Remuneration report

Introduction Although 3i is a constituent of the FTSE 100 Index, its business operates within the private equity and venture capital sector. The majority of the Company’s competitors comprise either partnerships of individuals managing funds for investment on behalf of third parties or unquoted subsidiaries of larger banking or financial services groups. After a difficult period, the environment in financial services has improved and recruitment activity has begun to increase. The venture capital market continues to be well funded and competitor organisations continue to be able to offer substantial rewards for their staff and competition for quality, trained executives remains aggressive. In addition to cash bonuses and share awards, investment executives in the venture capital market are often given the opportunity to participate in carried interest or co-investment schemes, which allow executives to share directly in the future profits on investments, subject normally to a variety of conditions relating to the performance of those investments.

It is against this challenging background that the Company’s Remuneration Committee (“the Committee”) has had to formulate and implement its remuneration policies to ensure that the Company is able to continue to attract, retain and motivate management of the quality required to ensure the continued vibrancy and success of the business as a whole. The Committee is also conscious of the need to align the interests of staff and shareholders. One of the ways in which this is achieved is by encouraging the holding of the Company’s shares by its staff. The Company’s policy has therefore been to provide long-term incentives to its executives through share plans and, where appropriate, investment performance plans and carried interest schemes.

Remuneration Committee
Composition and terms of reference The Committee comprises only independent non-executive Directors. Its members throughout the year to 31 March 2004 (“the year”) were Dr J R Forrest (the Committee Chairman), Baroness Hogg (who ceased to be a member on 31 March 2004), Mr F D Rosenkranz and Mr O H J Stocken. None of the members of the Committee sits with any executive Director on the board of any other quoted company. Mme C J M Morin-Postel joined the Committee on 1 April 2004 when Mr F D Rosenkranz became Committee Chairman. The Committee’s terms of reference take into account the provisions of the new Combined Code on corporate governance and are available on the Company’s website.

Activities during the year The Committee met seven times during the year to consider remuneration policy and to determine, on behalf of the Board, the specific remuneration packages for each of the executive Directors and all other members of the Chief Executive’s management committee (called “Executive Committee”). In addition, the Committee considered and made recommendations to the Board on the Company’s framework of executive remuneration and its costs. Details of attendance at meetings by members of the Committee are set out in the Directors’ report.

Assistance to the Committee Persons who materially assisted the Committee with advice on Directors’ remuneration in the year were: PricewaterhouseCoopers LLP (“PwC”), an external remuneration consultant appointed by the Committee; the Group’s Human Resources Director, Mr R B Gregory; and (except in relation to his own remuneration) the Chief Executive, Mr B P Larcombe. Mr Gregory was not appointed by the Committee. During the year, PwC provided the Group’s investment business with taxation, payroll and corporate restructuring advice, due diligence services, property services, and the services of an employee on secondment.

Performance graphs The first graph below compares the Company’s total shareholder return for the five financial years of the Company to 31 March 2004 with the total shareholder return of the FTSE All-Share index. The Directors consider that since the Company invests in a broad range of industrial and commercial sectors the FTSE All-Share index is the most appropriate index against which to compare the Company’s performance.

The second graph below compares the diluted net asset value per share at each of the last five financial year ends (with dividends reinvested) against the total shareholder return of the FTSE All-Share index on those dates. This has been included because changes in net asset value per share relative to the FTSE All-Share index are an important indicator of the long-term performance of the Company’s assets.

Directors’ remuneration policy
Non-executive Directors The Board’s policy for the current financial year in relation to non-executive Directors (including the Chairman) continues to be to pay fees which are competitive with the fees paid by other FTSE 100 companies. Non-executive Directors’ fees (other than those of the Chairman, which are determined by Remuneration Committee) are determined by the Board as a whole, within the limits set by the Company’s Articles of Association, having taken advice from PwC. During the year the basic non-executive Director’s fee was £30,000, the annual fee for Committee membership was £3,500 and the annual fee for Committee Chairmanship was £7,500. These fees were reviewed with effect from 1 April 2004 and the basic non-executive Directors’ fee was increased to £36,000 per annum, the Committee membership fee was reduced to £2,000 per annum and the Committee Chairmanship fee was left unchanged at £7,500 per annum. Non-executive Directors are not eligible for bonuses, share options, long-term incentives, pensions or performance related remuneration. Details of the non-executive Directors’ remuneration for the year are provided in the Directors' remuneration table.

The Company does not currently expect its policy on non-executive Directors’ remuneration for subsequent financial years to change significantly.

Executive Directors The Company’s policy for the current financial year in relation to executive Directors is to pay salaries and benefits sufficient to attract, retain and motivate Directors of the calibre required. The variable elements of each executive Director’s remuneration (comprising annual cash bonuses and long-term incentives) are intended to form a significant component of the executive Director’s total remuneration package. In particular, the salaries of the executive Directors are intended to represent less than half of the executive Directors’ potential rewards with the remainder of the rewards being related to individual and Company performance. The Committee is sensitive to wider issues including pay and employment conditions elsewhere in the Group when setting executive Directors’ pay levels and takes into account the Company’s reward strategy generally, before deciding specific packages for the executive Directors. The executive Directors’ performance related compensation is designed to encourage, where practicable, investment in, and the holding of, shares in the Company so as to align the interests of Directors and shareholders. The Company aims to provide pension benefits which are competitive with other FTSE 100 companies and companies in the financial services sector. The way in which this policy is applied in practice has been reviewed as described below.

Executive Directors’ remuneration packages The remuneration packages of the executive Directors consist of salaries, annual bonuses and long-term incentives. In addition, the US based Director participates in a carried interest plan.

Salaries Executive Directors’ base salaries are determined by the Committee in accordance with the policy referred to above.

During the year and for some years previously Directors’ salaries as well as the salaries of other members of Executive Committee have been benchmarked against salaries for comparable jobs in FTSE 100 companies of similar market capitalisation. The exception to this was Mr M M Gagen (who is based in the US and whose responsibilities include the Group’s US business) whose salary is benchmarked against comparable positions in US venture capital businesses. The Committee has decided that given their active role in the investment business, the remuneration of those UK based Directors (and other members of Executive Committee) with direct responsibility for investment businesses should be benchmarked against comparable positions in private equity and venture capital businesses. The only Director to whom this currently applies is Mr R W Perry.

Annual bonuses All employees, including executive Directors, are eligible for non-pensionable discretionary annual cash bonuses. Executive Directors’ bonuses are determined by the Committee. Bonuses for the year, details of which are set out in the Directors' remuneration table, have been determined by the Committee based on achievement against a range of corporate and personal objectives set at the beginning of the year.

The Committee has reviewed bonus policy and adopted a framework for setting future bonuses. The Committee will determine target bonuses for each Director at the beginning of each year based on appropriate market comparators. These target bonuses will be achievable if both corporate performance targets and personal performance targets are met. In the case of Directors with direct responsibility for investment businesses the target bonus also depends on meeting business unit objectives. Bonuses above target level will be granted for outstanding performance. The Committee has set target bonuses for the year to 31 March 2005 for Directors at 90% of salary. The maximum bonus achievable will be twice the target bonus. The Committee will consider each year the extent to which it would be appropriate for a part of the annual bonus to be payable in shares deferred for two years and only payable if the Director is still employed by the Company. Any bonus above the level of 1.5 times the target bonus will in any event be in the form of deferred shares. The Committee, however, retains the right to make discretionary adjustments in exceptional circumstances.

The main measures to be used for assessing corporate performance will be:

• total shareholder return and change in net asset value per share both in absolute terms and compared with the FTSE All-Share index;
• total non-market driven return compared with budget; and
• one to three year internal rate of return compared with performance of the venture capital industry as a whole.

The Committee will also take into account a number of more detailed indicators of performance and activity, such as the level of investment, realised profits and costs.

Long-term incentives and carried interest plans The Committee determines the levels of long-term incentives and carried interest granted to executive Directors. The Committee regards the purposes of such awards as being to align the interests of executives with those of shareholders and to make continued employment with the Company attractive in relation to opportunities available elsewhere in the venture capital and private equity industry. During the year the long-term incentive arrangements for executive Directors, except the US based Director, consisted of share options and performance share awards under The 3i Group Discretionary Share Plan (the “Discretionary Share Plan”). The US based Director received awards under the US carried interest plan.

The Discretionary Share Plan The Company operates a shareholder approved executive share plan, which conforms with the Association of British Insurers’ (“ABI”) guidelines on dilution limits. Awards under this plan are not pensionable. The level of annual awards is reviewed each year taking account of market practice and the specific circumstances facing the Company. The Committee determines awards to executives based on an assessment of performance. All awards are granted subject to a performance target, the achievement of which will normally be a condition precedent to the exercise of the awards. Careful consideration is given each year to appropriately demanding performance targets. During the year awards of share options and performance shares were made to Directors, details of which are set out in the share options and performance share awards tables.

During the year the Committee reviewed its practices on share awards for Directors. It decided that it would not make any changes to the way in which performance share awards are made under the Discretionary Share Plan.

Details of the performance condition used for share options from 2001 to 2003 are set out in note 4 of the share options table. From 2004, the Committee proposes to set a performance condition for share options that would result in 50% of options vesting if net asset value per share with dividends re-invested increases on average by more than RPI plus three percentage points per annum over a three year performance period and 100% vesting if such net asset value increases by RPI plus eight percentage points or more. At the same time, the Committee proposes to remove the opportunities for the performance condition to be retested after four and five years (if the performance condition is not satisfied earlier) which are contained in the condition used previously.

In line with the Committee’s desire to bring the Company’s long-term incentives at Board level closer to practice in the venture capital industry, from 2004 the Committee proposes to raise the maximum annual award. The maximum level of award will be increased (in terms of face value) from the existing maximum level of four times salary to six times salary. This maximum applies to performance share awards and share options in combination taking into account their relative expected values.

Carried interest plans During the year the executive Director responsible for the Company’s US business, currently Mr M M Gagen, participated in the carried interest plans available to investment executives based in the US. These awards are not pensionable. Details are set out in the US Carried Interest Plan Awards table.

Although the Committee believes the changes in share based long-term incentives referred to above will help to bridge the gap between the Company’s remuneration policies for executive Directors and arrangements in the venture capital industry, the Committee believes the Company should go further and extend to those executive Directors directly responsible for specific investment businesses the possibility of participating in the carried interest arrangements it has already put in place below Board level and for the US-based Director.

The Company therefore proposes to put forward at the 2004 Annual General Meeting proposals to allow executive Directors directly responsible for specific investment businesses to participate in the carried interest plans that have been established for the Group’s investment executives. It is not proposed that the Chief Executive or the Finance Director be eligible to participate in these plans. This year the Committee does not intend to extend such arrangements to any members of the Board other than the executive Director responsible for the Company’s US and Asia Pacific operations, Mr M M Gagen, who is already in such an arrangement in respect of his US responsibilities, which was approved by shareholders in 2002.

If the Company were to extend participation in carried interest to a Director, this would replace a major part of the share-based incentives which the Director would otherwise receive. Full details of the proposals relating to carried interest are set out in the Notice of the 2004 Annual General Meeting.