Between November 2008 and January 2009, the Financial Services Authority ("FSA") undertook a review of remuneration practices in a group of major UK-incorporated banks and building societies to consider the extent to which remuneration practices may have contributed to the current economic downturn. Following that review, the FSA published a draft code of practice on remuneration policies (the "Code"), a revised version of which was published on 18 March 2009 as part of a consultation paper (CP09/10) issued by the FSA.
The Code sets out one general requirement (which is supported by ten remuneration principles aimed at evidencing compliance with the general requirement) that remuneration policies must be consistent with effective risk management. The key provisions of the Code relating to remuneration and bonuses are as follows:
- the fixed component of remuneration should be a sufficient proportion of total remuneration to allow a firm to operate a fully flexible bonus policy – this is based on the concept that if employee remuneration is low, firms find it harder to pay small, or no, bonuses even when performance in the financial year has been poor;
- the performance-related component of remuneration should be based on longer-term performance and should not be assessed solely on the results of the current financial year;
- non-financial performance metrics should form a significant part of the assessment of an individual's performance – for example, factors such as adherence to effective risk management and compliance with regulatory requirements should be taken into account in the performance appraisal process;
- measurement of performance for long-term incentive plans, including those based on share performance, should be risk-adjusted;
- assessments of financial performance used to calculate bonus pools should be based principally on profits and should include an adjustment for current and future risk – this addresses the FSA's concern that measuring performance based wholly or mainly on revenues or turnover can provide an incentive for employees to pay insufficient regard to the quality of business undertaken and services provided, or their appropriateness for their clients; and
- the majority of any bonus should be deferred with a minimum vesting period if the bonus is a significant proportion of the individual's fixed remuneration – this is an attempt to align the interests of individuals receiving significant bonuses with the longer-term interests of the firm.
The consultation paper seeks comments on the FSA's proposals to introduce the Code's general requirement as an FSA Handbook rule and to include the ten remuneration principles in the FSA Handbook as evidential provisions or as guidance to support the general requirement. In addition, although it is currently the FSA's intention to limit the application of the Code to large banks, building societies and broker dealers, the paper asks for comments on the merits of extending the scope of the Code to all FSA-authorised firms.
It is proposed that the Code take effect from early November 2009. It is clear that the Code, in substantially the current form will be adopted and, in the meantime, the FSA are encouraging firms to benchmark their remuneration policies against it.
It remains to be seen the extent to which the Code – or something similar – may be adopted by employees outside the financial services sector. However, it seems likely that this will be the case, at least in the listed company sector.
Copies of the consultation paper are available to download at www.fsa.gov.uk and the consultation closes on 18 May 2009.