The design and operation of employee share plans and other remuneration arrangements are subject to a multitude of laws. As executive pay has been under particular scrutiny since the financial crash of 2008, EU regulators have gone to great lengths to address any perceived unfairness and inequity in the financial services arena to ensure that there should be no rewards for failure.
In the context of such a highly regulated area, what factors currently affecting the structure of share plans would need to be considered in the event of Brexit?
Malus and clawback
The financial crash led to the introduction of malus and clawback provisions capping bonuses and deferring compensation to link pay to longer-term performance. With a significant proportion of global finance being transacted through London, it can be argued that the UK has felt the force of these laws disproportionately compared to its European counterparts. Indeed, the Financial Conduct Authority (unsuccessfully) challenged the bonus cap through the Court of Justice of the European Union (ECJ) and it would not be unreasonable to suggest that were the UK to leave the EU, the cap could be scrapped.
Nevertheless, whilst European regulation only requires financial services companies to introduce malus and clawback, in the UK, the UK Corporate Governance Code provides that all UK listed companies (not just those in the financial services sector) must adopt malus and clawback rules, or explain to shareholders why they do not consider them to be appropriate. Given that these concepts have now become part of the fabric of most remuneration policies, and are expected by not just institutional shareholders but by executives themselves, it is unlikely that Brexit will result in their dilution.
The most basic of share plan concepts, the grant of options and awards, is subject to EU prospectus rules. This applies a single regime throughout the EU and provides a set of exclusions and exemptions to enable plans to be operated across the EU without the tortuous and expensive requirement to produce a prospectus.
However, companies based outside the EU cannot necessarily take advantage of these exemptions. As such, in the event of Brexit, UK companies with employees across the EU may find themselves subject to more onerous requirements than their EU competitors. This could make it harder for them to extend their share plan arrangements more widely.
Conversely, there is also the question of whether, outside the EU, the UK would operate a regime that makes it more difficult for overseas companies to import their share plans into. Already, in the current environment, many non-EU based companies (particularly those headquartered in the US) choose another EU country (commonly France or Belgium) as their "home" jurisdiction through which they passport share plans around the EU. Following Brexit and without the benefit of the passporting regime, there lies a risk of a non-UK parent finding the process more onerous and expensive and choosing not to extend its global share plans to UK-based employees.
The Equality Act 2010 (EqA 2010) implements the age aspects of the Equal Treatment Framework Directive (2000/78/EC) (the Framework Directive), prohibiting (amongst other things) direct and indirect age discrimination. There are certain touch points during the life of a share plan that require careful consideration to ensure a company is not discriminating by reference to age. In particular, in considering any qualifying period of employment, it is important to ensure the requirement does not unduly restrict the ability of certain age groups from being able to participate, unless objectively justified. Similarly, in determining whether an employee leaves by reason of "retirement" (and therefore is a good leaver), the interpretation of that rule should be assessed in a consistent manner, without reference to age.
The age discrimination provisions of the EqA 2010 are designed to implement the age aspects of the Framework Directive. As such, tribunals are obliged to interpret the EqA 2010, so far as possible, in the light of the Framework Directive's wording and purpose. If a claimant argues that the EqA 2010 is incompatible with the Directive, the tribunal or a higher court could decide to refer the matter to the ECJ for clarification.
Whilst it is unlikely that the basic principles around age discrimination will change following Brexit, without reference to the ECJ, UK courts will have more freedom to make independent determinations on points of interpretation. In addition there will obviously be an opportunity to review the EqA 2010 as it stands today, with the possibility that some changes will follow irrespective of whether there is any conflict with the Framework Directive.
Share dealing rules
Companies listed on the London Stock Exchange are subject to strict rules and standards, principally through the Model Code, that regulate when their directors and other senior managers are permitted to deal in shares and the clearance process that must be followed. In respect of share plans, this includes the grant and exercise of options and any subsequent sale of shares.
These rules will be subject to change with effect from 3 July 2016 as a result of the UK's implementation of the Market Abuse Regulation. Under current proposals, the EU-driven changes potentially bring more uncertainty into how the requirements can be satisfied, doing away with the Model Code altogether (although an industry-led development of codes and/or best practice would be supported by the FCA). Whilst there is every likelihood that UK companies will continue with their current practices in many respects, there will be areas of change that companies will need to adopt now. However, in the event of Brexit, it would be no surprise if those changes are short-lived with the UK reverting back to current rules and practice.
Disclosure of directors' remuneration
The UK has generally led the way on ensuring directors of UK listed companies remain accountable to shareholders by disclosing details of the remuneration paid to them. In 2013, new regulations introduced a requirement that UK listed companies produce a remuneration policy that is approved by shareholders and for an implementation report (describing how the policy has been applied) to be subject to a shareholder advisory vote. European regulation has previously not followed such a rigorous approach, although EU-wide "say on pay" rules are expected to be introduced later this year through the European Shareholder Rights Directive. This would require similar voting requirements as provided under UK law, although some elements might not be as stringent.
Whilst significant changes are not expected, the UK model would need to be amended to fall in line with the EU rules, such as those relating to disclosing relative change in board and employee pay over previous financial period. As such, whether Brexit happens or not, the playing field as far as directors' accountability on remuneration is concerned will remain broadly level as between the EU and the UK.
The operation of share plans naturally involves a flow of employee data between employing entities and any third party plan administrator. Currently, such data can be freely exchanged within the EU. However, were the UK to withdraw completely from the EU, the European Commission would have to rule that a post-Brexit UK provides an adequate level of protection for the rights and freedoms of data subjects. Without this ruling, employee data could not be exported from the EU to the UK without finding another lawful way of doing so, such as obtaining express consent or through model clauses, which would involve additional administrative burdens.
The UK is subject to the state aid regime, governed by the Treaty on the Functioning of the European Union (TFEU). The TFEU regulates "aid" granted by an EU member state which, broadly, distorts or threatens to distort competition by favouring certain undertakings over others. This is relevant to share plans in the context of enterprise management incentives (EMI) schemes because these provide tax reliefs (which are regarded as aid) to small and medium enterprises. They are therefore selective by their nature. As a result, a change that the UK government intends to make to the EMI legislation first requires consideration and approval from the European Commission. Indeed the entire EMI regime relies on continued approval from the European Commission. That approval expires in April 2018, at which point the UK would need to negotiate an extension to the EMI state aid approval.
Assuming the ongoing relationship between the UK and the EU does not include similar provisions, Brexit would mean the UK would no longer have regard to these state aid considerations in respect of EMI schemes, allowing the UK greater flexibility to determine the laws under which such arrangements are governed.
So where does this leave us?
Life after Brexit is unlikely to require a material change in how companies approach the design and compliance of their share plans and remuneration arrangements. Whilst there may be some operational and regulatory considerations to take into account, it would be expected that as part of the process of and discussions around withdrawing from the EU, the UK government will strive hard to ensure that the UK remains open for business and does not jeopardise the competitiveness of UK companies.
Of course, in the event of Brexit, there would also be opportunities for government to take a more protectionist approach to UK businesses, with remuneration arrangements playing a key part in ensuring they are able to compete to attract and retain the best talent. Whether this would lead to changes such as the removal of the bonus cap for financial services companies remains to be seen, but there is no doubt that matters such as these would be influenced by the precise form of a post-Brexit relationship with the EU.
The article was written by Stephen Diosi, Partner at Mishcon de Reya LLP. For more information, please contact Stephen Diosi. Reproduced from Practical Law with the permission of the publishers. For further information, please visit www.practicallaw.com.