Investors are even more focused this year on how remuneration committees exercise discretion, connect pay to performance and disclose key pay actions. Firms should scenario plan to guide decisions, anticipate curveballs and prepare for discussions with stakeholders.
Each year, the agenda for remuneration committees is challenging; however, this year there are factors that make it even more so. Not only has the COVID-19 pandemic had a real impact on the economy to-date, but there is still considerable uncertainty on how the economic situation will impact year-end results.
Whilst some financial services business lines have come through the year unscathed or even benefiting from market volatility, others have been particularly hard hit. Although no two firms have been impacted in precisely the same way, we are seeing a number of common issues making their way to the top of remuneration committee agendas.
Here are the six key areas that financial services’ remuneration committees will need to consider in the final quarter of the year:
#1. How to fund the bonus pool. We are not seeing fundamental changes to the approach in setting the bonus pool, but we are hearing some important questions being raised like which profit measure to use. Although it is common to use an adjusted profit measure, is it appropriate to use the normal adjustments in what has by no stretch of the imagination been a normal year? Discretion may be used to make suitable modifications but it will be critical to be able to justify the profit measure selected.
#2. How to allocate the bonus pool. This year will be a fine balance between rewarding performance and protecting areas where performance has suffered because of external factors. For areas that have performed strongly, the question will be: To what extent can true “out performance” be demonstrated and distinguished from market opportunity (e.g., benefiting from volatility)? It will be important to be able to articulate how pay reflects performance.
#3. How to reflect headcount decisions. Some companies have deferred headcount decisions during the pandemic. Decision-making on bonus pool allocation will have to take this into account and remuneration committees will need to revisit the extent to which job security will be prioritised into 2021.
#4. How to incorporate regulatory intervention. We have seen specific communication from the European Banking Authority (EBA), European Central Bank (ECB) and the UK Prudential Regulation Authority (PRA) on variable pay covering Material Risk Takers (MRTs) in 2020. The PRA has advised that it is not expecting cash bonuses to be paid to senior staff this year and the ECB expects firms to adopt “extreme moderation” on variable pay until 1 January 2021. We expect to see further statements from regulators with the objective of macro prudential stability and treating customers fairly, which could potentially restrict payouts in Q1 2021 or advocate increased deferral or increased delivery of variable pay in the form of equity.
#5. How, if at all, to apply risk adjustment and malus. One of the regulatory triggers for malus is when firms suffer a material downturn in financial performance. This should be brought to the attention of remuneration committees, but will be a particularly tough decision, especially where there have been no misconduct issues and the downturn in financial performance is due solely to market movements in a period where many staff may have demonstrated real resilience and commitment to maintain client service.
#6. How to navigate shareholder and other stakeholder expectations. With many shareholders likely to be disappointed on dividends this year, at a minimum they will expect executive pay to be aligned to shareholder returns. In addition, last year we saw UK Corporate Governance Code changes requiring remuneration committees to consider workforce pay alongside executive pay. And this year, interest in environmental, social and governance issues (ESG) is building, most recently in the area of inclusion and diversity. Although our experience is that very few financial services firms have taken government-funded assistance programs related to COVID-19 relief, some of the government initiatives have benefited their clients, and there will be an expectation that this be taken into consideration when assessing the performance underpinning pay decisions. This is in a year when the contribution of key workers in the fight against COVID-19 has been very visible and this will be top of mind for many when shareholders, the media and public look at pay disclosures for executives and incentive compensation spend in financial services.
Next Steps
These six key issues amount to a high-profile and thorny agenda for remuneration committees this year. It is important for the management team to be aligned with directors on how to approach year-end. When we speak to remuneration committee chairs, they are highly conscious that executive pay decisions and the overall cost of compensation will be reputationally important for the company.
We are working with our clients on scenario planning, including framing the issues and guiding remuneration committees through the considerations that will be paramount this year, curveballs that need to be anticipated and preparation for discussions with stakeholders. We are helping clients to establish a framework to support remuneration committees in exercising discretion and documenting the key decisions to support the use of discretion.
Outside of year-end decision-making, implementation of CRD V (effective end of 2020) and the Investment Firms Directive (IFD) (effective summer 2021) regulation are also key issues, requiring companies to consider changes to remuneration policy, remuneration structure as well as managing the likely increase in the Material Risk Taker (MRT) population.
If you have questions about the issues discussed in this article, please contact one of the authors or write to rewards-solutions@aon.com.
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