UK Reward Agenda: Enhanced Reporting on Malus and Clawback - 2024 UK Corporate Governance Code
The 2024 Corporate Governance Code (Code) (which takes effect for financial periods beginning after 1 January 2025) contains new requirements in relation to malus and clawback clauses. The Code now requires a description in the annual report of the malus and clawback provisions including:
- the circumstances in which malus and clawback provisions could be used;
- a description of the period for malus and clawback and why the selected period is best suited to the organisation; and
- whether the provisions were used in the last reporting period. If so, a clear explanation of the reason should be provided in the annual report.
The guidance to the provision clarifies that the disclosure requirement relates only to executive directors even where the malus and clawback clause has a wider remit.
For some companies this will be a minor change and, provided that the malus and clawback provisions have not been operated, will involve only repeating information currently given relating to malus and clawback in their remuneration policies on an annual basis. Indeed, many companies already disclose this information on a voluntary basis, not least because it is in their interests to take credit for the inclusion of these investor-friendly provisions in executive compensation arrangements. Other companies may wish to increase the level of disclosure to meet the new Code provision.
In both cases, the change is a prompt to consider the circumstances in which and period over which malus and clawback provisions apply.
The circumstances in which malus and clawback provisions apply are normally based on the examples in paragraph 331 of the FRC's Guidance to the Code (Guidance) as follows: 'payments based on erroneous or misleading data, misconduct, misstatement of accounts, serious reputational damage and corporate failure' however these should be tailored to the specific company and award structure. They may also be influenced by sector regulation and regulation in other applicable jurisdictions in which the group operates. In reviewing the criteria, in addition to considering factors specific to the company, it is important that:
- there is an interrogation of the criteria to confirm that they are diverse enough to cover the full range of circumstances in which the company may wish to operate malus and clawback. In addition, ideally, the criteria should have some specificity so although a 'catch-all' approach will usually be included to capture events which don't fall strictly within the criteria, such a provision should not be relied on to avoid engaging with determining the full list of specific events for the company in question. It should be easier to enforce malus or clawback where the event which has occurred falls clearly within one of the specified criteria.
- the criteria are not generally limited by reference to the 'fault' of the individual in question. So, for example, serious reputational damage will often be a specified criterion in additional to serious misconduct or material error of the participant.
A broad scope to the criteria protects the company/ remuneration committee by allowing the possibility of operating malus and clawback. Whether or not malus and clawback are operated and the extent to which they are operated are discretionary and in exercising discretion a full range of factors including culpability and responsibility will be taken into account.
The period over which a malus and clawback provision applies should again be considered in the light of the specific company and award structure. A starting point will usually be the performance period over which the award is tested plus a further two years. A recovery period should reflect the likely availability of subsequent audited financial information following the testing of performance and vesting of awards and should be capable of extension if an investigation is underway when the initial period is due to end.
The Investment Association's Principles of Remuneration cross refer to the Code and suggest having participants agree to the criteria as well as noting the importance of consistency between contracts, remuneration policy and plan rules, good communication with participants and documenting the process and decision making so that the company's approach to enforcement is clearly laid out. Indeed, clawback is unlikely to be enforceable if participants do not agree to it in advance.
Historically there has been some scepticism over where malus and, in particular, clawback clauses could and would be operated. It is now clear that, at least in the most high-profile cases, there is evidence of successful use of these provisions, albeit with an emphasis on first looking to implement by making in-year and in-flight adjustments or reducing other aspects of remuneration before looking at vested but unsettled awards and finally repayment. If a company does wish to operate malus and clawback, it will need to be careful and deliberate as to how it goes about this. There have been high profile instances of executives successfully refusing to comply where a company has, for example, not followed the correct procedure.
Arguably, malus and clawback provisions are most successful when they do not need to be used – the argument being that this means they have successfully deterred the bad behaviours they are targeting. However, this argument only holds water if the remuneration committee is prepared to use malus and clawback when appropriate. Furthermore, it would not be credible if all companies were to argue their malus and clawback policies are working as a deterrent all the time, so remuneration committees do need to give serious consideration to whether it is appropriate to operate malus and/or clawback at the point of vesting of awards and after. Where it is not already the case, a prompt to consider downwards adjustment and the operation of malus and clawback might helpful be included in remuneration committee agendas.
If you would like to discuss malus and clawback provisions or their operation in more detail do please contact Nick Hipwell, Martin Macleod and Tamsin Nicholds.