Last year, the FSA Remuneration Code was adopted as part of the financial regulator's response to the current financial crisis, in order to more tightly regulate the remuneration practices of the largest UK banks, building societies and broker dealers. The FSA launched a public consultation on changes to the Code in July this year to address recent developments, such as EU amendments to the Capital Requirements Directive, and changes to the Financial Services and Markets Act 2000. The consultation closed on 8 October 2010 and the amended Code is expected to come into force on 1 January 2011. In this article we outline the key changes proposed by the consultation, which employers should be aware of and start planning for.
Key changes outlined in the proposed Code:
- The Code will be widened to apply to a much larger number of organisations. The current Code applies to only the largest FSA-regulated banks, building societies and broker dealers (reportedly 26 or 27 firms). However, the FSA expects that more than 2,500 firms will be covered by the proposed new Code, including all banks and building societies, asset managers, hedge fund managers, UCITS investment firms as well as some firms that engage in corporate finance, venture capital, the provision of financial advice and stockbrokers.
- There is to be a proportional approach to its application to different firms. In effect, this means that the compliance requirements for different firms are likely to vary depending on the firm's size, internal organisation, and the nature, scope and complexity of their activities.
- The proposed changes include a new definition of the type of staff whose remuneration will be subject to rules, and is likely to bring many senior management personnel, risk takers, and employees exercising control functions within the scope of the rules. The Code will also cover any staff whose pay is in the same bracket as senior management and risk takers.
- Regulated firms will be required to specify an appropriate balance between fixed and variable remuneration, with the option of paying no variable remuneration if appropriate. There are no detailed provisions in the consultation about this change and this aspect is to be the subject of specific guidance from the Committee of European Banking Supervisors (CEBS) later in the year.
- The proposed changes include provisions for appropriate performance conditions to be introduced in connection with any performance related remuneration of Code staff.
- Adjustments will be required to the amounts of variable remuneration paid to Code staff to reflect current and future risks and the capital and liquidity costs of relevant business activities.
- There will be requirements for bonus deferral in certain circumstances, meaning that in many cases payment of 40% to 60% of bonuses will be deferred for at least three years.
- The updated Code allows for the adjustment of deferred bonuses on the basis of poor performance during the deferral period.
- The changes propose a limitation on the proportion of bonuses that can be taken in cash. In effect, at least 50% of bonuses should be taken in shares or other "non cash instruments". The CEBS will publish guidance on appropriate non-cash instruments later in the year.
- There will be restrictions on the circumstances in which guaranteed bonuses can be offered. In general, guaranteed bonuses will only be offered in exceptional circumstances and for the first year of service.
- There will also be further restrictions on severance pay to prevent "rewards for failure".
- Anti-avoidance provisions will prevent firms paying remuneration to Code staff through structures not subject to the revised Code and there will be a voiding provisions under which breaches of the provisions relating to guaranteed bonus, deferral and restrictions on the replacement of void remuneration will render the offending terms void and require employers to recover payments or property.
Impact on employers
The revised Code will apply to all remuneration due from 1 January 2011, with some transitional provisions for arrangements that were already in place on or before 29 July 2010.
Employers who will be subject to the new Code should:
- start identifying now which staff will be covered by the Code and those who may fall within the "de minimus" exception for some of the Code rules;
- review their existing remuneration structures and identify terms likely to require amendment to comply with the revised Code;
- consider whether the amendment of any offending terms is likely to lead to potential claims for breach of contract and how to manage any such risk;
- begin drafting appropriate remuneration policies, including appropriate deferral provisions and provisions for adjustment for poor performance during any deferral period;
- brief staff responsible for recruitment so that they are aware of the implications of the revised Code in relation to terms they can offer new joiners;
- consider staff communication regarding any changes, as a careful balancing act between responding to the provisions of the Code and retaining and incentivising key staff will be required.