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2020 ReportM c K a y S e c u r i t i e s P l c A n n u a l R e p o r t a n d F i n a n c i a l S t a t e m e n t s 2 0 1 9 Annual Report and Financial Statements 2019 McKay Securities Plc Annual Report and Financial Statements 2019 Introduction & Contents McKay is a specialist in the development, refurbishment and management of commercial property – ideally positioned to deliver quality, innovation and growth. We take great pride in creating environments where our occupiers can realise their ambitions and grow their business in a long term partnership. See more on page 22 Banbury Poyle LONDON Reading Maidenhead Windsor Staines Theale Newbury Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone What’s inside this report? 04 Year in Review 22 Property and Financial Review Contents Strategic Report 03 Highlights 04 Year in Review 06 Chairman’s Statement 10 At a Glance 12 Business Model 14 Strategy 18 Market Context 20 Property Portfolio 22 Property and Financial Review 28 Sustainability 38 Principal Risks and Uncertainties Governance Report 44 Board of Directors 46 Chairman’s Letter 47 Directors’ Report 50 Audit and Risk Committee Report 52 Nomination Committee Report 54 Remuneration Report 67 Statement of Directors’ Responsibilities 68 Independent Auditor’s Report Financial Statements 75 Financial Statements 100 Glossary 102 Company and Shareholder Information 28 Sustainability 20 Property Portfolio 06 Chairman’s Statement Banbury Poyle LONDON Reading Maidenhead Windsor Staines Theale Newbury Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone London 01 Office Industrial Other Office Industrial Other 7 7 77 McKay Securities Plc Annual Report and Financial Statements 2019 Our Vision Our vision is to build upon our reputation and status as the leading property specialist for occupiers and investors, focused entirely on London and the South East – and build a business based on markets that we know and understand. Our Mission Our mission is to develop, refurbish and manage commercial property; working in partnership with occupiers to deliver quality, innovation and growth. We provide the very best environments for our customers to thrive and businesses to grow. We deliver sustainable returns by operating an effective and established business model. Download the 2019 McKay Annual Report from www.mckaysecurities.plc.uk 02 McKay Securities Plc Annual Report and Financial Statements 2019 Highlights Operational • Completion of 30 Lombard Street, EC3, triggering commencement of the 15 year pre‑let to St. James’s Place plc • Commencement of construction of a • 134,430 sq ft distribution warehouse unit at Theale Logistics Park 19 open market lettings at a combined contracted rent of £1.29 million pa, 8.1% ahead of ERV • 74.0% occupier retention rate Financial Profits and earnings Shareholders’ funds Proposed final dividend per share £311.08m (2018: £306.44 million) 7.4p up 2.8% (2018: 7.2 pence), making the total dividend per share for the year 10.2 pence (2018: 10.0 pence) £13.19m Profit before tax (IFRS) (2018: £43.44 million) £9.27m1 Adjusted profit before tax (2018: £9.07 million) 8.8p2 EPRA earnings per share (2018: 9.6 pence) 326p3 EPRA net asset value per share (2018: 322 pence) 331p3 Net asset value per share (IFRS) (2018: 326 pence) Total property return Debt to portfolio value (LTV net debt) 33.3% (2018: 31.6%) 5.4%4 (2018: 12.3%) 1. See note 5 in financial statements 2. See note 9 in financial statements 3. See note 22 in financial statements 4. See KPIs on pages 24 and 25 5. See note 11 in financial statements Portfolio valuation £482.70m (2018: £460.15 million) £6.47m 1.4% Surplus5 (2018: £24.46 million / 6.1%) 03 McKay Securities Plc Annual Report and Financial Statements 2019 Year in Review £15.00psf Record rent Oakwood Trade Park, Crawley Portsoken House, EC3 Innovative refurbishment of 8th floor lets on PC £0.19m pa £67.50psf Record rent Castle Lane, SW1 12,720sq ft Pegasus 2, Crawley Refurbishment of entire building begins Sustainability Award GRESB 3 Star Mallard Court, Staines-upon-Thames Refurbishment of 11,390 sq ft begins £0.21m pa UBC lease completes The Mille, Brentford 04 McKay Securities Plc Annual Report and Financial Statements 2019 Portsoken House, EC3 Innovative refurbishment of 2nd floor lets on PC £0.28m pa Switchback Office Park, Maidenhead 3 lease renewals signed, 66% rental increase 18 tenants 329 Bracknell Fully let 8 Lease renewals signed at Lower Cherwell Street Industrial Estate, Banbury Conditional exchange for the sale of The Planets, Woking Completion of enabling works for Theale Logistics Park Practical completion of 30 Lombard Street, EC3 and St. James’s Place plc lease begins at net contracted rent of £3.40m pa 91.0% Portfolio occupancy (exc developments) 74.0% Tenant retention 05 McKay Securities Plc Annual Report and Financial Statements 2019 Chairman’s Statement This has been another successful year of delivery for the Company, during which we have continued to build on the growth strategy put in place at the beginning of 2014. Richard Grainger Chairman 20th May 2019 06 McKay Securities Plc Annual Report and Financial Statements 2019 Dear Shareholder This has been another successful year of delivery for the Company, during which we have continued to build on the growth strategy put in place at the beginning of 2014. Since then, we have delivered an 89.6% increase in portfolio value from £254.55 million to £482.70 million, and a 46.9% increase in shareholders’ funds from £211.79 million to £311.08 million. Valuation gains from our portfolio and development programme combined with the profitable disposal and recycling of assets totalling £67.97 million over the same period have enabled us to maintain a stable loan to value ratio that sits well within our target range. Shortly after the year end we were also able to improve our future investment firepower by £55.00 million with an increase in our loan facilities. Our focus on the office, industrial and logistics sectors in the UK’s strongest economic regions combined with our in‑house development, refurbishment and management skills, continued to deliver shareholder value. We are seeing the changing needs of business, building obsolescence and the loss of space to alternative uses combining to underpin a steady level of occupier demand and investor appetite. With historically constrained levels of supply and a limited development pipeline, capital and rental values within these markets have so far proved remarkably resilient and stable. It is not surprising that capital values have remained high for prime, well let assets, as investors seek security in these uncertain times. In this climate, we have been quite happy investing in our existing portfolio assets to extract value while being on the lookout for additional earnings enhancing acquisitions which also offer the potential to add value through McKay’s repositioning skills. There are signs that pricing for this more opportunistic stock is becoming more realistic and we now have greater headroom to capitalise on this. We took advantage of this strong pricing at the end of the prior year to sell three properties, and during the year have exchanged contracts for the sale of The Planets, Woking, conditional on planning consent. Despite the loss of £1.32 million of income from the properties sold last year and a further £0.75 million from the transition of property into development, adjusted profit before tax for the year increased by 2.3% to £9.27 million (March 2018: £9.07 million). As set out in more detail in the Property and Financial Review, this loss of income was offset by income contributions from our recently completed development schemes and interest savings as a result of the cancellation of our remaining legacy interest rate hedging facilities at the end of last year. EPRA net asset value per share increased by 1.2% to 326 pence (March 2018: 322 pence) predominantly due to the £6.47 million (1.4%) surplus generated by the independent valuation of the property portfolio at the end of the period of £482.70 million (March 2018: £460.15 million). This surplus and the 2.1% (£0.69 million pa) increase in portfolio rental value (“ERV”), which ended the year at £33.83 million pa (March 2018: £33.15 million), both outperformed the MSCI IPD (All property) benchmark which delivered movements for each of 0.2%. Our three main priorities over the year to maintain delivery of our growth strategy have been: • The continued implementation of our development programme • The release of the substantial income potential generated within the portfolio • Capitalising on our progress to date by improving our scope for further growth Good progress has been made in all three areas. Our development priority was the delivery of the two remaining active schemes at 30 Lombard Street, EC3 and at Theale Logistics Park on the outskirts of Reading, following the successful completion and letting of our office developments in Reading and Redhill last year. £228.15m increase in portfolio value since 31st March 2014 £99.29m increase in shareholders’ funds since 31st March 2014 07 McKay Securities Plc Annual Report and Financial Statements 2019 Chairman’s Statement continued In March 2018 we announced that the whole of the 30 Lombard Street (58,585 sq ft) scheme had been pre‑let to St. James’s Place plc on a 15 year lease at a contracted rent of £3.40 million pa (net of ground rent), with upward only rent reviews every five years. Construction works completed in January 2019, triggering commencement of the lease and the new tenant is now fitting out for occupation this summer. This was a complex construction project and the end result is a striking office headquarters building that has enhanced the streetscape of this core City of London location. Securing a financially strong tenant on a long lease, ahead of forecast, has also created a valuable high‑quality asset which contributed to the valuation surplus again this year. This has further de‑risked our development programme with ongoing construction now limited to our warehouse distribution scheme at Theale Logistics Park (134,430 sq ft). With excellent access adjacent to Junction 12 of the M4 motorway, low site cover and low passing rent, we identified the strong value‑ add potential when we purchased what was a dated chilled distribution unit on the site in 2015. It provided the scope for either refurbishment or redevelopment at lease expiry in 2021, or earlier if the tenant exercised a break option in January 2018. We achieved planning consent for a high bay warehouse and a 38.5% increase in floor area in 2017 and, with the benefit of a 12 month rent penalty when the break clause was exercised and encouraging market conditions, we took the decision at the end of last year to progress redevelopment. Demolition has now been completed and the contractor is on site with completion expected by December 2019. The improved specification and the substantial increase in floor area have increased the rental potential by 92.2% to £1.48 million pa in a sector that has seen strong demand driven by the growth of e‑commerce, and our marketing campaign continues to generate interest. The development programme has proven to have been well timed. The three completed office schemes are now let at a total contracted rent of £5.99 million pa, representing 22.0% of portfolio contracted rent. Our second priority area has been generating additional income from vacant properties and securing increases to ERV at lease expiry and rent review. This income potential, which totalled £4.66 million pa at the beginning of the period, has been built up as a result of positioning portfolio assets to benefit from rental growth in our markets. To release this income potential, we have continued with the selective refurbishment and direct management of the portfolio and implemented innovative and thorough letting campaigns. Office occupiers in particular increasingly expect choice and flexibility, and the increase in the serviced office sector over the last few years has resulted in a far wider range of occupational solutions on offer. In this evolving market we have continued to demonstrate our ability to design and deliver the right product with the completion of 19 open market lettings, at a combined contracted rent of £1.29 million pa, exceeding March 2018 ERV by 8.1%. We also pride ourselves on working in partnership with a diverse range of occupiers to deliver the very best business environments, with sustainability at the heart of our projects and the management of our buildings. We will be emphasising the “McKay way” to prospective and existing occupiers to highlight our commitment to create the right environment with high standards of customer service in directly managed buildings, offering flexibility and value for money. This operational approach contributed to high approval ratings in our most recent occupier survey. It also played an important part in our high occupier retention rate at lease break and lease expiry, when 74.0% of occupiers remained in occupation and a £0.21 million pa (31.6%) increase in passing rent was achieved. 08 McKay Securities Plc Annual Report and Financial Statements 2019 Dividend The Board is recommending a 2.8% increase in the final dividend to 7.4 pence per share (March 2018: 7.2 pence). The final dividend will be paid as an ordinary dividend on 25th July 2019 and will take the total dividend for the year to 10.2 pence per share (2018: 10.0 pence), an increase of 2.0%. Outlook The deferral of a Brexit solution has extended uncertainty over the future pace of economic growth and the trading environment for the year ahead. The occupier is at the heart of all we do, and much will depend on how this delay affects business confidence. However, our focus on the office, industrial and logistics markets of London and the South East provides us with exposure to the two strongest and most resilient economic regions of the UK. This, combined with the substantial income potential still to be released from the portfolio with a range of development and refurbishment initiatives and our additional headroom, leaves us well placed to deliver future shareholder value. Richard Grainger Chairman 20th May 2019 Having achieved these rental gains, the portfolio reversion has been topped up with several lease expiries over the period, as well as increases in ERV mainly driven by refurbishment and achieved rents. These expiries have provided us with a number of excellent refurbishment opportunities to improve occupier appeal and to achieve higher rental values including schemes at Crawley, Staines and Croydon, which are all well established markets with constrained supply. With the trend to greater flexibility in lease terms, our track record of cost effective refurbishment will be of increasing value. Taking this portfolio activity into account, we ended the period with contracted rents up slightly to £27.22 million pa (March 2018: £27.05 million) compared with the portfolio ERV of £33.83 million pa. The difference maintains the opportunity to increase contracted rents by a substantial £6.61 million pa (24.3%), of which the development at Theale represents £1.48 million pa. Our third area of priority over the year has been to capitalise on our strategic progress to date, by improving our scope for further growth. Since 2014, we have invested £63.05 million into acquisitions, and £90.02 million in capital expenditure on the development programme and other portfolio projects. This investment has added significant value to the portfolio, allowing us to increase our borrowings without pushing up gearing beyond acceptable levels. This, and the ability to add completed development schemes into the security pool, enabled us to increase our loan facilities by £55.00 million shortly after the year end to £245.00 million. This has provided us with substantial firepower and secured low margins for another five years. 09 McKay Securities Plc Annual Report and Financial Statements 2019 At a Glance As the only REIT specialising in the office and industrial markets of London and the South East, McKay offers a unique proposition for investors. Our portfolio (31st March 2019) 33 Properties £482.70m Portfolio value 1,474,471 sq ft Industrial Other Office Internally managed See more on page 20 1010 Other 5% In L o d u s t g i s r i t i a 1 6 c l s / % s e c fi f O t s % 4 a 5 E h t u o S s e c fi f % 5 n O 2 L ondo Banbury Poyle London Reading Maidenhead Windsor Staines Theale Newbury Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone McKay Securities Plc Annual Report and Financial Statements 2019 Banbury Poyle London Reading Maidenhead Windsor Staines Theale Newbury Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone Geographic locations Key Office Industrial Other Banbury Reading Poyle London Maidenhead Windsor Staines Theale Newbury Office Industrial Other Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone 11 Office Industrial Other Banbury Poyle London Reading Maidenhead Windsor Staines Theale Newbury Bracknell Woking Fleet Brentford Weybridge Wimbledon Croydon Leatherhead Farnborough Redhill Crawley Folkestone McKay Securities Plc Annual Report and Financial Statements 2019 McKay Securities Plc Annual Report and Financial Statements 2019 Business Model Our primary business objective is to deliver attractive and sustainable returns to shareholders over the long term, with exposure to those property markets where the benefit of our skills and experience will be most productive. 12 Key resources Our properties: We focus on quality office and industrial business space within the proven and established markets of London and the South East Our occupiers: We partner with our occupiers to provide the very best environments for teams to thrive and businesses to grow. Property management is run in‑house giving direct tenant/landlord relationships and high tenant retention Our suppliers: Our geographical focus means we know the local supply chains well. We operate a responsible procurement policy and work in partnership with our suppliers Our team: Our experienced team are experts in their field and we actively manage our assets to maximise property returns. The focus on just London and the South East means we know our markets intimately Respected brand: We take pride in everything we do and have developed a reputation for quality, innovation, ambition and growth, an approach stretching back to formation in 1946 Financial flexibility: Strong banking relationships and a robust balance sheet allow flexibility to invest in the portfolio throughout the cycle What we do: h t a h e e s s e t s t B u y et identifi ed crite ria w it h t uisition of pro p erty a otential to a d d v a l u p q c A e m D i s p o s S t o r a l o e c f m e ll y a t c l e c a u r e a pital ssets M A ctiv a n e in - h m a n a a o g g e u s e e m a e s n s t e t nt e m p D e velop e nt and develo p erties to enhance o rtfolio returns m b i s o f p r o r h u p f R e We create value through investment in our property portfolio to maximise income and capital returns. Occupiers We offer our occupiers choice and flexibility and quality business space. £13.79m development and refurbishment capital expenditure (2018: £23.31m) Investors We aim to deliver attractive and sustainable returns to shareholders. 7.4p final dividend (up 2.8%) Environment We are committed to our sustainability objectives. 44% Reduction over four years in carbon emissions Strategic priorities GRESB Green Star status 3 years running Delivery of development programme Release of portfolio income potential by capturing reversion Scope for future growth 13 McKay Securities Plc Annual Report and Financial Statements 2019 Strategy Our strategy is to apply entrepreneurial property initiatives to generate income and capital gains, primarily from office and industrial properties in London and the South East to maximise total portfolio return. Strategic priorities Delivery of development programme See KPIs and Remuneration Policy on pages 24 and 54 Release of portfolio income potential by capturing reversion See KPIs and Remuneration Policy on pages 24 and 54 Scope for future growth 14 See KPIs and Remuneration Policy on pages 24 and 54 McKay Securities Plc Annual Report and Financial Statements 2019 2018/2019 progress Key metrics Looking forward Risks • 30 Lombard St., EC3 completed • Development surpluses • Complete last letting at – 100% let enhance NAV, TPR and PCR Prospero, Redhill • Prospero, Redhill completed – • Lettings ahead of forecast • Complete and let Theale 94% let enhance NAV, TPR and PCR • Theale Logistics Park – • Well managed programme • demolition completed and contractor appointed could impact TSR Logistics Park Identify and progress new schemes • Market downturn • Delays in construction • Health and safety events • Availability of finance • Availability of new opportunities See KPIs and Remuneration Policy on pages 24 and 54 Link to remuneration • Development performance directly impacts on short and long term incentive plan measures of NAV, EPS and strategic targets • Fully fitted space successfully • Lettings, lease renewals and • Rollout of McKay fit out trialled at Portsoken House, EC3 • Developed and enhanced our occupier services offer • £1.29 million pa contracted rent from open market lettings • 74% tenant retention rate • 32% increase in contracted rent on renewal rent reviews improve earnings and reduce voids, which enhances NAV, TPR and PCR • Strong occupier relationships support high tenant retention rates, minimising voids and refurbishment expenditure which enhances TPR and PCR at selected portfolio voids • Trial the latest smart technology and development of community portal and building management app Improve occupier engagement and rollout of the McKay offer • Maintain high tenant retention • rate • Market downturn • Investment in technology and fit‑out not providing the required returns • Tenant default See KPIs and Remuneration Policy on pages 24 and 54 Link to remuneration • Releasing portfolio income reversion directly impacts on short and long term incentive plan measures of NAV, EPS and strategic targets • Monitor the market closely for • Capacity for future growth • Utilise increase in debt facilities • Lack of suitable investment potential acquisitions • Utilise value gains to secure increase in debt facilities • Capture value from portfolio initiatives • Recycle disposal proceeds effectively provides scope for gains in all KPIs, and should enhance TSR to add value • Maintain banking relationships • Secure earnings and value‑ enhancing acquisitions opportunities • Overpricing restricting purchasing • Covenant compliance Link to remuneration • Provides a general incentive for the workforce to deliver future incentive‑based gains • Enhancing of future prospects should impact on long term incentive plan measure of TSR 15 McKay Securities Plc Annual Report and Financial Statements 2019 Strategy continued Portsoken House, EC3 Innovative fully fitted our refurbishment of common areas, 2nd and 8th floors complete and now 100% let. See more on page 20 We create value through investment in our property portfolio. Theale Logistics Park New distribution warehouse under construction five miles from Reading adjacent to Junction 12 of the M4. Practical completion December 2019 134,430 sq ft 16 McKay Securities Plc Annual Report and Financial Statements 2019 30 Lombard Street, EC3 Practical completion in January 2019, this prime City core new office development is now fully let for 15 years. 58,590 sq ft See more on page 20 The Mille 12 storey landmark office building with rolling refurbishment programme and strong tenant retention. 96,750 sq ft See more on page 20 Mallard Court, Staines-upon-Thames 1st and 3rd floors currently under refurbishment to provide innovative office accommodation in the town centre. 11,390 sq ft See more on page 20 1717 McKay Securities Plc Annual Report and Financial Statements 2019 Market Context Why London and the South East? McKay is a specialist in the development, refurbishment and management of quality buildings within the established and proven markets of London and South East England. It is the only REIT focused entirely on these markets. UK businesses are in London or the South East 1 in 3 38% combined contribution to the UK economy of London and South East 18 Regional strength London and the South East are the most dynamic of the UK’s twelve regions, dominating in terms of population, business prosperity and productivity, with: • 27% of the total UK population • 34% of all UK businesses • 35% of the total UK disposable • household income the two highest ranking by earnings, productivity and GVA; all ahead of the UK average • 38% of total UK GVA Regional diversity Exposure to the economies of both London and the South East provides regional strength and diversity across a wide range of business sectors, minimising reliance on any one sector. This diversity is supported by: • a high concentration of leading • universities the UK’s two leading international airports • efficient road and rail networks • the Elizabeth Line and other planned infrastructure projects Regional focus With a portfolio invested in the office and distribution/warehousing sectors, the breadth and stability of demand from this diverse economy provides a strong operating platform. This is further underpinned by favourable market characteristics of limited choice of modern business space and a constrained development pipeline. 506 405 Number of businesses by UK regions (VAT and/or PAYE) (’000) London South East North West East South West West Midlands Yorkshire and The Humber East Midlands Scotland Wales Northern Ireland North East 104 73 69 Source: ONS 268 264 232 213 183 179 175 We continue to build up our portfolio in well established business centres at the heart of the UK’s economy. Simon Perkins Chief Executive McKay Securities Plc Annual Report and Financial Statements 2019 McKay Trading Estate, Poyle 73,955 sq ft Multi-let estate development by McKay, benefiting from the freight throughput of Heathrow Airport. 19 McKay Securities Plc Annual Report and Financial Statements 2019 Property Portfolio At 31st March 2019 £15m and over – 61.7% of portfolio £10m to £15m – 18.3% of portfolio £5m to £10m – 17.7% of portfolio Brentford The Mille, 1000 Great West Road (office) Croydon Corinthian House, Dingwall Road (office) EC31 EC31 SW19 SW1 1 Poyle Reading Reading Redhill Crawley Crawley EC2 30 Lombard Street (office) Portsoken House, Minories (office and ancillary retail) Wimbledon Gate, Worple Road (office and ancillary retail) Castle Lane (office) McKay Trading Estate, Blackthorne Road (industrial) Great Brighams Mead, Vastern Road (office) 9 Greyfriars Road (office) Prospero, London Road (office) Oakwood Trade Park, Gatwick Road (industrial) Pegasus Place, Gatwick Road (office) 66 Wilson Street (office) Maidenhead Switchback Office Park, Gardner Road (office) Weybridge Sopwith Drive, Brooklands (industrial) Woking Woking 1 Crown Square (office and ancillary retail) The Planets, Crown Square (leisure) Bracknell Building 329, Doncastle Road (office) Farnborough Columbia House, 1 Apollo Rise (industrial) Fleet One Fleet, Ancells Road (office) Folkestone 3 Acre Estate, Park Farm Road (industrial) Folkestone 5 Acre Estate, Park Farm Road (industrial) Leatherhead Ashcombe House, 5 The Crescent (office) SW11 Reading Staines Theale Theale Parkside, Knightsbridge (residential) 20/30 Greyfriars Road (office) Mallard Court, Market Square (office and ancillary retail) Brunel Road (industrial under construction) Station Plaza, Station Road (office) Windsor Gainsborough House, 59-60 Thames Street (office) £2m to £5m – 2.0% of portfolio Banbury Lower Cherwell Street Industrial Estate (industrial) Newbury Strawberry Hill House, Bath Road (medical) £2m and below – 0.3% of portfolio Percentages based on the valuation at 31st March 2019 1. Denotes leasehold properties Chobham Castle Grove Road (land) Staines 2 Clarence Street (office) 20 Area sq ft 96,700 44,590 58,590 49,570 58,690 14,250 73,955 84,840 38,490 50,370 52,400 50,790 11,890 37,155 63,140 50,190 98,255 32,800 40,755 34,580 44,290 60,535 17,450 2,900 33,345 21,860 134,430 41,420 18,660 40,060 15,230 — 3,440 McKay Securities Plc Annual Report and Financial Statements 2019 Top five assets The top five properties represent 42% of the portfolio by value The Mille, Brentford 96,700 sq ft Great Brighams Mead, Reading 84,840 sq ft 30 Lombard Street, EC3 58,590 sq ft Wimbledon Gate, SW19 58,690 sq ft Portsoken House, EC3 49,570 sq ft 21 McKay Securities Plc Annual Report and Financial Statements 2019 Property and Financial Review Table 1 Location and sector (by value) at 31st March 2019 Total £483m South East Offices London Offices Industrial/Logistics Other 54% 25% 16% 5% Overview McKay is a specialist in the development, refurbishment and management of commercial property, with Real Estate Investment Trust (“REIT”) status. We adopt a proactive approach to the release of value from our assets using in‑house skills, and manage completed projects internally. Our headquarters in Reading sits at the heart of our portfolio of 33 assets, ending the period valued at £482.70 million (March 2018: £460.15 million). The sector and location breakdown of these assets is shown in table 1, highlighting that we remain entirely focused on the office, industrial and logistics markets of London and the South East, where we have a clear expertise. These are the most dynamic regions of the UK, dominating in terms of population, business prosperity and productivity, and provide a strong platform for our continued growth. The rent and occupancy profile of the portfolio at the end of the period is shown in table 2. Contracted rental income and the rental value of the portfolio (“ERV”) both increased over the period, with the difference of £6.61 million representing the significant 24.3% reversionary potential still to be released from the portfolio. Occupancy has reduced slightly, ending the period at 88.0% (March 2018: 89.3%) and at 91.0% (March 2018: 92.6%) excluding developments. Occupational demand for office, industrial and logistics space within London and the South East has proved stable over the period, despite the continuing political uncertainly. The historically constrained supply of modern business space looks set to result in future shortfalls of available space across a number of centres, supporting current rents and increasing the prospects for future rental growth. We recognised the potential for successful development in these supply constrained markets in 2014 and embarked on the development of three office schemes with the benefit of the £86.70 million capital raise at that time. Having completed and let the schemes in Reading and Redhill last year, we achieved practical completion of the last of the three schemes at 30 Lombard Street, EC3 in January 2019 which triggered commencement of the 15 year lease to St. James’s Place plc for the entire building. These three schemes are now 98.0% let overall, on 10‑15 year leases with a combined contracted rent of £5.99 million pa. Sustainability has been of increasing importance to us, our occupiers and our supply chain for a number of years. We continue to evolve our sustainability strategy, which has ensured that the importance of creating and managing environmentally sustainable buildings has been integrated into our business since its adoption in 2014. In September 2018 we were delighted to be awarded our highest ever Green Star award by the Global Real Estate Sustainability Benchmark (“GRESB”), maintaining our status for the third year running as amongst the most sustainable companies in the commercial property sector. Market review The South East office market, which represents the largest sector in our portfolio (54.3% by value), is currently experiencing its lowest levels of both vacancy and supply for ten years. The vacancy rate across the market of 7.6% has almost halved from 14.2% five years ago and the vacancy rate for new floorspace of 1.9% (1.75 million sq ft) is now at an historic low. The supply of new stock shows no signs of alleviating this, with speculative development completions estimated to add just 0.5 million sq ft in 2019 and 0.4 million sq ft in 2020, well below the ten year annual average of 0.70 million sq ft. Building obsolescence is also restricting the supply of modern accommodation in this Table 2 Portfolio yields and reversions 31st March 2019 31st March 2018 Current rental income1 £ m pa 21.24 Yield2 Occupancy3 4.1% Contracted rental income1 27.22 5.3% 88.0% Uplifts at rent review/lease expiry Void properties (exc developments3) Void (developments) Portfolio reversion Total portfolio ERV Equivalent yield 2.53 2.60 1.48 6.61 33.83 9.0% 3.0% 6.6% 5.7% 1. Net of ground rents 2. Yield on portfolio valuation with notional purchaser’s costs (6.75%) added 3. By ERV £ m pa 19.66 27.05 2.55 2.11 1.44 6.10 33.14 Yield2 Occupancy3 4.0% 5.5% 89.3% 7.4% 3.3% 6.8% 5.8% 22 McKay Securities Plc Annual Report and Financial Statements 2019 Five year summary Financial measure Gross rental income (£’000) Net rental income from investment properties (£’000) Profit before taxation (£’000) Adjusted profit before taxation (£’000) Investment properties (£’000) Loans and borrowings (£’000) Total equity (£’000) Ordinary dividends per share (pence) Earnings per share – basic (pence) Earnings per share – adjusted basic (pence) Net asset value per share (pence) EPRA net asset value per share (pence) Interest cover Loan to value 2019 21,608 19,096 13,190 9,272 2018 21,844 20,453 43,443 9,067 2017 20,790 19,871 17,594 8,605 482,700 460,150 429,915 (163,176) (144,598) (134,100) 2016 20,159 17,664 53,160 7,943 401,170 (113,701) 311,083 306,440 270,792 261,223 10.2 14.0 9.9 331 326 2.1 33 10.0 46.3 9.7 326 322 2.0 32 9.0 18.8 9.2 289 303 2.0 32 8.8 57.2 8.5 280 301 1.9 29 2015 17,617 14,922 33,282 5,791 352,760 (91,302) 215,495 8.7 36.1 5.3 233 270 1.8 26 £6.61m pa 24% portfolio reversion 329 Bracknell Comprehensive refreshment incorporating co‑working breakout space and kitchens with smaller suites to suit tenant demand. 32,800 sq ft The building itself has provided us with the image required to support our business needs and growth plans – it’s been great in that sense. 2323 McKay Securities Plc Annual Report and Financial Statements 2019 Property and Financial Review continued market, with 50.1% of the stock within the relevant MSCI IPD (“IPD”) index now older than the generally held building design life of 25 years. Despite the political uncertainty, office take‑up in the South East in 2018 totalled 2.44 million sq ft, which was the highest for the last five years and comfortably above the ten year average of 1.92 million sq ft. A number of larger lettings that had been in the market for some time completed during the year, with these occupiers recognising the need to commit to protect against future supply constraints. However, 77.5% of 2018 take up was for unit sizes below 60,000 sq ft, maintaining the long term trend for smaller lettings which supports our continued focus on this area of the market. Whilst take up in Q1 2019 of 0.36 million sq ft was 16.2% below the ten year average, named demand at the end of the quarter of 3.02 million sq ft was only 6.7% lower than Q4/2018, of which 0.50 million sq ft was under offer. Our four central London office properties accounted for 25.0% of our portfolio at the end of the period, all of which are fully let. Market conditions in London have remained stable, as new supply is constrained by uncertainty while demand and take up have remained broadly in line with long term averages. Current availability in central London stands at 14.24 million sq ft compared to the ten year average of 16.12 million sq ft, showing a low vacancy rate of 6.2% (ten year average: 7.1%). The industrial and logistics sector remains buoyant with occupier demand being driven by the exponential rise of the e‑commerce sector and supply constrained by a scarcity of land on which to build conveniently located warehouses. Total supply in the South East of 4.50 million sq ft reflects a low vacancy rate of 4.5%, the lowest of any core region in the UK. This provides just 1.1 years’ supply based on current levels of take up. These market dynamics continue to support the development of our 134,430 sq ft distribution warehouse at Theale Logistics Park on the outskirts of Reading. There has undoubtedly been more caution generally in the investment market over the year given the protracted Brexit negotiations. Within our markets, fewer investment opportunities and stable yields suggest distressed sellers have been limited. Investment volumes within the South East office market totalled £2.80 billion in 2018 compared to the five year average of £3.57 billion. Local authorities remained the largest single investor group, accounting for 33.0% of the total volume. The weight of money seeking office investment opportunities in central London was still evident in 2018, with investment totalling £16.31 billion. This trend has been maintained in Q1 2019 with investment turnover totaling £5.04 billion, significantly ahead of the ten year quarterly average of £3.76 billion. Development programme Practical completion of our new build 58,590 sq ft City core office scheme at 30 Lombard Street, EC3 was achieved in January 2019. The building had been pre‑let to St. James’s Place plc in March 2018, and completion triggered commencement of the 15 year lease of the entire building. The net contracted rent of £3.40 million pa, equating to £65.00 per sq ft overall, was in line with ERV. Theale Logistics Park, our 134,430 sq ft distribution warehouse development at Junction 12 of the M4 motorway, is now under construction with completion due in December 2019. In the period, demolition of the old warehouse was completed, after which further planning conditions had to be resolved. During this time, we were able to negotiate a more favourable build contract which was signed in early April 2019. This self‑contained, innovatively designed distribution warehouse, with a large secure 72 metre yard, will provide best in class supply to meet growing industrial and distribution occupier demand, in a location which is already favoured by a number of blue chip companies. The marketing campaign is already under way with interesting leads, but tenant commitment within this sector is more likely once the building is fully, or substantially, built out. Key performance indicators: Portfolio Capital Return (capital) (%) (“PCR”) Total Portfolio Return (capital and income) (%) (“TPR”) 15% 20% 13.8 11.4 18.4 15.9 7.4 18 0% 1.4 19 12.3 6.8 1.7 17 16 15 5.4 19 0% 18 17 16 15 The annual valuation and realised surpluses from the Company’s investment portfolio expressed as a percentage return on the valuation at the beginning of the year, adjusted for acquisitions and capital expenditure. The portfolio capital return referred to above and net rental income from investment properties for the year expressed as a percentage return on the valuation at the beginning of the year, adjusted for acquisitions and capital expenditure. Link to strategy: Link to strategy: 24 McKay Securities Plc Annual Report and Financial Statements 2019 Asset management Following the letting success of our recent developments the focus over the year has been on releasing the substantial portfolio reversion and strengthening relationships with our occupiers to assist with retention at lease break and expiry. The occupational market in both London and the South East is witnessing increasing demand for flexibility and convenience. For tenants, there is the perceived flexibility of serviced offices at one end of the spectrum countered by the desire for identity, branding and a sense of ownership at the other. We have the assets and skills to offer a middle ground and can provide tenants with the benefits of a traditional lease across a range of unit sizes and lease lengths, whilst managing our buildings in‑house and giving occupiers direct access to their landlord. Having recognised this trend a number of years ago, we have evolved a flexible offer at One Crown Square, Woking (50,190 sq ft) and 329 Bracknell (32,800 sq ft) where we continue to deliver rental growth. This year saw 7.1% and 4.1% rental value growth respectively for these buildings compared to the IPD benchmark of 1.9%, driven by strong tenant demand for this model which is being actively applied elsewhere within the portfolio. At Portsoken House, EC3, as part of the refurbishment of the vacant floors (part 8th floor: 3,260 sq ft and 2nd floor: 5,146 sq ft) we fitted out the space to give potential occupiers the convenience of immediate occupation while also providing better value space compared to the equivalent serviced office market. With the trade‑ off of minimal letting incentives, we let both floors before practical completion at rents 8.2% ahead of ERV on the part 8th floor (£0.19 million pa) and 9.0% ahead on the 2nd floor (£0.28 million pa). In a number of cases, this flexible offer is combined within a building with longer lease arrangements. This has worked to our advantage at The Mille, where we completed the ten year pre‑let of the entire 2nd floor (8,312 sq ft at a contracted rent of £0.21 million pa) to serviced office provider UBC, which was previously operating under a legacy loss making management agreement on the 3rd floor. This in turn has enabled us to progress a refurbishment of the 3rd floor into four smaller suites of c. 2,000 sq ft each, which is the most sought after unit size in the Brentford market. At the end of the period, the rental value of the 9.0% portfolio void (excluding developments) totalled £2.60 million pa, of which 58.1% was undergoing refurbishment. The two most significant projects to begin during the period were at Pegasus Place, Crawley and at Mallard Court, Staines‑upon‑Thames. Pegasus Place is a campus of three office buildings developed by the Company in 2003, where we are carrying out a major overhaul of Pegasus Two (12,720 sq ft), to enable a multi‑letting campaign at top Crawley rents. Completion of the refurbishment is due in July and good interest is already apparent. At Mallard Court, in the centre of Staines‑ upon‑Thames, we are carrying out a wholesale refurbishment of two of the three office floors (11,390 sq ft) as well as upgrading the reception. Where this was previously a traditional multi‑let building with a manned reception, the refurbishment will deliver a modern, unmanned, smart building incorporating the latest technology with an occupier app enabling mobile‑device control of heating, cooling, lighting and access. Completion is due shortly and marketing is under way. Our South East industrial and logistics assets represented 15.6% of the portfolio (by value) at the end of the period and continue to deliver strong returns. Our seven existing industrial and logistics assets are 91.9% let and lease renewals and other management initiatives have continued to improve the value and quality of these holdings. Across the portfolio as a whole over the year, this activity resulted in a total of 19 open market lettings with a combined contracted rent of £1.29 million pa, which was 8.1% ahead of ERV. In addition, we achieved a high tenant retention rate of 74.0% of tenants at lease break and expiry, including the renewal of 21 leases at a 31.6% (£0.21 million pa) increase to the prior contracted rent. With the lack of new and Grade A supply in the South East office market, we continue to work up our pipeline of refurbishment and development initiatives which include Great Brighams Mead, Reading and Station Plaza, Theale. Great Brighams Mead is a standalone 84,840 sq ft office headquarters building exceptionally well located just a few minutes’ walk from the recently upgraded railway station. The Company developed and let the building to Hutchison 3G for 21 years in 2001. The potential exists at expiry in 2022 to refurbish and benefit from the recent uplift in central Reading rents and the opening of the Elizabeth Line, which is set to strengthen Reading’s position as the capital of the Thames Valley. Station Plaza is an estate of three office buildings totalling 41,420 sq ft situated opposite Theale railway station, purchased in 2014 with an income yield of 10.1%. The existing 20 year lease, which expires in July 2019, is currently generating a rent of £0.90 million pa (£21.82 psf) which compares to recent Grade A Theale rents in excess of £30.00 psf. The property has attracted a wide range of freehold and leasehold interest and a number of options are being reviewed, including refurbishment plans to refresh the buildings to create a vibrant estate next to the station. Acquisitions and disposals We continued to monitor potential investment properties both on and off market over the year but did not make acquisitions despite appraising many opportunities. We remain of the view that there will be better value available as the market continues to mature, and we are well placed to take advantage of any weakness or attractive prospects that become available. Net Asset Value Return (%) (“NAV”) 25% Total Shareholder Return (%) (“TSR”) 50% 22.7 36.2 14.7 24.8 9.4 18 3.6 17 0% 4.4 19 -11.3 -30% -8.6 -0.8 16 15 19 18 17 16 15 The growth in adjusted net asset value per ordinary share plus dividends reinvested per ordinary share expressed as a percentage of the adjusted net asset value per share at the beginning of the year. The growth in the value of an ordinary share plus dividends reinvested during the year expressed as a percentage of the share price at the beginning of the year. Link to strategy: Link to strategy: 25 McKay Securities Plc Annual Report and Financial Statements 2019 Property and Financial Review continued Having recycled £67.97 million from twelve disposals between 2015 and 2018 into new and existing portfolio properties, this has been a quieter year. However, we continue to keep a number of sales under review, particularly where we can take advantage of one‑off pricing or reinvest into new assets with better growth prospects The only disposal activity over the period was announced in March 2019 following the exchange of conditional contracts for the sale of The Planets (98,255 sq ft) in Woking town centre. It is let to Woking Borough Council until 2020, operating as a conference centre, amusement arcade, bingo hall and hotel. The asset has delivered an income yield in excess of 8.0%, and was purchased in 2014 with the intention to redevelop a mixed use scheme including offices on expiry of the lease. Having reviewed a range of scenarios with our professional team, it was clear that the most viable option would be residential use. To maximise value, we designed a 35‑storey scheme and presented it to Woking Council and, with approval in principle for its height and massing, we offered the site to the residential market rather than redevelop beyond our recognised area of expertise and focus. Completion of the sale is conditional on the buyer gaining planning consent, and the price will be determined by the number of units consented. Valuation Knight Frank’s independent valuation of the Company’s property portfolio as at 31st March 2019 totalled £482.70 million (March 2018: £460.15 million). This delivered a surplus of £6.47 million (1.4%) for the 12 month period, with the first half contributing 1.7% and the second half ‑0.3%. Tables 3 and 4 show the portfolio capital and rental values as determined by our valuers against the corresponding IPD benchmarks. Overall portfolio capital and rental growth outperformed IPD All Property, and the Table 3 Capital value movement 12 months to 31st March 2019 London offices South East offices Total offices Industrial/Logistics Other Total (excluding developments) Developments4 Total portfolio Valuation movements (%) after allowing for capex incurred during the period IPD monthly index allocations, IPD London = City segment IPD monthly index (All property) 1 2. 3 4 Theale Logistics Park and Lombard Street, EC3 Table 4 Rental value movement 12 months to 31st March 2019 London offices South East offices Total offices Industrial/Logistics Other Total (excluding developments) Developments4 Total portfolio 1. Segments analysed by IPD geographical area, exc dev 2. 3. 4. IPD monthly index – movement by segment where applicable, IPD London = City segment IPD monthly index (All property) Theale Logistics Park and Lombard Street, EC3 26 2019 portfolio valuation £m 2018 portfolio valuation £m 12 month1 movement IPD2 movement 57.20 261.90 319.10 65.65 24.55 409.30 73.40 482.70 56.25 260.10 316.35 60.85 21.65 398.85 61.30 460.15 0.5% ‑1.7% -1.3% 7.8% 12.1% 0.7% 4.9% 1.4% 2.6% 1.4% 1.6% 10.7% – 0.2%3 – 0.2% 2019 portfolio ERV £m pa 2018 portfolio ERV £m pa 12 month1 movement IPD2 movement 3.68 20.27 23.95 3.85 1.15 28.95 4.88 33.83 3.62 19.76 23.38 3.78 1.16 28.32 4.83 33.15 1.5% 2.6% 2.4% 1.9% ‑0.3% 2.2% 1.2% 2.1% 1.2% 1.9% 1.5% 4.5% – 0.2%3 – 0.2% McKay Securities Plc Annual Report and Financial Statements 2019 Adjusted profit before tax, our measure of recurring profit, increased by £0.20 million (2.3%) to £9.27 million (March 2018: £9.07 million) primarily due to lower interest costs as a result of cancelling the remaining interest rate swap in March 2018. Adjusted basic earnings per share increased by 2.1% to 9.85 pps (March 2018: 9.65 pps). Gross rents, including SIC 15 adjustments, increased on a like‑for‑like basis (excluding sales and developments) by 6.6% (£1.31 million). However, overall gross rents reduced by 1.1% (£0.24 million) to £21.61 million (March 2018: £21.84 million) due to the loss of income of £1.32 million from the profitable disposals made last year and the loss of £0.75 million of rental income following commencement of redevelopment at Theale Logistics Park. These anticipated reductions were partially offset by a rental contribution of £0.53 million from 30 Lombard Street, EC3 following the lease commencement in January 2019, in addition to further significant rental contributions from Prospero, Redhill (£0.78 million) and The Mille, Brentford (£0.25 million). Administration costs reduced to £6.25 million (March 2018: £6.31 million), primarily due to a reduced cost of bonus offsetting the inflationary rise in salaries. The interest cost for the year reduced to £6.13 million (March 2018: £6.74 million), despite the average debt in the period increasing to £157.96 million (March 2018: £144.82 million). This significant reduction reflects the benefit of cancelling the £33.00 million remaining swap in March 2018, which carried a coupon of 5.17%. The cancellation also contributed to the weighted average cost of debt reducing to 3.34% prior to amortisation and finance lease interest (March 2018: 4.06%). Balance sheet Shareholders’ funds increased from £306.44 million to £311.08 million over the period, principally due to the £6.47 million valuation surplus (£4.83 million excluding SIC 15 adjustment). EPRA NAV per share increased by 1.2% over the period to 326 pence (March 2018: 322 pence). NNNAV per share also increased by 1.2% to 326 pence (March 2018: 322 pence) and IFRS NAV per share increased by 1.5% to 331 pence (March 2018: 326 pence). At the year end, debt facilities totalled £190.00 million (March 2018: £190.00 million). Drawn debt at the end of the period was £165.00 million (March 2018: £147.00 million). The gearing ratio of drawn debt to portfolio value (LTV: net debt basis) as at 31st March 2019 was 33.3% (March 2018: 31.6%). The increase in drawings over the year was primarily a result of £13.79 million of capital expenditure being invested on portfolio development and refurbishment projects. On 8th April 2019, we announced an increase in available facilities from £190.00 million to £245.00 million. Building on our strong relationships with our banking group, three bilateral facilities (£125.00 million) were replaced by one club facility of £180.00 million. The club comprises Barclays, Lloyds, NatWest and Santander, all contributing equally. The facility is for five years and at commencement contributed to a weighted average length of debt of 6.6 years and a low weighted average cost of debt, if fully drawn, of 3.0%. The current £65.00 million facility with Aviva and the new club facility provides £80.00 million of headroom over our current drawings to support operational flexibility, deliver further portfolio initiatives and provide increased scope for new investments. Net cash inflow from operating activities was £8.42 million (March 2018: inflow £7.50 million) and interest cover based on adjusted profit plus finance costs as a ratio to finance costs was 2.08x (March 2018: 1.98x). As a REIT, the Company is tax exempt in respect of qualifying capital gains and qualifying rental income, which covers the majority of the Company’s activities. Any residual income has been offset by allowable costs, and there is therefore no tax charge for the period (March 2018: nil). Defined benefit pension scheme Under the application of accounting standard IAS19, the Company’s pension deficit reduced over the period from £2.16 million to £2.11 million. The decrease in the deficit was mainly due to the contributions paid into the scheme compensating for the increase in scheme liabilities resulting from a lower discount rate. As a result of the triennial valuation for the period to 31st March 2017, which showed a funding level of 87.5% on a continuing valuation basis, our annual contribution to the scheme remains at £0.24 million. The scheme was closed to new entrants in the 1980s, and now consists of six pensioners and no active members. Financial risks The financial risks are documented in the Principal Risks and Uncertainties section of the Strategic Report on page 38. S. Perkins Chief Executive G. Salmon Chief Financial Officer 20th May 2019 portfolio total return of 5.4% outperformed the IPD All Property return of 5.0%. Through our asset selection and refurbishment initiatives, the rental value of our largest weighting, South East offices, outperformed the benchmark, but the capital growth underperformed. There are two reasons for this. Firstly, as anticipated with future pipeline opportunities at Great Brighams Mead, Reading and Station Plaza, Theale, values have declined by 7.8% and 18.1% respectively as the leases approach expiry. The subsequent uplift in value following refurbishment will see values enhanced. Secondly, at Pegasus Place, Crawley and One Crown Square, Woking we suffered tenant defaults which led to capital value declines of 5.4% and 8.2% respectively, which will be recovered on re‑letting. Our South East industrial and logistics portfolio saw capital growth of 7.8% compared to the IPD benchmark of 10.7%. Our two largest assets by value in this sector, The McKay Industrial Estate at Poyle, next to Heathrow, and Oakwood Trade Park in Crawley, increased in value by 12.8% and 11.1% respectively. The overall performance was below the benchmark due to lease expiries over the period and other properties holding their value after a strong performance last year. Although rental growth of 1.5% in our London offices outperformed IPD, capital growth was marginally lower due to characteristics of the small number of assets in this sector. The Planets in Woking (within “Other”) saw strong capital value growth of 20.2% to reflect the uplift in the conditional sale price over the March 2018 book value. Development properties over the year consisted of Brunel Road, Theale and 30 Lombard Street, EC3. Much of the value created by the pre‑letting of 30 Lombard Street was included within the 2018 valuation, but the 4.9% overall valuation surplus incorporated further gains primarily due to lease completion. Dividends The final dividend of 7.4 pence per share (March 2018: 7.2 pps) will be paid on 25th July 2019 to those on the register on 31st May 2019. With the interim dividend of 2.8 pence per share, this takes the total dividend for the year to 10.2 pence per share, an increase of 2.0% on the previous year. As a REIT, the Company is required to distribute at least 90.0% of rental income profits arising each financial year by way of a Property Income Distribution (“PID”). Subject to exemptions, this is paid after deduction of withholding tax, at present 20.0%. Previous losses attributed to the cost of cancelling interest rate hedging instruments has offset the profits attributable to the PID. As a result, the final dividend will be paid as an ordinary dividend rather than a PID. Income statement Profit before tax (“IFRS”) totalled £13.19 million (March 2018: £43.44 million). This included the unrealised surplus on valuation (including SIC 15 adjustment) for the period of £4.83 million (March 2018: £25.07 million). 27 McKay Securities Plc Annual Report and Financial Statements 2019 Sustainability A new sustainability vision We have again made great progress against our sustainability targets this year, fully achieving 89%. 68 2018 GRESB score 44% reduction in CO2e since 2015/16 Introduction As well as working hard to achieve our targets, another important action undertaken this year has been the in‑depth review and reframing of our sustainability strategy. Our existing sustainability framework of Creating Sustainable Buildings, Managing Sustainable Buildings, and Engaging Stakeholders has served us well since it was first launched in 2013. However, as we were developing and moving forward into the next ambitious phase of our business strategy, we felt it was timely to look also at our sustainability ambitions over the next 5‑10 years. The pace of technological, social and environmental change is breathtaking and therefore there is also rapid change in tenant, community and shareholder expectations in this area. We want to make sure our business is future‑proofed, resilient and able to respond to these changing expectations. We completed our detailed sustainability strategy development process in March 2019 and will set out our new strategy later in the sustainability update together with our new sustainability targets for 2019/20. In the meantime, the following pages provide an update on all our activities and achievements during 2018/19 against our existing objectives and targets. Our progress to date Since the launch of our sustainability strategy in 2013, the Company has delivered some notable achievements, including: MANAGING SUSTAINABLE BUILDINGS To add value to the Company’s portfolio by improving the efficiency of the buildings and reducing their environmental impact CREATING SUSTAINABLE BUILDINGS To achieve best practice green building standards in order to deliver quality buildings ENGAGING OUR STAKEHOLDERS To maintain an active dialogue with key stakeholders about sustainability performance • High sustainability ratings for all new developments and major refurbishments, including a BREEAM ‘Outstanding’ rating for 9 Greyfriars Road, Reading and BREEAM ‘Excellent’ ratings for Prospero, Redhill and 30 Lombard Street, EC3 • A 13% reduction in like‑for‑like landlord‑ controlled electricity consumption and a 41% reduction in like‑for‑like landlord‑controlled gas consumption between 2015/16 and 2018/19 • A 31% reduction in like‑for‑like landlord‑ controlled water consumption in the same period • A 44% reduction in carbon footprint over four years (far surpassing our original target which was to reach a 16% reduction by March 2020). A great leap forward was made in the 2018/19 period in particular, as we agreed Like-for-like energy consumption (MWh) Like-for-like greenhouse gas emission (tonnes CO2e) Like-for-like water consumption (m³) 3.5m 3.4m 3.3m 2.1m 6.0m 6.1m 5.6m 5.2m 3,599 3,293 2,668 2,000 10,770 8,682 7,364 7,419 FY 15/16 FY 16/17 FY 17/18 FY 18/19 FY 15/16 FY 16/17 FY 17/18 FY 18/19 FY 15/16 FY 16/17 FY 17/18 FY 18/19 Electricity Natural gas 28 McKay Securities Plc Annual Report and Financial Statements 2019 supply contracts for renewable electricity across the portfolio such that all landlord‑ supplied electricity is now zero carbon, which equates to an 84% reduction in carbon footprint from 2017/18 • An Environmental Management Programme running over a period of several years for the five most resource intensive assets in the portfolio, where the Company has implemented energy and water saving measures. Energy consumption at those five assets has been reduced by 26% • Significant improvement in our GRESB score, from 37 in 2014 to 68 in 2018, equivalent to a three‑star rating Creating sustainable buildings As well as the importance of a low carbon development, evidence of the connection between healthy office buildings and workforce productivity continues to build, pushing developers to integrate health and wellbeing features into building design and corporate occupiers to specify space which demonstrates these credentials. Within McKay’s own portfolio, demand for sustainable buildings has been evidenced by the positive market response to our recent office developments in Redhill and Reading. The fact that 78% of our occupiers rank the total cost of occupancy as one of the most important attributes of a building also underlines the significance of promoting a design and management approach that balances a reduction in resource consumption with an increase in occupier wellbeing. Composition of total annual predicted energy bill £ 300,000 250,000 200,000 150,000 100,000 50,000 0 £2 per sq ft Typical UK office Prospero, Redhill A sustainability success story • Prospero, Redhill achieved BREEAM ‘Excellent’ and EPC ‘A’ ratings upon completion in November 2016. The building features significant levels of natural light, LED lighting and a highly energy efficient building envelope • These design features meant that electricity consumption was predicted to be 60% lower than a typical UK office building, thereby reducing annual occupancy costs and greenhouse gas emissions • This was already a great news story for McKay and for tenants, but energy modelling on the building in‑use has revealed that its real energy performance even surpasses these excellent design stage expectations, enabling us to save around £20,000 this year on our electricity bill in spite of an increase in the unit cost 29 McKay Securities Plc Annual Report and Financial Statements 2019 Sustainability continued Progress against development targets New development targets Status Progress against occupier engagement targets Achieved Occupier engagement targets Status Continue to monitor the compliance of contractors with McKay’s Sustainability Requirements for Development and Refurbishment Projects, ensuring that sustainability is consistently integrated as part of the tendering process. Ensure all new developments and major refurbishments achieve minimum BREEAM ‘Excellent’ and an EPC rating of at least ‘B’. Follow up on the results and recommendations of the post‑occupancy evaluation of Prospero, Redhill, to ensure that all aspects of operational performance meet design intent. Achieved Achieved In the year ending March 2019, we completed one new office development at 30 Lombard Street, EC3 and embarked upon the development of the Theale Logistics Park in Reading. McKay maintains a commitment to ensure that all new developments and major refurbishments achieve minimum BREEAM ‘Excellent’ and an EPC rating of at least ‘B’. Our development standards also help ensure that all five of the material issues for our portfolio identified in our recent strategy review are managed for our development pipeline. For both the 2019 developments our Sustainability Requirements for Development were included in the tendering process, forming a pre‑ requisite to appointment of contractors and involving engagement on an ongoing basis with contractors to support their implementation. Managing sustainable buildings We set ourselves two targets in relation to occupier engagement for completion during the year ending March 2019. One of these was already achieved, and the other was still in progress as at the end of March, as we were holding off designing the building awards until we had received customer feedback through our occupier survey. 30 Include information about assets’ sustainability, including energy efficiency and health and wellbeing features, within marketing materials, highlighting their benefits for occupiers. Introduce a building awards/ competition to encourage uptake of sustainability practices amongst tenants. Achieved In progress Occupier survey In late 2018 and early 2019, we sent a satisfaction survey to 118 occupiers, receiving responses from 27%. We asked occupiers to rate their overall satisfaction with McKay as a landlord, as well as a range of other aspects including: • McKay’s understanding of their business needs • Their experience of the leasing process • Quality of relationship with McKay’s management teams • Presentation of the property • Their own sustainability priorities The survey captured both quantitative and qualitative feedback and provided very useful insights on McKay’s current performance as a landlord and areas for further action. We were particularly proud that 85% of responses stated they would be very or highly likely to recommend McKay as a landlord. Moreover, 94% indicated that they were satisfied with McKay’s understanding of their business needs, with 75% rating this attribute as ‘strong’ or ‘exceptional’. McKay’s approach to occupier engagement and the quality of its relationships with customers was also indexed well, suggesting that McKay’s overall approach to customer service is working well and should be maintained. In terms of sustainability, employee health, wellbeing and productivity stood out as being of greatest importance to occupiers. Occupiers’ assessment of the relative importance of these issues has been reflected within McKay’s sustainability strategy review, and objectives have been set to steer future action in relation to each one. Monitoring and improving the environmental performance of our portfolio By taking action to increase efficiencies wherever possible within our assets, particularly the largest contributors to our environmental footprint, we have made significant improvements in the energy and water consumption and carbon emissions of our portfolio over the last few years as shown in the charts in the introduction and in the table overleaf. Snapshot of occupier survey results How likely are you to recommend McKay as a landlord? How well does McKay understand your business needs? Highly likely Very likely Likely Somewhat likely Unlikely 47% 38% 9% 6% 0% Strong understanding Exceptional understanding Good understanding Little understanding No understanding 50% 25% 19% 6% 0% McKay Securities Plc Annual Report and Financial Statements 2019 Progress against environmental performance targets Environmental performance targets1 Status Performance Achieve a 12% reduction in like‑for‑like landlord‑controlled electricity consumption relative to a 2015/16 baseline. Achieved 13% reduction Achieve a 12% annual reduction in like‑for‑like landlord‑ controlled gas consumption (adjusted for heating degree days) relative to a 2015/16 baseline. Achieved 41% reduction Achieve a 12% reduction in like‑for‑like landlord‑controlled carbon emissions, against a 2015/16 baseline. Achieved 44% reduction Achieve a 9% reduction in like‑for‑like landlord‑controlled water consumption, against a 2015/16 baseline. Achieved 31% reduction Maintain 100% of operational waste diverted from landfill for landlord‑managed portfolio. Achieved 100% diversion Increase the recycling rate across all properties for which the Company has management control to 48% by 31st March 2019, in line with ‘Good Practice’ according to the Real Estate Environmental Benchmark (“REEB”). Not achieved 35% rate 1. Like‑for‑like analysis takes into account occupancy rates across the portfolio in the gas, electricity and water consumption trend calculations. It also incorporates ‘heating degree day’ analysis to normalise gas consumption. The water like‑for‑like analysis has excluded a very large proportion of the portfolio due to missing data and should be viewed with significant caution. Calendar year 2018 recycling rate and disposal routes are taken as an approximation of the financial year 2018/19 recycling rate and disposal routes Waste: Disposal routes (tonnes) 3.83 37.55 17.75 17.75 6.86 45.02 9.26 4.91 90.45 FY 17/18 106.78 FY 18/19 Incineration (with energy recovery) facility Refuse derived fuel Off-site materials recovery facility Recycling facility Composting We also continue to send zero waste direct to landfill across our portfolio as per the chart illustrating our waste disposal routes. Unfortunately, as the table to the right shows, we have not been able to increase the recycling rate of the properties where we have management control in line with the REEB for ‘Good Practice’, so our waste recycling rate is still lower than our target. Waste: Recycling rate (%) We are already working to improve on this. In autumn 2018 we commissioned a waste review to identify potential solutions to boost recycling rates across our directly managed portfolio and followed up on the recommendations in early 2019 through engagement with waste contractors. We hope that with due attention to this aspect we will be able to improve recycling rates in line with our target. Progress against environmental management targets Environmental management targets Pilot an innovative energy‑saving technology at one of the Company’s major energy consuming assets. Pilot an innovative water‑saving technology at one of the Company’s major water consuming assets. Continue to review EPC risk associated with new purchases and create improvement plans for any asset with an ‘E’ rating or below, to bring it up to at least a ‘D’ rated EPC. Roll out phase two of the Company’s Renewable Energy Review Strategy, which will involve conducting detailed studies into the feasibility of incorporating solar PV panels at five properties, and then select at least one property at which to take forward an installation, subject to commercial viability. Status Achieved Achieved Achieved Achieved 64.7 64.6 35.3 FY 17/18 35.4 FY 18/19 Total recycled Total non-recycled 31 McKay Securities Plc Annual Report and Financial Statements 2019 Sustainability continued Employee training To engage and inspire our workforce to create and manage sustainable buildings, we organise Continuing Professional Development (“CDP”) on these themes. In the year to March 2019, this included two separate training sessions on both environmental and health and wellbeing certification standards. Following these sessions, we have introduced health and wellbeing initiatives for occupiers at 329 Bracknell as a pilot project, including the offer of weekly exercise classes with a personal trainer. We are also organising further building tours for our employees to explore examples of successful tenant engagement programmes focused on sustainability. One of the reasons for the observed improvements in energy and water performance across the portfolio is that McKay implemented a rolling programme of upgrades and improvements across the portfolio. As part of any refurbishment programme, energy and water efficiency upgrades are made wherever the cost‑effective opportunity arises. The most significant reductions in energy consumption between 2015/16 and 2018/19 have been achieved at The Mille, Brentford and One Crown Square, Woking, due to the upgrades carried out to multiple aspects of HVAC and lighting, among a raft of other improvements. Recent upgrades at Corinthian House, Croydon have included individually mounted PIR urinal flushing sensors and sensor hand basin taps installed in newly refurbished toilets, replacing old automatic cistermiser flushing and traditional taps. We will look to roll out this new water‑saving technology across the portfolio wherever we are refurbishing toilets. We have also benefited from an award‑winning new lift system created by Kone, called NMX, which is 28% more energy efficient than the current equivalent, and includes an EcoDisc hoisting motor and regenerative drive, standby power saving and LED lighting. Our improvement programme also helps us to manage portfolio EPC risk. The minimum energy efficiency standard (“MEES”), which 32 As well as increasing our assets’ energy efficiency, we have also been proactive in assessing the viability of installing renewable energy systems within its existing sites. In 2018/19, we commissioned some more detailed technical and commercial feasibility studies on assets where initial surveys had indicated potential for installing solar photovoltaic panels (“PV”) and we are now reviewing the results of these assessments. Engaging our stakeholders We have continued to make good progress in this area of our strategy, and details are provided below. Progress against stakeholder targets Status Achieved Achieved Achieved Achieved Investor and employee engagement targets Maintain or enhance GRESB performance relative to 2017. Hold a minimum of two sustainability‑related CPD sessions to increase awareness of key sustainability issues amongst employees. Continue to organise annual sustainable building tours to inform and inspire employees. Continue to ensure compliance with the Company’s Responsible Procurement Policy through the agreed annual auditing process. Industry benchmarking We continue to participate in the GRESB and in 2018 were particularly proud to obtain a GRESB score of 68, a six‑point increase on our 2017 performance and an improvement of over 30 points since our first year of participation in 2014. Reflecting the ongoing evolution of our approach and delivery of management and performance targets, we have now moved from a 2‑star to 3‑star GRESB rating. Health and safety management Although not forming part of our sustainability targets, health and safety (“H&S”) is a critical element of the Company’s oversight of the portfolio, and as such, is a key item to update on here. The Company’s H&S Policy and Procedures reflect legislation and latest best practice; a copy of the General Statement is available on the Company’s website and has been shared with all suppliers and employees. Implementation of the Company’s H&S is managed by the Safety Management Company (“SMG”). The SMG meets monthly when it originates from the Energy Act 2011, came into force on 1st April 2018, making it unlawful to let any properties in England and Wales with an EPC rating of ‘F’ or ‘G’. Having taken a proactive approach to managing EPC risk, working with our asset managers and development team to improve our EPCs at every opportunity, less than 0.5% of the assets within the Company’s portfolio (by ERV) are currently ‘F’ or ‘G’ rated. Breakdown of EPC rating across the portfolio by ERV No EPC held A B C D E F G 12% 8% 18% 19% 24% 19% 0% 0% McKay Securities Plc Annual Report and Financial Statements 2019 reviews any legislative changes that may affect the Company and its portfolio and takes appropriate action on any risks highlighted to actively reduce the Company’s risk profile. A programme of health and safety training has been implemented for employees, alongside a programme of training with the Company’s contractors and consultants to ensure they are working to the same standard. For the year to March 2019, there have been no accidents of a nature reportable to Health and Safety Executive. Modern slavery and sustainable procurement The Modern Slavery Act 2015 (“the Act”) was introduced with the objective of reducing human trafficking and slavery. The Company is not obliged to report under the Act as its turnover is well below the £36 million turnover threshold. Despite this, the Company has in place a number of policies supporting a zero‑tolerance approach to slavery, human trafficking, as well as bribery and corruption which accord with the Act’s objectives. These include our policies on responsible procurement, health and safety, equal opportunities and other staff policies in place in respect of bullying, harassment, grievance and whistleblowing. As part of the regular review of these policies, the Company will look to improve and enhance this framework. Suppliers and contractors play a fundamental role in delivering McKay’s sustainability objectives and we updated our Responsible Procurement Policy and pre‑qualification questionnaires with more ambitious social and environmental requirements in 2017/18. Building on that, over the past year, we have created a supplier assessment questionnaire covering aspects such as the Real Living Wage, environmental policies and management procedures and the use of products with lower environmental impact and we have sent that out to a sample of our suppliers to check on their performance. Supporting local communities At present, McKay engages with local communities principally through the planning process and its community investment activities. Community investment activities are co‑ordinated by our Charity Committee and focus on supporting local children’s charities. Low carbon design in practice at Theale Logistics Park Theale Logistics Park will be a new, high quality, 134,430 sq ft industrial/ distribution unit located next to Junction 12 of the M4 in Reading. McKay is undertaking works to deliver a self‑contained, high specification warehouse unit. The project is on track to achieve BREEAM ‘Excellent’ for Industrial New Construction, Core and Shell, and boasts a range of integral features designed to reduce carbon emissions and resource consumption, as well as lower our impact on the surrounding environment, and support occupier health and wellbeing. For example, building materials with high Green Guide ratings and responsible sourcing certification have been specified, and we have selected prefabricated steel frames to reduce resource consumption and waste. The site falls within the Berkshire Biodiversity Action Plan area, and wildlife friendly planting will be installed as well as bird and bat boxes. Most significantly, an 800 sq ft array of PV panels will be installed on the building, providing an annual electrical output of 7,875 kWh and reducing building CO2 emissions by 21%. The office areas have been designed to maximise daylight levels, thereby supporting better occupier health and wellbeing, as well as reducing lighting requirements. Indoor air quality will be enhanced through locating air intakes and exhausts a significant distance apart and far from the main road. Sustainable mobility is also encouraged by the provision of cycling facilities and a 70‑space cycle park, as well as the site’s proximity to Theale train station. 33 McKay Securities Plc Annual Report and Financial Statements 2019 Sustainability continued Mandatory carbon reporting We fulfil our statutory obligations for corporate reporting, which includes disclosure of the Company’s carbon footprint. Under the Companies Act 2006 (Strategic and Directors’ Reports) Regulations 2013, quoted companies are required to report their annual emissions in their Directors’ report. McKay’s Mandatory Greenhouse Gas Emissions Reporting statement covers the reporting period 1st April 2018 to 31st March 2019 and has been prepared in line with the main requirements of the Greenhouse Gas (“GHG”) Protocol Corporate Accounting and Reporting Standard and ISO 14064‑1:2006. The table below provides the relevant data with the accompanying explanatory notes. The significant reduction in the Company’s overall carbon footprint in 2018/19 is due to three key aspects: 1) gas consumption decreased by 35% compared to last year’s usage; 2) ‘location‑based’ electricity emissions reduced due both to improvements in energy efficiency and to the ongoing decarbonisation of the grid; and 3) in FY 2018/19, the Company procured 100% renewable electricity, resulting in the complete decarbonisation of its Scope 2 and 3 emissions (calculated using the ‘market‑based’ method). Sources of greenhouse gas emissions Scope 1 emissions Energy Gas (EPRA sBPR fuels‑Abs) Fugitive emissions Energy Scope 2 emissions Scope 3 emissions Energy Refrigerant emissions Landlord‑controlled electricity (EPRA sBPR Elec – Abs) Landlord‑obtained energy sub‑metered to tenants and all transmission and distribution losses (EPRA sBPR 3.6) Total Carbon Intensity3: Scope 1+2 emissions of tCO2e/£m adjusted profit before tax 2018/19 tonnes of CO2e (location‑based calculation1) 2018/19 tonnes of CO2e (market‑based calculation2) 2017/18 tonnes of CO2e 451 451 706 De minimis De minimis De minimis 1,942 0 2,091 233 2,626 258 0 451 49 294 3,091 302 Data qualifying notes • This is the Company’s sixth year of disclosure under the Mandatory Greenhouse Gas Emissions Reporting regulations • The Company’s emissions for the year to March 2018 have been restated due to Q4 2017/18 data not being available at the time of reporting in 2018; this final period of data is estimated in every Annual Report. For the financial year to March 2019, 27% of energy consumption, and therefore carbon emissions, is estimated. FY 18/19 Q4 accounts for 99% of this estimated data • This statement has been prepared in line with the main requirements of the GHG Protocol Corporate Accounting and Reporting Standard and ISO 14064‑1:2006. For the first time this year, Scope 2 dual reporting was undertaken, which discloses one Scope 2 emission figure according to a location‑based method and another according to a market‑based method • Within Scope 1 emissions, refrigerant‑related emissions for the period were de minimis • An operational control consolidation approach has been adopted 1 2 For the ‘location‑based’ method of emissions calculations, standard emissions factors from the UK Government Emissions Conversion Factors for Greenhouse Gas Company Reporting 2018 were used For the ‘market‑based’ method, the Company’s contractual instruments for the purchase of certified renewable electricity were accounted for, resulting in a significant reduction in the Company’s real carbon footprint 3 Carbon intensity only includes Scope 1 and Scope 2 emissions in the calculation Looking to the 2020s: A new sustainability vision Five years on from our first sustainability strategy, environmental and social trends have continued to evolve apace, and new sub‑trends have risen up the agenda. Coupled with this, we are actively pursuing our ambitions to reposition our brand, engage more deeply with occupiers and grow our portfolio. Hence we decided that 2018/19 was an appropriate time to review and refresh our sustainability strategy in line with the latest trends and the Company’s strategic direction. The Right Choice for a Sustainable Business Our mission is to work in partnership to deliver quality, innovation and growth. As a specialist REIT focused on London and the South East, we need to anticipate and prepare for the future evolution of our market and the trends that affect our customers’ prosperity. By harnessing innovations in office designs and technologies to create low carbon, resource efficient and healthy buildings we aim to help people feel positive and businesses to thrive. Strategy review process In autumn 2018, McKay kickstarted the process of refreshing its sustainability strategy with support from external adviser JLL. This involved six ‘materiality tests’, which covered a review of McKay’s baseline activities and achievements to date; assessments of future trends, peer practices and legislation to gauge future market direction; a tenant survey to understand occupiers’ sustainability concerns; and a review of investor expectations, focusing on the requirements of GRESB and the Task Force on Climate‑related Financial Disclosures (“TCFD”). The findings of these tests enabled us to refocus our sustainability strategy and vision, and pinpoint 14 ‘material’ sustainability issues which underpin our new focus areas and suite of objectives. 34 McKay Securities Plc Annual Report and Financial Statements 2019 Our new framework Our new sustainability vision – The Right Choice for a Sustainable Business – is fully aligned to our corporate vision, mission and purpose and is supported by a strategic framework based around three focus areas. Sustainability Strategy Framework The Right Choice for a Sustainable Business A customer-focused and flexible landlord Low carbon, resource efficient and healthy buildings A progressive and transparent business We have defined ten objectives which will guide our annual target setting, motivate our employees and provide clarity to investors, occupiers and other stakeholders as to the wider ambitions of our business and the contribution that we can make towards key sustainability trends. Our objectives are also aligned to our 14 ‘material’ sustainability issues. The details of our programme and our 2019/20 targets are provided below. A customer-focused and flexible landlord Our approach Delivering outstanding customer service is paramount to our business, and this principle is reflected in our approach to sustainability. By actively marketing our sustainability credentials to attract and retain customers we can demonstrate that we are the right choice of landlord for businesses which have their own sustainability goals. By anticipating, understanding and acting upon feedback from our customers, we can bolster our reputation as a business partner and support business growth. Material issues • Tenant attraction and retention • Technological innovation • Diversity, equal opportunity and inclusivity 3 4 Undertake a gap analysis of a selection of current assets’ digital infrastructure provision against good practice references, aiming to define a minimum standard for digital infrastructure provision for different asset types, and to trial smart technology in one property Develop questions to be included within the next customer survey, to ask more specifically about customers’ needs and expectations with regard to building‑related features and amenities to support diversity and inclusivity Low carbon, resource efficient and healthy buildings Our approach Creating low carbon, resource efficient and healthy buildings will be essential to meet a range of stakeholder requirements in the 2020s. We are pleased that over the last five years we have already made great strides in this area as reported above, which we can further build on to continue to ensure our portfolio is future‑proofed and fit for purpose in the coming decade. Material issues • Energy and carbon • Building health, wellbeing and productivity • Waste and resource management • Water • Building labels and standards Objectives • Actively participate in the transition towards a low carbon economy by increasing our assets’ energy efficiency, generating and procuring renewable sources of energy and providing infrastructure for electric vehicles • Pursue a circular approach to resource use that reduces construction and fit‑out costs, increases the flexibility of our buildings, benefits local communities, reduces operational costs and reduces environmental impacts from waste • Put health at the forefront of our property development and management strategy to help our customers’ businesses prosper and the people using our buildings to feel fit and well 2019/20 targets Objectives • Provide outstanding customer service by being an approachable, • responsive and proactive landlord Invest in digital infrastructure that enables our customers to be better connected, more productive and have a lower environmental impact • Seek to ensure that our assets support modern workplace requirements and continue to engage our existing customers 2019/20 targets 1 2 Create and implement a follow‑up action plan in response to the 2019 customer survey Implement the building awards/competition to encourage uptake of sustainability practices amongst our customers 5 6 7 8 Ensure the electricity procured for any new asset acquired in the 2019/20 period is shifted to a renewable electricity tariff by the end of the year, to maintain McKay’s 100% zero carbon electricity procurement status Achieve a year‑on‑year 4% reduction in like‑for‑like landlord controlled electricity and gas consumption and work towards 20% reduction in carbon emissions by FY 2024/25 from FY 2019/20 Proceed with the implementation of new energy saving technologies at a minimum of one asset Secure approval for the implementation of PV panels on at least one new development or major refurbishment, following the results of the Renewable Energy Strategy Review 35 McKay Securities Plc Annual Report and Financial Statements 2019 Sustainability continued 9 10 11 12 13 14 15 16 17 18 19 20 Continue to ensure that all new developments and major refurbishments achieve minimum BREEAM ‘Excellent’ and an EPC rating of at least ‘B’ Define and approve an ambitious 2030 carbon reduction target and action plan to achieve this through a combination of energy efficiency measures, on‑site renewables and purchase of green energy tariffs Identify a development/refurbishment project (if a suitable opportunity arises) where McKay could seek to achieve net zero carbon (as a pilot) before 2022 Increase the recycling rate across all properties for which the Company has management control to at least 52% by 31st March 2020, in line with ‘Good Practice’ in office assets according to the latest available REEB Implement the recommendations of the waste review at assets where McKay has management control social value that our business can create in the communities where we operate. This will enable us to preempt pressure from investors and prepare our business for more demanding planning and/or regulatory requirements on these aspects. Investor attraction and retention Material issues • • Transparent disclosure • Corporate governance • Community health and wellbeing • Sustainable procurement • Health and safety Objectives • Protect and enhance the value of our assets and future‑proof our business by anticipating and responding to evolving environmental and social trends • Communicate clearly and directly with our stakeholders and maintain Organise at least one CPD session on the circular economy to provide information and inspiration to employees on this topic • our culture of sound corporate governance Identify opportunities to support the resilience of local communities around our assets, co‑creating places where people and business can thrive • Monitor and report transparently on our sustainable business performance by using KPIs linked to each of our focus areas, and maintain our position in the GRESB 2019/20 targets 21 22 23 24 25 26 27 28 29 Continue to ensure that sustainability health and wellbeing are integrated into asset marketing and communications, including asset websites and asset profiles on the corporate website Create asset‑level sustainability scorecards which can be used to track asset performance, with this performance data also used in asset marketing Review and update McKay’s acquisitions and developments checklists in line with the sustainability trends and material issues identified through the 2018/19 strategy review Define the brief for a review of the portfolio (and local transport links) against key climate risk criteria – looking out to 2030 As part of McKay’s rebranding, integrate our new sustainability vision into our value proposition and corporate website content Over a two‑year period, identify key locations and a shortlist of projects/charities focused on community resilience which McKay could support Maintain or enhance GRESB performance relative to 2018 Take forward the recommendations of the gap analysis undertaken against the requirements of the TCFD Aim to increase environmental data coverage with a focus on tenant energy, GHG emissions and water data, in line with GRESB requirements Achieve a year‑on‑year 4% reduction in like‑for‑like landlord‑ controlled water consumption, and work towards 20% reduction by FY 2024/25 from FY 2019/20 Proceed with the implementation of new water saving technologies in a minimum of two assets Undertake a gap analysis of a selection of current assets’ health and wellbeing features against good practice references, aiming to define a minimum standard for health and wellbeing that can be applied to all assets (by type), aligned to an appropriate certification standard (e.g. WELL or Fitwel). Undertake a post‑occupancy evaluation at a suitable asset, to identify the extent to which occupier experience matches with the design intent Develop questions to be included within the next occupier survey, to ask more specifically about occupiers’ perceptions of their demised area and common parts building areas in relation to health and wellbeing Organise at least one tour of an exemplary sustainable building for health and wellbeing, to inform and inspire employees A progressive and transparent business Our approach We are proud of our brand and reputation as the leading property specialist in our region, and it is of utmost importance for us to maintain our status as a progressive and transparent business that is open and responsive to trends within both the investor community and wider society. Whilst we continue to uphold high standards of corporate governance, procurement and health and safety management, we will also be sharpening our focus on the management and disclosure of sustainability risk and unlocking the 36 McKay Securities Plc Annual Report and Financial Statements 2019 A BREEAM ‘Excellent’ development in the heart of the City of London 30 Lombard Street, EC3 is located in the City of London and McKay completed the redevelopment in January 2019. This triggered the completion of the pre‑let of the entire building to one financial services tenant. Awarded a BREEAM ‘Excellent’ rating and an EPC ‘B’, the building was fitted with a well‑ performing façade and highly efficient LED lighting system, incorporating daylight dimming. Supportive of occupier comfort and productivity, the building also features a HVAC system zoned such that the BMS is able to keep the temperatures of the indoor environment well controlled across the floorplate. Occupants have access to a planted roof terrace with views across the City, and public transport links, the walkability of the area, and local amenities are all excellent. 37 McKay Securities Plc Annual Report and Financial Statements 2019 Principal Risks and Uncertainties Risk governance structure Risk appetite The Risk Management Committee identified four key areas of risk to the business: External Financial Portfolio Corporate Low Medium Risk appetite High The Company’s strategy of sector and geographic diversity within these markets adds value in positive market conditions and spreads risk in negative market conditions. An ongoing process for identifying, evaluating and managing emerging and principal risks faced by the Company was in place throughout the year to 31st March 2019 and up to the date of approval of the Annual Report and Financial Statements. A robust assessment of the principal risks facing the Company has been carried out and the principal risks are listed on pages 40 to 42. The Board’s overall strategy is based on a low/medium risk appetite determined by an assessment of the prospects within our chosen real estate markets and compliance with the stringent requirements of the REIT regime. This consistent long term strategy has proved to be successful through numerous property cycles with the inherent risks of property development and investment mitigated by internal portfolio management by professionals with extensive market experience located at the geographic centre of the portfolio. Decision making is based on an open culture, with clearly defined terms of reference for the internal Risk Management Committee, overseen by an independent Board. Although economic conditions within our selected markets of London and the South East are beyond our control, they have proven to be more resilient and less volatile through the regular property cycles than the market as a whole. The Board The Board develops the Company’s strategic approach to risk and maintains overall responsibility for monitoring the effectiveness of the Company’s risk management and internal control systems. The Audit and Risk Committee Membership: Independent Non‑Executive Directors The Audit and Risk Committee, on behalf of the Board, reviews the effectiveness of the Company’s internal financial control and internal control risk management systems. The Risk Sub-committee Membership: Executive Directors The Risk Sub‑committee maintains the Company’s Risk Register, designs and maintains the Company’s financial control and internal risk management systems and advises on future potential risk exposure. 38 McKay Securities Plc Annual Report and Financial Statements 2019 Viability statement In accordance with provision C.2.2 of the 2016 UK Corporate Governance Code (provision 31 of the 2018 Code) the Directors have assessed the viability of the Company beyond the 12 month period required by the going concern provision. Assessment period A five year period has been used for this assessment, with particular focus on years one to three. This timeframe is considered appropriate for the following reasons: • The Company’s internal modelling is for a five • year period It is a reasonable period for matters including the assessment of income generation and the availability of debt funding • The majority of the Company’s contracted income expires within five years • Clearing bank loans are currently for a five • year term In the past, property has proved cyclical and a five year time horizon is considered a reasonable timeframe to assess future cycles • The time taken from acquiring an asset, finalising a strategy, obtaining planning permission through to letting is approximately three to five years Assessment process The principal risks to the continued operation of the Company have been reviewed and are described in the table on pages 40 to 42. These risks were subjected to quantitative and qualitative analysis. Scenario testing, based on current economic circumstances, was undertaken, including consideration of: • the implications of a decline in income • a decline in capital values • increasing interest costs • an increased length in the period an asset is vacant In order to stress test these risks on a quantitative financial basis five key business areas were identified: • dividend cover • • REIT compliance • • lending covenants (“LTV”) lending covenants (“ICR”) liquidity These key business areas were tested using four scenarios being: Scenario 1: reduction in rental income Scenario 2: reduction in capital values Scenario 3: increase in interest costs Scenario 4: increased length in the period an asset is vacant Assumptions and expectation The result of the testing against these four scenarios demonstrated that the Company can accommodate each of these scenarios, either without any mitigation, or with mitigation where the scenario imposes stress. Further, the Board considered the impact on the business of a combination of the four scenarios, which could result, for example, from a disorderly Brexit, and concluded that it was reasonable to expect the Company to accommodate this further scenario without threatening the viability of the Company. Based upon the robust risk assessment described above, the Board has a reasonable expectation that the Company will be able to continue operations and meet its foreseeable liabilities as they fall due over the period to March 2024, subject to any significant events beyond its control. This long term viability statement was approved by the Board on 20th May 2019. Going concern statement In accordance with provision C.1.3 of the 2016 UK Corporate Governance Code (provision 30 of the 2018 Code) the Directors have reviewed cashflow forecasts which show that the Company has sufficient facilities to meet forecast outgoings and expects to comply with all covenants for the next five years. In April 2019 the Company successfully renegotiated an increase in its facilities with its long terms lenders and entered into a new facility on the basis of a pool of lenders. For more detailed information please see page 27. After making the appropriate enquiries the Directors have a reasonable expectation that the Company has adequate resources to continue in operation for the foreseeable future (a period of at least 12 months from the date of the approval of the financial statements). For this reason, they continue to adopt the going concern basis in preparing the financial statements. 39 McKay Securities Plc Annual Report and Financial Statements 2019 Principal Risks and Uncertainties continued Principal risks and their impact How risk is managed Macroeconomic environment Lack of economic growth and a recessionary environment leading to reduced tenant demand and higher voids. Whilst the Board recognises it has limited control over many external risks, it monitors economic indicators and tailors delivery of the Company’s strategy accordingly. Disorderly Brexit damages the UK economy. Financial Interest rate rise Leading to lower profits. The Board’s policy is to borrow at both fixed and floating rates of interest. Lack of liquidity Increasing the cost of borrowing and the ability to borrow. This is managed through a mixture of short and long term bank facilities to ensure sufficient funds are available to cover potential liabilities arising against projected cashflows. Risk exposure change in the year Ongoing Brexit discussions continue to maintain a climate of uncertainty that could impact on corporate decision making and increased sector risk. A £65 million facility with Aviva provides 39% of total borrowings fixed or hedged. Further hedging remains under review. A newly secured £180 million revolving credit facility in April 2019 with a syndicate of lenders replaced the previous bilateral facilities and secures debt facilities for the next five years. Breach of financial covenants on bank borrowings As a result of rental or capital movement. Compliance with bank covenants is closely monitored by the Board which regularly reviews various forecast models to help its financial planning. Throughout the period the Company complied with all such covenants. Major tenant default Losing a significant tenant that materially impacts profits. This is monitored using Dun & Bradstreet checks for new tenants together with ongoing credit checks and internal credit control. The Board receives regular information on rental arrears and rent collection activities. Credit control environment remains constant. Taxation REIT non‑compliance. As a REIT, the Company is required to distribute at least 90% of rental income profits each year. It is tax exempt in respect of capital gains. Internal monitoring is in place to monitor compliance with the appropriate rules. Throughout the period the Company complied with the regulations. Auditor rotation Disorderly change of external auditors. The audit tender process ensures the successful auditor has a thorough understanding of the Company’s structure in order to ensure sufficient resourcing and timetabling for a smooth and timely audit process. 40 McKay Securities Plc Annual Report and Financial Statements 2019 Key Risk exposure in the last year has: Link to strategy: Increased Unchanged Reduced Delivery of development programme Release of portfolio income potential by capturing reversion Scope for future growth Principal risks and their impact How risk is managed Risk exposure change in the year Portfolio Portfolio strategy Strategy at odds with economic conditions and occupier demand. The Board continually reviews its strategy against its objectives, taking into consideration the economic climate, the property market cycle and occupier demand. Market conditions remain generally unchanged. Development/refurbishment Delays, overruns or other contractual disputes leading to increased costs, delayed delivery and reduced profitability. Failure of contractor. Construction cost inflation. Planning constraints. Reduction in rental values Exposure to volatility of rental values. Reduction in capital values Exposure to volatility of capital values. The Company focuses entirely on London and the South East in established and proven markets. An experienced and proven acquisition team with a wide network of contacts and advisers ensure the Company is well placed to view and assess potential investment opportunities. All investment opportunities are subject to full due diligence procedures including physical, legal and environmental considerations. The Board is regularly presented with details of capital expenditure and progress on developments, including appraisals and sensitivity analysis. Regular appraisals of developments and refurbishments are carried out. Contractors are assessed for financial stability and historic performance. Design and build contracts are issued where appropriate; others are fully designed prior to commencement of works. The Company continually monitors planning and regulatory reform and takes advice from external advisers and industry specialists. Developing, refurbishing and managing the portfolio in order to offer new and Grade A space to attract and retain quality tenants. Actively managing the portfolio, identifying appropriate rental values alongside lease length and maintaining an open dialogue and good relationship with tenants. An open market valuation of the Company’s properties is undertaken at the year end and half year by independent external valuers in accordance with RICS guidelines and analysed by the Company’s auditors. Valuations are then reviewed by the Audit and Risk Committee and approved by the Board. The Company retains a borrowing headroom should there be an overall decline in capital values. Constant review by management of tenant covenant, lease length and asset management of buildings to preserve/ increase capital values. With practical completion of the Company’s Lombard Street development in January 2019 this leaves one speculative industrial development at Theale ongoing, thereby reducing development risk exposure. Occupier demand in smaller lot sizes. Supply constraints in the Company’s markets have contributed to improved rental values. Increased uncertainty in macro environment has increased the volatility of capital values. 41 McKay Securities Plc Annual Report and Financial Statements 2019 Principal Risks and Uncertainties continued Principal risks and their impact How risk is managed Risk exposure change in the year Corporate Reputational risk Adverse publicity/inaccurate media reporting. Major incident at a property. Actions by Directors or staff including fraud and bribery. Legal and regulatory risk No‑compliance with regulations and laws resulting in planning and project delays, fines and loss of reputation. The Company retains an external investor and public relations consultancy. Press releases are approved by the Chief Executive prior to release. The Company produces a staff handbook that sets out an employee code of conduct and other guidelines. No significant main factors to increase risk. The Company employs experienced staff and external advisers to provide guidance on regulatory requirements. Continued compliance with regulation. The Board approves and adopts the Company’s policies for compliance with current legislation. Retention/recruitment Failure to retain or attract key individuals could impact on major decision making and the future prosperity of the Company. Reviews are undertaken with staff on a regular basis to maintain a positive and encouraging working environment. The remuneration package is at market levels to attract and retain individuals with the skills, knowledge and experience required for the business. Sector employment opportunities remain constant. Health and safety Accidents to employees, contractors, occupiers and visitors to properties resulting in injury, litigation or the delay of refurbishment/redevelopment projects. The SMG meets regularly to review the health and safety risk profile and to implement new management systems required. These meetings review the Company’s Fire Risk Assessments, Safety Inspections, and contractors’ insurance and safe working practices. The SMG is supported by specialist external advisers. There were no significant issues to report in the year. IT/cyber Cyber attack resulting in IT systems failure. Antivirus software and firewalls protect IT systems. Data and programmes are regularly backed up and backups are secured offsite. Increase in global incidents of this nature. Implementation of Company’s Business Continuity Plan. Cyber fraud insurance is in place. Terrorism Terrorist attack impacting a building from the Company’s portfolio resulting in loss of income or building costs. Terrorist attack affecting employees. All buildings have insurance to cover a terrorist incident and loss of rent. All three Executive Directors generally avoid travelling over longer distances together. Government advises that the threat level indicates the likelihood of a terrorist attack in the UK is severe. Approval of Strategic Report The Strategic Report for the year end 31st March 2019 has been approved by the Board and was signed on its behalf by: S Perkins Chief Executive 20th May 2019 42 McKay Securities Plc Annual Report and Financial Statements 2019 Governance Report 44 Board of Directors 46 Chairman’s Letter 47 Directors’ Report 50 Audit and Risk Committee Report 52 Nomination Committee Report 54 Remuneration Report 67 Statement of Directors’ Responsibilities 68 Independent Auditor’s Report 43 McKay Securities Plc Annual Report and Financial Statements 2019 2 3 6 4 7 Board of Directors 1 5 44 McKay Securities Plc Annual Report and Financial Statements 2019 1 Richard Grainger ACA Chairman 3 Giles Salmon FCA Chief Financial Officer Aged 58. Chartered Accountant. Appointed Chairman in July 2016, having been appointed a Non-Executive Director in May 2014. Chairman of Close Brothers Corporate Finance Limited until 2009 and Chairman of Safestore Plc until December 2013. Chairman of Liberation Group. A member of the Remuneration and Nomination Committees. 2 Simon Perkins MRICS Chief Executive Aged 54. Chartered Surveyor. Joined the Company in August 2000 after ten years with business park developer, Arlington Securities PLC. Appointed a Director in April 2001 and Chief Executive in January 2003. Member of the Nomination Committee. Aged 53. Chartered Accountant. Joined the Company in May 2011 and appointed as Chief Financial Officer in August 2011. Previously at BAA Lynton, managing the Airport Property Partnership. 4 Tom Elliott MRICS Property Director Aged 44. Chartered Surveyor. Joined the Company in September 2016 after 11 years with Land Securities Group PLC, where his latest role was Head of Investment for the London Portfolio. Appointed a Director in April 2017. 5 Jon Austen FCA Senior Independent Director Aged 62. Chartered Accountant. Appointed a Non-Executive Director in July 2016. Currently Chief Financial Officer of Audley Group Limited and a Non-Executive Director of Supermarket Income REIT plc. Formerly Group Finance Director of Urban&Civic plc to July 2016. Chairman of the Audit and Risk Committee and a member of the Nomination and Remuneration Committees. 6 Nick Shepherd FRICS Independent Non-Executive Employee Representative Non-Executive (“desNED”) Aged 60. Chartered Surveyor. Appointed a Non-Executive Director in January 2015. Formerly Senior Partner of Drivers Jonas until 2010 and Vice Chairman of Deloitte UK until May 2013. Chairman of the Property Income Trust for Charities and Non-Executive Chairman of Hectare Agritech Ltd. Chairman of the Remuneration Committee and a member of the Audit and Risk, and Nomination Committees. 7 Jeremy Bates MRICS Independent Non-Executive Aged 53. Chartered Surveyor. Appointed a Non-Executive Director in January 2017. Director of Savills UK Limited, EMEA Head of Occupational Markets and UK Head of Transaction Services. Chairman of the Nomination Committee and a member of the Audit and Risk, and Remuneration Committees. 45 McKay Securities Plc Annual Report and Financial Statements 2019 Chairman’s Letter Dear Shareholder I am pleased to introduce our Corporate Governance Report for the year ended 31st March 2019. Richard Grainger Chairman At McKay we continue to strive for high standards of corporate governance throughout the business and aim to work in the best interests of our shareholders and other stakeholders in a responsible and ethical manner. Sound corporate governance is embedded into the culture of the Company and continues to be an essential part of the Board’s stewardship and the delivery of our business strategy over the long term. We continue to comply with the requirements of the 2016 UK Corporate Governance Code (the “2016 Code”) throughout the year. The 2018 UK Corporate Governance Code (the “2018 Code”) comes into effect for companies with reporting periods starting on or after 1st January 2019 and therefore the Company is not required to report on its compliance until next year. However, we have already adopted many of the recommendations and have made reference to the 2018 Code throughout this year’s report. The Board and its Committees operate under a clear mandate with specific Terms of Reference for each Committee, a Schedule of Matters Reserved for the Board and a clear division of responsibilities between me as Chairman and the Chief Executive. Each of the Committees annually review their Terms of Reference and this year each Committee has incorporated updates to comply with the 2018 Code. Consequently, early adoption of two significant new provisions were put in place in advance of the requirement to do so. The first of these was the introduction of the newly appointed position of Employee Representative Non-Executive Director (desNED). After careful consideration of the requirements of this role for a Company of our size, the Board approved the recommendation of the Nomination Committee that existing Non-Executive Director Nick Shepherd should be appointed to this role. The second is the requirement that the Chair of the Board is not a member of the Audit and Risk Committee and my resignation from this Committee was announced in February 2019. Both of these early adopted provisions were put in place with effect from 1st April 2019. Further explanation can be found in the Nomination Committee and Audit and Risk Committee Reports respectively, and copies of the Committees’ Terms of Reference can be found on the Company’s website at www.mckaysecurities.plc.uk. We continue to regularly review the composition of the Board, and although no changes to the Board have been made this year, succession planning remains high on the Nomination Committee’s agenda. I am satisfied that we have a strong Board with the appropriate balance of skills, experience and independence to add value to Board decision making and debate. Board meetings are conducted in an open and transparent manner, with all Directors engaging in open and honest debate. This is reflected in the responses received when undertaking our 46 annual Board, Committee and individual Director evaluations. All Non-Executive Directors have confirmed to me their ability to provide the time commitment required to discharge their responsibilities effectively. Further details of this year’s evaluation process and outcomes can be found within the Nomination Committee Report on page 52. This year the Audit and Risk Committee led the important process of tendering for a new external auditor. This was a thorough and well executed exercise which resulted in the recommendation to the Board to appoint Deloitte as successor to KPMG for the financial year to 31st March 2020. A full report on the tender process can be found in the Audit and Risk Committee Report on page 50. Our Annual General Meeting will be held on 4th July 2019 and the Board and me hope you will be able to attend. Details of all business to be transacted is included within the Notice of Meeting. Richard Grainger Chairman 20th May 2019 McKay Securities Plc Annual Report and Financial Statements 2019 Directors’ Report Introduction The Directors have pleasure in submitting their report and audited financial statements for the year ended 31st March 2019. As permitted under legislation (Companies Act 2006 Section 414C (11)) some of the matters in this report have been included in the following pages of the Annual Report: Sections of the report and audited financial statements for the year ended 31st March 2019 Section Business Model and Strategy Future Business Developments Principal Risks and Uncertainties Viability and Going Concern Statements Greenhouse Gas Emissions Financial Instruments Statement of Directors’ Responsibilities Diversity Policy Page 12 9 38 39 34 94 67 53 Profit and distribution The profit for the year is set out in the Consolidated Profit and Loss and other Comprehensive Income Statement. Profit before tax was £13.2 million (2018: £43.4 million). Under the REIT regime the Company will, in the normal course of business, be required to pay at least 90% of its income arising in each accounting period, by way of a Property Income Distribution (“PID”) but in addition may also make distributions to shareholders by way of non PID dividend payments. The Directors have recommended a final dividend of 7.4 pence per share, all of which will be paid as an ordinary dividend, making a total for the year of 10.2 pence per share (2018: 10.0 pence). If approved at the Annual General Meeting on 4th July 2019 the dividend will be paid on 25th July 2019 to shareholders recorded on the register at the close of business on 31st May 2019. Activity and assets The business of the Company is that of property investment and development in the United Kingdom. The subsidiary undertaking principally affecting the profits or net assets of the Company in the year is listed in note 13 of the Annual Report and Financial Statements. Property valuations The Company’s properties were valued by an external professional valuer at 31st March 2019. An increase in value of £4.83 million (2018: £25.07 million) has been included in the Consolidated Profit and Loss and other Comprehensive Income Statement. After taking into account retained profits and dividends paid during the year, basic net asset value per share at 31st March 2019 was 331 pence (2018: 326 pence). Directors The Board of Directors for the financial year to 31st March 2019 was: R Grainger1 S Perkins G Salmon T Elliott J Austen J Bates N Shepherd 1. Independent on appointment as Chairman Details of the Chairmen and members of the Audit and Risk Committee, Nomination Committee, and Remuneration Committee are provided in each of the Committee Reports. Biographical details of the Directors are set out on pages 44 and 45. In accordance with the Company’s Articles of Association and the UK Corporate Governance Code all the Directors being eligible will offer themselves for re-election at the 2019 AGM. Apart from service contracts and share options, details of which are set out in the Directors’ Remuneration Report on pages 54 to 66, no Director had a material business interest during the year in any contract with the Company. Details of the Directors’ interests in the ordinary shares of the Company and share options are provided in the Directors’ Annual Remuneration Report on pages 62 and 63. Directors’ and officers’ liability insurance In accordance with Article 140 of the Articles and to the extent permitted by the Companies Act, the Company maintains directors’ and officers’ liability insurance, which is reviewed annually. Substantial shareholdings In addition to the Directors’ interests referred to on page 63 of the Directors’ Annual Remuneration Report, the Company has been notified in accordance with the UK Listing Authorities Disclosure Guidance and Transparency Rules of the following holdings of the Company’s shares (see note 19 of the financial statements) as at 31st March 2019: Aberforth Partners LLP Bank of Montreal* (BMO) ING Groep N.V. J.O. Hambro Capital Management UK Shares % 12,294,642 13.06 12.41 11,685,996 5.60 5,269,972 4,752,510 5.06 * The aggregate interest held by BMO includes 9.90% held by Thames River Capital LLP Notification since 31st March 2019: ING Groep N.V. 5,290,186 5.62 Shares % Political donations No political donations were made during the year (2018: nil). Charitable donations The Company donates to local and national charities as appropriate during the year. Share capital The issued share capital of the Company as at 31st March 2019 was 94,124,425 ordinary shares of 20 pence each. There are no restrictions on transfer or limitations on the holding of the ordinary shares. None of the shares carry any special rights with regard to control of the Company. There are no known arrangements under which financial rights are held by a person other than the holder of the shares and no known agreements or restrictions on share transfers or voting rights. The Company has employee share schemes in which the voting rights in respect of the shares are exercisable by the employees. The rules about the appointment and replacement of Directors are contained in the Company’s Articles. Changes to the Articles must be approved by shareholders in accordance with the Articles and applicable legislation. The Company’s Articles will be available for inspection at the Annual General Meeting and in accordance with applicable legislation. 47 McKay Securities Plc Annual Report and Financial Statements 2019 Directors’ Report continued Annual General Meeting The 73rd Annual General Meeting of the Company will be held at The Royal Thames Yacht Club, 60 Knightsbridge, London SW1 on 4th July 2019 at 3.00pm. At the forthcoming Annual General Meeting the following special resolutions will be proposed which constitute special business: Power to allot shares The Directors were granted authority at the last AGM held in 2018 to allot relevant securities up to a nominal amount of £6,263,673. That authority will apply until the conclusion of this year’s AGM. At this year’s AGM shareholders will be asked to grant an authority to allot shares in the Company and to grant rights to subscribe for or convert any security into shares in the Company (i) up to a nominal amount of £6,274,961 and (ii) comprising equity securities up to a nominal amount of £12,549,923 (after deducting from such limit any shares or rights allotted or granted under (i)), in connection with an offer by way of a rights issue, (the “Section 551 authority”), such Section 551 authority to apply until the end of the next AGM (or, if earlier, until close of business on 30th September 2020). Two special resolutions will also be proposed to grant the Directors power to make non pre-emptive issues for cash consideration with rights issues and otherwise up to a total nominal amount of £1,882,488. Market purchase of shares A special resolution will be proposed to renew the Directors’ authority to repurchase the Company’s ordinary shares in the market. The authority will be limited to a maximum of 9,412,442 ordinary shares and sets the minimum and maximum prices which may be paid. Significant agreements There are no agreements between the Company and its Directors or employees providing for compensation for loss of office or employment that occurs because of a takeover bid. Some of the Company’s banking arrangements may be terminable upon a change of control of the Company’s. 48 Auditor KPMG LLP undertook the audit for the year to 31st March 2019. The Company will seek shareholder approval to change its auditor at the AGM from KPMG LLP to Deloitte LLP if approved, and Deloitte LLP will undertake the half year review for the period to 30th September 2019 and a full audit for the year ending 31st March 2020. Details of the tender process to select Deloitte LLP can be found in the Audit and Risk Committee Report on page 51. In accordance with Section 489 of the Companies Act 2006, a resolution for the appointment of Deloitte LLP as auditor of the Company is therefore proposed at the forthcoming AGM. The Directors who held office at the date of approval of this Directors’ Report confirm that, so far as they are each aware, there is no relevant audit information of which the Company’s auditor is unaware and each Director has taken all reasonable steps that he ought to have taken as a Director to make himself aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given in accordance with Section 418(2) of the Companies Act 2006. Disclosures required under Listing Rule 9.8.4R Section Information Page 87 Interest capitalised and tax relief Details of long term incentive plans 54-66 Waiver of Director emoluments 55 1 4 6 Throughout the year to 31st March 2019 the Company has complied with the 2016 UK Corporate Governance Code and is working towards compliance with the 2018 Code, details of which can be found at www.frc.org.uk. The Role of the Board The Board of Directors (the “Board”) formulates strategy and is responsible for the management of the Company. A Schedule of Matters Reserved for the Board, the content of which is reviewed annually, has been adopted and includes the approval of the dividend policy, major capital expenditure, investments and disposals. The Board For the year to 31st March 2019 the Board comprised of three Executive Directors, and four Non-Executive Directors. Their biographical details are set out on pages 44 and 45. The composition of the Board complies with provision B.1.2 of the 2016 Code and provision 11 of the 2018 Code. The Board considers the Non-Executive Directors to be independent in that they have no business or other relationship with the Company that might influence their independence or judgment. The Board formally met ten times during the period and is provided with full and timely information in order to discharge its duties. Attendance at Board and Committee meetings is set out in the table on page 49. The roles of the Chairman and Chief Executive are, and will continue to be, separate. The Chairman is responsible for the leadership of the Board and its effectiveness. He ensures a constructive relationship exists between the Executive and Non-Executive Directors. Responsibility for the day to day running of the Company and the implementation of the Company’s strategy is delegated to the Chief Executive with the support of the Executive Directors. The division of responsibilities between the Chairman and the Chief Executive is set out in writing and approved by the Board. Mr J Austen is the Senior Independent Director and Mr N Shepherd has been appointed from 1st April 2019 to the newly formed role of Employee Representative Non-Executive Director (“desNED”). The Board is satisfied that no individual or group of Directors has unfettered powers of discretion and that the Board and its Committees have an appropriate balance of skills and experience and are of sufficient size to discharge their duties. The Board has access to the advice and services of the Company Secretary and independent legal advice at the Company’s expense, if required. Continuing professional development training is available for Directors as necessary. McKay Securities Plc Annual Report and Financial Statements 2019 The Board has adopted a policy and effective procedures for managing and, where appropriate, approving conflicts or potential conflicts of interest should they arise. Only Directors who have no interest in the matter being considered will be able to make the relevant decision and, in taking the decision, the Directors must act in a way they consider in good faith will be the most likely to promote the success of the Company. Committees There are three Committees that make their recommendations to the Board, all of which have clear Terms of Reference that comply with the Code; these are reviewed annually and are available on the Company’s website, www.mckaysecurities.plc.uk. Audit and Risk Committee Mr J Austen FCA is Chairman of the Audit and Risk Committee, which met five times in the last year. Mr J Austen is identified as having recent and relevant financial experience as required by the Code. In compliance with provision 24 of the 2018 Code Mr R Grainger, being Chairman of the Board, stepped down from the Audit and Risk Committee from 1st April 2019. Further details, along with the Committee’s responsibilities and activities are set out in the Audit and Risk Committee Report on pages 50 and 51. Nomination Committee Mr J Bates MRICS is Chairman of the Nomination Committee. The Committee met twice in the last year and its responsibilities and activities, including the appointment of new Directors, their induction and the performance evaluation of the Board are set out in the Nomination Committee Report on pages 52 and 53. Remuneration Committee Mr N Shepherd FRICS is Chairman of the Remuneration Committee which met three times in the last year. The Committee members, the Directors’ Remuneration Policy and the Directors’ Annual Remuneration Report are set out in the Directors’ Remuneration Report on pages 54 to 66. Risk management and internal control The following should be read in conjunction with the principal risks and uncertainties on pages 38 to 42 of the Strategic Report. The Board is responsible for establishing and reviewing the Company’s system of internal control to safeguard shareholders’ investment and the Company’s assets. The Audit and Risk Committee reviews the effectiveness of the Company’s internal financial control and internal control risk management systems on behalf of the Board. The Risk Sub-committee is responsible for identifying key risks and assessing their likely impact on the Company and maintaining the Risk Register. The Sub-committee members comprise the Executive Directors and it reports to the Audit and Risk Committee. Important areas include property, financial and corporate risks. Other important areas such as corporate taxation, legal matters, defined benefit pension scheme, detailed insurance cover and contracts including maintenance and property management all come under the direct control of the Executive Directors and are reviewed on an ongoing basis. Identification of business risks The Company has an established system of internal financial control which is designed to ensure the maintenance of proper accounting records and the reliability of financial information used within the business. However, such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance against material misstatement or loss. Annual and long term revenue, cash flow and capital forecasts are updated quarterly during the year. Results and forecasts are reviewed against budgets and regular reports are made to the Board on all financial and treasury matters. The Directors confirm that they have specifically reviewed the framework and effectiveness of the system of internal control for the year ended 31st March 2019. Relations with shareholders The UK Stewardship Code aims to enhance the quality of engagement between the Company and its shareholders. The Board recognises the importance of maintaining an ongoing relationship with the Company’s shareholders and achieves this through regular dialogue. The Directors meet with current and prospective shareholders and shareholders have an opportunity to question the Board at the Company’s AGM. Shareholders are given at least 20 working days notice of the AGM. The Chairmen of the Audit and Risk Committee, Nomination Committee and Remuneration Committee attend the AGM to answer questions. Shareholders are given the opportunity of voting separately on each proposal and are informed of proxy voting figures. These figures are posted on the Company’s website, www.mckaysecurities.plc.uk. There is also an investor relations section on the Company’s website, which includes annual and interim reports. The website also includes stock exchange releases, details of the Company’s portfolio and day to day contact details. The Company has a share account management and dealing facility for all shareholders via Equiniti Shareview. This offers shareholders secure access to their account details held on the share register to amend address information and payment instructions directly, as well as providing a simple and convenient way of buying and selling the Company’s ordinary shares. For internet services visit www.shareview.co.uk or the investor relations section of the Company’s website. The Shareview dealing service is also available by telephone on 03456 037 037 between 8.30am and 4.30pm Monday to Friday. Signed by order of the Board: J McKeown Secretary 20th May 2019 Reading Table of Board meeting attendance (for the financial year to 31st March 2019) Board (10 meetings) Audit and Risk Committee (5 meetings) Remuneration Committee (3 meetings) Nomination Committee (2 meetings) 10 10 10 10 10 10 10 5 51 41 31 5 5 5 3 31 – – 3 3 3 2 2 – – 2 2 2 R Grainger S Perkins G Salmon T Elliott J Austen J Bates N Shepherd 1. In attendance by invitation 49 McKay Securities Plc Annual Report and Financial Statements 2019 Audit and Risk Committee Report Dear Shareholder I am pleased to present the Audit and Risk Committee Report for the year ended 31st March 2019. Jon Austen Chairman of the Audit and Risk Committee 50 KPMG LLP undertook the audit for the year ended 31st March 2019 and their Auditor’s Report can be found on pages 68 to 74. My report last year made reference to the Company’s proposed engagement of a new external auditor for the audit of the year to 31st March 2020 to maintain compliance with EU audit reforms and FRC guidance. Following a competitive tender process, the Company intends to appoint Deloitte LLP. As is normal practice, shareholders will be asked to authorise its appointment at the AGM on 4th July 2019. KPMG LLP has provided the Company with many years of exemplary service and I would like to thank all those involved both this year and over past years for their thorough work and assistance. When the Committee reviewed its Terms of Reference this year it took the opportunity to incorporate the requirements of the 2018 UK Corporate Governance Code. Provision 24 of the 2018 Code introduced a requirement that the Chair of the Board should not be a member of the Audit Committee, to reinforce independence. Following discussions between the Nomination Committee and the Audit and Risk Committee, early adoption of this provision was recommended to the Board and consequently Richard Grainger stepped down as a member of the Committee on 1st April 2019. The focus of the Committee for 2020 will be to ensure the smooth transition between the outgoing and incoming auditors. In addition we will continue to play a key role in maintaining the quality of our financial reporting and the adequacy and effectiveness of internal controls and risk management. Jon Austen Chairman of the Audit and Risk Committee 20th May 2019 McKay Securities Plc Annual Report and Financial Statements 2019 Committee membership The Audit and Risk Committee (the “Committee”) consists solely of independent Non-Executive Directors. The members of the Committee are: J Austen FCA – Chairman J Bates MRICS N Shepherd FRICS Jon Austen is identified as having recent and relevant financial experience and the Committee believes as a whole it has competence relevant to the sector in which the Company operates. The Committee met five times in the last year with full Committee attendance at all meetings. The table of attendance is set out in the Directors’ Report on page 49. The Chief Executive (“CEO”) , Chief Financial Officer (“CFO”) and external auditors regularly attend by invitation. The Committee meets twice a year with the external audit engagement partner to provide the opportunity to discuss matters without executive management being present. The Committee’s annual appraisal process was an internally run exercise using the Company’s digital board solution in the format of a questionnaire, completed by all members and submitted on line. This was reviewed by the Committee Chairman and feedback was provided at a meeting of the Committee. Future actions included improvements to the induction process and Committee members enhancing their knowledge through attendance of training programmes. The evaluation concluded that the Committee continued to operate in an efficient and effective way. Committee role and responsibilities The main role and responsibilities of the Committee are set out within its Terms of Reference which are reviewed annually and are available on the Company’s website, www.mckaysecurities.plc.uk. These responsibilities include: • Financial reporting: monitoring and assessing the integrity of the financial statements of the Company including its annual and half yearly reports and advising the Board on whether taken as a whole these are fair, balanced and understandable; • Risk management and internal controls: reviewing the Company’s risk management and internal control systems; • Compliance, whistleblowing and fraud: reviewing the adequacy and security of the Company’s arrangements; and • External and internal audit: recommending to the Board for shareholder approval at the AGM the appointment or re-appointment of the external auditor and overseeing the relationship with the external auditor. Managing the selection process for the appointment of the external auditor and regularly reviewing its independence and objectivity. Committee consideration is also given annually to the requirement of an internal audit function. Main activities of the Committee during the year Financial statements The Committee focused on the significant judgement in the Annual Report and Financial Statements in respect of the Company’s property valuation. The valuation of the Company’s portfolio is undertaken by an external professional valuer, Knight Frank LLP, and the assumptions and judgements are discussed and reviewed with the Committee. The valuation was reviewed along with its associated risks, and the Committee gained comfort from the valuer’s methodology and other supporting market information. As requested by the Board, the Committee undertook a review of the Annual Report and Financial Statements for the year ended 31st March 2019 and advised the Board that, taken as a whole, these were fair, balanced and understandable and provided the information necessary for shareholders to assess the Company’s position and performance, business model and strategy. Risk management and internal control The Committee is responsible for reviewing the Company’s risk management and internal control systems. The Risk Management Sub-committee has delegated responsibilities including overseeing and advising on the current and future risk exposure of the Company, maintaining the Company’s risk register and reviewing the effectiveness of the Company’s internal financial controls. The Risk Management Sub-committee met three times during the year and reported its findings to the Audit and Risk Committee. For further information on the Company’s risk appetite, principal risks and uncertainties and the long-term viability statement please see pages 38 to 42. Whistleblowing policy The Audit and Risk Committee reviewed arrangements by which staff of the Company may in confidence raise concerns in respect of the financial reporting and other matters. These detailed procedures are set out in the Company’s Staff Handbook and the Company’s policy is available on the website www.mckaysecurities.plc.uk. External auditor KPMG LLP undertook the audit for the year ended 31st March 2019 and their audit fee was £75k with related assurance work of £25k. Non-audit fees, being tax services and debt advisory services, are provided by PwC. As reported last year the Committee was aiming to engage an alternative external auditor for the 2020 audit. This proposed appointment was subject to a rigorous competitive tender process, which commenced in September 2018. The tender process The tender process was divided into a number of stages: • An initial shortlist of four firms was produced, made up of two of the Big 4 and two outside the Big 4. The Company did not approach PwC due to a conflict of interest as PwC provide non-audit services. • The Chairman of the Audit and Risk Committee wrote to the Company’s principal investors and major representative bodies to outline the tender proposals, inform them of the selected parties for the shortlist and offer the opportunity to discuss any aspect of the process. • A steering group was appointed to oversee the project. This comprised the Audit and Risk Committee Chairman, CFO and the Financial Controller (“FC”), who was charged with leading the day to day process. • The most recent FRC Audit Quality Review reports for the shortlisted firms were reviewed. • A Request for Proposal (“RFP”) was issued to the head of audit of the four shortlisted firms. The RFP contained the key information regarding the tender process, e.g. timings, contact details, and the deliverables expected from the audit firms along with the selection criteria to be used to make the final decision. • The CFO and the FC subsequently met with the audit partners of the four shortlisted firms. • The FC was the conduit for the firms to gain an understanding of the business. He met and assessed the proposed audit team members. • At this stage the shortlist was reduced to three. • The Audit and Risk Committee Chairman met with the audit partner of the three shortlisted candidates and a separate meeting between the audit partner and the CEO was also held. • The three shortlisted firms presented their tenders early in 2019. All members of the Audit and Risk Committee attended the presentation along with the CEO and the CFO. Following the presentations, the Audit and Risk Committee held a meeting to discuss and review the presentations. • The Committee then presented two firms to the Board as possible options for the appointment of the statutory auditor, with a clearly justified preference for one of those options, being Deloitte LLP. • The recommendation of the Committee was approved by the Board and announced on 11th February 2019. Internal audit The Committee reviewed the requirement for an internal audit function and concluded that as there is a small management team operating from one location enabling close involvement of the Executive Directors in the day to day operational matters of the Company, coupled with the comprehensive internal controls currently in place, no requirement to establish an internal audit function was needed at this time. This recommendation was made to the Board. 51 McKay Securities Plc Annual Report and Financial Statements 2019 Nomination Committee Report Dear Shareholder I am pleased to present the report of the Nomination Committee for the year ended 31st March 2019. Jeremy Bates Chairman of the Nomination Committee In addition, with the removal of the 2018 Code’s provision enabling Chairs of smaller companies to be a member of the Audit Committee, the membership of the Audit and Risk Committee was reviewed and Richard Grainger, the Company’s Chairman, stood down from the Audit and Risk Committee. These changes were announced to the market on 11th February 2019 and came into effect on 1st April 2019. The Committee will continue to support the Board and its Committees, to ensure they continue to have the appropriate balance of skills, experience, independence and knowledge to enable them to discharge their respective duties and responsibilities effectively. Jeremy Bates Chairman of the Nomination Committee 20th May 2019 During the year, the Committee focused on the composition of the Board and Committees, and early adoption of a new provision of the 2018 UK Corporate Governance Code, that highlighted the increasing need to consider the employee voice at Board level. The composition of the Board and Committees continues to comply with the independence requirements of the 2016 UK Corporate Governance Code. Maintaining this compliance is an important responsibility for the Committee, and we place an emphasis on succession planning at Board level in particular, to provide sufficient time to enable managed change as far as possible. As with the other Committees, when the Committee Terms of Reference were reviewed, the opportunity was taken to incorporate the requirements of the 2018 Code. These revised Terms of Reference are available to view at the Company’s website, www.mckaysecurities.plc.uk. There has been much coverage of the importance of ensuring that the views of employees are represented at Board level. Having considered the different options to achieve this, and to meet the new 2018 Code requirements, the Committee recommended to the Board a new role of Employee Representative Non-Executive Director as a suitable way to achieve this. The Committee’s recommendation that this position be filled by existing Non-Executive Director Nick Shepherd was agreed by the Board. 52 McKay Securities Plc Annual Report and Financial Statements 2019 Committee membership Members of the Nomination Committee are: J Bates MRICS – Chairman J Austen FCA R Grainger ACA N Shepherd FRICS S Perkins MRICS The Nomination Committee met twice in the last year with 100% attendance. The required majority of the members of the Committee are independent Non-Executive Directors. Committee role and responsibilities The main roles and responsibilities of the Committee are set out within its Terms of Reference which are reviewed annually and are available on the Company’’s website, www.mckaysecurities.plc.uk. These responsibilities include: • regularly reviewing the structure, size and composition of the Board; • membership of Board Committees; • succession planning for Directors and other • • • senior executives; identifying and nominating for the approval of the Board candidates, to fill Board vacancies as and when they arise including the role of Senior Independent Director and Employee Representative Non-Executive Director; reviewing the results of the Board performance evaluation process that relate to the composition of the Board; reviewing the equality and diversity policy of the Company; • making recommendations to the Board concerning the re- election of Directors by shareholders; and • annual review of the Nomination Committee Policy on diversity The Company is committed to treating all employees equally and considers all aspects of diversity, including gender and ethnicity, when considering recruitment at any level of the business. The Board supports the principle of the Hampton-Alexander review for greater female representation on the Board and the Parker Review on ethnic diversity and ensures that any list of candidates for any Board position includes both male and female candidates with a wide range of backgrounds. The Board is mindful that the right balance of skills and experience of the candidate is key and therefore all candidates are considered on merit and no diversity targets are set. The Board takes overall responsibility for the development of equality and diversity and ensures that progress is reviewed and further actions taken as necessary. The Company’s policy on equality and diversity is available to view on the website. The gender diversity of the Company is set out below: Gender diversity of the Company as at 31st March 2019 Board Senior management Other employees Terms of Reference. Total Board performance appraisal A formal annual appraisal of the Board, its Committees and individual Directors was undertaken during February and March 2019. The appraisal process was an internally run exercise undertaken using the Company’s digital board solution in the format of a series of questionnaires that were completed by the Directors and submitted on-line. The process was implemented and administered by the Company Secretary. The Board and Committee appraisals concluded that the Board and Committees operated in an effective manner with open and transparent dialogue and a high level of challenging and constructive debate. Future actions included the introduction of an employee representative Non-Executive Director (appointment in place), ways to improve the Director induction process, increasing the number of meetings held at portfolio assets and a continued emphasis on succession planning. The Chairman assessed the individual Directors’ questionnaires and the Senior Independent Director assessed the questionnaire completed by the Chairman. Feedback was provided to all Directors. The appraisals concluded that each individual Director continued to provide an effective and appropriate range of skills and experience, whilst demonstrating commitment and independence. Collectively, the Directors have a wide range of knowledge, skills and many years of experience in the commercial sector, working at both strategic and operational level. Re-election of Directors As recommended under Provision B.7.1. of the 2016 UK Corporate Governance Code, all Directors of the Company, being eligible, will offer themselves for election at the 2019 AGM. The biographical details of the Directors are available on pages 44 and 45. 0 4 8 12 16 20 24 Male Female Our operations are based solely in the UK and are low risk in relation to human rights issues. No human rights issues have arisen in the period. Succession planning The Nomination Committee considers succession planning for Directors and other senior executives. The succession plans are based around any identified future skill shortages, are regularly reviewed and ensure a formal, rigorous and transparent procedure for new appointments. Non-Executive Directors are appointed for an initial three year term and are subject to annual re-election at the AGM. Any term beyond six years is subject to particularly rigorous review in line with the Company’s strategy for progressive refreshing of the Board. The longest serving Non-Executive is Richard Grainger, who joined the Board in May 2014. There have been no new appointments made to the Board in the last 12 months. 53 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report 1 Annual Statement Dear Shareholder I am pleased to present the Directors’ Remuneration Report for the year ended 31st March 2019, which has been prepared by the Remuneration Committee (“the Committee” and approved by the Board. Nick Shepherd Chairman of the Remuneration Committee The report is divided into three sections: 1 2 3 The Annual Statement of the Remuneration Committee Chairman for the year ended 31st March 2019, which summarises remuneration outcomes and how the Remuneration Policy will operate for the year ending 31st March 2020; the Remuneration Policy Report, which details the Company’s policy on the remuneration of Executive and Non-Executive Directors which was last approved by shareholders at the 2017 AGM; and the Annual Report on Remuneration, which provides further detail on page 60 how the Remuneration Policy was implemented in the year ended 31st March 2019, and how the Remuneration Policy will operate for the year ending 31st March 2020. The Committee has continued to work closely with the Board to ensure delivery of the Directors’ Remuneration Policy, approved by shareholders at the 2017 AGM. This work is summarised below, and set out in detail in subsequent sections of this report. Publication in July 2018 of the Revised UK Corporate Governance Code by the Financial Reporting Council (“FRC”) introduced a number of new and updated remuneration policies and practices. The 2018 Code applies to accounting periods beginning on or after 1st January 2019, so we will be required to comply with the Code for the financial year to 31st March 2020. Despite this, and a number of requirements only applying to companies with more than 250 employees, this report includes a number of voluntary early disclosures in respect of requirements of the 2018 Code. This demonstrates our commitment to provide shareholders with a remuneration structure that continues to comply with the most recent guidance. At the 2020 AGM we will be tabling a binding resolution to seek shareholder approval to renew our existing Directors’ Remuneration Policy being three years since the last vote. There are likely to be a number of updates, but the Committee is satisfied that the 2017 Policy remains relevant and robust, and therefore no changes are proposed for approval at this year’s AGM. Only the Annual Statement and Annual Report on Remuneration will be subject to a vote (advisory) at the forthcoming 2019 AGM. 54 McKay Securities Plc Annual Report and Financial Statements 2019 Fees for the Chairman This year, the Chairman of the Board has taken the decision to waive any increase in his fee for the year commencing 1st April 2019 and therefore his fee will remain at the same level as 2018 (i.e. £90,000). Conclusion I hope you remain supportive of the approach to Policy implementation for 2019/20 which is a continuation of our considered and prudent approach to remuneration at McKay, and that you will therefore vote in favour of the remuneration related resolution that will be tabled at the forthcoming AGM. Nick Shepherd Chairman of the Remuneration Committee 20th May 2019 Committee activities during the year The Committee met three times during 2018/19. The main Committee activities during the year (full details of which are set out in the Annual Report on Remuneration) included: • determining Executive Directors’ base salary levels for 2019/20; • setting the Executive Directors’ bonus targets for 2018/19 and agreeing the outturn in respect of the 2017/18 annual bonus; • agreeing the structure of the annual bonus for 2019/20; • determining vesting of the 2016 PSP awards which reached the end of the three year performance period on 31st March 2019; • overseeing the grant of the PSP awards in 2018/19 which was made over shares worth 100% of salary to the Executive Directors and which vest subject to the achievement of a blend of challenging absolute NAV per share growth targets and relative TSR targets; • considering the 2018 UK Corporate Governance Code and new disclosure requirements; and • considering risk in respect of the Remuneration Policy. Pay and performance The positive performance for the year ended 31st March 2019 has been reflected in the payments made to the Executive Directors under the annual bonus plan – performance against the EPS, NAV and strategic targets resulted in a bonus of 64% of the maximum. The excess annual bonus over 50% of salary will be deferred into shares for three years. In respect of the PSP awards granted in 2016, which vest in June 2019, three-year performance to 31st March 2019 against the NAV targets will result in 14% of that element vesting while performance against the relative TSR targets will result in 0% of that element vesting. Further details (including information regarding the targets and performance against them) are set out in the Annual Report on Remuneration. Discretion The Committee has full discretion to vary performance related pay, but this was not considered necessary during the year or post year end. Policy implementation for the year ending 31st March 2020 The Directors’ Remuneration Policy will be operated for 2019/20 as follows: • base salaries increased in line with the general workforce rate of increase; • pension provision will remain unchanged for existing Executive Directors. Pension provision for the future appointment of Executive Directors will be consistent with the general workforce; • • maximum bonus potential for 2019/20 will continue to be set at 100% of basic salary with performance continuing to be based on NAV growth (30%), EPS growth (45%) and strategic targets (25%), consistent with those targets operated for the general workforce; long term incentive awards will continue to be granted under the 2017 Performance Share Plan, with Executive Directors receiving awards over shares equivalent in value to 100% of base salary, with 40% of the potential award based on NAV performance targets and 60% based on relative TSR targets; • performance targets for the 2019 grant of PSP awards will remain unchanged. The three year NAV growth targets will be 12% (25% of this part of an award vests) to 35% (100% of this part of an award vests). The TSR targets will range from median (25% of this part of an award vests) to upper quartile (100% of this part of an award vests) as measured against a FTSE Real Estate sector group; • a two year post vesting holding period will continue to apply to PSP awards after the three year performance period; • malus and clawback provisions will continue to operate; and • shareholding guidelines will remain at 200% of salary. 55 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 2 Remuneration Policy Report A summary of the Remuneration Policy approved by shareholders at the 2017 AGM is as follows: Element Base salary Benefits Pensions Annual bonus Purpose and link to strategy Operation To recruit and reward executives of the quality required and with appropriate skills to manage and develop the Company successfully. Reviewed annually by the Committee, on the basis of the performance of the individual Executive Director and comparability with other similarly sized companies within the sector and the market generally. Paid on a monthly basis. To provide appropriate levels of benefits to executives of the quality required and appropriate skills to manage and develop the Company successfully. To provide appropriate levels of pension provision to executives of the quality required and appropriate skills to manage and develop the Company successfully. To incentivise and reward the delivery of the Company’s strategic objectives. The Company typically provides: Car allowance (paid monthly) Medical insurance Life assurance The Committee reserves the discretion to introduce new benefits where it concludes that it is appropriate to do so, having regard to the particular circumstances and to market practice. Where appropriate, the Company will meet certain costs relating to Executive Director relocations (which are not subject to the benefits cap). Executive Directors can receive pension contributions to personal pension arrangements or, if a Director is impacted by annual or lifetime limits on contribution levels to qualifying pension plans, the balance (or all) can be paid as a cash supplement. Annual bonus plan levels and the appropriateness of measures are reviewed annually as close as is practicable to the commencement of each financial year to ensure they continue to support our strategy. Once set, performance measures and targets will generally remain unchanged for the year, except to reflect events such as corporate acquisitions or other major transactions where the Committee considers it to be necessary in its opinion to make appropriate adjustments. Annual bonus plan outcomes are paid in cash up to 50% of salary, with three year deferral into shares for outcomes greater than 50% of salary. The number of shares subject to vested deferred share awards may be increased to reflect the value of dividends that would have been payable during the vesting period. Malus/clawback provisions apply in the event of material misstatement, error or misconduct up to three years following the relevant payment date. Performance Share Plan (“PSP”) To incentivise and reward the delivery of the Company’s strategic objectives and to provide further alignment with shareholders through the use of shares and to aid retention. Awards under the PSP may be granted as nil/ nominal cost options or conditional awards which vest to the extent that performance conditions are satisfied over a period of at least three years. A two year posting vesting holding period will also normally apply. Part/all of vested awards may also be settled in cash. The PSP rules allow that the number of shares subject to vested PSP awards may be increased to reflect the value of dividends that would have been paid in respect of any dividends payable falling between the grant and the release of shares. Non- Executive Director fees To attract and retain a high-calibre Chairman and Non-Executive Directors by offering appropriate fees. The fees paid to the Chairman and Non- Executive Directors are set by reference to comparability with other similarly sized companies within the sector and the market generally. The fees payable to the Non- Executive Directors are determined by the Board, with the Chairman’s fees determined by the Committee. The Chairman and Non-Executive Directors will not participate in any cash or share incentive arrangements. The Company reserves the right to provide benefits including travel and office support. Fees are paid on a monthly basis. 56 Maximum opportunity Performance measures The Committee is guided by the general salary N/A increase for the broader employee population and market conditions but on occasions may need to recognise, for example, a change in the scale, scope or role and/or market movements. However, a formal cap on salaries will apply such that no incumbent Executive Director’s base salary shall be increased beyond £500,000. The aggregate value of any benefits provided to N/A any single Director will not exceed £75,000. Up to 20% of salary N/A Up to 100% of salary The performance measures applied may be financial or non-financial and corporate, divisional or individual and in such proportions as the Committee considers appropriate. Where a sliding scale of targets is used, attaining the threshold level of performance for any measure will not typically produce a pay-out of more than 30% of the maximum portion of overall annual bonus attributable to that measure, with a sliding scale to full pay-out for maximum performance. The Committee will also retain the flexibility to adjust the bonus outturn based upon a formulaic assessment of performance against the targets if it believes that this outturn does not reflect overall performance and/or shareholders’ experience. The Committee may set such performance conditions on PSP awards as it considers appropriate, whether financial or non-financial and whether corporate, divisional or individual. Performance periods may be over such periods as the Committee selects at grant, which will not be less than, but may be longer than, three years. No more than 25% of awards vest for attaining the threshold level of performance. Normal grant policy: Up to 100% of salary Maximum normal grant level: Up to 150% of salary Exceptional grant level: Up to 200% of salary When determining fee increases, the Company N/A is guided by the general increase for the broader employee population and market conditions but on occasion may need to recognise, for example, change in responsibility, time commitment and/or market movements. The aggregate fees and any benefits of the Chairman and Non-Executive Directors will not exceed the limit from time to time prescribed within the Company’s Articles of Association for such fees. McKay Securities Plc Annual Report and Financial Statements 2019 Element Base salary Purpose and link to strategy Operation To recruit and reward executives of the quality required and with Reviewed annually by the Committee, on the basis of the performance of the individual Executive Director and comparability with appropriate skills to manage other similarly sized companies within the and develop the Company sector and the market generally. successfully. Paid on a monthly basis. Benefits To provide appropriate levels The Company typically provides: The Committee reserves the discretion to of benefits to executives of Car allowance (paid monthly) the quality required and Medical insurance appropriate skills to manage Life assurance introduce new benefits where it concludes that it is appropriate to do so, having regard to the particular circumstances and to market practice. and develop the Company successfully. Where appropriate, the Company will meet certain costs relating to Executive Director relocations (which are not subject to the benefits cap). Pensions To provide appropriate levels Executive Directors can receive pension of pension provision to executives of the quality required and appropriate contributions to personal pension arrangements or, if a Director is impacted by annual or lifetime limits on contribution levels skills to manage and develop to qualifying pension plans, the balance (or all) the Company successfully. can be paid as a cash supplement. Maximum opportunity Performance measures N/A The Committee is guided by the general salary increase for the broader employee population and market conditions but on occasions may need to recognise, for example, a change in the scale, scope or role and/or market movements. However, a formal cap on salaries will apply such that no incumbent Executive Director’s base salary shall be increased beyond £500,000. The aggregate value of any benefits provided to any single Director will not exceed £75,000. N/A Up to 20% of salary N/A Annual bonus To incentivise and reward the Annual bonus plan levels and the Annual bonus plan outcomes are paid in cash up delivery of the Company’s appropriateness of measures are reviewed to 50% of salary, with three year deferral into strategic objectives. annually as close as is practicable to the shares for outcomes greater than 50% of salary. Up to 100% of salary commencement of each financial year to The number of shares subject to vested deferred ensure they continue to support our strategy. share awards may be increased to reflect the value of dividends that would have been payable Once set, performance measures and targets during the vesting period. will generally remain unchanged for the year, except to reflect events such as corporate Malus/clawback provisions apply in the event of material misstatement, error or misconduct up to three years following the relevant payment date. acquisitions or other major transactions where the Committee considers it to be necessary in its opinion to make appropriate adjustments. Performance Share Plan (“PSP”) To incentivise and reward the Awards under the PSP may be granted as nil/ The PSP rules allow that the number of shares delivery of the Company’s strategic objectives and to provide further alignment with shareholders through the use of shares and to aid retention. nominal cost options or conditional awards subject to vested PSP awards may be increased which vest to the extent that performance to reflect the value of dividends that would have conditions are satisfied over a period of at been paid in respect of any dividends payable least three years. A two year posting vesting falling between the grant and the release of holding period will also normally apply. Part/all shares. of vested awards may also be settled in cash. Normal grant policy: Up to 100% of salary Maximum normal grant level: Up to 150% of salary Exceptional grant level: Up to 200% of salary The performance measures applied may be financial or non-financial and corporate, divisional or individual and in such proportions as the Committee considers appropriate. Where a sliding scale of targets is used, attaining the threshold level of performance for any measure will not typically produce a pay-out of more than 30% of the maximum portion of overall annual bonus attributable to that measure, with a sliding scale to full pay-out for maximum performance. The Committee will also retain the flexibility to adjust the bonus outturn based upon a formulaic assessment of performance against the targets if it believes that this outturn does not reflect overall performance and/or shareholders’ experience. The Committee may set such performance conditions on PSP awards as it considers appropriate, whether financial or non-financial and whether corporate, divisional or individual. Performance periods may be over such periods as the Committee selects at grant, which will not be less than, but may be longer than, three years. No more than 25% of awards vest for attaining the threshold level of performance. Non- Executive Director fees To attract and retain a The fees paid to the Chairman and Non- The Chairman and Non-Executive Directors will high-calibre Chairman and Executive Directors are set by reference to not participate in any cash or share incentive Non-Executive Directors by comparability with other similarly sized arrangements. offering appropriate fees. companies within the sector and the market generally. The fees payable to the Non- The Company reserves the right to provide Executive Directors are determined by the benefits including travel and office support. Board, with the Chairman’s fees determined by the Committee. Fees are paid on a monthly basis. When determining fee increases, the Company is guided by the general increase for the broader employee population and market conditions but on occasion may need to recognise, for example, change in responsibility, time commitment and/or market movements. N/A The aggregate fees and any benefits of the Chairman and Non-Executive Directors will not exceed the limit from time to time prescribed within the Company’s Articles of Association for such fees. Notes 1. Executive Directors are required to build a holding of shares in the Company to the value of 200% of salary 2. The Committee operates incentive plans according to their respective rules and where relevant in accordance with the Listing Rules. Consistent with market practice, the Committee retains discretion over a number of areas relating to the operation and administration of the plans. These include, but are not limited to, determining who participates, the timing of awards, award levels, setting performance targets, amending performance targets (if an event occurs, in exceptional circumstances, to enable the targets to fulfil their original purpose), assessing performance targets, treatment of awards on a change of control, treatment of awards for leavers and adjusting awards (e.g. as a result of a change in capital structure) 3. The annual bonus and PSP are based on performance against targets that are aligned with the Company’s short, medium and long term strategic plan. Where appropriate, a sliding scale of targets is set for each metric to encourage continuous improvement and the delivery of stretch performance 4. There are currently no material differences in the broad structure of remuneration arrangements for the Executive Directors and the general employee population, aside from participation rates in incentive schemes. While the appropriate benchmarks vary by role, the Company seeks to apply the philosophy behind this policy across the Company as a whole. To the extent that the Company’s pay policy for Directors differs from its pay policies for groups of staff, this reflects the appropriate market rate position and/or typical practice for the relevant roles. The Company takes into account pay levels, bonus opportunity and share awards applied across the Company as a whole when setting the Executive Directors’ Remuneration Policy 5. For the avoidance of doubt, in approving this Directors’ Remuneration Policy, authority was given to the Company to honour any commitments entered into with current or former Directors (such as the payment of the prior year’s annual bonus or the vesting/exercise of share awards granted in the past). Details of any payments to former Directors will be set out in the Annual Report on Remuneration as they arise 6. The Regulations and related investor guidance encourages companies to disclose a cap within which each element of the Directors’ Remuneration Policy will operate. Where maximum amounts for elements of remuneration have been set within the Directors’ Remuneration Policy, these will operate simply as caps and are not indicative of any aspiration 7. While the Committee does not consider it to form part of benefits in the normal usage of that term, it has been advised that corporate hospitality, whether paid for by the Company or another, and business travel for Directors and in exceptional circumstances their families, may technically come within the applicable rules and so the Committee expressly reserves the right for the Committee to authorise such activities within its agreed policies 8. The Committee may make minor amendments to the Policy set out above for regulatory, exchange control, tax or administrative purposes or to take account of a change in legislation, without obtaining shareholder approval for that amendment 57 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 2 Remuneration Policy Report continued Remuneration scenarios for Executive Directors The charts illustrate how the potential composition of the Executive Directors’ remuneration packages varies at four performance levels, namely, at basic (i.e. fixed pay only), target, maximum and maximum plus share price growth. Chief Executive Officer (£’000) Chief Financial Officer (£’000) Property Director (£’000) £1,519 £1,318 12% 30% 27% 31% 27% £814 12% 25% £512 £1,004 14% £872 31% 26% 30% 26% £286 £459 13% 25% £748 31% 31% £864 13% 27% 27% £543 12% 24% £345 100% 63% 39% 34% 100% 63% 39% 34% 100% 62% 38% 33% Minimum On-target Maximum Fixed pay Annual bonus Maximum with share price growth Minimum On-target Maximum Fixed pay Annual bonus Maximum with share price growth Minimum On-target Maximum Fixed pay Annual bonus Maximum with share price growth Long term incentive plan Share price Long term incentive plan Share price Long term incentive plan Share price Maximum Based on the maximum remuneration receivable (excluding share price appreciation and dividends): • Annual bonus: consists of maximum bonus of 100% of base salary. • PSP: consists of the face value of awards of 100% of salary under PSP. Maximum with share price growth As per the maximum scenario albeit with a 50% share price growth assumption on the PSP awards above. Target Based on what the Director would receive if performance was on target (excluding share price appreciation and dividends): • Annual bonus: consists of the on-target bonus (50% of maximum opportunity of 100% of salary used for illustrative purposes). PSP: consists of the threshold level of vesting (25% vesting) of awards of 100% of salary under PSP. Basic • Consists of base salary, benefits and pension. • Base salary is the salary to be paid in 2019/20. • Benefits have been estimated for the year ending 31st March 2020. • Pension measured as the defined • contribution or cash allowance in lieu of Company contributions of up to 20% of salary. 58 McKay Securities Plc Annual Report and Financial Statements 2019 How the views of shareholders are taken into account The Remuneration Committee considers shareholder feedback received each year following the AGM. This feedback, plus any additional feedback received during any meetings from time to time, is then considered as part of the Company’s annual review of the operation of our remuneration practices. In addition, the Remuneration Committee will seek to engage directly with major shareholders and their representative bodies should any material changes be proposed to the Remuneration Policy. Details of votes cast for and against the resolution to approve this Remuneration Policy and last year’s remuneration report and any matters discussed with shareholders during the year are set out in the Directors’ Remuneration Report (subject to issues of commercial sensitivity). How the views of employees are taken into account When determining salaries and other elements of remuneration for our executives the Committee takes account of general pay movement and employment conditions elsewhere in the Company, as well as the relevant general markets. The Committee takes due account of employees’ views when determining the design of the Company’s senior executive Remuneration Policy although, reflecting typical current practice, the Committee does not formally consult with employees when determining remuneration of the Executive Directors. External appointments The Company’s policy is to permit an Executive Director to serve as a Non-Executive Director elsewhere when this does not conflict with the individual’s duties to the Company, and where an Executive Director takes such a role they may be entitled to retain any fees which they earn from that appointment. Such appointments are subject to approval by the Chairman. At present no Executive Director holds any such external appointments. Service contracts The Executive Directors’ service contracts are terminable by the Company on not less than one year’s notice. In each case the contracts (which are available for inspection at the Company’s head office) are subject to six months’ notice by the Executive Director. The service contracts are dated as follows: Executive Director Date of service contract S Perkins G Salmon T Elliott 16th March 2004 2nd May 2011 8th July 2016 The Non-Executive Directors have rolling terms of appointment, providing for them to retire by rotation in accordance with the Articles of Association. In line with the UK Corporate Governance Code all Directors will submit themselves for re-election annually. The terms of appointment for the Non-Executive Directors are dated as follows: Non-Executive Director Date of service contract R Grainger J Austen N Shepherd J Bates 1st May 2014 8th July 2016 21st January 2015 17th January 2017 Approach to recruitment and promotions The remuneration package for a new Executive Director would be set in accordance with the terms of the Company’s prevailing approved Remuneration Policy at the time of appointment and take into account the skills and experience of the individual, the market rate for a candidate of that experience and the importance of securing the relevant individual. Salary would be provided at such a level as required to attract the most appropriate candidate and may be set initially at a below mid-market level on the basis that it may increase once expertise and performance has been proven and sustained. The caps on fixed pay in the policy table will not apply to a new recruit, as provided for in the Regulations. The annual bonus potential would be limited to 100% of salary and grants under the PSP would be limited to 100% of salary (up to 200% of salary in exceptional circumstances). In addition, the Committee may offer additional cash and/or share-based elements to replace deferred or incentive pay forfeited by an executive leaving a previous employer. It would seek to ensure, where possible, that these awards would be consistent with awards forfeited in terms of vesting periods, expected value and performance conditions. For an internal Executive Director appointment, any variable pay element awarded in respect of the prior role may be allowed to pay out according to its original terms. For external and internal appointments, the Committee may agree that the Company will meet certain relocation and/or incidental expenses as appropriate. Approach to leavers There are no predetermined provisions for compensation within the Executive Directors’ service contracts in the event of loss of office. The Committee considers all proposals for the early termination of the service contracts for Executive Directors and senior executives and would observe the principle of mitigation. It has been the Committee’s general policy that the service contracts of Executive Directors (none of which are for a fixed term) should provide for termination of employment by giving up to 12 months’ notice or by making a payment of an amount equal to 12 months’ basic salary and pension contributions in lieu of notice. It is the Committee’s general policy that no Executive Director should be entitled to a notice period or payment on termination of employment in excess of the levels set out in his or her service contract. Annual bonus may be payable with respect to the period of the financial year served although it will normally be prorated and paid at the normal pay-out date. Any share-based entitlements granted to an Executive Director under the Company’s share plans will be determined based on the relevant plan rules. However, in certain prescribed circumstances, such as death, ill-health, disability, retirement or other circumstances at the discretion of the Committee, “good leaver” status may be applied. For good leavers, awards will normally vest on the date of cessation, subject normally to the satisfaction of the relevant performance conditions at that time and reduced pro rata to reflect the proportion of the performance period actually served, although the Remuneration Committee has the discretion to disapply the application of time prorating if it considers it appropriate to do so. Deferred share awards would normally vest on cessation (save where “good leaver” status is not conferred). 59 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 3 Annual Report on Remuneration Committee role and membership The Committee consists solely of Non- Executive Directors. The members of the Committee who served during the year are: N Shepherd – Chairman J Austen J Bates R Grainger No member has any personal interest in the matters decided by the Committee, nor any day to day involvement in the running of the business and therefore all members are considered by the Company to be independent. The Committee members have no personal financial interest, other than as shareholders, in the matters to be decided. The Terms of Reference of the Remuneration Committee are available on the Company’s website www.mckaysecurities.plc.uk. Details of the Committee members’ attendance at Committee meetings during the financial year are as follows: Committee member Number of meetings attended N Shepherd J Austen J Bates R Grainger 3 out of 3 3 out of 3 3 out of 3 3 out of 3 Remuneration related risk The Committee is satisfied that neither the structure of the remuneration packages (i.e. the combination of cash versus shares and short versus long term), nor the performance measures operated under the annual bonus and Performance Share Plan, encourages inappropriate risk taking or exposes the Remuneration Committee to material remuneration-related risks. The remuneration arrangements at McKay: • have been designed to align the interests of the executives (and employees, given that there is strong alignment of packages internally) with shareholders and to support the sustainable delivery of the Company strategy; and • contain a number of shareholder protections (i.e. malus and clawback provisions, shareholding guidelines, bonus deferral and post vesting holding periods on PSP awards). As such, the Committee is satisfied that the controls and procedures in place to mitigate remuneration-related risks for Executive Directors and employee population more generally are appropriate and proportionate. External advisors During the year the Committee received independent advice from FIT Remuneration Consultants LLP (“FIT”) on a range of remuneration issues. FIT has no other connection nor does it provide any other services to the Company. Total fees paid to FIT in respect of its services to the Committee during the year were £25k ex VAT. FIT is a member of the Remuneration Consultants Group and abides by the Remuneration Consultants Group Code of Conduct, which requires its advice to be objective and impartial. The Chief Executive attends meetings by invitation, but is not involved in the discussion of his own remuneration. Directors’ remuneration for the year ended 31st March 2019 (audited) The remuneration of the Directors for the years 2019 and 2018 was as follows: Directors’ remuneration Fees/salary fees £’000 Benefits £’0001 Pension including salary supplement £’000 Annual bonus £’000 Value of long term incentives £’000 Total remuneration £’000 Executive S Perkins G Salmon T Elliott Non-Executive R Grainger J Austen J Bates N Shepherd Former Directors* 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 2019 2018 395 384 259 251 227 220 90 80 45 44 40 39 45 44 – 25 28 28 34 32 27 25 – – – – – – – – – – 69 67 42 41 25 24 – – – – – – – – – – 252 259 165 170 144 149 – – – – – – – – – – 61 154 40 99 33 77 – – – – – – – – – – 805 892 540 593 456 495 90 80 45 44 40 39 45 44 – 25 * Nigel Aslin retired from the Board on 22nd May 2017 while Viscount Lifford retired from the Board on 18th September 2017 Notes 1. Benefits Benefits comprise car allowance and medical insurance 60 McKay Securities Plc Annual Report and Financial Statements 2019 The annual bonus for the year ended 31st March 2019 was based on the following NAV per share targets, EPS and strategic targets: Weighting 30% 45% 25% 100% % of salary maximum 30% 45% 25% 100% Threshold Maximum Actual % of maximum % of salary RPI + 3% 90% RPI + 10% 110% < RPI + 3% > 110% See below 0% 100% 75% 0% 45% 18.75% 63.75% 63.75% Metric NAV growth EPS growth Strategic targets Total Strategic targets Target 1. Rent collection 2. Voids (ex-development) 3. Tenant retention 4. Development progress 5. Sustainability Strategy and H&S delivery Total Weighting Committee assessment 5% 5% 5% 5% 5% 100% 75% 100% 25% 75% Out-turn 5% 3.75% 5% 1.25% 3.75% 18.75% Bonus payments (cash or shares) are subject to clawback. Overpayments may be reclaimed in the event of performance achievements being found to be materially misstated or erroneous, or in the event of misconduct. Long term incentives The PSP award granted on 16th June 2016 was subject to performance, for the 3 years ended 31st March 2019. The performance conditions attached to this award and actual performance against these conditions were as follows: Metric NAV growth Weighting 40% Relative TSR 60% Performance condition Threshold target Maximum target RPIX + 6% RPIX + 25% Actual performance 36% of maximum Vesting level 14% Median Upper quartile < median 0% Average NAV per share growth of RPIX + 6% to 25% (full vesting) over three financial years Relative TSR performance against a group of quoted real estate sector companies over three financial years. 30% of this part of the award vests for achieving threshold performance, increasing on a straight line basis to full vesting for achieving for achieving the stretch target. Total 14% Based on the vesting percentage above, details of the shares under award and their estimated value (based on the share price at 31st March 2019 of £2.35 per share) is as follows: Executive S Perkins G Salmon T Elliott Number of shares at grant 181,643 118,841 96,618 Number of shares to vest 26,029 17,030 13,845 Number of shares to lapse 155,614 101,811 82,733 Estimated value vesting £1 61,169 40,020 32,537 Face value of awards vesting £2 Impact of share price on vesting £3 53,881 35,252 28,660 7,288 4,768 3,877 1. Based on the three month average share price to 31 March 2019 2. Based on the number of shares vesting multiplied by the share price at the date of grant (£2.07) 3. Based on the estimated value at vesting, less the face value of awards vesting The awards granted in 2016 do not receive the value of dividend equivalents. A two year post vesting holding period applies to the 2016 awards. 61 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 3 Annual Report on Remuneration continued Details of PSP awards granted in the year (audited) The following awards were granted to the Executive Directors on 8th June 2018: Number of type of award Basis of award granted Share price at date of grant1 S Perkins G Salmon T Elliott Nil-cost option Nil-cost option Nil-cost option 100% of salary 100% of salary 100% of salary £2.67 £2.67 £2.67 1. Based on the average 5 day share price prior to 8th June 2018 Details of outstanding share awards (audited) Number of shares over which award was granted 147,940 96,816 84,869 Face value of award £’000 £395,000 £258,500 £226,600 % of face value that would vest at threshold performance Vesting determined by performance over 25% 25% 25% Three financial years to 31st March 2021 31st March 2018 Number of shares Granted in 2018/19 Number of shares Vested in 2018/19 Number of shares Lapsed in 2018/19 Number of shares 31st March 2019 Number of shares Share price at grant £ Date from exercisable/ vesting Expiry PSP Awards S Perkins 2015 PSP 2016 PSP 2017 PSP 2018 PSP G Salmon 2015 PSP 2016 PSP 2017 PSP 2018 PSP T Elliott 2015 PSP 2016 PSP 2017 PSP 2018 PSP Deferred bonus awards S Perkins 2016 Deferred bonus 2017 Deferred bonus 2018 Deferred bonus G Salmon 2016 Deferred bonus 2017 Deferred bonus 2018 Deferred bonus T Elliott 2017 Deferred bonus 2018 Deferred bonus 62 140,392 181,643 167,467 – 489,502 90,196 118,841 109,607 – 318,644 69,688 96,618 96,070 – 262,376 34,996 – 25,227 60,223 22,484 – 16,511 38,995 – 14,472 14,472 – – – 147,940 147,940 – – – 96,816 96,816 – – – 84,869 84,869 – – – – – – – – 56,157 – – – 56,157 36,078 – – – 36,078 27,867 – – – 27,867 – – – – – – – – 84,235 – – – 84,235 54,118 – – – 54,118 41,821 – – – 41,821 – – – – – – – – – 181,643 167,467 147,940 497,050 – 118,841 109,607 96,816 325,264 – 96,618 96,070 84,869 277,557 34,996 – 25,227 60,223 22,484 – 16,511 38,995 – 14,472 14,472 2.55 2.07 2.29 2.67 2.55 2.07 2.29 2.67 2.55 2.07 2.29 2.67 18.06.2018 16.06.2019 18.07.2020 08.06.2021 17.06.2021 15.06.2022 17.07.2027 07.06.2028 18.06.2018 16.06.2019 18.07.2020 08.06.2021 17.06.2021 15.06.2022 17.07.2027 07.06.2028 18.06.2018 16.06.2019 18.07.2020 08.06.2021 17.06.2021 15.06.2022 17.07.2027 07.06.2028 2.07 – 2.67 16.06.2019 – 08.06.2021 15.06.2022 – 07.06.2028 2.07 – 2.67 16.06.2019 – 08.06.2021 15.06.2022 – 07.06.2028 – 2.67 – 08.06.2021 – 07.06.2028 McKay Securities Plc Annual Report and Financial Statements 2019 Statement of Directors’ shareholdings and share interests (audited) S Perkins G Salmon T Elliott R Grainger J Austen J Bates N Shepherd Beneficially owned at 31st March 2018 304,1382 133,283 17,187 Beneficially owned at 31st March 2019 Outstanding PSP performance awards 333,9012 152,306 31,734 497,050 325,264 277,557 Outstanding deferred bonus awards Shareholding as a % of salary1,3 60,223 38,995 14,472 229 165 48 47,638 10,000 – 15,575 47,638 20,500 – 23,315 1. Based on year end salaries and share price as at 31st March 2019 of £2.35 per share, and based on beneficially owned shares and vested PSP awards (using the net of tax numbers where awards are yet to be exercised) 2. Beneficial holdings, as defined by the Companies Act, would include a further 5,602 shares 3. Executive Directors are required to build up a holding of shares in the Company to the value of 200% of salary Post employment shareholding policy Following the publication of the new UK Corporate Governance Code, the Remuneration Committee has developed a post cessation shareholding policy for Executive Directors as follows: • Unvested deferred annual bonus and PSP awards will be treated in line with the good leaver/bad leaver provisions explained in the shareholder approved Remuneration Policy; • Any PSP awards which vested pre-cessation but which are still subject to the two year holding will need to be retained by the individual, post cessation, until the relevant two year holding period has expired; and • No restrictions will apply in respect of own shares held (whether held as part of the shareholding guideline or not). The Remuneration Committee will review the above policy as part of the three year Remuneration Policy review in advance of the 2020 AGM. Payments within the year to past Directors (audited) No payments were made to past Directors in the year ended 31st March 2019 (2018: £25,000). Percentage change in the remuneration of the Chief Executive 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 Total remuneration (£’000) Annual bonus (% of salary) PSP vesting (% of max) £409 38 27 £309 0 0 £410 10 0 £413 13 0 £802 45 60 £1,139 55 100 £1,197 70 100 £690 28 40 £902 68 40 £805 64 14 The table below shows the percentage change in the Chief Executive’s remuneration between 2017/2018 and 2018/2019 compared to that of the average for all employees of the Company. Chief Executive Average employees % Change from 2017/18 to 2018/19 Remuneration Benefits Bonus1 1% -1% 1% 2% -3% -11% 1. Remuneration is the total of basic salary, benefits and bonus payments 2. Whilst outturn of the bonus fell to 64% from 90%, as explained in last year’s report, the CEO bonus opportunity rose from 75% to 100% of salary for the year to 31st March 2019 63 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 3 Annual Report on Remuneration continued Comparison of TSR performance The chart below shows the Company’s TSR compared to the FTSE Real Estate Index and the FTSE All Share Index over the past ten years. This chart shows the value of £100 invested in the FTSE Real Estate Index and the FTSE All Share Index. These indices have been chosen by the Remuneration Committee as they are considered to be an appropriate benchmark against which to assess the relative performance of the Company. (£) 600 500 400 300 200 100 0 31 March 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 McKay Securities plc FTSE 350 Real Estate Index FTSE All Share Index Source: Thomson Reuters The total remuneration figures for the Chief Executive during each of the last ten financial years are shown in the table on page 63. The total remuneration figure includes the annual bonus based on that year’s performance and PSP awards based on three year performance periods ending just after the relevant year end. The annual bonus payout and PSP vesting level, as a percentage of the maximum opportunity are also shown for each of these years. Relative importance of the spend on pay The following table shows the Company’s actual spend on pay (for all employees) relative to dividends. Staff costs (£’m) Dividends (£’m) 2017/18 2018/19 % change £4.9 £9.4 £4.7 £9.61 -4.1% 2.0% £1.7 million of the staff costs in 2018/19 figures relate to pay for the Executive Directors. This is different to the aggregate of the single figures for the year under review due to the way in which the share based awards are accounted for. The dividend figures relate to amounts payable in respect of the relevant financial year. 1. The final dividend of 7.4 pence per share will be paid on 94.12 million shares (93.95 million for 2017/18) 64 McKay Securities Plc Annual Report and Financial Statements 2019 CEO pay ratio CEO pay ratio data is presented below on a voluntary basis for the year ended 31st March 2019 (as McKay has fewer than 250 employees, it will not be required to disclose this information). The data shows how the CEO’s single figure remuneration for 2018/19 (as taken from the single figure remuneration table) compares to equivalent single figure remuneration for full-time equivalent UK employees ranked at the 25th, 50th and 75th percentiles. Year 2018/19 Method 75th percentile pay ratio Median pay ratio 25th percentile pay ratio Option A 4.9 : 1 8.0 : 1 11.3 : 1 No components of pay and benefits have been omitted for the purpose of the above calculations. Option A was selected by the Committee given that this method of calculation was considered to be the most robust approach statistically. Option A is a single total remuneration figure for each employee on which to identify the lower quartile, upper quartile and median individuals for the calculation. Option B is more suitable for entities with a high number of employees. Year 2018/19 CEO basic salary for year ended 31st March 2019: £395,000 CEO single figure for year ended 31 March 2019: £805,000 Quartile Salary Data: Quartile Total Pay and Benefits Data: 75th percentile Median 25th percentile 75th percentile Median 25th percentile £94,600 £54,400 £46,400 £164,222 £100,434 £71,560 Gender pay McKay is not required to publish Gender Pay statistics given that it has fewer than 250 employees. However, the Board has considered gender pay in detail and is committed to fairness. Voluntary disclosure was considered, but the calculations are not considered to be statistically robust given McKay’s low number of employees. Statement of shareholder voting The following table presents the voting at the 2017 AGM in respect of the Directors’ Remuneration Policy and the 2018 AGM in respect of the Directors’ Remuneration Report: Proxy votes cast in favour1 Proxy votes cast against Total votes cast Proxy votes withheld 1. Includes discretionary votes of 880,161 Remuneration Policy 2017 AGM Remuneration Report 2018 AGM Number of votes % Number of votes 59,611,717 259,887 99.57% 0.43% 63,165,201 16,608 59,871,604 100% 63,181,809 13,792 15,000 % 99.97% 0.03% 100% The disclosure on Directors’ remuneration in the tables on pages 60 to 63 has been audited. 65 McKay Securities Plc Annual Report and Financial Statements 2019 Remuneration Report continued 3 Annual Report on Remuneration continued Implementation of the Remuneration Policy for the year ending 31st March 2020 Salaries The Executive Directors’ salaries were reviewed by the Committee in February 2019 and it was concluded that they should be increased by 2% (reflecting the general workforce increase). Therefore, base salaries for 2019/20, effective 1st April 2019, will be S Perkins – £402,900, G Salmon – £263,700 and T Elliott – £231,100. Benefits and pension The Company will continue to operate a policy whereby Executive Directors are offered a car allowance, medical insurance, life assurance, income protection and pension contributions, or cash in lieu of pension contributions. Annual bonus scheme The maximum bonus potential for 2019/20 will continue to be set at 100% of basic salary with performance continuing to be based on NAV growth – 30% of salary, EPS growth – 45% of salary and strategic targets – 25%. These targets will include such areas as portfolio occupancy, tenant retention, rent collection and environmental, health and safety and will be consistent with those targets operated for the general workforce. Full disclosure of the targets, and performance against the targets will be included in the 2020 Directors’ Remuneration Report to the extent that they are not considered to be commercially sensitive. Deferral and clawback provisions will continue to apply. Performance Share Plan PSP awards to be granted in the year ending 31st March 2020 will be subject to the following targets: Performance condition Threshold target (25% vesting) Stretch target (100% vesting) End of performance period Relative TSR against a bespoke group of quoted real estate companies (60% of award) Absolute NAV per share growth (40% of award) Median Growth of 12% 31st March 2022 Upper quartile Growth of 35% 31st March 2022 The Committee considers the above targets to be appropriately challenging. Consistent with previous years, Executive Directors will receive a PSP award equivalent in value to 100% of salary. Clawback provisions will continue to apply, as will a two year post vesting holding period. Fees for the Chairman and Non-Executive Directors The Chairman of the Board has waived any increase in his fee for the year commencing 1st April 2019 and his fee will remain at the same level as 1st April 2018. R Grainger J Austen J Bates N Shepherd The Directors’ Annual Remuneration Report has been approved by the Board of Directors. Fees as at 1st April 2018 Fees as at 1st April 2019 £90,000 £44,800 £39,700 £44,800 £90,000 £45,500 £40,500 £45,500 Signed on behalf of the Board of Directors. By Order of the Board: Nick Shepherd Chairman of the Remuneration Committee 20th May 2019 66 McKay Securities Plc Annual Report and Financial Statements 2019 Statement of Directors’ Responsibilities in respect of the Annual Report and the Financial Statements The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the parent Company’s transactions and disclose with reasonable accuracy at any time the financial position of the parent Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They are responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error, and have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, Directors’ Report, Directors’ Remuneration Report and Corporate Governance Statement that complies with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.1 Responsibility statement of the directors in respect of the annual financial report We confirm that to the best of our knowledge: the financial statements, prepared in • accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and the report of Directors’ includes a fair review of the development and performance of the business and the position of the issuer and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. • We consider the Annual Report and Accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the group’s position and performance, business model and strategy. S Perkins Chief Executive G Salmon Chief Financial Officer 20th May 2019 The Directors are responsible for preparing the Annual Report and the Group and parent Company financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and parent Company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with International Financial Reporting Standards as adopted by the European Union (IFRSs as adopted by the EU) and applicable law and have elected to prepare the parent Company financial statements on the same basis. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent Company and of their profit or loss for that period. In preparing each of the Group and parent Company financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable, relevant and reliable; • state whether they have been prepared in accordance with IFRSs as adopted by the EU; • assess the Group and parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and • use the going concern basis of accounting unless they either intend to liquidate the Group or the parent Company or to cease operations, or have no realistic alternative but to do so. 1 Where the financial statements are published on the internet 67 McKay Securities Plc Annual Report and Financial Statements 2019 Independent Auditor’s Report to the members of McKay Securities Plc 1. Our opinion is unmodified We have audited the financial statements of McKay Securities Plc (“the Company”) for the year ended 31 March 2019 which comprise the Consolidated Profit and Loss and Other Comprehensive Income, Group Statement of Financial Position, Company Statement of Financial Position, Group Cash Flow Statement, Company Cash Flow Statement, Consolidated Statement of Changes in Equity, Company Statement of Changes in Equity, and the related notes, including the accounting policies in note 1. In our opinion: • • • • the financial statements give a true and fair view of the state of the Group’s and of the parent Company’s affairs as at 31 March 2019 and of the Group’s profit for the year then ended; the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union (IFRS as adopted by the EU); the parent Company financial statements have been properly prepared in accordance with IFRS as adopted by the EU and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (“ISAs (UK)”) and applicable law. Our responsibilities are described below. We believe that the audit evidence we have obtained is a sufficient and appropriate basis for our opinion. Our audit opinion is consistent with our report to the Audit & Risk Committee. We were first appointed as auditor by the shareholders before 1947. The period of total uninterrupted engagement is for more than the 72 financial years ended 31 March 2019. We have fulfilled our ethical responsibilities under, and we remain independent of the Group in accordance with, UK ethical requirements including the FRC Ethical Standard as applied to listed public interest entities. No non-audit services prohibited by that standard were provided. Overview Materiality: Group financial statements as a whole Coverage Key audit matters Recurring risks Event driven £3.9m (2018:£4.6m) 0.8% (2018: 1.0%) of total Group assets 100% (2018:100%) of total Group assets vs 2018 Valuation of Investment property (Group and parent Company) New: The impact of uncertainties due to the UK exiting the European Union on our audit New: Going concern 68 McKay Securities Plc Annual Report and Financial Statements 2019 2. Key audit matters: including our assessment of risks of material misstatement Key audit matters are those matters that, in our professional judgement, were of most significance in the audit of the financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. We summarise below the key audit matters in arriving at our audit opinion above, together with our key audit procedures to address those matters and, as required for public interest entities, our results from those procedures. These matters were addressed, and our results are based on procedures undertaken, in the context of, and solely for the purpose of, our audit of the financial statements as a whole, and in forming our opinion thereon, and consequently are incidental to that opinion, and we do not provide a separate opinion on these matters. The impact of uncertainties due to the UK exiting the European Union on our audit Refer to page 9 (The Chairman’s Statement), page 39 (Viability Statement) and page 40 (Principal Risks and Uncertainties). The risk Our response Unprecedented levels of uncertainty: All audits assess and challenge the reasonableness of estimates, in particular as described in valuation of investment property below, and related disclosures and the appropriateness of the going concern basis of preparation of the financial statements (see below). All of these depend on assessments of the future economic environment and the Group’s future prospects and performance. In addition, we are required to consider the other information presented in the Annual Report including the principal risks disclosure and the viability statement and to consider the directors’ statement that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy. Brexit is one of the most significant economic events for the UK and at the date of this report its effects are subject to unprecedented levels of uncertainty of outcomes, with the full range of possible effects unknown. We developed a standardised firm-wide approach to the consideration of the uncertainties arising from Brexit in planning and performing our audits. Our procedures included: • Our Brexit knowledge: We considered the directors’ assessment of Brexit-related sources of risk for the Group’s business and financial resources compared with our own understanding of the risks. We considered the directors’ plans to take action to mitigate the risks. • Sensitivity analysis: When addressing valuation of investment property and other areas that depend on forecasts, we compared the directors’ analysis to our assessment of the full range of reasonably possible scenarios resulting from Brexit uncertainty and, where forecast cash flows are required to be discounted, considered adjustments to discount rates for the level of remaining uncertainty. • Assessing transparency: As well as assessing individual disclosures as part of our procedures on valuation of investment property we considered all of the Brexit related disclosures together, including those in the strategic report, comparing the overall picture against our understanding of the risks. Our results • As reported under valuation of investment property and going concern below, we found the resulting estimates and related disclosures of valuation of investment property and disclosures in relation to going concern to be acceptable. • However, no audit should be expected to predict the unknowable factors or all possible future implications for a company and this is particularly the case in relation to Brexit. 69 McKay Securities Plc Annual Report and Financial Statements 2019 Independent Auditor’s Report continued Valuation of Investment Property (Group and parent Company) (Group: £464 million; 2018: £446 million; parent Company £395 million; 2018: £387 million) Refer to page 50 (Audit and Risk Committee Report), page 84 (accounting polices) and page 89 (financial disclosures). The risk Our response Subjective valuation: Our procedures included: Investment properties represent 93% (2018: 95%) of gross assets of the Group and 85% (2018: 88%) of gross assets of the parent Company. The Group portfolio comprises 33 (2018: 33) properties which are externally valued by a qualified independent valuer and held at fair value at the balance sheet date. Each property is unique and determining its fair value requires significant judgement and estimation, in particular over the key assumptions of the estimated rental value and the yield. The key assumptions will be impacted by a number of factors including location, quality and condition of the building and occupancy. Valuing investment properties under development can be further complicated by the need to estimate the progress of development and forecast costs to complete. The unique nature of each property means that significant judgement is required in relation to these assumptions and this was a focus area for our audit. The effect of these matters is that, as part of our risk assessment, we determined that the valuation of investment properties has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. The financial statements (note 11) disclose the sensitivity estimated by the Group. • Assessing valuer’s credentials: We assessed the valuer’s objectivity, professional qualifications and experience through discussions with the valuer and reading their valuation report and terms of engagement. • Methodology choice: We held discussions with the Group’s external property valuer to determine the valuation methodology used. We used our own property valuation specialist to assist us in assessing the results of the valuer’s report by evaluating whether the valuations were in accordance with the RICS Valuation Professional Standards “the Red Book” and IFRS and that the methodology adopted was appropriate by reference to acceptable valuation practice. • Benchmarking assumptions: With the assistance of our own property valuation specialist, we held discussions with the Group’s external property valuer to understand movements in property values. For a sample of properties where the fair value movements were outside our predetermined thresholds, we challenged the key assumptions used by the valuer upon which these valuations were based including those relating to forecast rents, yields, vacant periods and irrecoverable expenditure by making a comparison to our own understanding of the market and to industry benchmarks. • Test of detail: For the property under development, we assessed the progress of the development and evaluated assumptions over construction costs agreeing them to construction contracts and the Group’s project appraisals. • Assessing transparency: We considered the adequacy of the Group’s disclosures about the degree of estimation and sensitivity to key assumptions made when valuing properties. • Our results We found the valuation of investment properties to be acceptable (2018 result: acceptable). 70 McKay Securities Plc Annual Report and Financial Statements 2019 Going concern Disclosure quality The risk Refer to page 39 (Going concern statement) and page 83 (accounting polices). The financial statements explain how the Board has formed a judgement that it is appropriate to adopt the going concern basis of preparation for the Group and parent Company. That judgement is based on an evaluation of the inherent risks to the Group’s and Company’s business model and how those risks might affect the Group’s and Company’s financial resources or ability to continue operations over a period of at least a year from the date of approval of the financial statements. The risks most likely to adversely affect the Group’s and Company’s available financial resources over this period were : • • increased cost of debt from interest rate rises; tenant default impacting cash flow and earnings; and • significant reduction in property values. There are also less predictable but realistic second order impacts, such as the impact of Brexit, which could result in a rapid reduction of available financial resources. The risk for our audit was whether or not those risks were such that they amounted to a material uncertainty that may have cast significant doubt about the ability to continue as a going concern. Had they been such, then that fact would have been required to have been disclosed. Our response Our procedures included: • Funding assessment: Assessed the committed level of financing available to the Group for at least the next 12 months through review of the facility agreements, including its ability to meet covenants in place by reviewing of management’s forecasts; • Historical comparisons: Considered the Group’s historical budgeting accuracy, by assessing actual performance against budget. • Sensitivity analysis: We considered sensitivities over the level of available financial resources indicated by the Group’s financial forecasts taking account of reasonably possible (but not unrealistic) adverse effects that could arise from these risks individually and collectively; and We critically assessed and challenged the sensitivities applied and the mitigating actions available to the Directors. • Assessing transparency: Assessed the completeness and accuracy of the matters covered in the going concern disclosures by comparing this to the key assumptions, key sensitivities and mitigating actions considered by the Directors. Our results: We found the going concern disclosure without any material uncertainty to be acceptable (2018 result: acceptable). 71 McKay Securities Plc Annual Report and Financial Statements 2019 Group materiality £3.9m (2018: £4.6m) £3.9m Whole financial‚ statements materiality‚ (2018: £4.6m) £0.20m Misstatements reported to the Audit and Risk Committee (2018: £0.23m) Independent Auditor’s Report continued 3. Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £3.9 million (2018: £4.6 million), determined with reference to a benchmark of total Group assets of £497.0 million (2018: £467.1 million), of which it represents 0.8% (2018: 1.0%). Total Group assets £497m (2018: £467m) In addition, we applied a lower materiality of £0.35 million (2018: £0.45 million) to net rental income from investment properties, administration costs and net finance costs, for which we believe misstatements of lesser amounts than materiality for the financial statements as a whole could reasonably be expected to influence the Company’s members’ assessment of the financial performance of the Group. Materiality for the parent Company financial statements as a whole was set at £3.5 million (2018: £4.4 million), determined with reference to a benchmark of Company total assets of £463.5 million (2018: £441.7 million), of which it represents 0.8% (2018: 1.0%). We agreed to report to the Audit & Risk Committee any corrected or uncorrected identified misstatements exceeding £0.20 million (2018: £0.23 million), in addition to other identified misstatements that warranted reporting on qualitative grounds. Total Group assets Group materiality The Group team performed the audit of the Group as if it was a single aggregated set of financial information. This approach is unchanged from the prior year. The audit of the Group was performed using the Group materiality level set out above. 4. We have nothing to report on going concern The Directors have prepared the financial statements on the going concern basis as they do not intend to liquidate the Company or the Group or to cease their operations, and as they have concluded that the Company’s and the Group’s financial position means that this is realistic. They have also concluded that there are no material uncertainties that could have cast significant doubt over their ability to continue as a going concern for at least a year from the date of approval of the financial statements (“the going concern period”). Our responsibility is to conclude on the appropriateness of the Directors’ conclusions and, had there been a material uncertainty related to going concern, to make reference to that in this audit report. However, as we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgements that were reasonable at the time they were made, the absence of reference to a material uncertainty in this auditor’s report is not a guarantee that the Group and the Company will continue in operation. We identified going concern as a key audit matter (see section 2 of this report). Based on the work described in our response to that key audit matter, we are required to report to you if: • we have anything material to add or draw attention to in relation to the directors’ statement in note 1 to the financial statements on the use of the going concern basis of accounting with no material uncertainties that may cast significant doubt over the Group and Company’s use of that basis for a period of at least twelve months from the date of approval of the financial statements ; or • the related statement under the Listing Rules set out on page 39 is materially inconsistent with our audit knowledge. We have nothing to report in these respects. 72 McKay Securities Plc Annual Report and Financial Statements 2019 5. We have nothing to report on the other information in the Annual Report The directors are responsible for the other information presented in the Annual Report together with the financial statements. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except as explicitly stated below, any form of assurance conclusion thereon. Our responsibility is to read the other information and, in doing so, consider whether, based on our financial statements audit work, the information therein is materially misstated or inconsistent with the financial statements or our audit knowledge. Based solely on that work we have not identified material misstatements in the other information. Strategic report and directors’ report Based solely on our work on the other information: • we have not identified material misstatements in the strategic report and the directors’ report; • • in our opinion the information given in those reports for the financial year is consistent with the financial statements; and in our opinion those reports have been prepared in accordance with the Companies Act 2006. Corporate governance disclosures We are required to report to you if: • we have identified material inconsistencies between the knowledge we acquired during our financial statements audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy; or • the section of the annual report describing the work of the Audit & Risk Committee does not appropriately address matters communicated by us to the Audit & Risk Committee. We are required to report to you if the Corporate Governance Statement does not properly disclose a departure from the eleven provisions of the UK Corporate Governance Code specified by the Listing Rules for our review. We have nothing to report in these respects. 6. We have nothing to report on the other matters on which we are required to report by exception Under the Companies Act 2006, we are required to report to you if, in our opinion: Directors’ remuneration report In our opinion the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006. • adequate accounting records have not been kept by the parent Company, or returns adequate for our audit have not been received from branches not visited by us; or Disclosures of principal risks and longer-term viability Based on the knowledge we acquired during our financial statements audit, we have nothing material to add or draw attention to in relation to: • • • the directors’ confirmation within the Directors’ Viability Statement on page 39 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency and liquidity; the Principal Risks and Uncertainties disclosures describing these risks and explaining how they are being managed and mitigated; and the directors’ explanation in the Directors’ Viability Statement of how they have assessed the prospects of the Group, over what period they have done so and why they considered that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. Under the Listing Rules we are required to review the Directors’ Viability Statement. We have nothing to report in this respect. Our work is limited to assessing these matters in the context of only the knowledge acquired during our financial statements audit. As we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgements that were reasonable at the time they were made, the absence of anything to report on these statements is not a guarantee as to the Group’s and Company’s longer- term viability. • the parent Company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or • certain disclosures of directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. We have nothing to report in these respects. 7. Respective responsibilities Directors’ responsibilities As explained more fully in their statement set out on page 67, the directors are responsible for: the preparation of the financial statements including being satisfied that they give a true and fair view; such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; assessing the Group and parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and using the going concern basis of accounting unless they either intend to liquidate the Group or the parent Company or to cease operations, or have no realistic alternative but to do so. 73 McKay Securities Plc Annual Report and Financial Statements 2019 8. The purpose of our audit work and to whom we owe our responsibilities This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. Richard Kelly (Senior Statutory Auditor) for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants 15 Canada Square London, E14 5GL 20th May 2019 Independent Auditor’s Report continued Auditor’s responsibilities Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or other irregularities (see below), or error, and to issue our opinion in an auditor’s report. Reasonable assurance is a high level of assurance, but does not guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud, other irregularities or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. A fuller description of our responsibilities is provided on the FRC’s website at www.frc.org.uk/auditorsresponsibilities. Irregularities – ability to detect We identified areas of laws and regulations that could reasonably be expected to have a material effect on the financial statements from our general commercial and sector experience and through discussion with the directors (as required by auditing standards), and discussed with the directors the policies and procedures regarding compliance with laws and regulations. We communicated identified laws and regulations throughout our team and remained alert to any indications of non-compliance throughout the audit. The potential effect of these laws and regulations on the financial statements varies considerably. Firstly, the Group is subject to laws and regulations that directly affect the financial statements including financial reporting legislation (including related companies legislation), distributable profits legislation and taxation legislation and we assessed the extent of compliance with these laws and regulations as part of our procedures on the related financial statement items. Secondly, the Group is subject to many other laws and regulations where the consequences of non-compliance could have a material effect on amounts or disclosures in the financial statements, for instance through the imposition of fines or litigation or the loss of the Group’s licence to operate. We identified the following areas as those most likely to have such an effect: health and safety, anti-bribery, employment law, REIT legislation and certain aspects of company legislation recognising the financial nature of the Group’s activities and its legal form . Auditing standards limit the required audit procedures to identify non-compliance with these laws and regulations to enquiry of the directors and inspection of regulatory and legal correspondence, if any. These limited procedures did not identify actual or suspected non-compliance. Owing to the inherent limitations of an audit, there is an unavoidable risk that we may not have detected some material misstatements in the financial statements, even though we have properly planned and performed our audit in accordance with auditing standards. For example, the further removed non-compliance with laws and regulations (irregularities) is from the events and transactions reflected in the financial statements, the less likely the inherently limited procedures required by auditing standards would identify it. In addition, as with any audit, there remained a higher risk of non-detection of irregularities, as these may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls. We are not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations. 74 McKay Securities Plc Annual Report and Financial Statements 2019 Financial Statements 2019 76 Consolidated Profit and Loss and other Comprehensive Income 77 Group Statement of Financial Position 78 Company Statement of Financial Position 79 Group Cash Flow Statement 80 Company Cash Flow Statement 81 Consolidated Statement of Changes in Equity 82 Company Statement of Changes in Equity 83 Notes to the Financial Statements 75 McKay Securities Plc Annual Report and Financial Statements 2019 Consolidated Profit and Loss and other Comprehensive Income For the year ended 31st March 2019 Gross rents and service charges receivable Other property income Direct property outgoings Net rental income from investment properties Administration costs Operating profit before gains on investment properties Profit on disposal of investment properties Revaluation of investment properties Operating profit Finance costs Finance income Profit before taxation Taxation Profit for the year Other comprehensive income: Items that will not be reclassified subsequently to profit or loss Remeasurement on defined benefit pension scheme Total comprehensive income for the year Earnings per share Basic Diluted Adjusted earnings per share figures are shown in note 9. Dividends 31st March 2018 final dividend of 7.2p (31st March 2017: 6.3p) paid during the year Notes 2 2 3 11 4 6 6 7 9 10 2019 £’000 25,344 73 (6,321) 19,096 (6,245) 12,851 – 4,833 17,684 (4,498) 4 13,190 – 13,190 2018 £’000 25,500 792 (5,838) 20,454 (6,305) 14,149 5,746 25,066 44,961 (5,089) 3,570 43,442 – 43,442 (135) 13,055 (70) 43,372 14.02p 13.91p 46.25p 45.91p 6,765 5,910 30th September 2018 interim dividend of 2.8p (30th September 2017: 2.8p) paid during the year 2,635 2,631 Proposed final dividend of 7.4p (31st March 2018: 7.2p) 6,965 6,765 The total comprehensive income for the year is all attributable to the equity holders of the parent Company. The accompanying notes on pages 83 to 99 form an integral part of these financial statements. 76 McKay Securities Plc Annual Report and Financial Statements 2019 Group Statement of Financial Position As at 31st March 2019 Non-current assets Investment properties – Valuation as reported by the valuers – Adjustment for rents recognised in advance under SIC 15 – Assets held for sale – Adjustment for grossing up of headleases Plant and equipment Trade and other receivables Total non-current assets Current assets Trade and other receivables Assets held for sale Cash and cash equivalents Total current assets Total assets Current liabilities Loans and other borrowings Trade and other payables Finance lease liabilities Interest rate derivatives Total current liabilities Non-current liabilities Loans and other borrowings Pension fund deficit Finance lease liabilities Interest rate derivatives Total non-current liabilities Total liabilities Net assets Equity Called up share capital Share premium account Retained earnings Revaluation reserve Total equity Net asset value per share EPRA net asset value per share Notes 2019 £’000 2018 £’000 482,700 460,150 (8,326) (14,400) 4,404 464,378 71 10,292 474,741 3,501 14,400 4,363 22,264 (6,691) (11,925) 4,404 445,938 42 5,861 451,841 1,617 11,925 1,725 15,267 497,005 467,108 – (16,234) (285) – – (9,501) (285) – (16,519) (9,786) (163,176) (144,598) (2,108) (4,119) – (2,164) (4,120) – (169,403) (150,882) (185,922) (160,668) 311,083 306,440 18,825 79,652 79,981 132,625 311,083 331p 326p 18,791 79,235 80,622 127,792 306,440 326p 322p 16 11 12 14 14 11 15 15 16 15 15 24 16 15 19 22 22 The accompanying notes on pages 83 to 99 form an integral part of these financial statements. These financial statements were approved by the Board of Directors on 20th May 2019 and were signed on its behalf by R Grainger and S Perkins. 77 McKay Securities Plc Annual Report and Financial Statements 2019 Company Statement of Financial Position As at 31st March 2019 Registration number 421479 Non-current assets Investment properties – Valuation as reported by the valuers – Adjustment for rents recognised in advance under SIC 15 – Assets held for sale – Adjustment for grossing up of head leases Plant and equipment Investments in subsidiary Trade and other receivables Total non-current assets Current assets Trade and other receivables Assets held for sale Cash and cash equivalents Total current assets Total assets Current liabilities Loans and other borrowings Trade and other payables Finance lease liabilities Interest rate derivatives Total current liabilities Non-current liabilities Loans and other borrowings Pension fund deficit Finance lease liabilities Trade and other payables Interest rate derivatives Total non-current liabilities Total liabilities Net assets Equity Called up share capital Share premium account Retained earnings Revaluation reserve Total equity Notes 2019 £’000 2018 £’000 11 12 13 14 14 11 15 15 15 15 24 15 19 413,650 (7,618) (13,500) 2,883 395,415 71 – 6,839 402,850 (6,691) (11,925) 2,883 387,117 42 – 5,861 402,325 393,020 43,339 13,500 4,363 61,202 35,049 11,925 1,725 48,699 463,527 441,719 – (11,749) (180) – – (9,536) (180) – (11,929) (9,716) (163,176) (144,598) (2,108) (2,703) (203) – (2,164) (2,703) – – (168,190) (149,465) (180,119) (159,181) 283,408 282,538 18,825 79,652 63,380 121,551 18,791 79,235 64,002 120,510 283,408 282,538 The accompanying notes on pages 83 to 99 form an integral part of these financial statements. These financial statements were approved by the Board of Directors on 20th May 2019 and were signed on its behalf by R Grainger and S Perkins. 78 McKay Securities Plc Annual Report and Financial Statements 2019 Group Cash Flow Statement For the year ended 31st March 2019 Operating activities Profit before tax Adjustments for: Depreciation Other non-cash movements Profit on sale of investment properties Movement in revaluation of investment properties Net finance costs Cash flow from operations before changes in working capital (Increase) in debtors Increase/(decrease) in creditors Cash generated from operations Interest paid Interest received Cash flows from operating activities Investing activities Proceeds from sale of investment properties Purchase and development of investment properties Purchase of other fixed assets Cash flows from investing activities Financing activities Increase in borrowings Equity dividends paid Cancellation of derivative Cash flows from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year The accompanying notes on pages 83 to 99 form an integral part of these financial statements. 2019 £’000 2018 £’000 13,190 43,442 46 1,725 – (4,833) 4,494 14,622 (6,274) 5,623 13,971 (5,560) 4 8,415 – (14,304) (76) (14,380) 18,003 (9,400) – 8,603 2,638 1,725 4,363 34 1,350 (5,746) (25,066) 1,519 15,533 (497) (1,373) 13,663 (6,171) 5 7,497 26,773 (25,031) (14) 1,728 9,908 (8,541) (13,352) (11,985) (2,760) 4,485 1,725 79 McKay Securities Plc Annual Report and Financial Statements 2019 Company Cash Flow Statement For the year ended 31st March 2019 Operating activities Profit before tax Adjustments for: Depreciation Other non-cash movements Profit on sale of investment properties Movement in revaluation of investment properties Net finance costs Cash flow from operations before changes in working capital (Increase) in debtors Increase in creditors Cash generated from operations Interest paid Interest received Cash flows from operating activities Investing activities Proceeds from sale of investment properties Purchase and development of investment properties Purchase of other fixed assets Cash flows from investing activities Financing activities Increase in borrowings Equity dividends paid Cancellation of derivative Cash flows from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the year The accompanying notes on pages 83 to 99 form an integral part of these financial statements. 2019 £’000 2018 £’000 9,417 38,545 46 1,704 – (1,041) 4,457 14,583 (9,181) 1,306 6,708 (5,500) 1,243 2,451 – (8,340) (76) (8,416) 18,003 (9,400) – 8,603 2,638 1,725 4,363 34 1,345 (5,746) (15,755) 1,535 19,958 (18,770) 1,474 2,662 (6,066) 1,477 (1,927) 26,773 (15,607) (14) 11,152 9,908 (8,541) (13,352) (11,985) (2,760) 4,485 1,725 80 McKay Securities Plc Annual Report and Financial Statements 2019 Consolidated Statement of Changes in Equity For the year ended 31st March 2019 At 31st March 2017 Profit for the year Other comprehensive income: Transfer surplus on revaluation of properties Transfer on disposal of investment properties Remeasurement on defined benefit pension scheme Total comprehensive income for the year Issue of new shares net of costs Dividends paid in year Deferred bonus Costs of share based payments At 31st March 2018 Profit for the year Other comprehensive income: Transfer surplus on revaluation of properties Remeasurement on defined benefit pension scheme Total comprehensive income for the year Issue of new shares net of costs Dividends paid in year Deferred bonus Costs of share based payments At 31st March 2019 Attributable to equity holders of the parent Company Share capital £’000 18,762 Share premium £’000 78,929 – – – – – 29 – – – – – – – – 306 – – – Revaluation reserve £’000 117,929 – 25,066 (15,203) – 9,863 – – – – 18,791 – 79,235 – 127,792 – – – – 34 – – – – – – 417 – – – 4,833 – 4,833 – – – – Retained earnings £’000 55,172 43,442 (25,066) 15,203 (70) 33,509 (335) (8,541) 21 796 80,622 13,190 (4,833) (135) 8,222 (451) (9,400) 110 878 Total equity £’000 270,792 43,442 – – (70) 43,372 – (8,541) 21 796 306,440 13,190 – (135) 13,055 – (9400) 110 878 18,825 79,652 132,625 79,981 311,083 The accompanying notes on pages 83 to 99 form an integral part of these financial statements. 81 McKay Securities Plc Annual Report and Financial Statements 2019 Company Statement of Changes in Equity For the year ended 31st March 2019 At 31st March 2017 Profit for the year Other comprehensive income: Transfer surplus on revaluation of properties Transfer on disposal of investment properties Remeasurement on defined benefit pension scheme Total comprehensive income for the year Issue of new shares net of costs Dividends paid in year Deferred bonus Costs of share based payments At 31st March 2018 Profit for the year Other comprehensive income: Transfer surplus on revaluation of properties Transfer on disposal of investment properties Remeasurement on defined benefit pension scheme Total comprehensive income for the year Issue of new shares net of costs Dividends paid in year Deferred bonus Costs of share based payments At 31st March 2019 Share capital £’000 18,762 Share premium £’000 78,929 – – – – – 29 – – – – – – – – 306 – – – Revaluation reserve £’000 119,958 – 15,755 (15,203) – 552 – – – – 18,791 – 79,235 – 120,510 – – – – – 34 – – – – – – – 417 – – – 1,041 – – 1,041 – – – – Retained earnings £’000 34,138 38,545 (15,755) 15,203 (70) 37,923 (335) (8,541) 21 796 64,002 9,417 (1,041) – (135) 8,241 (451) (9,400) 110 878 Total equity £’000 251,787 38,545 – – (70) 38,475 – (8,541) 21 796 282,538 9,417 – – (135) 9,282 – (9,400) 110 878 18,825 79,652 121,551 63,380 283,408 The accompanying notes on pages 83 to 99 form an integral part of these financial statements. 82 McKay Securities Plc Annual Report and Financial Statements 2019 Notes to the Financial Statements For the year ended 31st March 2019 1 Accounting policies Basis of preparation The Group and Company financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union (EU) and therefore comply with Article 4 of the EU IAS Regulation. In accordance with Section 408 Companies Act 2006 a separate Profit and Loss and other Comprehensive Income for McKay Securities Plc (the Company) is not presented. The profit for the year after tax of the Company is £9,417,000 (2018: £38,545,000). The Group is required to adopt IFRS 9 Financial Instruments, IFRS 15 Revenue Recognition, both effective from 1st January 2018, and IFRS 16 leases effective from 1st January 2019. Newly effective accounting standards Management has considered the impact on the Group of new standards IFRS 9, IFRS 15, IFRS 16, amendments to standards and interpretations that are endorsed by the EU. The Group’s assessment of the impact of these new standards is set out below. IFRS 9 Financial Instruments IFRS 9 Financial Instruments was issued in July 2014 and was endorsed by the EU in 2016. It replaces existing financial instruments guidance, including IAS 39 Financial Instruments: Recognition and Measurement. This standard is effective for accounting periods commencing on or after 1st January 2018. The standard addresses the classification and measurement of financial instruments and will require additional disclosures. Further to this, a new impairment measurement model for financial assets based around expected credit losses has been introduced. There is no longer a requirement for a credit event to have occurred before a credit loss is recognised. The Group has adopted the new standard in its consolidated financial statements for the year ended 31st March 2019. The Group has considered the impact of adopting IFRS 9 and determined that there was no material impact on the results and as such there is no required restatement disclosure. IFRS 15 Revenue from Contracts with Customers IFRS 15 Revenue from Contracts with Customers was issued in 2014 and was endorsed by the EU in 2016. IFRS 15 establishes a comprehensive framework for determining whether, how much and when revenue is recognised. It replaces existing revenue recognition guidance, including IAS 18 Revenue. IFRS 15 is effective for annual periods beginning on or after 1 January 2018, with early adoption permitted. The Group has adopted the new standard in its consolidated financial statements for the year ended 31 March 2019. The Group has considered the impact of adopting IFRS 15 and determined that there was no material impact on the Group’s revenue accounting policies. Standards issued but not yet effective IFRS 16 Leases IFRS 16 Leases was issued in January 2016, and was endorsed by the EU in 2017. IFRS 16 introduces a single on-balance sheet lease accounting model for lessees. A lessee recognises a right-of-use asset representing its right to use the underlying asset and a corresponding lease liability representing its obligation to make lease payments. There are optional exemptions for short term leases and leases of low value items. IFRS 16 replaces existing leases guidance including IAS 17 Leases, IFRIC 4 Determining whether an Arrangement contains a Lease, SIC-15 Operating Leases-Incentives and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. The standard is effective for annual periods beginning on or after 1st January 2019. Early adoption is permitted for entities that apply IFRS 15 Revenue from Contracts with Customers at or before the date of initial application of IFRS 16. The Group did not early adopt this standard. No material impact is expected with the adoption of IFRS 16 as the Group has no current lease commitments. The financial statements are prepared on a going concern basis as explained in the Principal Risks and Uncertainties and going concern Statement on page 39. Basis of consolidation The consolidated financial statements of the Company and its subsidiary (the Group) have been prepared on a historical cost basis, except for investment property which is measured at fair value through the Profit and Loss and other Comprehensive Income. The subsidiary company is under the control of the Company. Control means being exposed or have rights to variable returns from its involvement and has the ability to affect those returns through its power over the subsidiary. Intra-group balances, income and expenses and unrealised gains and losses resulting from intra-group transactions are eliminated in preparing the consolidated financial statements. Significant judgements and estimates In the process of preparing the Group’s financial statements management is required to make judgements, estimates and assumptions when applying accounting policies that may affect the reported amounts of revenues, expenses, assets and liabilities. Any judgements, estimates and associated assumptions used in the preparation of the financial statements are based on management’s best information at the time, however actual outcomes may differ from estimates used. Not all accounting policies require estimates and assumptions, however management consider them significant in applying to valuations, for which qualified external advisors are used, of investment properties and are disclosed in the applicable policies and notes below. 83 McKay Securities Plc Annual Report and Financial Statements 2019 1 Accounting policies continued Investment properties The Group’s properties are held as investments to earn rental income and for capital appreciation and are stated at fair value at the balance sheet date. The value, reflecting market conditions, is determined at each reporting date by independent external valuers and any gain or loss arising from a change in value is recognised in the Profit and Loss and other Comprehensive Income and transferred to the revaluation reserve in the Group Statement of Financial Position. Any accrued rent receivable recognised as a separate asset in accordance with the Group’s accounting policy on lease incentives is deducted from the external valuation. Properties purchased are recognised on legal completion in the accounting period and measured initially at cost including transaction costs. Sales of properties are recognised on unconditional exchange of contracts when the significant risks and rewards of ownership have been transferred. Gains and losses arising on the disposal of investment properties are recognised in the Profit and Loss and other Comprehensive Income, being the difference between net sale proceeds and the carrying value of the property. Subsequent expenditure on investment properties is capitalised only when it increases the future economic benefits associated with the property. All other expenditure is charged to the Profit and Loss and other Comprehensive Income. Interest and other outgoings less rental income relating to investment properties in the course of development are capitalised, and added to the cost of the property. Interest capitalised is calculated on development outgoings, including material refurbishments to investment property, using the weighted average cost of general Group borrowings for the year. A property ceases to be treated as being in the course of development when substantially all the activities that are necessary to prepare the property for use are completed. Properties held under long leases where the Group has substantially all the risks and benefits of ownership are accounted for as finance leases and carried at the lower of fair value or present value of future minimum lease payments. The present value of the future minimum lease payments is recognised as a liability with a corresponding asset added to the carrying value of the leasehold property. The minimum lease payments are apportioned between finance charges in the Profit and Loss and other Comprehensive Income and the reduction of the Group Statement of Financial Position liability. Contingent rents are charged as an expense in the Profit and Loss and other Comprehensive Income in the period incurred. Assets held for sale Properties held for sale are classified as non-current assets if their carrying amount will be recovered principally through sale rather than through continuing use, they are available for immediate sale and sale is highly probable within one year. Investment Properties held for sale are carried at fair vale in the Statement of Financial Position. Intangible assets and property, plant and equipment once classified as held for sale or distribution are not amortised or depreciated. Plant and equipment Plant and equipment is stated at cost less accumulated depreciation. Depreciation is provided on a straight line basis at rates calculated to write off the cost less estimated residual value over their useful lives, which are estimated to be between three and five years. Cash and cash equivalents Cash comprises cash at bank and short term deposits held on call. Cash equivalents comprise investments with minimal risk to changes in value that are readily convertible into cash with an original maturity of three months or less. Bank overdrafts that are repayable on demand and form an integral part of the Group’s cash management are included as a component of cash and cash equivalents for the purpose only of the cash flow statement. Trade and other receivables and payables Trade and other receivables are recognised at invoice cost unless an impairment provision has been made. Impairment provisions are always measured at an amount equal to lifetime expected credit losses. Balances are written off when the probability of recovery is assessed as being remote. Interest bearing loans and borrowings All loans and borrowings are initially recognised at fair value less directly attributable transaction costs. Subsequent to initial recognition, loans and borrowings are measured at amortised cost using the effective interest rate method. Reserves The revaluation reserve represents the unrealised surpluses and deficits arising on revaluation of the Group’s properties and is not available for distribution until realised through sale. This forms part of retained earnings. Segmental analysis All of the Group’s revenue is derived from the ownership of investment properties located in South East England and central London. The management team works within a single structure which includes the Executive Directors acting as chief operating decision maker. Responsibilities are not defined by type or location, each property being managed individually and reported on for the Group as a whole directly to the Board of Directors. Properties under development generate no revenue and are treated as investment properties in the portfolio. The Directors therefore consider there to be only one reporting segment. 84 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 1 Accounting policies continued Revenue The Group has entered into commercial property leases on its investment property portfolio. The Directors consider, based on the terms and conditions, the significant risks and rewards of ownership of the properties are retained and therefore account for the leases as operating leases. Rental income receivable under operating leases less initial direct costs on arranging the leases is recognised on a straight line basis over the non-cancellable term of the lease. The aggregate value of incentives for lessees to enter into lease agreements, usually in the form of rent free periods or capital contributions, is recognised over the lease term or to tenant option to break as a reduction of rental income. The Revenue recognition policy for the following revenue streams are in line with IFRS 15, as revenue is recognised when it transfers control over a product or service to a customer. Premiums received from tenants to terminate leases are recognised as income from investment properties when they arise. Service charges and other such receipts arising from expenses recharged to tenants, with the Group acting as principal, are recognised in the period that the expense can be contractually recovered and included gross in income from investment properties. Interest received on short term deposits is recognised in finance income as it accrues. Borrowing costs Interest on borrowings, including interest on finance leases, is recognised in the Profit and Loss and other Comprehensive Income in the period during which it is incurred, except for interest capitalised in accordance with the Group’s policy on properties under development (see Investment Properties above). Costs incurred on putting in place borrowing facilities are recognised in finance costs over the term of the facility. Derivative financial instruments The Group uses derivative financial instruments, such as interest rate swaps, to manage its exposure to interest rate risk. The differences between interest payable by the Group and interest payable to the Group by the swap counterparties are dealt with by using an effective interest rate. At each reporting date the instruments are stated at fair value in the Group Statement of Financial Position which is the estimated amount that the Group would receive or pay to terminate the instruments based on the current interest rate yield structure. The Group has not applied hedge accounting for any financial instrument in place and any movement in fair value is recognised in the Profit and Loss and other Comprehensive Income. Share-based payments The Group operates an equity-settled share-based performance plan outlined in the Directors’ Remuneration Report under which Directors and employees are able to acquire shares in the Company. The fair value cost benefit of the employee services received for the options granted is recognised over the vesting period in employee costs within administration expenses with a corresponding amount recognised in equity. The charge is measured using valuation models and assumptions outlined in note 18 with adjustment for when non-market conditions are not expected to be met. This also includes the share-based payment element of the bonus. Post employment benefits The Group operates two pension schemes. The defined benefit scheme is based on final pensionable pay and has been closed to new entrants since 1989. The assets of the scheme are held separately from those of the Group and are measured at fair value, the scheme obligations being calculated at discounted present value, with any net surplus or deficit recognised in the Group Statement of Financial Position. Current service cost and net interest on scheme liabilities and scheme assets are recognised as an expense in the Profit and Loss and other Comprehensive Income. Actuarial gains and losses on scheme assets and liabilities are recognised in equity through the Profit and Loss and other Comprehensive Income. The assumptions used by a qualified actuary are outlined in note 24. The Group contributes to eligible employees’ defined contribution personal pension plans and does not accept any responsibility for the benefits gained from these plans. The contributions are recognised as an expense in the Profit and Loss and other Comprehensive Income as incurred but the Group does not recognise any gains or losses arising from movements in the value of the personal pension plans. Taxation Any tax charge recognised in the Profit and Loss and other Comprehensive Income comprises current and deferred tax except to the extent that it relates to items recognised directly in equity, in which case the related tax is recognised in equity. Current tax is the expected tax liability on the results for the year adjusted for items that are not taxable or deductible, or taxable and deductible in other periods, together with any adjustment in respect of previous years calculated using tax rates and laws enacted or substantively enacted at the balance sheet date. Deferred tax is the tax expected to be paid or recovered on temporary differences arising between the carrying amounts of assets and liabilities for financial reporting purposes and their tax base. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantively enacted at the balance sheet date. Tax liabilities are recognised for all taxable temporary differences and tax assets to the extent that future taxable profits will be available against which the asset can be utilised. 85 McKay Securities Plc Annual Report and Financial Statements 2019 1 Accounting policies continued The Group converted to REIT status on 1st April 2007 and as a consequence substantially all the Group’s activities as a property rental business are exempt from tax, including rental profits and gains on rental property disposals. 2 Net rental income from investment properties Gross rents receivable SIC 15 adjustment (spreading of rental incentives) Gross rental income Service charges receivable Other property income Direct property outgoings Rent receivable under the terms of the leases is adjusted, in accordance with SIC 15, for the effect of any incentives given. 3 Administration costs Group Directors’ – remuneration Staff – bonus1 – costs – bonus National Insurance Pension costs – defined benefit scheme – defined contributions Share based payment accounting charge (IFRS 2)2 Depreciation (note 12) Office costs Legal and professional fees General expenses 1. Amount charged to income in year to 31st March 2019. 2. Including prior year deferred bonus charges and adjustments. The average number of persons employed by the Group and Company during the year was 20 (2018: 19). 2019 £’000 20,287 1,321 21,608 3,736 25,344 73 (6,321) 19,096 2018 £’000 21,545 299 21,844 3,656 25,500 792 (5,838) 20,454 2019 £’000 2018 £’000 1,290 440 1,043 339 502 49 194 837 4,694 46 560 935 10 1,271 577 977 398 570 50 217 796 4,856 34 415 938 62 6,245 6,305 86 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 3 Administration costs continued In advance of each audit, the Committee obtains confirmation from the external auditor that it remains independent and that the level and nature of non-audit fees are not an independence threat. Note 3 details the total fees paid to KPMG. The Committee considers KPMG to be independent to the Company. Fees paid to auditor Statutory audit services McKay Securities Plc audit Subsidiary audits Assurance services Interim review Service charge audits 2019 £’000 2018 £’000 73 2 19 6 100 72 2 19 10 103 Details of Directors’ remuneration can be found on page 60 in the Directors’ Annual Remuneration Report. 4 Operating profit Operating profit is identified in the income statement and represents the profit on activities before finance costs, share of associated undertakings and taxation. 5 Adjusted profit before tax Adjusted profit before tax is the Group’s preferred measure to provide a clearer picture of recurring profits from core rental activities before tax, adjusted as set out below. Profit before tax Cancellation of derivatives Change in fair value of derivatives Movement in revaluation of investment properties Other property income (see note 2) Profit on disposal of investment properties IFRS 2 adjustment to share based payments Adjusted profit before tax 6 Net finance costs Interest on bank overdraft and loans Commitment fee Finance lease interest on leasehold property obligations Finance arrangement costs Capitalised interest (note 8) Cancellation of derivatives Change in fair value of derivatives Interest receivable Net finance costs 2019 £’000 13,190 – – (4,833) (73) – 988 9,272 2019 £’000 5,025 250 285 575 (1,637) 4,498 – – (4) (4) 4,494 2018 £’000 43,442 13,352 (16,917) (25,066) (792) (5,746) 795 9,068 2018 £’000 5,633 240 285 590 (1,659) 5,089 13,352 (16,917) (5) (3,570) 1,519 87 McKay Securities Plc Annual Report and Financial Statements 2019 7 Taxation Total tax in the Consolidated Profit and Loss and other Comprehensive Income Reconciliation to effective rate of tax: Profit on ordinary activities before tax Tax charge on profit at 19% (2018: 19%) Effects of: REIT tax exemption Tax for period (as above) 2019 £’000 – 13,190 2,506 2018 £’000 – 43,442 8,254 (2,506) (8,254) – – 8 Capitalised interest Interest relating to investment properties in the course of development is dealt with as explained in note 1. Interest capitalised during the year amounted to £1,637,218 (2018: £1,658,692) and relates to works to London, 30 Lombard Street, EC3; and Theale, Brunel Road. Total development interest capitalised amounts to £14,186,547 (2018: £12,549,320). 9 Earnings per share Basic earnings per share Cancellation of derivatives Change in fair value of derivatives Movement in revaluation of investment properties Other property income Profit on disposal of investment properties Share based payments Adjusted earnings per share 2019 p 14.02 – – (5.14) (0.08) – 1.05 9.85 2018 p 46.25 14.22 (18.02) (26.69) (0.84) (6.12) 0.85 9.65 Basic earnings per share on ordinary shares is calculated on the profit in the year of £13,190,000 (2018: £43,442,000) and 94,087,315 (2018: 93,925,375) shares, being the weighted average number of ordinary shares in issue during the year. Weighted average number of ordinary shares in issue Number of shares under option Number of shares that would have been issued at fair value Diluted weighted average number of ordinary shares in issue Basic earnings per share Effect of dilutive potential ordinary shares under option Diluted earnings per share Cancellation of derivatives Change in fair value of derivatives Movement in revaluation of investment properties Other property income Profit on disposal of investment properties EPRA earnings per share 88 2019 Number of shares 2018 Number of shares 94,087,315 93,925,375 1,721,064 1,516,011 (974,797) (808,206) 94,833,582 94,633,180 2019 p 14.02 (0.11) 13.91 – – (5.10) – – 8.81 2018 p 46.25 (0.34) 45.91 14.11 (17.88) (26.49) – (6.07) 9.58 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 9 Earnings per share continued EPRA earnings per share is calculated on the same profit after tax and on the weighted average diluted number of shares in issue during the year of 94,833,582 (2018: 94,633,180) shares, which takes into account the number of potential ordinary shares under option. Adjusted earnings per share excludes the after tax effect of profit from the disposal of investment properties, surrender premiums received, the change in the fair value of derivatives, the cancellation of derivatives, the movement in revaluation of investment properties and share-based payments. The EPRA measure includes all of these adjustments except surrender premiums included in other property income, which are added back. 10 Dividends The final dividend is not included in the accounts as a liability as at 31st March 2019, as it is subject to shareholder approval at the Annual General Meeting. The final dividend for 2018 and interim for 2019 paid in the year are included in the Consolidated Statement of Changes in Equity on page 81. Ordinary dividends 31st March 2018 final dividend of 7.2p (31st March 2017: 6.3p) paid during the year 30th September 2018 interim dividend of 2.8p (30th September 2017: 2.8p) paid during the year Total recognised in financial statements Proposed final dividend of 7.4p (31st March 2018: 7.2p) 11 Investment properties 2019 £’000 6,765 2,635 9,400 6,965 2018 £’000 5,910 2,631 8,541 6,765 Valuation At 1st April 2018 Additions – development Revaluation surplus/(deficit) Adjustment for rents recognised in advance under SIC 15 Disposals Amortisation of grossed up headlease liabilities Group Company Freehold £’000 Long leasehold £’000 Total £’000 Freehold £’000 Long leasehold £’000 Total £’000 368,957 88,906 457,863 368,957 30,085 399,042 8,213 1,987 7,869 4,481 16,082 6,468 8,213 1,987 (1,032) (602) (1,634) (1,032) – – – (1) – (1) – – 619 (19) 105 – – 8,832 1,968 (927) – – Book value as at 31st March 2019 378,125 100,653 478,778 378,125 30,790 408,915 Adjustment for grossing up of headlease liabilities Adjustment for rents recognised in advance under SIC 15 Valuation as at 31st March 2019 – (4,404) (4,404) – (2,883) (2,883) 7,325 385,450 1,001 97,250 8,326 7,325 293 7,618 482,700 385,450 28,200 413,650 89 McKay Securities Plc Annual Report and Financial Statements 2019 11 Investment properties continued Group Company Freehold £’000 Long Leasehold £’000 Total £’000 Freehold £’000 Long Leasehold £’000 Total £’000 Valuation At 1st April 2017 Additions – development Revaluation surplus/(deficit) Adjustment for rents recognised in advance under SIC 15 Disposals Amortisation of grossed up headlease liabilities 368,718 4,738 17,217 (726) (20,990) – 428,333 368,718 28,014 396,732 59,615 20,023 9,247 24,761 26,464 4,738 17,217 22 – (1) (704) (726) (20,990) (20,990) (1) – 2,113 (64) 22 – – 6,851 17,153 (704) (20,990) – Book value as at 31st March 2018 368,957 88,906 457,863 368,957 30,085 399,042 Adjustment for grossing up of headlease liabilities Adjustment for rents recognised in advance under SIC 15 – (4,404) (4,404) – (2,883) (2,883) 6,293 398 6,691 6,293 398 6,691 Valuation as at 31st March 2018 375,250 84,900 460,150 375,250 27,600 402,850 In accordance with the Group’s accounting policy on properties there was an external valuation at 31st March 2019. These valuations, were carried out by Knight Frank LLP, Chartered Surveyors and Valuers. All valuations were carried out in accordance with the Appraisal and Valuation Standards of RICS, on an open market basis. The historical cost of properties stated at valuation is approximately £335 million (2018: £319 million) for the Group and £278 million (2018: £269 million) for the Company. The amount of interest capitalised during the year was £1,637,218 (2018: £1,658,692). The Group is a REIT and therefore does not obtain relief from Corporation Tax. Investment property valuation method and assumptions The fair value of the property portfolio has been determined using income capitalisation techniques, whereby contracted and market rental values are capitalised with a market value for properties under development, the fair value is calculated by estimating the fair value of the completed property using the income capitalisation technique less estimated costs to completion and a risk premium. The resulting valuations are cross-checked against the equivalent yields and the fair market values per square foot derived from comparable recent market transactions on arm’s length terms. One of the assets held for sale has been valued based on the capital value per square foot. If the capital value per square foot were to increase or decrease by 10%, the year end calculation will increase or decrease by £1.4 million. These techniques are consistent with the principles in IFRS 13 Fair Value Measurement and use significant unobservable inputs such that the fair value measurement of each property within the portfolio has been classified as Level 3 in the fair value hierarchy. There were no transfers in or out of Level 3 for investment properties during the year. Gains and losses recorded in profit or loss for recurring fair value measurements categorised within Level 3 of the fair value hierarchy amount to £4.8 million (2018: £25.1 million) and are presented in the Group income statement in the line item ‘Revaluation of investment properties’. 90 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 11 Investment properties continued The significant unobservable inputs used in the fair value measurement categorised within Level 3 of the fair value hierarchy of the Group’s property portfolio, together with the impact of significant movements in these inputs on the fair value measurement, are shown below: Valuation technique Fair value ERV (per sq ft pa) – average ERV (per sq ft pa) – range True equivalent yield – average True equivalent yield – range Capital value per sq ft A further £24.55 million has been designated other and not included in the analysis above. Definitions for ERV and true equivalent yield are provided in the glossary on page 100. Sensitivity analysis Change in value of investment properties 12 Plant and equipment London Offices Income Capitalisation South East Offices Income Capitalisation South East Industrial Income Capitalisation £120,800,000 £261,900,000 £75,450,000 £56.93 £28.41 £10.47 £10.00–£80.00 £15.00–£47.50 £4.65–£15.50 4.70% 6.81% 5.20% 4.35%–5.75% 5.71%–8.57% 4.49%–6.90% £900.57 £367.05 £148.15 Change in ERV Change in equivalent yield +5% -5% +0.25% -0.25% £23.0m £(23.3)m £(23.9)m £25.5m Group £’000 2019 Company £’000 Group £’000 2018 Company £’000 Cost Opening Additions Disposals Closing Depreciation Opening Charge for year Disposals Closing Net book value 218 75 (13) 280 176 46 (13) 209 71 215 75 (13) 277 173 46 (13) 206 71 214 14 (10) 218 152 34 (10) 176 42 211 14 (10) 215 149 34 (10) 173 42 91 McKay Securities Plc Annual Report and Financial Statements 2019 13 Investments Company At 1st April 2018 At 31st March 2019 Shares in subsidiary undertakings £’000 – – Total £’000 – – At 31st March 2019 McKay Securities Plc had the following wholly owned subsidiary undertaking which operates in England and is registered in England and Wales: 20 Greyfriars Road, Reading, Berkshire, RG1 1NL. Baldwin House Limited The above subsidiary is included in the consolidation. The principal activity of the subsidiary undertaking is property investment and development. The Directors are of the opinion that the investment in the subsidiary undertaking is not worth less than the current book value. 14 Trade and other receivables Current Trade receivables Amounts due from subsidiary undertakings SIC 15 lease incentives Other debtors and prepayments Non-current SIC 15 lease incentives Group trade receivables that were past due but not impaired are as follows: Less than three months due Between three and six months due Between six and twelve months due The Group holds no collateral in respect of these receivables. The transactions relate to capital expenditure funded by the parent £7,354,000. Group £’000 – – – 3,501 3,501 2019 Company £’000 – 40,790 1,486 1,063 43,339 Group £’000 – – 830 787 1,617 2018 Company £’000 – 33,436 830 783 35,049 10,292 6,839 5,861 5,861 2019 £’000 2018 £’000 – – – – – – – – 92 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 15 Liabilities Trade and other payables Rent received in advance Other taxation and social security costs Amounts owed to subsidiary undertakings SIC 15 creditor Other creditors and accruals Group £’000 4,975 1,732 – 1,964 7,563 16,234 2019 Company £’000 4,969 1,609 – 505 4,666 11,749 Group £’000 4,238 967 – 4,296 9,501 2018 Company £’000 4,220 1,020 – 4,296 9,536 The fair value of current liabilities is estimated as the present value of future cash flows which approximate their carrying amounts due to the short term maturities. Creditor days for the Group were 7 days (2018: 4 days). Loans and other borrowings The analysis of bank loans which are secured on certain of the freehold and leasehold properties of the Group is as follows: Group and Company Secured bank loans Bank facility fees The bank loans are secured against land and buildings with a carrying amount of £403,300,000 (2018: £395,125,000). Group £’000 – 66,698 32,432 – 64,046 163,176 2019 Company £’000 – 66,698 32,432 – 64,046 163,176 Repayable in: Less than 1 year 1–2 years 2–5 years 5–10 years Greater than 10 years Changes in liabilities arising from financing activities Current loans as at 1st April Non-current loans as at 1st April Total loans as at 1st April Increase in borrowings Facility fee amortisation Total loans as at 31st March 2019 £’000 2018 £’000 165,000 (1,824) 147,000 (2,402) 163,176 144,598 Group £’000 – – 2018 Company £’000 – – 80,639 80,639 – 63,959 144,598 – 63,959 144,598 2019 £’000 2018 £’000 – 144,598 144,598 18,003 575 34,973 99,127 134,100 9,908 590 163,176 144,598 93 McKay Securities Plc Annual Report and Financial Statements 2019 15 Liabilities continued Borrowing facilities The Group has various undrawn committed borrowing facilities. The facilities available in respect of which all conditions precedent had been met were as follows: Expiring in less than 1 year Expiring in 1 – 2 years Expiring in 2 – 5 years Expiring in 5 – 10 years 2019 £’000 – 18,000 7,000 – 2018 £’000 – – 43,000 – 25,000 43,000 Liquidity risk Liquidity risk is managed through committed bank facilities that ensure sufficient funds are available to cover potential liabilities arising against projected cash flows. The Group’s facilities are revolving, allowing the Group to apply cash surpluses to temporarily reduce debt. On 8th April the company increased total facility to £245m (from £190m). Three bilateral facilities (£125m) were replaced with one credit facility (RCF) of £180m. Financial instrument maturity At 31st March 2019 Non-derivative financial liabilities Bank overdraft Secured bank loans Finance lease liabilities Trade payables At 31st March 2018 Non-derivative financial liabilities Bank overdraft Secured bank loans Finance lease liabilities Trade payables Total 2 months or less 2–12 months 1–2 years 2–5 years More than 5 years Contractual cash flows – 165,000 26,083 9,185 200,268 – – – 9,185 9,185 – 285 – 285 – – 67,000 33,000 285 – 857 – – 65,000 24,656 – 67,285 33,857 89,656 Total 2 months or less 2–12 months 1–2 years 2–5 years More than 5 years Contractual cash flows – 147,000 26,369 5,209 178,578 – – – 5,209 5,209 – – 285 – 285 – – 285 – 285 – 82,000 855 – – 65,000 24,944 – 82,855 89,944 Credit risk Credit evaluations are performed on all tenants looking to enter into lease or pre-lease agreements with the Group. Credit risk is managed by tenants paying rent in advance. Outstanding tenants’ receivables are regularly monitored. At the Statement of Financial Position date there were no significant concentrations of credit risk, except for the low risk lease commitments which were either government departments or held a top credit rating. The maximum exposure to credit risk is represented by the carrying amount of each financial asset including derivative financial instruments on the Group Statement of Financial Position. The Group has no exposure to currency risks. 94 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 15 Liabilities continued Market risk The Group is exposed to market risk through changes in interest rates or availability of credit. Interest rate risk The Group adopts a policy of ensuring that its exposure to interest rate fluctuations is mitigated by the use of financial instruments. The remaining swap was cancelled on 28th March 2018 for £13,352,210. A 25 basis points change in interest rate levels would increase or decrease the Group’s annual profit and equity £250,000 (2018: £367,500). This sensitivity has been calculated by applying the interest rate change to the variable rate borrowings at the year end. The comparative figure for 2018 was also based on a 25 basis points change in interest rates. The 25 basis points change being used shows how the profit or loss and equity would have been affected by changes in the relevant risk variable that were reasonably possible at the year end. Interest rate derivatives The remaining swap was cancelled on 28th March 2018 in full at a cost to the Group of £13,352,210. Weighted average cost of borrowing 2019 3.34% 2018 4.06% The Group does not hedge account its interest rate derivatives and states them at fair value in the statement of financial position based on quotations from the Group’s banks, any movement passing through the Statement of Profit and Loss and other Comprehensive Income. Interest rate swaps are classed as level 2 in accordance with the fair value hierarchy stated in IFRS 13. The fair value of these level 2 contracts are estimated by discounting expected future cash flows using current market interest rates and yield curve over the remaining term of the instrument. There are no liabilities at maturity and no material unrecognised gains or losses. In both 2019 and 2018 there was no difference between the book value and the fair value of all the other financial assets and liabilities of the Group and Company. 16 Obligations under finance leases Group finance lease liabilities are payable as follows: Within one year In second to fifth years inclusive Later than five years Less future finance charges Present value of lease obligations Minimum lease payments 2019 £’000 2018 £’000 285 1,142 24,656 26,083 (21,679) 4,404 285 1,142 24,943 26,370 (21,966) 4,404 The above finance lease liabilities relate to investment properties with a carrying value of £97,250,000 (2018: £84,900,000). The terms of these lease agreements are for periods of between 99 and 125 years. There are no restrictions imposed by the lease agreements. No contingent rents are payable. Finance lease liabilities are effectively secured as the rights to the leased assets revert to the lessor in event of default. 17 Operating leases The Group leases out all of its investment properties under operating leases. The future aggregate minimum rentals receivable under non-cancellable operating leases are as follows: Not later than one year Later than one year but not later than five years Later than five years 2019 £’000 22,503 56,293 61,519 140,315 2018 £’000 21,142 58,060 28,424 107,626 95 McKay Securities Plc Annual Report and Financial Statements 2019 18 Share based payments During the year to 31st March 2019, the Group had one share based payment arrangement, which is described below. In the case of the PSP awards, the expected volatility was determined by calculating historical volatility of the Group’s share price. Performance Share Plan The performance targets for PSP awards are a combination of TSR and absolute NAV performance over a three year period. If the performance criteria have not been met at the end of the vesting period then the awards will lapse. The nil cost awards outstanding at 31st March 2019 have been fair valued using a Monte Carlo valuation pricing model using the following main assumptions: Share price Term Risk free rate Dividend yield Volatility – Company TSR fair value NAV fair value 19 Called up share capital Ordinary 20 pence shares in issue At 1st April Issue of shares in year At 31st March 8th June 2018 £2.67 3 years 0.80% 0% 31.0% £1.73 £2.70 18th July 2017 £2.26 3 years 0.26% 0% 29.0% £1.42 £2.26 16th June 2016 £2.07 3 years 0.27% 4.27% 21.27% £0.77 £1.81 Issued £ 2019 Number of shares Issued £ 2018 Number of shares 18,791,022 93,955,109 18,761,690 93,808,450 33,857 169,316 29,332 146,659 18,824,879 94,124,425 18,791,022 93,955,109 20 Capital management The Group’s objectives when managing capital are to safeguard its ability to continue as a going concern, to provide returns to shareholders and to maintain an appropriate capital structure to minimise the cost of capital. The current capital structure of the Group comprises a mix of equity and debt. Equity comprises issued share capital, reserves and retained earnings, as disclosed in the Group Balance Sheet. The Group uses a number of key metrics1 to manage its capital structure: • gearing • LTV The Board monitors the ability of the Group to pay dividends out of available cash and distributable profits. 1. See glossary. 21 Related party transactions Subsidiary undertakings Baldwin House Limited Balance owed to/(owing from) 2019 £’000 2018 £’000 (40,790) (40,790) (33,436) (33,436) There were no transactions with Directors, who are considered key management personnel, other than remuneration, details of which are provided in the Directors’ Annual Remuneration Report on pages 54 to 66. The estimated IFRS 2 share based payment charge to the Directors is £697,000 (2018: £592,000). These related party transactions are between Baldwin House Limited and the Company. They relate to property payments and receipts for the two properties held in Baldwin House Limited. This balance is zero at Group level. 96 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 22 Net asset value per share 31st March 2019 31st March 2018 Basic Number of shares under option Diluted/EPRA NNNAV Adjustment to fair value of derivatives Net assets £’000 311,083 1,635 312,718 – Shares ’000 94,124 1,732 95,856 – EPRA NAV 312,718 95,856 23 Commitments and contingent liabilities Capital expenditure committed but not provided for Net asset value per share p 331 (5) 326 – 326 2019 Group ’000 11,381 Net assets £’000 306,440 1,200 307,640 – 307,640 Company £’000 11,381 Shares ’000 93,955 1,593 95,548 – 95,548 2018 Group £’000 10,703 Net asset value per share p 326 (4) 322 – 322 Company £’000 190 These commitments relate to the Group’s one current development in place at the end of the year. 24 Pensions The Group and Company operates a defined benefit pension scheme in the UK providing benefits based on final pensionable salary. The assets of the scheme are held separately from those of the Group, being invested with insurance companies and managed funds. The contributions are determined by a qualified actuary on the basis of a triennial valuation using the attained age method. The most recent actuarial valuation was as at 31st March 2017. The assumptions which have the most significant effect on the results of the valuation are those relating to the rate of return on investments and the rate of increase in salaries. It was assumed that the investment returns would be 5.0% per annum. The Group contributes £240,000 per annum into the Scheme. At the 31st March 2017 actuarial valuation the scheme was 88% funded on the continuing valuation basis. A recovery plan and schedule of contributions has been agreed designed to address this shortfall. The IAS 19 valuation for the pension scheme disclosures is based on the most recent actuarial valuation at 31st March 2017 and updated by First Actuarial in order to assess the liabilities of the scheme at 31st March 2019. Scheme assets are stated at their market value at 31st March 2019. The Scheme has been closed to new entrants since 1989. The assets of the scheme have been taken at market value and the liabilities have been calculated using the following principal actuarial assumptions: Inflation Salary increases Rate of discount Pension in payment increases The mortality assumptions adopted at 31st March 2019 imply the following life expectancies for members currently aged 60: Male = 26.3 years The fair value of scheme assets are as follows: Equities Gilts Corporate and overseas bonds Absolute return portfolios Property Cash Other 2019 3.2% n/a 2.2% 3.1% 2018 3.1% n/a 2.4% 3.0% £’000 £’000 1,909 334 277 2,322 149 312 29 723 59 40 4,575 – 77 57 5,332 5,531 97 McKay Securities Plc Annual Report and Financial Statements 2019 24 Pensions continued The asset split is approximated using the current fund splits for each manager. Changes in the value of scheme assets over the year Market value of assets at start of year Return on scheme assets Actuarial gain Employer contributions Benefits paid 2019 £’000 5,531 131 (148) 240 (422) 2018 £’000 5,600 127 (23) 240 (413) Market value of assets at end of year 5,332 5,531 Analysis of changes in the value of the defined benefit obligation over the period: 2019 £’000 7,695 180 (422) (148) (74) 209 2018 £’000 7,884 177 (413) 109 25 (87) 7,440 7,695 Change in assumption Change in defined benefit obligation +/-0.5% p.a. +/-0.5% p.a. +1 year -/+5% +3%/-4% +5% 2019 £’000 2018 £’000 – (131) 180 49 49 – (127) 177 50 50 Value of defined benefit obligation at start of period Interest cost Benefits paid Actuarial gains: experience differing from that assumed Actuarial gains: changes in demographic assumptions Actuarial gains: changes in financial assumptions Value of defined benefit obligation at end of period Sensitivity analysis Assumption Discount rate RPI inflation Assumed life expectancy Analysis of the amount charged to operating profit: Operating profit Current service cost Analysis of the amount (credited)/charged to finance costs/(income) Return on pension scheme assets Interest on pension scheme liabilities Net return Total charge to profit and loss 98 McKay Securities Plc Annual Report and Financial Statements 2019Notes to the Financial Statements continuedFor the year ended 31st March 2019 24 Pensions continued Analysis of the amount recognised directly in equity via other comprehensive income: Difference between expected and actual return on assets Experience gains and losses arising on the scheme liabilities Effects of changes in the demographic and financial assumptions underlying the present value of the scheme liabilities Total Analysis of the movement in the balance sheet deficit: Deficit in scheme at beginning of year Movement in year: Current service cost Net interest/return on assets Contributions Actuarial gain/(loss) Deficit in scheme at end of year The last active member reached retirement age in May 2013. 2019 £’000 148 (13) – 135 2018 £’000 23 47 – 70 0% of scheme assets 0% of the present value of the scheme liabilities 0% of the present value of the scheme liabilities 2% of the present value of the scheme liabilities 2019 £’000 (2,164) – (49) 240 (135) 2018 £’000 (2,284) – (50) 240 (70) (2,108) (2,164) 99 McKay Securities Plc Annual Report and Financial Statements 2019 Glossary Adjusted EPS Earnings per share based on profits and adjusted to exclude certain items as set out in note 9. Gearing Drawn debt to shareholders’ funds. Adjusted profit before tax Profit before tax adjusted to exclude certain recurring and non-recurring items relating to non-core rental activity as set out in note 5. Book value The amount at which assets and liabilities are reported in the accounts. BREEAM Building Research Establishment Assessment Method. An environmental standard that rates the sustainability of buildings in the UK. Carrying value The value of an asset based on prior valuation with the addition of any subsequent capital expenditure. Contracted rent Rent payable under the terms of a lease, less ground rent, with no allowance for the value of incentives granted at lease commencement. GRESB Global Real Estate Sustainability Benchmark. Industrial property Term used to include light industrial, industrial and distribution warehouse property falling within classes B1c, B2 and B8 of the Town & Country Planning Use Classes Order. The term does not include retail warehousing, falling within class A1 of the Order. Initial yield Net rents payable at the valuation date expressed as a percentage of the value of property assets after allowing for notional purchasers’ costs. Interest cover (“ICR”) The number of times Group net interest payable is covered by underlying profit before interest and taxation. Interest rate swap A financial instrument where two parties agree to exchange an interest rate obligation for a pre-determined amount of time. CRC Carbon Reduction Commitment. A mandatory emissions reduction standard in the UK and covers all forms of energy excluding transportation fuels. IPD/MSCI Investment Property Databank. Leading provider of independent statistical analysis to the commercial property sector. Diluted figures Reported amount adjusted to include the effects of potential shares issuable under employee share schemes. Loan to value (“LTV”) Drawn debt divided by the value of property assets. Dun and Bradstreet Provider of business information and risk management insight. Net asset value (“NAV”) per share Total equity divided by the number of ordinary shares in issue at the period end. Earnings per share (“EPS”) Profit after taxation attributable to ordinary shareholders divided by the weighted average number of ordinary shares in issue during the year. Net debt Total borrowings less cash credit balances. EPC Energy Performance Certificate. Certificates carry ratings which measure the energy and carbon emission efficiency of the property using a grade from an ‘A’ to a ‘G’. EPRA Standard calculation methods for adjusted EPS, NAV and NNNAV as set out by the European Public Real Estate Association (EPRA) in their Best Practice and Policy Recommendations. Equivalent yield The internal rate of return from an investment property, based on the value of the property assuming the current rent passing reverts to ERV and assuming the property becomes fully reoccupied over time. It assumes that rent is received quarterly in advance. Estimated Rental Value (“ERV”) The valuers estimated amount for which floor space should let on the date of valuation on appropriate lease terms net of ground rents payable. Also known as MRV. Extensible Business Reporting Language (“XBRL”) A computer language for electronic transmission of business and financial information. 100 Property Income Distribution (“PID”) PID dividend payments are taxable as letting income in the hands of shareholders who pay tax. They are paid after deduction of withholding tax at the basic rate. (Real Estate Investment Trust (“REIT”) A tax efficient structure for the management of property. It must be publicly quoted with 75% of its profits and assets derived from a qualifying property rental business which is exempt from tax on income and gains. Rental value growth Increase in rental value, as determined at the valuation date, over the period on a like-for-like basis. Reversion Potential uplift in rental value to market rent, as determined at the valuation date, likely to arise from a rent review, lease renewal or letting. RPIX Retail Price Index excluding mortgage interest. Shareholders’ funds Total equity of the Company. McKay Securities Plc Annual Report and Financial Statements 2019 SIC 15 The IFRS treatment in respect of letting incentives. It requires the Company to offset the value of incentives granted to lessees against the total rent due over the length of the lease, or to a break clause if earlier. Stamp duty land tax Government tax levied on certain legal transactions including the purchase of property. Total shareholder return (“TSR”) The growth in the value of an ordinary share plus dividends reinvested during the year expressed as a percentage of the share price at the beginning of the year. True equivalent yield The constant capitalisation rate, which, if applied to all cash flows from an investment property, including current net reversions and such items as voids and expenditure, equates to the market value having taken into account notional purchasers’ costs and assuming rents paid quarterly in advance. Weighted average unexpired lease term (“WAULT”) The average lease term remaining to expiry across the portfolio weighted by rental income. This is also disclosed assuming all break clauses are exercised at the earliest date. 101 McKay Securities Plc Annual Report and Financial Statements 2019 Company and Shareholder Information Financial calendar Annual Report posted to shareholders Annual General Meeting Final dividend Interim announcement Interim Statement posted to shareholders Interim dividend Financial year end Preliminary announcement Secretary J McKeown ACIS Registered Office 20 Greyfriars Road, Reading Berkshire RG1 1NL Tel: 0118 950 2333 Registered Number 421479 Website www.mckaysecurities.plc.uk 2019 3rd June 4th July 25th July November December 2020 January March May/June Registered Auditor KPMG LLP Chartered Accountants 15 Canada Square London E14 5GL Corporate Solicitors Slaughter and May One Bunhill Row London EC1Y 8YY Registrar and Transfer Office Equiniti Limited Aspect House, Spencer Road Lancing West Sussex BN99 6DA UK: 0371 384 2101* Overseas: 44(0) 121 415 7047 Enquiries relating to shareholders, such as queries concerning notification of change of address, dividend payments and lost share certificates, should be made to the Company’s registrars. The Company has a share account management and dealing facility for all shareholders via Equiniti Limited Shareview. This offers shareholders secure access to their account details held on the share register to amend address information and payment instructions directly, as well as providing a simple and convenient way of buying and selling the Company’s ordinary shares. For internet services visit www.shareview.co.uk or the investor relations sections of the Company’s website. The Shareview Dealing service is also available by telephone on 03456 037 037 between 8.30am and 4.30pm Monday to Friday. The best way to ensure that dividends are received as quickly as possible is to instruct the Company’s registrars to pay them directly into a bank or building society account; tax vouchers are then mailed to shareholders separately. Dividend mandate forms are available from the registrars. This method also avoids the risk of dividend cheques being delayed or lost in the post. Financial information about the Company including the Annual and Interim Reports, public announcements and share price data are available from the Company’s website at www.mckaysecurities.plc.uk and on the internet at www.morningstar.co.uk. The document is printed on a combination of two papers which are both produced from 100% recycled fibres sourced from post consumer waste. The papers are also FSC certified and manufactured at an ISO 14001 accredited mill. FSC – Forest Stewardship Council This ensures there is an audited chain of custody from the tree in the well-managed forest through to the finished document in the printing factory. *Lines are open 8.30am to 5.30pm, Monday to Friday, excluding Bank Holidays. ISO 14001 – A pattern of control for an environmental management system against which an organisation can be credited by a third party. 102 McKay Securities Plc Annual Report and Financial Statements 2019 103 McKay Securities Plc Annual Report and Financial Statements 2019 104 McKay Securities Plc Annual Report and Financial Statements 2019 M c K a y S e c u r i t i e s P l c A n n u a l R e p o r t a n d F i n a n c i a l S t a t e m e n t s 2 0 1 9 McKay Securities Plc 20 Greyfriars Road, Reading, Berkshire, RG1 1NL T. 0118 950 2333 www.mckaysecurities.plc.uk
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