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Media Briefing Note: BIS Revised Reporting Regulations Consultation Raises Concerns

26 September 2012

LONDON, 26 September 2012 - The Department for Business Innovation and Skills' (BIS) consultation on revised reporting regulations for executive remuneration raises some serious concerns regarding the practicality and cost of compliance according to Hogan Lovells. The regulations will come into force in October 2013 but there are practical steps companies may want to take now in preparation.

Louise Whitewright, partner and co-head of Hogan Lovells' Executive Compensation, Employee Benefits and Share Incentives team commented:

"The political aim of the proposed legislation is to boost transparency so that what people are paid is clear and easily understood, and to give shareholders more power through binding votes so they can hold companies to account. From a legal and commercial point of view it is far from clear that the proposed legislation achieves this purpose. In addition, companies will face substantial costs in adjusting to these revised reporting regulations.

"There already exists a concern that current legislation results in over-complex reporting by companies which shareholders have difficulty understanding. The new legislation proposes yet lengthier disclosure and it is questionable whether this additional material will be useful to shareholders and other stakeholders. A single total figure for remuneration will, for example, require considerable explanation to ensure it is not misleading.

"There will be significant costs involved in gathering the information, which will not necessarily be readily available. An increase in compliance costs for the first time is to be expected. However, there will undoubtedly be an overall increase in the continuing costs to quoted companies which is likely to affect smaller quoted companies more than larger companies.

"There are a number of issues with the proposed draft legislation and clearly further changes will be necessary. The draft regulations, under paragraph 21, state that a company must set out "all the provisions that relate to remuneration contained in the directors' service contracts". Under the existing rules all directors' service contracts are displayed and can be reviewed by shareholders at any time, and the rules require disclosure of any information relating to service contracts. The new requirements will not necessarily provide more meaningful information.

"In addition, it appears that a payment under a share plan is still subject to the new regime even if the plan has been separately approved by shareholders. There should be some level of certainty that as long as a company operates within the confines of the plan previously approved by shareholders it should not be subject to additional shareholder approval."

Jo Broadbent, Of Counsel in the employment team at Hogan Lovells, added:

"Although the regulations will not come into force until October 2013 there are steps that could be taken by employers now in preparation. The first is to review existing executive service contracts with a view to "mapping" existing pay and benefits into the table that will be used to calculate a single figure for executive pay. This will include salary, taxable benefits, pension-related benefits, bonus or other performance-related pay, and awards under a share scheme or other long-term incentive plan. Once the "mapping" exercise is complete, it should be possible to identify whether or not there are areas of each director's remuneration that could give shareholders cause for concern. Steps can then be taken to address any issues, including amending service contracts if necessary (subject to the usual restrictions on changing terms and conditions of employment).

"The second task is to review director entitlements on termination of employment. Although individual termination payments will not be subject to a vote, a company's approach to termination payments is one of the matters that will be subject to a binding vote as part of the policy report. A key consideration will be how payments in lieu of notice (PILONs) are calculated, in particular whether these reflect salary only or include an allowance for other benefits or bonuses. A restrictively drafted PILON provision is obviously more likely to be acceptable to shareholders. Generous PILONs, which would have been relatively common in service contracts entered into some years ago, may need to be revisited.

"Finally, once the contractual arrangements of existing directors have been reviewed, the company will need to consider what arrangements to put in place for newly appointed directors who will be subject to the new policy. Service agreements need to be drafted with one eye on the Regulations even though these are not yet in final form. It is likely to be particularly important to make sure that contracts contain a clear link between pay and performance. It remains to be seen whether or not one unintended consequence of the new voting arrangements will be a demand for higher levels of base pay from new directors, if other benefits are likely to be subject to greater levels of scrutiny - and potentially a binding vote - in the future."

The consultation closed on 26 September 2012, with the regulations due to take effect in October 2013.

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