In December 2015 the European Banking Authority (EBA) published its final guidelines on remuneration policies that apply to firms subject to the Capital Requirements Directive (CRD IV). The FCA and PRA have now published consultations (CP16/28, CP33/16) on their proposals to comply with these guidelines. The regulators have maintained their previous position that they will comply with all aspects of the guidelines except for the provision that the limit on awarding variable remuneration to 100% of fixed remuneration (or 200% with shareholder approval) – the ‘bonus cap’ – must be applied to all firms subject to CRD IV. The FCA and PRA will retain the current approach of only requiring firms in proportionality levels one and two to comply with the bonus cap and requiring level three firms simply to set an appropriate ratio between fixed and variable remuneration.
The FCA is also consulting on new non-Handbook guidance to address key areas of ambiguity which form the basis of FAQs to the regulators.
The FCA proposes amendments to its Handbook to align domestic guidance with the EBA guidelines, to simplify the Handbook by deleting some guidance that is now addressed through the EBA guidelines or the FAQ guidance (see below) and to introduce new guidance in SYSC 19A and SYSC 19D to make it clearer how to apply existing FCA requirements on assessing performance when awarding variable remuneration.
The PRA is consulting over the creation of a unified supervisory statement (SS) on remuneration, which will draw together the PRA’s existing SSs on proportionality, malus, and other elements of remuneration in relation to the Remuneration Part of the PRA Rulebook which implements the CRD IV provisions on remuneration.
A summary of the EBA guidelines can be read here with a link to the guidelines themselves.
The consultations will close on 28 November 2016. The consultation papers can be read here.
Who does the consultation affect?
The FCA consultation affects all firms within the scope of CRD IV, namely banks, building societies, investment firms and overseas firms who are required to comply with the FCA Remuneration Code under SYSC 19A or 19D. The PRA consultation applies to all Capital Requirements Regulation (CRR) firms and third-country CRR firms in relation to activities carried on from an establishment in the UK.
The FCA suggests that firms outside the scope of CRD IV may also find the consultation useful to understand what it expects from firms’ remuneration policies and practices.
Policy statements will be published as soon as possible after consultation ends with a view to helping firms to be compliant with the EBA guidelines from 1 January 2017.
FCA: New non-Handbook guidance
The FCA asks whether firms agree with the proposals in each of the areas in the guidance and whether there are other areas where additional clarification would be helpful. The proposed guidance addresses the following:
- material risk takers (MRT): the guidance addresses identification of a MRT; the process for identifying (and excluding) MRTs and who can be excluded as a MRT. The guidance suggests that firms should follow four steps when identifying MRTs: qualitative criteria; quantitative criteria; whether any are exclusions appropriate; and who can be excluded as a MRT
- governance: the guidance has clarified what ‘significant’ means for the purpose of a subsidiary needing to establish a Remuneration Committee (as set out in SYSC 19A or SYSC 19D)
- groups: the CRD IV remuneration rules need to be applied on a group, parent and subsidiary level. The FCA guidance considers whether: 1. the pay-out process rules and the bonus cap apply to non-CRD entities within the UK consolidation group 2. BIPRU firms in the same group as a CRD firm are required to apply SYSC 19A or SYSC 19D 3. a Level 3 BIPRU firm that is part of a UK consolidation group with a level 1 CRD IV firm can apply the BIPRU remuneration principles proportionality rule
- proportionality: the FCA explains its non-compliance with the EBA guidelines. Firms other than those falling into proportionality levels 1 or 2 may choose to rely on domestic Proportionality Guidance to disapply the bonus cap
- variable remuneration: the guidance considers: 1. how to measure individual performance in a Long-Term Incentive Plan (LTIP) award. This should be based on an assessment of the financial and non-financial performance of the individual, business unit and firm as a whole 2. whether the upfront and deferred components of variable remuneration need to have the same split of cash and instruments. The FCA considers not - it is good practice for the deferred portion of variable remuneration to contain a larger proportion of instruments 3. how bonus pools can take account of ex-ante risk adjustments. Firms should have a clear and verifiable mechanism for measuring performance. When communicating their approach to the FCA firms should be able to demonstrate how risk adjustments have been applied in a transparent manner
PRA: unified supervisory statement on remuneration
- the proposals in the PRA consultation are to consolidate the three existing remuneration statements; confirm PRA expectations with regard to the EBA guidelines and to provide additional guidance on:The EBA guidelines: whilst firms must comply with the EBA guidelines, the bonus cap will continue to be applied only to proportionality level one and two firms
- MRTs: all firms should identify MRTs regardless of proportionality level. Firms should identify all traders with the ability to materially affect the firm’s risk profile
- malus and clawback: firms should develop procedures to decide and document cases that could lead to in-year adjustments. The use of malus and clawback and individual or collective adjustments should be clearly communicated to staff
- remuneration committees: the PRA expects remuneration committees to fulfil the roles and functions required under the Remuneration Part and the EBA guidelines
- LTIPs: firms should use a balance of financial and non-financial metrics; quantitative criteria should be risk adjusted and used only as part of a balanced scorecard; discretionary approaches should be applied with appropriate controls, be well-documented and transparent
- guaranteed variable remuneration should continue to be subject to rules for variable remuneration (including malus, clawback and bonus cap)
- buy-outs – determination by the previous employer refers to the final determination by the approving body or committee of the previous firm. The expectations on buy-outs should be read alongside the PS on buy-outs (below)
Final rules on buy-outs
In January 2016 the PRA consulted on buy-outs of variable remuneration. The consultation (CP2/16) can be read here.
In response to the feedback, the PRA has made changes to the proposed rules set out in the CP. In Policy Statement 26/16 the PRA sets out the final rules on buy-outs which amend the Remuneration Part of the PRA Rulebook.
Who does it apply to?
The PS applies to MRTs at PRA-regulated banks, building societies and PRA-designated investment firms, including UK branches of non-EEA headquartered firms. The PS should be read alongside the Remuneration Part.
The rules will be applied to buy-out contracts concluded on or after 1 January 2017.
The aim of the buy-out rule is to put a brake on the undermining of malus and clawback by the practice of buy-outs whereby an individual moves employer and has his cancelled bonus ‘bought out’, so insulating himself against an ex-post risk adjustment of his past award. The PRA confirmed it would follow the proposal to apply ex-post risk adjustments to bought-out awards. The FCA did not consult over this proposal but has stated that it would follow the PRA changes and consider at a later stage whether to apply any rules on buy-outs more widely across the FCA solo-regulated population.
The PRA model allows for malus and clawback to be applied to bought-out awards, based on a determination (a ‘reduction notice’) reached fairly and reasonably by the ex-employer. The principal mechanism will be a contract between the new employer and employee, which provides for the application of malus/ clawback to this buy-out. The grounds on which the ex-employer can apply malus/clawback are misconduct, material error or material failure of risk management.
PS26/16 adds the following in response to consultation:
- to address the administrative burden on employers of having to trace an individual’s employment history, previous employers must, upon receipt of a request by the employee, provide the employee with a remuneration statement containing details of unvested variable remuneration. The employee may pass some/ all of these to the new employer who can then decide whether to provide a buy-out and if so, for how much
- the remuneration statement must set out MRT status at each firm, the amount of unvested variable remuneration which could be bought out and the duration of retention, deferral, performance adjustment and clawback arrangements
- the new employer should use the remuneration statement to identify previous employers and buy-out details and must then provide a buy-out notice to all relevant previous employers in relation to the unvested variable remuneration to which the buy-out is attributed
- an ex-employer can then make a determination as to the application of malus or clawback
- the PRA has clarified that the term ‘determination’ relates to the final determination made by the previous employer