Extracted from newspad July 2017
Despite 40 years of regulatory intervention in the UK executive reward market, on the ground very little had changed, said Damian Carnell, director of consulting services at Willis Towers Watson.
Speaking at the recent newspad summit, hosted by Clifford Chance at its Paris offices, Damian was addressing the clash between core capital and top talent in executive reward. There had been “vicious disputes” about the alleged effects of global capitalism – as witnessed in executive compensation – it was a “very emotional” issue, stoked up by the mass media, he said. Critics complained that the link between executive reward and performance was weak and that companies were even paying some executives for failure.
As companies pushed costs down, total average earnings in the workforce were rising by a bit less than three percent, while executive reward – two thirds of which comprised variable pay – was much higher. However, the seemingly high cost of large executive reward packages was actually cheap compared to the huge returns for business and the economy as a whole.
Executive share options had fallen out of favour in many companies, especially since the advent of IFRS accounting requirements and to those who thought Long-Term Incentive Plans would be abolished soon, he said: “Dream on.” The corporate sector was moving towards variable and long-term pay and LTIPs were increasingly seen throughout south-east Asia and in South America. “There’s been a huge amount of government intervention over executive reward, but despite all this, not much has changed. Companies tell us that pay for performance is the issue and they don’t think that the reward system is broken,” added Damian.
Much had been made about 2017 being the year for remuneration policy renewal, with the first binding vote under the new rules, but it was not a good year in which to change overall remuneration policy, he said. Core capital had the whip-hand, but there were constraints, though shareholder activists as in Say On Pay were not really effective, he said.
His speech led to an invitation to contribute to the journal of the Institute of Economic Affairs, edited by Prof J R Shackleton.
Unavoidably kept away by a family wedding, Centre chairman Malcolm Hurlston sent delegates a message, which was read out by Centre international director Fred Hackworth, who chaired the event in his absence.
Mr Hurlston said: “The Centre came to Paris for its first world event; on that occasion David Reid of Clifford Turner, who shared responsibility with me for bringing the American Esop to Europe and founding the Centre, was the star speaker and I believe Marcel Hipszman, then helping the president’s Delegate to the Social Economy, came to support us. We held it not here – I think neither Clifford Turner nor Coward Chance, the constituents of the merged firm of Clifford Chance, boasted such fine premises – but in the Lutetia Hotel, which was known as the grand hotel of the left bank: a nice approximation to the breadth of our interests.
“Then and subsequently France and the UK – in our different ways – have been the main protagonists of employee financial participation in Europe, as we no doubt shall continue to be – both protagonists and in different ways.
“Both I and our international director, your host today and the reader of this speech, live in France. With such political oddities on both sides of our channel it is tempting to join all the others who don’t know what they are talking about and speculate on the political future. However I have found that the success of employee ownership goes in fits and starts according to chance and caprice more than as a result of the political nature of the government.
“It is better to concentrate on what can be done and that is a message we have passed to the European Commission – leave grand plans aside while you lack tax power and concentrate on nudge and tidying aspects which are under your control and affect us.
“Our work with the Commission is greatly helped by our taking part in the multi-country group ProEFP, chaired by Marco Cilento of the European Trades Union Confederation, who is with us today. Now we have rediscovered Paris. Your numbers ensure this is the first of many newspad summits which I hope we shall hold here regularly – the decisive vote will lie with you and how much you enjoy and value this event.”
French President Emmanuel Macron is very interested in The Third Way, which fits into his political ideology, said Michel Bon, chairman of FONDACT, the French organisation which supports participative management and profit sharing in all its forms. “I am optimistic that Macron will encourage performance based share awards,” he told delegates. “I hope that the president will extend company employee savings schemes to companies with less than 50 employees too,” he added. About €120bn (£105bn) is invested in French employee financial participation (EFP) plans and the average percentage of the equity of CAC 40 companies owned by employee shareholders was around 3.5 percent, said Mr Bon. The percentage of employee equity was predictably higher in ex state owned companies, like the bank Societe Generale because the employees had been given shares as part of the privatisation process. As in the UK, there was a big gap at the smaller company end – those employing between ten to 49 people, where only 20 percent benefited from profit-sharing.
Sonia Gilbert, partner at Clifford Chance, asked what had French companies done to make EFP (employee share ownership) successful outside France itself. The classic French Eso plan was based on employees buying shares at a discount, but under lock-up terms. Next was the leveraged plan, in which participants had the right to the eventual upside on discounted share purchases and thirdly, the free shares plan, in which participants received their free shares after vesting. Sonia said that Clifford Chance was trying to get French companies interested in the UK’s Share Incentive Plan, especially the feature which allowed employees to get free shares matching those they had bought. Regulation was an issue because French companies were worried about their plans being compliant worldwide. They were used to using local champions to get HR on side, but there was danger of too much info being required and sometimes too much jargon – so many employees couldn’t be bothered to read it. Translation was the key to the success of French plans in the UK because hardly any Brits spoke good French.
Anne Lemercier, a Clifford Chance partner based in Paris, spoke about the participation of French employee shareholders in the corporate governance of companies, which was a key issue in France. Employee shareholders in France had to be treated in the same way as ‘ordinary’ shareholders and some French companies didn’t like that, which was “regrettable” because financial participation by employees gave them a better understanding of their place in the company and its objectives. Their rights included having employee representatives on the company board, which UK companies didn’t want, but there were constraints – French employees had collectively to own at least five percent of the equity to permit them to table resolutions to company meetings. Was the hurdle too high? Another key hurdle was the requirement for at least three percent of the company equity to be held by employee shareholders before they could have a representative on the board. Individual French employee shareholders tended not to exercise their voting rights at agms, said Anne. In addition, since 2013 there had been an obligation for French companies with more than 5,000 employees, or 10,000 worldwide, to have an employee director. Nor was it unusual to see an employee shareholder representative to be a member of the company remuneration committee. Some criticised the appointment of employee shareholder representatives on company boards and there was an issue about how independent in their decisions they really were, added Anne.
Bastien Martins da Torre, corporate solutions director at Centre member Solium and David Lee, product management director at Solium delivered an impressive survey review on what French corporate issuers wanted from their employee plans. To help them, they enlisted client Jacqueline Vidales of the food services and facilities management giant Sodexo, which employs 425,000 people in 80 countries.
The employee participant experience was the number one concern, the survey revealed, said Bastien. Although high technology could accelerate concerns like voting rights, Excel spreadsheets were still prevalent in parts of the industry. It was helpful that Google was a client because “they forced us to keep things simple” in share plan delivery, he said. David said that improving participant experience revolved around the question of “what information they need and how do we give it to them?” Companies wanting to track their mobile employees and companies in both the UK and France were looking for similar systems online and worldwide, which could be adapted to local needs. Performance criteria were important to them for executive plans – would it be TSR, EPS or ROCE, or a combination of these? There might be valuation challenges and, as plans grew more complex, so did accounting demands, added David.
Jacqueline was asked by Bastien to outline Sodexo’s free share plan for 1,270 senior managers throughout its vast empire. Although the plan was automated, some local offices still depended on Excel sheets, she said. Teething problems in some jurisdictions had included privacy of information and the mobility of participants.
A panel comprising senior officials from the Paris based International Association for Financial Participation (IAFP) then discussed what kind of Eso plan was best suited to the millennial generation. US based IAFP president David Hildebrandt explained that millennials were either not buying traditional financial products in the traditional way, or not buying them at all. He was upset to see evidence from the US that some companies were adopting Eso structures solely to get the Esop tax benefits. Their survey showed that millennials were changing jobs frequently, didn’t plan to retire at 65 and trusted the internet more than their parents or employers. They judged it more important to work for a socially-conscious company than to be paid a high salary, said David. “About 87 percent of them think that money is not the best measure of success. 83 percent of the 18–29s in our survey admitted to sleeping with their cell phones either next to, or even on, their pillows and they use Facebook in work situations too – so we are seeing the fundamentals changing in employee relationships.” Kevin O’Kelly, a former EU official and executive committee member of IAFP, said that it was a great shame that EFP/Eso had been downgraded in importance by the European Commission and that DG Justice now ruled the roost, so that Eso was largely seen through the prism of the Shareholder Rights Directive. The traditional labour market was shrinking – 34 percent of people doing paid work did so mainly through online platforms and millennials were struggling to get on the housing market.
Fred Hackworth asked whether the current sacrifice of all employee shareholdings when people moved jobs before plans vested could be justified for much longer. It seemed a heavy price to pay for job mobility. The millennials phenomenon raised the issue of whether it was sensible for companies to continue to offer five-year share or share options savings plans – e.g. SAYE plans – when not so many participants would still be in post five years on.
Next up was Hannah Needle, senior associate at Tapestry Compliance, who discussed global share plans in the fast-changing workplace. Yes, the rationale behind such plans remained productivity improvements, staff attraction and retention and risk management, but the focus was changing to concerns about tax avoidance, data protection and diversity reporting. In the UK, corporate governance had pushed itself onto the agenda – companies were looking at worker dissent, whether Long-Term Incentive Plans should end and an overhaul of their own corporate governance procedures, said Hannah. The EU was at the centre of some controversial changes: e.g. the Markets in Financial Instruments Directive II, known as MiFID II, which from January 3 next year, will migrate the European regulatory landscape from a principles-based philosophy toward a more US-style rules-based regulatory regime. It extends the MiFID framework across asset classes and into markets in which central bid/offer markets and pre-and post-trade transparency have never existed. This is expected to have a tremendous impact on how OTC markets operate. Then there were the revised Prospectus Directive share schemes exemption and threatened fines of up to four percent of annual turnover for data protection infringement, said Hannah.
Richard Nelson, md of Centre member Cytec Solutions, looked at the Market Abuse Regulation (MAR) a year on. The EU had got itself involved in surveillance of how companies managed price sensitive information. Did we need to rewrite our disclosure policy? – well, MAR had not proved to be the major headache once feared, said Richard. Company focus was on compliance – getting all the papers into the right order, but what about prevention? For instance, by setting up more controlled access to insider information, he said. The Reckitt Benckiser case had shown that everyone had to know what their responsibilities were, warned Richard. In January 2015, the Financial Conduct Authority (FCA) fined consumer goods giant Reckitt Benckiser £539,800 for inadequate systems and controls to monitor share-dealing by its senior executives in its own shares. This had contributed to late and incomplete disclosure to the market of share dealings by two senior executives. RB had breached key requirements in the listing, disclosure and transparency rules and had failed to identify breaches of the Model Code, which is designed to ensure that senior executives do not abuse, and do not place themselves under the suspicion of abusing, inside information. French companies had shown a lot of interest in Insider Track, the special software developed by Cytec Solutions to cope with the regulatory challenge. Around two-thirds of quoted UK companies had permanent lists of six people on average who were ‘in the know’ and who therefore could be regarded as ‘insiders’ when push came to shove, he added. Many companies had at least 16 external advisers (e.g. consultants, lawyers and PR teams) who fell into the same category.
Rob Collard, partner at Centre member Macfarlanes, addressed the recent issue of gender reporting. The EU average for pay disparity between men and women was 16 percent, but the UK was lower at ten percent, said Rob. Austria and Germany seemed to be the worse for pay discrimination against women, he added. To date only 17 major UK companies had reported on gender pay, but all that would change next year when it would become compulsory for UK listed companies to publish official reports on gender pay within their organisations. Such info to date – year to year comparisons – was mostly published on websites.
Though companies would be encouraged to set targets for reducing pay discrimination, the trouble was that there was no enforcement regime, said Rob. “It’s a PR issue for companies to get this right,” he said. The policy would catch around 8,000 UK companies who each employ more than 250 people, in total about 11m people, though partnerships would escape. Intriguingly, share plan awards were included in gender pay reporting, but the yardstick for comparison would be the size of the reward when the awards were exercised and not when they were granted, he added.
Stephen Woodhouse, partner at Centre member Pett Franklin, said that international share plans were still suffering from the wash created by the global 2007–8 financial crash. The expansion of such plans in the UK might be restrained by the twin uncertainties of Brexit and the Tory failure to achieve an overall majority in the recent general election, he said. For example, the hugely successful share options based Enterprise Management Incentive was being viewed by some in Brussels as akin to illegal ‘state aid’ so what would happen next year when EMI was due for review, given that by then the UK would be well down the road towards Brexit? However he predicted, on balance, increased use of employer share plans in the future. “Share plans help companies to better manage their cash by providing more variable pay to their employees, as an alternative to redundancies, which are often expensive,” said Stephen. The BEIS corporate governance report had called for Long-Term Incentive Plans (LTIPs) to be phased out by 2018 and that existing LTIPs should not be renewed.
Marco Cilento, of the European Trade Union Confederation, warned that employee share ownership in Europe could turn selective by becoming accessible only to those who could afford to pay to participate. France was the only country within the EU which had solid legislation that recognised the wider interest of society in supporting and regulating employee share ownership, said Marco. In the UK, which was second to France in the universality of Eso, it essentially belonged in the sphere of private companies and their employees. “However, Eso/EFP never appears in the toolbox of decision makers at European level, which is at odds with the fact that the use of such plans has been increasing in the aftermath of the economic crisis” he added.
Louise Jenkins, md of European tax and reward solutions at the global consultant and tax adviser FTI Consulting, examined the UK tax treatment of internationally mobile employees (IMEs). Louise said that the tax treatment of the increasing number of highly mobile employees was “quite complicated” and that quite a lot of companies were still getting it wrong under the 2014 Finance Act, effective from April 2015, which had brought in major changes in the way IMEs are taxed in the UK on their share-based reward. Breaches could lead to very nasty fines. The idea behind it was to align the UK tax treatment of share based pay with general international practice. In general terms, the ‘winners’ had been UK IMEs, incentivised with options, and sent on secondment to another jurisdiction, whereas the ‘losers’ were UK IMEs who came back to the UK with unvested options or restricted stock. Apportionment of the gain and time spent by IMEs in each jurisdiction was necessary and obligatory, so good corporate tracking processes for each grant, vesting, exercise of equity rights, sales, lapses or lifting of restrictions for each IME were essential, said Louise.
Garry Karch, managing partner at Centre member RM2 outlined the latest trends in employee ownership and executive incentives in both the US and UK. Garry said that a lot of US Esops were the result of the significant tax incentives. Some Esop companies were very large – the biggest one he had worked on in the US involved a company with a turnover of $800m. Yes, the tax Esop incentives cost the US Treasury $2bn a year in lost revenue, but the US economy benefited overall by up to $17bn a year due to the extra jobs created, as well as other jobs which were saved by Esop creations. Financing was the key and in that respect, the UK was on the “ground floor.” By way of comparison, there were 12,000 Esop companies in the US and perhaps a maximum 150 UK companies controlled by the Employee Ownership Trust. It was ironic that employees in EOT companies only really benefited from their ‘ownership’ (which he maintained was indirect) when the company was being sold, because they had crucial votes on whether a proposed sale was in the employees’ interests or not. Why was it that in the US, owners could get CGT relief by selling just 30 percent of the company’s equity to its employees, whereas in the UK, to qualify for EOT status, the owner had to sell or give more than 50 percent of the equity to the employees? “We are still paying the price in the UK for the once tremendous misuse of employee benefit trusts in the 1980s” Garry said.
However, the successful Enterprise Management Incentive had put the UK ahead of the US in management incentives.
Sian Halcrow, head of reward analytics at New Bridge Street, an Aon Hewitt company, said the new EU Shareholder Rights Directive, introduced shareholder votes on forward-looking executive remuneration policy, as well on actual reward paid out for the previous year, as disclosed in the remuneration report.
Member states had until September to put the Directive into effect. The Commission would publish a template shortly on the advisory remuneration report; there would be more focus on external people like shareholders, whose views had to be considered; there would be benchmarking against peer companies, but pay ratios were not explicitly mentioned in the Directive, though no executive base salary increase should be greater, percentage-wise, than what was given to the workforce, it said. Any additional reward increases should be paid in shares, rather than cash and long-term incentive plans should not reward failure.
Nicholas Greenacre, partner at White & Case, posed the question: Singapore of the North Sea, or a one-way ticket to Mars? – The impact of Brexit on international equity plans. It was unclear how Brexit would impact international share plans, because it was unclear how long Mrs May’s government would last and how hard Brexit would be, said Nicholas. “I suspect that the so-called ‘hard Bexit’ option has ended and that maybe it will take the form of a Norway or EFTA deal in which the UK has tariff-free access to the single market, but no say in the EU’s policies.”
International share plans had been exposed already to the slump in the value of sterling on money markets and people were interested in companies with strong US dollar earnings. Another problem was that share prices would fluctuate because of the uncertainty, so would employers remain confident about share plans in general? Much had been said about the UK’s comparatively low productivity rates, vis-à-vis those of many continental rivals, so looking beyond Brexit, would employees want shares in low-performing UK companies? In turn, would UK companies be put off from launching new international Eso plans in the wake of the new Data Protection Regulation, which gave the regulator power to impose fines of up to €20m or four percent of worldwide turnover in the event of serious breaches, asked Nicholas? “Regulators have the appetite to raise fines across the board,” he warned.
The summit e-brochure was logo sponsored by Channel Islands based trustee member Ocorian. Selected slide presentations are available to members on request .