Mercer Executive Reward Governance Update - The IA's Principles of Remuneration for 2025 

There is a new requirement to disclose peer groups where benchmarking is being used as a rationale for changes.

New joiners' salaries should also take into account the salary of the previous incumbent but should not automatically match or exceed them.

The previous provisions relating to pensions and benefits have been simplified, shortened, and modernised. With respect to pensions, this reflects the trend toward cash pensions for Directors and the fact that most companies have aligned pensions for Directors with those of the wider workforce.

The guidance related to bonus deferral has been revised to allow companies more flexibility.  Bonus deferral is generally expected, however, there is now explicit flexibility to link the requirement for deferral to the achievement of Share Ownership Requirements (SORs) which will allow executives who have significant holdings of company shares and have met their SORs to receive all of their bonus in cash.

In a significant step to modernise the guidelines, the 5% in 10 years dilution on discretionary share schemes (e.g. LTIPs) which has been a feature of UK governance for many decades, but which has been looking increasingly outdated, has been removed from the guidelines.  

Only the 10% in 10 years limit in respect of all share schemes now remains and the guidance states that allowances to this limit may also be made in exceptional circumstances, such as for newly listed companies with high growth potential. Although the 5% limit in 10 years limit no longer features in the guidelines, companies should be cautious about amending existing limits and not assume that their individual shareholders will automatically be comfortable with its removal from their current share plan rules.  

In addition:

• The requirement for threshold LTIP vesting amounts not to be significant relative to base salary has been removed; it is now sufficient to ensure that the monetary amount is appropriate.
• There is a new expectation that share buybacks will be excluded from the calculation of Earnings Per Share (EPS) and/or allowed for when setting targets.
• There is an acknowledgement that hybrid LTIs (a combination of performance and restricted share awards) may be suitable in certain situations. Where introduced, these must have a vesting and holding period of at least five years.
• There appears to be a softening regarding the “haircut” on Restricted Share Plans (RSPs); it previously stated "at least" and now reads "typically 50%", opening the possibility of a different discount rate being appropriate in some circumstances; e.g. where existing LTI grant levels are determined as being uncompetitive.
• A new provision states that annual (i.e. phased) vesting of Restricted Stock Units (RSUs) is generally not supported.
• Value Creation Plans (VCPs) must have a minimum five-year performance period and should only reward exceptional performance. 
• A new requirement requires Remuneration Committees to conduct an annual review of LTI grant sizes, considering various factors to mitigate against windfall gains.
• In a move to avoid employee share ownership trusts being used to block potential takeovers, a new 5% cap has been introduced on the percentage of issued share capital that may be warehoused in an employee share ownership trust at any one time.

Not surprisingly given the rapid increase in the prevalence of ESG related performance metrics in UK company incentives plans, there is new guidance on the use of ESG targets with the objective that, where used, ESG measures should align with the company's strategy and stakeholder interests, and provide demonstrable performance outcomes.

Share ownership requirements (SORs) are another area where a number of changes have been made:

• The minimum SOR should be aligned to the annual LTI grant level.  The guidance does not differentiate between PSP and RSU grants for this purpose, presumably because PSPs are so prevalent in the UK. However, for companies that grant RSUs rather than PSPs we would interpret this as requiring that the level of the SOR should be based on the PSP equivalent award level (i.e. roughly double the annual RSU grant level in most cases). 
• Non-compliance with the SORs should lead to consequences such as withholding or reducing future LTI grants or deferring a portion of the annual bonus. Again, we would expect that the reasons for non-compliance would be a material factor in deciding on whether and to what extent there should be consequences, as it would seem unreasonable to expect an executive who has not had the benefit of any LTI vesting or whose shareholding has been diminished by a share price fall to face consequences for non-compliance.
• There is a requirement aimed at ensuring that post-employment Share Ownership Requirements are legally enforceable; e.g. by including them in Directors’ contracts, LTI plan rules, or trust documents.

There is increased specificity with regard to malus and clawback provisions, including an expectation to incorporate these provisions into all relevant documents to ensure enforceability, and that any incentive payments to leavers should be subject to malus and clawback.

There is new guidance on the use of discretion. Of particular note is acknowledgement that positive as well as negative discretion can be used.  

In addition: 

• In exercising discretion, Remuneration Committees are expected to consider broader contexts, including long-term interests and stakeholder impacts.
• There is an expectation to disclose and thoroughly explain in-year adjustments to bonus targets to shareholders before approving the changes and a new expectation has been established for Remuneration Committees to monitor the frequency and magnitude of discretion used and to regularly review the effectiveness and appropriateness of the discretion framework.

The new guidelines indicate companies should provide more clarity regarding the definitions of Good Leavers and Other Leavers that are used by the company.

There is also an expectation that the structure of any payments to leavers should remain unchanged compared to other employees. We understand that this means, for example, that deferred awards should normally continue to vest on the original schedule and not be accelerated and that where Remuneration Committees agree to apply discretion, this should be clearly explained; including how other employees within the company would be treated in the same circumstances.