The Prudential Regulation Authority (PRA) has recently issued two papers – one releasing the PRA’s long-awaited final rules on buy-outs of variable remuneration and the other proposing to update its guidance generally on remuneration in the banking sector. The FCA has also put out a paper updating its guidance.
The PRA has been consulting on “buy-outs” for some time and has issued several papers here. Buy-outs are arrangements where a new employer agrees to offer a new hire compensatory arrangements for bonuses or share awards from his old employer which the employee loses through resignation. Typically a senior hire will lose both the right to current year bonus and unvested deferred bonuses when he leaves, and will therefore not normally move without compensation for losing those. The trend towards ever greater deferral of remuneration means that senior employees have more and more at stake when they leave, and so ideally need larger buy-out packages.
The issue that the PRA has with these arrangements is that even if the new employer subjected buy-outs to malus and clawback (effectively reduction and repayment) for events/circumstances at the new employer, they would not be subject to malus and clawback for events/circumstances at the old employer, and therefore employees who had moved and been compensated by a new employer for loss of awards without these terms were actually in a better position than employees who had stayed. Remaining employees would have awards still subject to malus/clawback for those events/circumstances, whereas the leaver who had joined another employer/firm would not have what was in effect the same remuneration subject to the same conditions. This could even be an incentive to move firms periodically to escape the long-tail of malus and clawback.
The industry tried to convince the PRA that this was not a sufficient issue to be of wide concern and/or a solution involving the exchange of relevant information about replacement bonuses and malus/clawback events between old employers, new employers and employees to deal with the problem was too complicated. The PRA itself acknowledged it has been a difficult issue to address.
However, the PRA has now come up with final rules which it appears will operate as follows:
- When a firm caught by the PRA Remuneration Rules recruits someone who was a material risk taker in another PRA Remuneration Rules firm and chooses to “buy-out” remuneration that person forfeits on leaving that employment, the following must happen:
- The old employer must provide the new employer details of what the employee is forfeiting, and any deferral, malus and vesting terms. The new employer must have this information before awarding the buy-out and so, if an employee is seeking a new job without his old employer knowing, any agreement to buy-out remuneration will have to be conditional on this. The new employer’s buy-out must only compensate for loss of award. It must not award more, which raises difficult questions of valuation, nor allow it to vest faster.
- The new employer then tells the old employer of the terms of the new award once it is made in compliant form.
These are the obligations when the buy-out is made. Going forward:
- The old employer then has an obligation to tell the new employer (and employee) of any malus/clawback provisions it would have operated against the employee had he kept his original award, and the new employer must operate malus/clawback accordingly by reference to the buy-out award.
Tight timetables operate for exchange of information. The employee has the express right to be given details of proposed malus/clawback and the opportunity to make representations to the old employer about them to try to persuade them not to do this, and is arguably in a better position than an employee with his existing employer.
These are still difficult proposals to operate, and it may be that these make buy-outs less common. It will also be interesting to see if these proposals flow through into general quoted company practice, where malus and clawback are also becoming more popular, particularly the part of the proposal which requires the old employer to back up the employee’s assertions about the amount of remuneration he has forfeited, which is often a subjective issue.
The PRA’s proposed rules are not subject to further consultation and will take effect for all PRA firms. The PRA also gives guidance where there have been successive moves and so buy-outs relate to remuneration at various employers and the relatively unusual cases where a waiver from these requirements can be sought. The rules apply to buy-outs concluded on or after 1 January 2017. Click here (http://www.bankofengland.co.uk/pra/Pages/publications/ps/2016/ps2616.aspx) to see the relevant rules and the PRA’s explanation of them.
General remuneration paper
The PRA has for some years operated a statement on proportionality inherited from the FSA, a statement on malus/clawback and a more general statement on remuneration. It proposes bringing these together into one statement, and is also taking the opportunity to update this to reflect the EBA remuneration guidelines, which come into effect from 1 January 2017, where it is departing from them (e.g. on the bonus cap for smaller banks, though the PRA says that they should still have an appropriate ratio) or is giving additional guidance.
Unlike the buy-out rules, which are final, this statement is in draft. Consultation is open until 28 November 2016.
The PRA’s previous guidance remains largely the same, but there are some points of difference and some emphasis:
- Intriguingly, the PRA’s old guidance used to say that it did not normally think it necessary for Level 3 firms to apply deferral, retention, pay-out in shares and malus/clawback, but the new wording says that “it may be appropriate for a firm in proportionality level three to disapply” these rules. Is there a subtle shift in emphasis here?
- The PRA gives extra guidance when considering how to categorise traders and asset managers as Material Risk Takers.
- The PRA reminds firms how in-year adjustments can be made in lieu of malus and clawback as well as how they should put in place arrangements in case malus and clawback need to be operated, ahead of them actually needing to be used. Firms should also actively explain how malus and clawback should work – this should not just be assumed to be understood. Appropriate evidence of this needs to be retained. The PRA reinforces its expectation that firms should have a firm-wide policy on performance adjustment as well as a firm-wide policy on deferral. The PRA goes further than the EBA in expecting guaranteed variable remuneration to be included in the bonus cap, where it applies.
The PRA says nothing extra about the new EBA guidelines on dividend equivalents, longer deferral and retention periods, and how awards are valued for bonus capping purposes, although it seems to confirm that the shareholders who have to approve a bonus cap of 2 s salary as opposed to 1 x salary are the shareholders of the firm, not the ultimate shareholders. There may be requests for clarity on this in the final draft as well as on other points of practice.
Click here (http://www.bankofengland.co.uk/pra/Pages/publications/cp/2016/cp3316.aspx) to see the consultation paper.
The FCA has also put out a consultation on similar points. Click here (https://www.fca.org.uk/publications/consultation-papers/remuneration-crd-iv-firms) to see the relevant paper.