI awards of 200% of salary). LGIM has also removed the expectation that the post-exit requirement should be no less than 300% of salary for FTSE100 companies. LGIM will continue to vote against the remuneration policy where a post-exit shareholding requirement that meets this updated minimum guidance is not included.

Share price falls

Where a company has suffered a significant share price fall (>20%) since the last LTI award was made, committees are expected to reduce the size of the next award to ensure there is no prospect of reward for failure. The updated Principles confirm LGIM’s expectation that this reduction in upfront award opportunity should be applied to restricted share as well as performance share awards. Where no such reduction has been applied, and where the committee has not provided an undertaking to reduce awards at vesting, LGIM will vote against the remuneration report.

Annual bonus plans

LGIM continues to encourage a reduction in short-term annual bonus levels, advocating that a bonus of 200% of salary should be reserved for only the largest global companies. However, whilst previously LGIM would not support any increases to annual bonus opportunity, the updated Principles are softened slightly to ‘generally not support’ such increases. Upon engagement, we understand that LGIM may support increases on a case-by-case basis provided that maximum opportunity remains below the 200% of salary maximum level.

LGIM is also revising its approach to consultations with companies on executive remuneration. Going forward, they will respond to remuneration consultations only on an “exceptional basis”. For example, where the proposal is unusual (i.e. not covered by their existing guidance set out in the Principles) or if the committee is considering the application of discretion. We understand they will be writing out to companies directly in the coming weeks to explain this approach.

Ellason commentary: LGIM continues to advocate simplicity in remuneration design (discouraging the use of one-offs, multiple plans and/or too many performance measures). The updated Principles also emphasise the importance of remuneration committees demonstrating, in the remuneration report, how the wider stakeholder context has been considered when making decisions on executive pay. A growing area of focus for LGIM is understanding the remuneration committee’s oversight of the broader pay practices within the company, including policies around the use of living wage and minimum working conditions, as well as any other steps a company is taking to reduce inequality in the workforce. LGIM will look to the Remuneration Committee Chair’s statement to explain why the single total figure of remuneration is appropriate in the context not only of the performance of the company and shareholder value created, but also the wider employee experience. They are also encouraging companies to offer free shares to all employees to not only motivate, but also enable employees to share in the success they help to create.

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