On 29 July 2010, the Financial Services Authority (“FSA”) published its Consultation Paper "Revising the Remuneration Code?” The draft revised Code will apply to a much wider range of firms (roughly 2,500 rather than the current 26) and sets out various requirements regarding remuneration policies and terms for a wide range of staff. The FSA will be consulting about the Code until 8 October and plans to publish the final Code in mid-November. It will come into effect on 1 January 2011 and will apply to all remuneration (including 2010 remuneration) paid on or after 1 January 2011.
The main implications of the Code (in précis and if it remains as drawn) are as follows:
- Basis of measurement – variable remuneration (i.e., bonuses and long-term incentives) should be based on profit (not revenue), be adjusted for risk and be at least in part based on non-financial performance;
- Deferral – at least 40% must be deferred over at least three years (60% for some staff, and for any variable remuneration over £500,000);
- Payment in shares – at least 50% of variable remuneration should be paid in shares (or non-cash instruments);
- Guarantees – guaranteed bonuses are prohibited except for the first year of employment in limited circumstances;
- Performance Adjustment – there should be a power to adjust unvested deferred compensation where there is misbehaviour, a material downturn or a material failure in risk management;
- Severance arrangements – should reflect performance over time and should not reward failure;
- Governance – firms of a significant size should have a Remuneration Committee; otherwise, arrangements must be in place to ensure that there is no conflict of interest in setting remuneration; and
- Voiding – new contractual provisions which contravene prohibitions of the Code will be void. Existing contractual provisions will not be void, but must be amended to comply by 1 July 2011.
The FSA has indicated that certain firms may be allowed not to comply (or at least not comply in full) with many of the requirements of the Code on the basis that it would not be proportionate for them to comply. They will, however, be expected to be able properly to explain why their non-compliance is proportionate (the “comply or explain” approach). To date, the FSA has not given any clear guidance as to which firms could rely on the proportionality principle, nor in which circumstances. This will hopefully be clarified following the current consultation process and on publication of the final Code.
While the full implications of the draft Code will not become clear until the final Code is published, firms who are potentially caught by the draft Code could usefully take the following steps now:
- First, for all new contracts entered into, affected firms should consider including an express provision which provides flexibility to amend the remuneration provisions to comply with the final Code.
- Secondly, firms should draw up two lists of staff:
- those who will definitely fall to be Code Staff;
- those who may be Code Staff.
- Thirdly, firms should assess whether any of those on the list may fall below the de minimis threshold. Employees fall outside aspects of the code if they (i) earn less than £500,000 in total and (ii) less than 33% of their pay is in variable remuneration (i.e., bonus and long term incentive).
- Finally, firms should summarise the remuneration structures for these staff, including:
- The proportion of remuneration made up of bonus and LTIP
- How much (if any) of bonus or LTIP is paid in shares or non-cash investments
- How much is deferred
- Over what period
- Whether there is any ability to reduce the unvested deferred amounts for misconduct, etc.
- Whether there are any guarantees
- Whether there are any special severance arrangements
The above will give affected firms a head start in assessing compliance with the final form of the Code, given the very short period between the likely publication date (mid November) and it coming into effect (1 January 2011).
For full details of the draft Remuneration Code, please see “The FSA’s Proposed Revision of its Remuneration Code”, DechertOnPoint, Special Alert (August 2010) available at http://www.dechert.com/library/FS_Employment-08-10-FSA_Provised_Revision-SA.pdf.