The PRA and the FCA’s new remuneration rules were published by way of a joint Policy Statement (PRA PS12/15, FCA PS15/16) on 23 June 2015, with most (but not all) of the rules coming into force on 1 July 2015.
The new set of rules applies to all UK banks, building societies and PRA-designated investment firms, as well as to UK branches of equivalent non-EEA firms (Relevant firms). As Relevant firms are required to apply the rules at group, parent undertaking and subsidiary undertaking levels, the new rules will also affect firms so associated with a Relevant firm.
These ‘new’ rules are an enhancement of the previously applicable remuneration framework in Chapter 19A of SYSC, and so many of the provisions already will be familiar to Relevant firms. That said, the new rules contain a number of changes, and introduce some significantly tougher provisions which in some cases go far beyond what is required by CRD IV.
The FCA’s rules and guidance are set out in the new Chapter 19D of SYSC, and the PRA’s rules are set out in the Remuneration Part of the PRA Rulebook for CRR firms. As the PRA Rulebook does not contain guidance provisions, the PRA’s guidance is set out in a new Supervisory Statement, which should be read alongside its rules.
Consequently, Relevant firms will need to ensure that they are familiar with both regulators’ rules and guidance. Whilst these are largely similar, as before they are not identical and firms no longer have the convenience of finding them both in the combined version of SYSC. The table below provides an overview of where to find the relevant rules and guidance.
What has changed?
The most significant changes relate to the provisions on deferral and clawback of bonuses. Relevant firms will, however, have longer to implement these changes, as unlike the rest of the rules which apply as from 1 July 2015, the new provisions in relation to deferral and clawback will only apply to variable remuneration awarded for performance periods beginning from 1 January 2016.
Under the previously applicable remuneration framework, variable remuneration paid to all material risk takers had to be deferred for at least three years, vesting no earlier than the first anniversary of the award. The new rules divide material risk takers into the following three categories, extending deferral periods in relation to individuals who fall within the first two categories:
- individuals carrying out a PRA-designated senior management function: deferral periods for variable remuneration will need to be at least seven years, with vesting taking place no earlier than the third anniversary of the award;
- individuals who are PRA-designated risk managers with senior, managerial or supervisory roles (as defined in the PRA’s rules): deferral periods for variable remuneration will need to be at least five years, with vesting taking place no earlier than the first anniversary of the award; and
- all residual material risk takers not falling within the two categories outlined above: deferral periods for variable remuneration will continue to be at least three years, with vesting taking place no earlier than the first anniversary of the award (the regulators having reneged on their original proposal to extend the minimum deferral period to five years in relation to all material risk takers, accepting that this would be disproportionate).
To align with the recently amended PRA rules, the FCA is introducing clawback rules in relation to variable remuneration paid to material risk takers, requiring the application of a minimum clawback period of seven years from the date of the award.
More significantly, both regulators are introducing rules which will mean that Relevant firms should extend the clawback period by a further three years in relation to an individual carrying out a PRA-designated senior management function, in circumstances where:
- the firm has commenced an investigation into potential material failures which could lead to the application of clawback were it not for the expiry of the clawback period; or
- the firm has been notified by a regulatory authority (in the UK or overseas) that it has commenced such an investigation.
Thus, certain senior managers may be subject to clawback periods of up to ten years where the outcome of an investigation is pending. There need not be a specific investigation into the individual, but the firm would need to consider the degree of responsibility of an individual in relation to a potential failure in deciding whether to extend the clawback period. It remains to be seen whether and how firms will be able to claw back vested awards after such a long time period.
Other changes (in force from 1 July 2015)
The new rules formalise pre-existing expectations that non-executive directors should not receive a bonus, by explicitly prohibiting variable remuneration being paid to non-executive directors in relation to their role as such.
Although the rules already indicated that variable remuneration should not be paid to the management of a firm in receipt of taxpayer support, the new rules clarify that this includes discretionary payments of any kind. This change will not apply retrospectively and so will not apply to Relevant firms already in receipt of such support prior to 1 July 2015.
Additionally, the PRA’s rules strengthen its requirements in relation to Relevant firms’ application of effective risk adjustment measures when determining the size of their annual bonus pools, and limit circumstances in which Relevant firms can rely on certain performance metrics in making these calculations.
What does this mean for smaller firms?
The regulators’ approach to proportionality remains unchanged under the new rules; although the FCA has issued new General Guidance on Proportionality specific to SYSC 19D, and the PRA has updated its Supervisory Statement on proportionality, the substance of the guidance has not changed.
Thus it appears that, depending on a firm’s individual circumstances, the regulators consider that proportionality level three firms (broadly, firms with total relevant assets which do not exceed £15 billion) may still consider it appropriate to disapply certain of the rules on bonuses, namely the rules relating to retained shares or other instruments, deferral and performance adjustment (i.e. malus and clawback), and, for some firms, the rules relating to bonus caps.
This means that, in practice, the key changes in relation to deferral and clawback may have less impact for smaller firms which are subject to the new rules.
Where do uncertainties remain?
The regulators’ approach to proportionality may, however, be subject to change once the new European Banking Authority guidelines on sound remuneration policies have been finalised, which is expected by the end of this year. In a departure from previous guidance the draft guidelines, which were published in March 2015, state that the proportionality principle in CRD IV does not allow firms to disapply any of the requirements in their entirety. If the guidelines remain in this form, this would have significant consequences for smaller firms in relation to their application of the rules on bonuses.
There is also still no clear conclusion in relation to buy-outs, which are used by firms to compensate new hires for lost bonuses. The PRA and the FCA consulted on a number of options in the July 2014 consultation, but no changes have been proposed as yet. The regulators have indicated that they will explore further the option of requiring buy-out awards to be held in a form that permits them to be subject to clawback by the previous employer, whilst in the meantime looking to ensure that firms have robust clawback arrangements. This option will require careful consideration as this is a difficult area for the regulators to manage, given that it is not immediately evident how such arrangements could be made to work in practice.
What are the employment implications of these changes?
In principle, these new rules should not bring additional firms or employees within the scope of the requirement to operate deferral and clawback on variable pay. This is good news for firms as it should minimise the scope of the changes needed to contracts of employment in order to achieve compliance.
However, Relevant firms will need to ensure that their existing contracts for material risk takers give sufficient flexibility to introduce the new longer clawback periods, without breaching contractual or statutory pay protections. In practice, reclaiming sums against future earnings will be the simplest mechanism where the relevant individual is still in employment, so the contractual wording will need to be broad enough to account for this.
If clawback does become necessary, care will also need to be taken not just to comply with the letter of the contract but also with implied duties to employees, particularly the duty not to destroy the relationship of trust and confidence.
As to the broader context, in light of these more onerous rules as well as their potentially broader application given the European Banking Authority’s proposals in relation to the application of proportionality, a tendency for fixed pay to increase seems somewhat inevitable. Even that may not ultimately comfort senior staff in the City, given Mark Carney’s comments last November that clawback also may need to be extended into fixed pay.
The new remuneration landscape
The creation of a new set of remuneration rules for Relevant firms means that, under the UK regulatory framework, there are now four separate remuneration codes, and firms need to make sure they understand which code is applicable.
The below table sets out an overview of the new landscape and summarises key changes.
Click here to view the table