FSA Guidance on new proportionality levels

The FSA has recently published finalised guidance on proportionality and remuneration in respect of its Remuneration Code.  The changes, which came into force on 25 September 2012, see the end of the current four tier proportionality system (based on capital resources), which has been replaced with a new system comprising three proportionality levels (based on total assets).

The new approach is intended to further clarify how Code firms comply with the Remuneration Code in a manner that takes account of their size, internal organisation and the nature scope and complexity of their activities.  It also allows the FSA to focus on those firms which pose the greatest risk to financial stability.

The reallocation of Code firms from the capital resources based tiering system to the new system based on total assets is unlikely to have a significant impact on those previously in tier 3 or tier 4, who are now likely to fall within new Proportionality Level Three and will therefore continue to be able to dis-apply many of the Remuneration Code provisions. The reallocation could be good news for certain firms previously within tier 1 or 2, as they now find themselves having been assigned to a lower level under the new system.

The new system could affect Code firms' remuneration structures and Pillar 3 Disclosure requirements.

As no objections were raised to the proposed guidance during the consultation period, which ended on 6 September 2012, the guidance has remained unchanged from the consultation draft.

Set out below is a summary of the guidance, including the impact on remuneration rules and Pillar 3 Disclosures.

Proportionality levels

The table below sets out the relevant proportionality levels.

Click here to view table.

The term “relevant total assets” means the average of the firm’s total assets on the firm’s last three relevant dates.   For BIPRU firms, the “relevant date” will be the accounting reference date, whereas for third country BIPRU firms, the “relevant date” will be 31 December 2012.

Capital resources and relevant total assets

BIPRU Firms

Rather than using the BIPRU firm's capital resources as at its last accounting date, BIPRU firms should now use the average of the firm's total assets during the last three years to assess its proportionality level.  Total assets are calculated based on the general policy on valuation set out in the FSA’s GENPRU Sourcebook.

It will need to be determined on a case by case basis whether the proposed switch of quantitative measurement, from capital resources to relevant total assets, will have a significant effect on the proportionality level of BIPRU firms. However, the switch to a three year average, as opposed to relying solely on the last accounting reference date, should result in a calculation which is a better reflection of the firm’s overall size and business operations than was previously the case.

Third country BIPRU firms

For a third country BIPRU firm (in summary, a firm which would have been a BIPRU firm had its head office not been outside the EEA), its relevant total assets (that is the total assets of the firm that cover the activities of its UK branch) on the last relevant date is currently the quantitative measurement used to determine its proportionality tier.  There are two changes under the guidance:

  • the relevant total asset amount will be determined by calculating an average over the last three calendar years; and
  • the relevant total asset monetary thresholds (as set out in the proportionality level table above) will increase from those currently used for determining the proportionality tiers.  The increase in the monetary thresholds should result in fewer firms falling within the top two proportionality levels than is the case under the current proportionality tier system.

Solo firms, group firms and individual guidance

  • Solo remuneration firms - For those firms which do not form part of a group which contains on or more other in-scope firm, its proportionality level will depend on its individual characteristics.
  • Group remuneration firms - For those firms which are a part of a group in which two or more firms are in-scope, each firm should adopt the highest proportionality level among the group firms (subject to individual guidance).

The FSA acknowledges that the proportionality levels do not provide comprehensive guidance on how proportionality rules apply to particular firms, and firms need to consider the application of the rules to their individual circumstances.

Disapplication of certain remuneration principles

For those firms in Level Three, it will normally be appropriate to disapply the following rules:

  • Awards in equity-instruments
  • Deferrals
  • Performance adjustment (malus)
  • Establishment of Remuneration Committee - the FSA's view is that it is desirable for a remuneration committee to be established and expect larger Level Three firms to do so. However, it accepts that it may be appropriate for the firm’s governing body to act as the remuneration committee in certain circumstances. (This is in line with previous guidance in respect of tier 3 and tier 4 firms).
  • Ratio between fixed and variable remuneration - helpfully, the FSA has confirmed that it may also be appropriate for limited licence firms and limited activity firms are able to dis-apply the requirement to set a ratio between fixed and variable components of total remuneration if appropriate.

Pillar 3 Disclosures

The guidance contains a table at Appendix 2, setting out the FSA’s expectations in respect of disclosures under Pillar 3 by BIPRU firms.

All BIPRU firms will be required to produce information concerning the decision making processes used for determining their remuneration policy and structures, as well as aggregate quantitative information on remuneration, broken down by senior management and risk takers.

For those firms in Level One, they will also be required to provide details of new sign-on and severance payments made during the financial year, and the number of beneficiaries of such payments, as well as details of the highest severance award made to a single person that financial year.