Directors' remuneration report

Governance and risk-management

An essential component of our approach to remuneration is the governance process that underpins it. This ensures that our policy is robustly applied and risk is managed appropriately.

The remuneration committee reviews the remuneration policy for the top management group. The committee's role is to ensure that members of the executive management are provided with appropriate incentives to encourage them to enhance the performance of the Group and that they are rewarded for their individual contribution to the success of the organisation.

The committee advises on major changes of employee benefits schemes and it also agrees the policy for authorising claims for expenses from the group chief executive and the chairman. It has delegated power for settling remuneration for the chairman, the group executive directors, the company secretary and any group employee whose salary exceeds a specified amount, currently £350,000.

All the independent non-executive directors are invited to attend meetings if they wish, and they receive the minutes and have the opportunity to comment and have their views taken into account before the committee's decisions are implemented.

The committee's terms of reference are available from the company secretary and are displayed on the Group's website, www.lloydsbankinggroup.com.

The committee met on nine occasions during 2008, and the members were as follows:

• Dr Wolfgang Berndt (chairman)
• Sir Victor Blank
• Mr Philip Green
• Sir Julian Horn-Smith
• Sir David Manning (from 1 May 2008)

We welcomed Sir David Manning to the committee in May 2008, which was the only change to the committee membership during the year.

The committee retains independent consultants to provide advice on specific matters according to their particular expertise. Towers Perrin, Hewitt New Bridge Street and Kepler Associates were retained by the committee during 2008 to advise on various matters relating to executive remuneration. In addition, PricewaterhouseCoopers LLP (PwC) were also retained in 2008 specifically to support the committee with a one-off project to review executive remuneration arrangements in light of the acquisition of HBOS, given their particular expertise in relation to the remuneration aspects of transactions. In recognition that PwC are also the auditors to the Lloyds Banking Group and to mitigate any threat to audit independence, Kepler Associates continue to be retained as the remuneration committee's primary independent advisers, and were commissioned to provide comment on PwC's advice.

In addition to their advice on executive remuneration, during 2008 Towers Perrin also provided market remuneration data as well as other remuneration consulting services to the Group, Hewitt New Bridge Street provided pension consulting services and PwC were the Group's auditors.

During 2008, Alithos Limited continued to provide information on behalf of the committee for the testing of the total shareholder return (TSR) (calculated by reference to both dividends and growth in share price) performance conditions for the Group's long-term incentive schemes.

Mr Daniels, Mrs Risley (Group Human Resources Director), Mr Farley (Reward & Employment Policy Director) and Ms Kemp (HR Director, Total Reward) provided guidance to the committee (other than for their own remuneration).

The remuneration committee takes an interest in ensuring that appropriate remuneration and governance arrangements are in place throughout the organisation, with the Group functions providing an oversight role in the development of remuneration policy and practice below the senior executive population. In particular, divisional remuneration decisions are subject to independent oversight from the human resources function and the appointment and remuneration for risk officers in the divisions is reviewed in conjunction with the chief risk officer for the Group.

During 2008, the committee received a review of the Group’s remuneration practices against a number of criteria including customer, shareholder alignment, conflict of interest and risk. This was prior to the review of practices requested by the Financial Services Authority (FSA) in October 2008. In general, the review found that there was good alignment between remuneration practices and the policy objectives. However, changes are being implemented to the practice in some areas of the business. In particular we had put in place for those employees in our Wholesale and International Banking division a bonus deferral plan appropriate to the roles they perform. As described above we have also implemented a deferral arrangement for senior executives, and have increased the use of our risk-adjusted economic profit measure in our incentive plans.

Following the FSA's approach to a number of major UK banks in October 2008, we submitted an analysis of our current remuneration policies against their proposed good practice criteria. The assessment showed a generally favourable comparison. We have met with representatives from the FSA and will continue to co-operate with them as they develop their updated guidance in 2009. Their draft Code of Conduct was published as this report was being finalised. Although we believe our approach is well aligned with the Code of Conduct, our approach will be subject to a further detailed review.

As a result of this review, and discussions with the FSA, we have identified some areas of governance where we will be implementing changes for the future, as part of our plan for integrating the Lloyds TSB and HBOS businesses:

• We will be enhancing the formal role of control functions in the oversight of remuneration. Input is already sought from the risk and finance functions into remuneration design and decisions. However, we believe that our governance would benefit from a more formalised role for control functions in our remuneration processes.
• We will be reviewing the oversight of divisional remuneration. Already we apply independent oversight of divisional remuneration from the Group’s centre function. During the year, the group HR function, in conjunction with the risk function, undertook the group wide review of remuneration practices summarised above, and we will be reviewing the oversight processes and governance controls relating to divisions to identify areas where they can be further strengthened. Our particular emphasis will be on ensuring that the linkage between good risk practices and remuneration can be robustly demonstrated.
• Regulators have identified the remuneration of risk officers as one of their areas of interest. The decision on risk officer remuneration is already held at the Group’s centre function. We will be reviewing the remuneration setting processes for all of our control functions to ensure that all potential conflicts of interest are identified and managed.