On 5 August 2011, the FSA announced a four week consultation in respect of two proposed 'Dear CEO' letters, which set out further draft guidance to assist firms in complying with the revised FSA Remuneration Code (the "Code"). The letters set out the FSA's expectations about how firms should be complying with the Code, as well as its proposals as to how compliance will be monitored during the period up to the 2011/2012 annual remuneration review. The letters also include general guidance from the FSA on three key policy issues.
On the same day, the FSA also published in final form a template Remuneration Policy Statement ("RPS") for firms in Tier 2, and for firms in Tier 3 or 4. The RPS templates remain in substantially the same format as the consultation drafts. However, one important change is that the FSA has confirmed that the deadline for completion of the RPS had been extended from 1 September 2011 to the end of the year (subject to the requirement that the RPS must be completed no later than three months before the date on which bonus amounts are to be signed off). A template for RPS Tier 1 firms will be included as part of the consultation.
Consultation on 'Dear CEO' letters
The 'Dear CEO' letters published by the FSA are subject to consultation, which is open for responses until 2 September 2011. One of the letters applies to firms in proportionality Tier 1, and the other to those in proportionality Tiers 2, 3 and 4.
Dear CEO letter – Tier 1 firms
The letter to Tier 1 firms sets out a detailed timetable for firms to submit an RPS under an annual review process. The RPS must be submitted no later than three months before the proposed date on which bonuses are to be finalised by the firm's remuneration committee or equivalent body. The FSA then proposes to meet with relevant senior executives to discuss the RPS during Q4 of the relevant financial year. Information in relation to the final payout data must then be provided to the FSA no later than five working days before the firm's payout. The annual review process will, ordinarily, replace any equivalent ARROW discussion. In addition, the FSA has confirmed that it will expect to see evidence that remuneration risk is taken into account under ICAAP / SREP and intends to place greater focus on remuneration risk in this regard.
The template RPS for Tier 1 firms is also subject to consultation during this period. The information provided in the RPS will be used by the FSA to meet the EBA (previously CEBS) requirements in regards to data collection in respect of the remuneration structures of significant institutions and aggregated data on the number of the individuals with total remuneration in excess of €1m.
Dear CEO letter – Tiers 2, 3 and 4 firms
The approach in relation to these firms is less onerous. Firms will be required to complete their RPS by the end of the year, provided that this is no later than three months before the date on which their proposed bonus amounts are to be finalised and signed off by the remuneration committee or equivalent body. The FSA highlights that, for a small number of Tier 2 firms, the assessment approach is likely to be tailored to reflect more closely the business model and risk profile of the relevant firm (relevant firms will be notified by their FSA relationship contact in due course if this approach is to be taken).
The FSA has stated that it will usually ask for a copy of a firm's RPS as part of the information requests prior to an ARROW review and, if any remuneration risks are identified during the ARROW review, a risk mitigation plan will be agreed according to ARROW procedures. As is the case with Tier 1 firms, the FSA will expect to see evidence that remuneration risk is taken into account under ICAAP (and potentially as part of a SREP where relevant).
The FSA has indicated that it wants to focus on risk adjustment and, in particular in respect of: (i) the risk adjustment technique(s) employed in the specific firm; and (ii) the role of the remuneration committee or other senior committee in reviewing and approving, where appropriate, the ex ante risk adjustment of bonus pools. In this regard, the final form RPS provides that firms must have available copies of documents which are to be supplied to the relevant body on this subject, together with extracts from the relevant committee meeting minutes.
As with Tier 1 firms, the information provided in the RPS will be used by the FSA to meet the EBA data collection requirements.
The RPS templates for these firms have now been finalised, as discussed in further detail below.
General guidance on policy issues
Both of the "Dear CEO" letters contain guidance from the FSA on a number of policy issues, the stated intention being to make the policy position of the FSA in these areas clearer.
- Defining Remuneration Code Staff – the FSA acknowledges that some firms have had difficulty in interpreting the definition in the Code relating to Code Staff and, in particular, the part of the definition which refers to employees whose remuneration takes them into the same bracket as senior management and risk takers, whose activities have a material impact on the firm's risk profile. The FSA has clarified that, in terms of process, it expects firms to first identify Code Staff falling within the three initial categories (senior management, risk takers and those engaged in control functions). Firms should then prepare a list of employees whose remuneration takes them into the same remuneration bracket as the identified group of Code Staff. This list should be reviewed and any employees whose professional activities have a material impact on the firm's risk profile should be designated as Code Staff.
- Long Term Incentive Plans (LTIPs) – the FSA provides additional guidance on the qualities an LTIP should have in order to qualify as part of deferred remuneration, i.e. to meet the requirement that the "upside incentives are adequately balanced by the downside adjustments". The FSA confirms that, as a general principle, the downside adjustments applied to the LTIPs must be at least comparable to those applied to other deferred remuneration if they are to be included in deferred remuneration. In addition, the FSA expects that the following conditions would also need to apply:
- explicit shareholder approval;
- awards subject to risk adjustment as appropriate;
- performance conditions allow the realistic possibility of a zero payout; and
- specific provision for performance adjustment in accordance with the Code requirements at a minimum.
- Structure of alternative investments – the FSA provides further information in relation to the types of instruments which can be used as alternatives to shares. The policy is stated to be subject to any further guidelines which may be published by the EBA.
- Share linked instruments – this would encompass a traditional phantom share scheme in which the value of the instrument tracks the share price and, upon maturity, would be paid out in cash to the holder.
- Equivalent non-cash instruments – firms who are not listed entities, or part of a listed group, are directed to the relevant paragraph in the CEBS guidelines which highlights the need for the value of such instruments, which must have comparable features to shares in terms of their loss absorbency, to be valued directly on the moment of awarding and to be determined by a third party. The FSA has clarified that these requirements will be met if: (a) the firm commissions a full valuation by an independent third party on a periodic basis and the instrument is structured to reflect and track these valuations over the life of the instrument; (b) the firm uses an instrument that reflects the value of the firm by reference to the firm's Return on Risk-weighted Assets (or a similar risk-based measure) subject to verification by an independent third party.
- Capital instruments – the FSA indicates that there are only a limited number of instruments in this category currently and confirms its aim to provide an update following the publication of the views of the Basel Committee on this point.
Remuneration Policy Statement templates (Tier 2, 3 and 4 firms)
The RPS templates, one for Tier 2 firms and one for Tier 3 and 4 firms, are designed to assist firms to document their remuneration policies, practices and procedures, as required by the Code. As set out above, the RPS templates remain in substantially the same format as the consultation drafts, however, many firms will now have until the end of the year to complete their RPS. A note of caution, however, for firms that notify employees of their bonus amounts at year end, the three month provision will effectively mean a 30 September deadline.
The templates set out the questions the FSA are likely to ask in conducting a review of a firm's remuneration policies and indicate the level of detail the FSA expects. While it will not be compulsory to use the templates, the FSA considers that it would be good practice for firms to do so and that, even if firms choose not to use them, they should still ensure that all the information indicated by the templates is recorded in a clear and structured way. There is no requirement for the RPS to be submitted to the FSA, but the RPS (or records containing the equivalent information) must be completed, and be reviewed and approved by the firm's remuneration committee or equivalent body, within the revised deadline.
Code Staff list templates
Included as an annex to the RPS templates are template Code Staff lists, again one for Tier 2 firms and one for Tier 3 and 4 firms which contain the information that the FSA expects firms to record in respect of their Code Staff.
Other guidance documents
The FSA has also published the draft guidance documents set out below in final form. Again, these remain in substantially the same format as the consultation drafts:
- Guaranteed Variable Remuneration. Guidance has been produced in relation to guaranteed variable remuneration provided as both sign-on and retention bonuses. In particular, the guidance addresses whether prior notification to the FSA is required.
- Retention Periods. This guidance provides the FSA's view as to the appropriate retention period that should apply to shares or other instruments paid as part of variable remuneration, as well as to how firms can structure the retention of shares or instruments where a tax withholding obligation (such as PAYE) exists.
- Remuneration Code FAQs. The FAQs are intended to address some of the most common questions raised by in-scope firms in relation to the Code, and address issues including the scope of the Code, the designation of Code Staff and the application of proportionality in determining how the Code applies to specific firms.
If you would like to discuss the proposed consultation or any of the other items referred to above, please let us know.
Links to relevant documents