The great pay debate

21 Feb 2012 | Tim Ward

MOST will have caught the recent headlines on executive pay - which predominantly started as a result of David Cameron's tough words on 'big rewards for failure' in the Telegraph in January.

Vince Cable's statement in Parliament a few weeks ago reinforced those views and announced a number of upcoming proposals to curb excessive pay, including reformatting remuneration reports, requiring companies to explain how they have consulted with employees on executive pay, introducing binding shareholder votes on pay and more.

As we wait for the detail of these proposals to be published by the Department of Business, Innovation and Skills, I can't help but think about the cause of this debate - and I don't think it is the remuneration of small and mid-sized company directors.

The boardroom pay issue has come to a head because of the activities of a minority of very large companies - predominantly the big banks in light of the financial crisis. And it continues to happen - just this week Barclays has come under fire for bonuses paid out in 2011 and RBS's CEO was forced to give up his £1m bonus after mounting political pressure. So it's not surprising that the Government is pursuing these proposals - they want to see more clear explanations on pay to shareholders and ensure that pay is matching up with performance and not encouraging excessive risk-taking. I'm not sure anyone can argue against that.

But we can certainly argue over what should be done. We at the Quoted Companies Alliance are concerned that these proposals may be passed down to small and mid-sized quoted companies. As I suggested earlier, small and mid-size quoted companies generally do not pay their executives excessive salaries and their failure would not present a systemic risk to the UK economy.

A proportionate approach to the proposals on executive pay must be adopted for small and mid-sized quoted companies so that they can grow and create employment, which is necessary for the UK's economic recovery. This is why the Quoted Companies Alliance is publishing a Remuneration Committee Guide for Smaller Quoted Companies at the end of this month, with the goal of helping these companies develop their remuneration policy and how they communicate it to their shareholders and other stakeholders.

A number of the Government's pay proposals could present practical difficulties for smaller companies in particular. In our most recent QCA/BDO Small and Mid-Cap Sentiment Index survey, we asked the small and mid-cap sector what they thought about a binding shareholder vote - and we got some robust responses - but, you'll have to wait until the report is published at the end of February to find out what they said.

In the end, the devil is in the detail - and the detailed Government proposals on executive pay are due to be published for consultation any day now. I'm sure that there is a long and continued pay debate ahead of us.

Tim Ward is chief executive of the Quoted Companies Alliance, the independent membership organisation that champions the interests of small and mid-size quoted companies. His past roles have included head of issuer services and head of marketing at the London Stock Exchange and finance director at FTSE, the index company.

CIMA aims to break the US, but to what effect?

01 Feb 2012 | Richard Crump

IN THE world of pop music, success can often be defined by the artist's ability to break America. I am not sure if management accounts are the pop stars of finance, but the tie up between the AICPA and CIMA to create the CGMA will undoubtedly give its members some bling in the US.

The union will broaden the scope of both organisations, which must be hailed as a good thing. But beyond that I am not sure what practical benefits it will bring.

The CGMA was launched with much fanfare at a live event held in both London and the US, which also launched an extensive report into the need for management accountants to be at the forefront of improving the measurement and reporting of the value of non-financial assets.

But it seems that CIMA members do not need to do anything to earn the new designation. Without entry standards being lifted or a greater width in exam topics it is difficult to see how the newly branded accreditation will tangibly help management accountants to excel in non-financial areas.

Did PwC dodge a bullet with JP Morgan fine?

06 Jan 2012 | Richard Crump

PwC may have just been dealt the largest fine ever handed out by the Financial Reporting Council's disciplinary arm, the Accounting and Actuarial Discipline Board (AADB), over its work at JP Morgan, but the £1.4m fine is miniscule compared to the other figures bandied around during the process of up to £44m.

So was the fine excessive, fair or inadequate? And how did £44m become £1.4m?

The fine was levied for PwC failing to flag up non-segregation of JP Morgan Securities Limited's (JPSML) client assets for seven years to 2008, which PwC accepted had "fallen short of the standards reasonably to be expected of members and member firms".

The FSA fined JPMSL £33.2m for the breach, equivalent to 1% of the average amount of client assets at risk over the eight years in question. A similar proportion of the profits after tax of PwC would have been £44.3m. If this were not accepted, AADB's counsel, Simon Browne-Williamson, urged the tribunal to adopt a similar tack suggesting it might consider sums such as the £6.5m fees JPMSL paid to PwC during the period in question.

Both arguments relied heavily on the fact that the overall profit of PwC was larger than that of its client. However, the AADB accepted that the relative profits of the client and the auditor are not appropriate measures of the penalty. Although this does raise the question whether the increases in the fees paid by the likes of JP Morgan to firms such as PwC need a hike in the penalties payable for misconduct of the type in question.

Tim Dutton of law firm Herbert Smith and counsel to PwC, on the other hand, suggested that the appropriate fine should be between £500,000 and £1m and should fall at the lower end of the range. Previously, the largest penalty imposed by the JDS tribunal - the forerunner of the AADB - had been £1.2m in the case of the auditors of the companies connected with Robert Maxwell.

That is quite a startling disparity and leaves the AADB in a quandary. Without concrete guidelines in place the AADB can only base its sanctions on what has gone before - such as the Maxwell case. But clearly there needs to be some sort of review by the AADB. After all, a fine should be levied as a deterrent and it is questionable whether a £1.4m fine will make much impact to a firm that reported £2.3bn in fee income for 2011.

So the fine was both fair and inadequate at the same time. Fair based on the current guidelines but inadequate given that when you deduct the fine from the fees paid by JPMSL, PwC still comes out £5.1m up.

While a fine of £44m was never going to become a reality, PwC should be thankful that the AADB has yet to reform its guidelines for financial sanctions on accountants.

Was this Osborne's New Deal?

29 Nov 2011 | Gavin Hinks

MORE than at any other time since he was elevated to his job as chancellor, George Osborne now sounds like he is fully committed to growth for the UK economy with a set of grand measures in the Autumn Statement to get things going.

Make no mistake, as the BBC's Robert Peston quickly pointed out, this was no Autumn Statement as envisaged by Osborne; this was a mini Budget, if not a full blown affair. This adds to the sense that Osborne now feels he has to do more and that austerity alone (we know it was just austerity, but it's a matter of balance) was not working. His critics will renew their claim that austerity was not working and that Osborne has been forced to change tack.

So we have measures to 1. Protect the economy; 2. Build the economy and 3. Ease credit.

Taking the last one first easing credit is critical. Abuse continues to be slung at the banks for hoarding money and not making a bigger effort - the chancellor had to move. So he pledged that the taxpayer will guarantee small business loans. The questions will remain about how the loans are accessed. The devil will be ensconced in the detail. If the criteria are too tough the scheme will do too little to help. If too loose the government will be taking a risk with taxpayers money.

Next the infra structure projects - 500 of them - to reinvigorate the economy. One felt that Osborne was only just held back from calling it his ‘New Deal'. Of course, it doesn't compare with Roosevelt's depression era efforts but all the same, something on a grand scale was called for. The question will be where the costs falls. Can the pension funds really plough £20bn into the project? Will they really find projects they want to invest in anf get the returns that they want. His Osborne finding a way to take a risk with our pensions?

Once the banks were told to lend - but the results were frankly middling. And was there a suggestion that local authorities would be allowed to borrow against future tax receipts to get projects underway. Won't that be wracking up public sector debt again? Government will need to tread carefull on this.

Lastly, protecting the economy appears to be a duty falling on public sector costs. A day ahead of public sector strike action the chancellor urged the unions to call it off but reaffirmed his plan to cap pay rises when current pay freezes end, and he won't change his tune on pensions. The prospect of conflict between government and public sector workers remains and we can expect disruption on the horizon.

Lastly, looks I won't be retiring until I'm 67, on today's announcement. There's plenty of time for that to be raised again. Cheery thought.

SME Funding – unwilling banks or uninvestable business plans?

25 Nov 2011 | Patrick Murray, The FD Centre

THE LATEST Project Merlin figures from the Bank of England show that the lenders have made available £158bn of new lending, or 83% of their lending target. However, most small and medium-size enterprises seem unable to attract funding on acceptable terms. So is the root cause an unwillingness to lend or the lack of investable business plans?

My contention is that actually the whole issue of SME funding is more structural, and we will not solve the problem by the target-oriented approach set out in Merlin.
Banks run a pretty simple business model. They borrow money from depositors which they need to loan out. For this they charge a modest return. Portfolio theory suggests that risk and return should be positively correlated, so it seems fair that this return should attract a low or modest risk profile.

Above all, banks need to ensure they get their money back. So it follows that they are quite fussy about who they give the money to and what it will be used for. For this reason the bank's credit committee is detached from the customer and will look dispassionately at the application. Typically they will look at the management team, whether the lending falls into no-go segments (eg pubs, and commercial property are not in favour at the moment), and the strength and risks in the business plan. If all of these factors tick the boxes, then the bank will also look at what security is on offer. Unless the loan is for physical assets which the bank can use as security, they will normally look to take personal guarantees from the entrepreneurs. At this stage, most entrepreneurs find the idea of personal guarantees deeply unpalatable, and the conversation ends there.

In fairness to the banks, they typically look for a return of a few percentage points above the base rate and also take an arrangement fee. All told, their return at the moment would probably cap out at 5 per cent. At this level of return, they just can't risk losing their capital.

Outside debt finance, venture capital is the other avenue open to an SME. This is normally used in scenarios where the capital invested is more at risk. It is a very different animal from bank finance. For a start, the return expected can be quite eye watering (an IRR 30% would not be unusual). For this reason, a venture capitalist will only be interested in very high growth businesses which can generate this level of return. They will need the company to sign an investment agreement which puts controls in place, and will give the VC complete control if things go badly. Also, the investment itself is an expensive process with typical investment fees in excess of £80K for lawyers and due diligence. In order to be worth doing, this effectively limits venture capital to quite large sums.

Is there a third way?

Basically we have a situation where banks are able to offer lending under very restricted circumstances for a very modest return, and we have venture capitalists offering funding which is high risk for a much more aggressive return. My contention is that there needs to be a third way which offers funding to companies who find themselves in the middle. This kind of finance would work with business plans which offer strong returns, are too risky for banks and don't meet the criteria for venture capital. We can look abroad for some of the answers. For example, I don't think it any coincidence that Germany has a very strong SME segment (Mittelstand) and also one of the most supportive funding models for SMEs.

George Osborne recently announced that the government was looking at addressing this area with ‘credit easing', although the details were sketchy. My view is that this would be a fantastic way of getting the economy back on its feet; however, it would need to be done in the right way.

If it were my decision, I would create a bank network (perhaps using some of the branches hived off from RBS or Lloyds) specifically focused on SMEs. These banks would have the ability to make marginally more risky investments than conventional banks, and would be able to countenance loans with security from the government if there was a lack of security in the company itself. In certain circumstances, the bank would also be able to take equity as well as debt. They would not interfere with the way the company was run in the same way as a venture capitalist might expect to, but would have certain power of veto (ie to prevent owners drawing excessively until the loan is repaid etc).

These SME banks could expect much higher return on invested capital than a conventional bank. I would also go further and offer some tax breaks to the SMEs who were chosen for these investments (for example, lowering their rate of employer's National Insurance), hence helping to ensure all the money goes to making the business plan a success, not immediately back to the exchequer. In return, the SMEs would be required to spend the funding on UK-based projects, and/or create employment of UK workers.

I am not particularly confident that any of the ‘credit easing' measures will go this far, but until we address some of the structural issues, we will be starving good business plans of the investment they need to the detriment of the British economy.

Patrick Murray, principal, The FD Centre

Lloyds leadership: Don't panic!

04 Nov 2011 | Gavin Hinks

READING yesterday about the travails affecting the board at Lloyds Bank one felt like invoking Dads Army’s Corporal Jones and his famous exhortation to his commanding officer: “Don’t panic Mr Manwaring!”

The coverage of CEO Antonion Horta-Osorio’s unexpected decision to take leave of absence, apparently for over work and exhaustion, and his replacement at the helm by finance director Tim Tookey, could well have given the impression that the roof had fallen in on Britain’s biggest High Street bank.

Has it? I’m no banking expert (I know, that’s my cue to shut up) but I suspect the leadership issue is not nearly as grave as some commentators would have us believe.

Brought into the bank and groomed as its next group FD, Tookey is experienced and viewed as a decent pair of hands. He’s had five years to get to know the bank, been with it through some pretty tough times and, by all accounts, has some fairly robust ideas about the direction it should be taking.

The question is not really whether he is a worthy leader. The issue is really that he is a leader that finds himself in quite an unworthy position. Due to leave early next year Tookey finds himself temporarily heading a bank that is in the midst of strategic change.

Possibly even overseeing change that he doesn’t entirely think is good for the bank. Professional that he is, he will have to see it through. Unless it becomes clear that Horta-Osorio will not return.

At the moment the bank is adamant that he will, but even this morning the Financial Times saw fit to run a speculative piece on who might replace him if he doesn’t. Among those? Well, Tookey of course, plus previous finance director Helen Weir and Standard Chartered’s FD Richard Meddings and a clutch of investment bank.

Among the big FTSE companies that a growing sense that the FD’s position is now a vital route to the CEO’s post. Events at Lloyds and recent speculation seem to be fulfilling the prophecy.

Deputy editor's blog: Better off out of it?

28 Oct 2011 | Richard Crump

I WOULD not be surprised if Wednesday's agreement by Europe's top political brass on how to fix the knackered eurozone ends up a damp squib - so often have these agreements fizzled out in the past.

Yet there is a feeling of inevitability that the agreement to raise the European Financial Stability Fund to €1tn to support a 50% Greek haircut on the country's sovereign debt will eventually lead to greater fiscal union to support the monetary union among eurozone members.

The motivation for the UK to throw in its lot with euro is now non-existent. But I do not agree that now is the time for the UK to begin looking inwards and start questioning whether we should even be a member of the EU, or even more fancifully "renegotiate" our position within the EU.

I believe that the UK's best business interests are served by being in the EU, after all 50% of the country's international trade is conducted with our noisy neighbours, and regulation will always continue to be heaped on companies with, or without edicts emanating from Brussels.

Days after facing a Conservative rebellion over a vote on whether to hold a referendum on the repatriation of powers from Brussels, David Cameron Cameron told a Commonwealth Heads of Government summit in Australia that the City of London was under 'constant attack' from Europe.

Protecting London as a pre-eminent financial centre is of vital importance to the government and the UK, but surely the best interests of UK business will be best served by being closely involved with the European game. If the UK were to step back from Europe, rather than being a player jostling on the same board as everyone else it would be left kicking at it whenever from the sidelines.

Some UK economists have predicted the break up of the euro and collapse of the eurozone for some time. We even covered it in Financial Director a year ago, but it is important to note that despite the eurozone's plight the euro has been more stable than sterling and was on track for its best monthly performance against the pound since June.

Business Matters: We're alright, it's everyone else that's in trouble

28 Oct 2011 | Tim Ward

THE QUOTED Companies Alliance, in conjunction with BDO, has just launched its inaugural quarterly survey of the small and mid-cap quoted community. It is aimed at tracking the relative confidence levels of companies and their advisers in this important sector.

In our first survey, there is a general pessimism towards the UK economy's outlook, with an average score of 39 out of a possible 100. But it is interesting (and perhaps counter-intuitive?) to see that companies feel optimistic about their own prospects over the next 12 months, with an average optimism score of 64.

The divergence reflects a trend where companies, despite feeling secure about their own projected growth, are questioning the state of the UK's broader economic health and the implications for this.

More than half (60%) of small and mid-cap quoted companies are telling us that the capital markets are hindering their growth plans. Of those saying markets are hindering their projected growth, more than three quarters (76%) of small and mid-cap quoted companies cite a lack of liquidity as the principal reason for this. Just 14% say that capital markets are helping.

Small and mid-cap companies' lack of confidence in the UK's economic recovery is exacerbated by a perceived absence of governmental support. Only 4% of companies believe that the UK government views small and mid-cap companies as a priority.

It's clear to me that small and mid-cap quoted companies believe that the Government could do much more to foster an environment to help them raise the finance they need to grow and create jobs. The majority of companies feel that regulation is going to increase over the next 12 months which is at odds with the Government's current anti-red tape agenda. Real change is required from our policymakers and market providers to improve the channels of finance to these companies which are a key source of growth for the UK.

So what do companies want Government to do? Almost half (49%) want tax incentives introduced for investors in small and mid-cap quoted companies and 23% want regulation reduced. These findings validate the Quoted Companies Alliance campaign for capital gains tax reform so that all people that contribute to a business, not just those that own 5% of shares, can get the tax relief.

On a more upbeat note 77% of companies tell us that they expect to see turnover grow, with an average expected growth of 15%. And a majority (62%) also expect to be hiring over the next 12 months, increasing their workforce by an average of 6.9%.

Do you agree with these headlines?

If you'd like to take part in our next survey or would like a copy of our survey report please email me at tim.ward@theqca.com.

Tim Ward is Chief Executive of the Quoted Companies Alliance (QCA), the membership organisation of the small and mid-cap quoted sector.