Welcome to the latest edition of our Employee Incentives Update. The Update contains a round-up of key developments in this area during December 2015.
- European Banking Authority (EBA) issues its opinion on the application of the proportionality principle (Opinion) and publishes its final guidelines on sound remuneration policies (Guidelines)
- HMRC updates its guidance on Share Incentive Plans (SIPs) in the Tax Advantaged Share Scheme User Manual
- The High Court considers whether the exercise of contractual discretion by an employer in respect of a bonus award is subject to a reasonableness test
- Pensions and Lifetime Savings Association (formerly the NAPF) publishes revised Corporate Governance Policy and Voting Guidelines (Guidelines)
European Banking Authority (EBA) issues opinion on the application of the proportionality principle and publishes final guidelines on sound remuneration policies
- The Opinion
There has been huge disparity between how the EU member states have applied the proportionality principle in practice. The EBA considers that this has led to an uneven playing field between institutions across the EU. The Opinion states that legislative action should be taken in order to clarify the proportionality principle and to ensure that the CRD remuneration requirements are applied consistently across the EU.
Helpfully, the Opinion states that "the EBA believes that a proposal for a legislative change should be considered to explicitly support specific exemptions on the application of deferral arrangements and pay out of instruments, where certain criteria are met" and, in particular, "the disapplication of these requirements should be possible for small and non-complex institutions and for staff that receives only a small amount of variable remuneration". This will come as a relief to many UK institutions that currently rely on the proportionality principle to disapply specific requirements of the applicable UK Remuneration Code.
However, the Opinion also clarifies that the application of the ‘bonus cap' should not be subject to any exemption – in contrast, currently the PRA and the FCA guidance on proportionality states that it may be appropriate for PRA-designated proportionality level three investment firms, PRA-designated limited licence firms or PRA-designated limited activity investment firms, IFPRU full scope investment firms, IFPRU limited licence investment firms and IFPRU limited activity investment firms to disapply the specific ratio of variable pay to fixed pay
- The Guidelines
The final Guidelines include a number of changes from the draft published in March 2015, which will be welcomed by many firms. The Guidelines run to almost 90 pages (excluding the cost-benefit analysis and consultation feed-back set out in the appendices); the key issues include:
- A statement by the EBA that the Guidelines "ensure that institutions calculate correctly and consistently the so called ‘bonus cap' by setting out specific criteria for mapping all remuneration components into either fixed or variable pay and detailing how specific remuneration elements such as allowances, sign-on bonuses, retention bonuses and severance pay are to be recognised over time".
- Broadly, the Guidelines now provide that long-term incentives can be treated as variable remuneration for the performance year in respect of which they are awarded, rather than the year in which they vest.
- The Guidelines make it clear that firms will be required to seek approval from their ultimate public shareholder (rather than just from their immediate shareholder within a group structure) in order to allow the bonus cap to be extended from a ratio of 1:1 to 1:2 fixed to variable.
- The Guidelines clarify the process for identifying those categories of staff to whom the specific remuneration provisions of the Capital Requirements Directive apply (with additional requirements included around the governance of identifying material risk takers (MRTs) as well as the process for disapplication for specific MRTs).
- Guidance is also provided on the application of deferral arrangements and the pay-out instruments ensuring that variable remuneration is aligned with the institution's risk profile in the long-term and that ex-post risk adjustments can be applied as appropriate.
The EBA Guidelines will apply to competent authorities across the EU, as well as to institutions on a solo and consolidated basis, including all subsidiaries which are not subject to the CRD IV framework from 1 January 2017 (rather than 1 January 2016 as originally proposed). The next step in the UK will be for the PRA and FCA to consult on changes to the PRA Rulebook and to SYSC 19A and 19D. We are expecting these consultations to be issued in the Spring.
Despite the current legal uncertainty around the issue of proportionality, the Guidelines nonetheless state that the bonus cap should apply to all MRTs at all instiutions. However, as the Guidelines apply on a "comply or explain" basis, it is open for the PRA and FCA to state that they do not intend to comply with that part of the Guidelines that excludes the bonus cap from the proportionality principle. Therefore, until such time as the CRD itself is amended to make it clear that the bonus cap applies to all MRTs at all instiutions (when compliance will be compulsory), if the PRA and FCA wish to continue with their current proportionality regime in respect of the bonus cap (as set out in the Opinion section above) they would need to to indicate to the EBA that they do not intend to comply with that part of the Guidelines pending legal clarification.
A copy of the Opinion and the Guidelines can be found here.
SIPs – HMRC updates Tax Advantaged Share Scheme User Manual
The legislation governing SIPs states that the SIP trust deed must include a requirement that trustees give SIP participants notice "as soon as practicable" after the award of free, matching or partnership shares, or after the acquisition of dividend shares.
HMRC has now updated the Tax Advantaged Share Scheme User Manual to included guidance on how it interprets this requirement (this formalises HMRC's position as previously set out in the HMRC Employment-related Securities Bulletin issued in May 2012). It confirms that annual or six-monthly notification is likely to be consistent with the requirement to give notice "as soon as practicable" whereas intervals greater than 12 months are unlikely to be acceptable. In addition, the SIP trust deed can qualify the statutory wording to specify that notification will be given less frequently than monthly - although, the trust deed must not omit (or substitute) the statutory wording entirely, as this will not be consistent with the legislation.
A copy of the relevant page of the Manual can be found here.
Is the exercise of contractual discretion by an employer subject to a reasonableness test?
A claim by a financial trader that his employer was in breach of contract when it awarded him a lower discretionary bonus than colleagues and, in particular, that his employer acted unreasonably in doing so has been rejected by the High Court, allowing an application for summary judgment on the grounds that the case had no real prospect of succeeding (Paturel v DB Services (UK) Ltd  EWHC 3659).
It had been well established that the courts would not interfere in an exercise of contractual discretion by an employer if the employer has exercised its discretion honestly and in good faith and in a way that was not arbitrary, capricious or irrational. However, Braganza v BP Shipping Ltd  UKSC 17 (where the Supreme Court applied the public law concept of "Wednesbury unreasonableness" in an employment context) appeared to mark a more interventionist approach by the court to an employer's decision-making process.
The Wednesbury unreasonableness test is well established in cases of judicial review and will apply, broadly, if the action was so unreasonable that no reasonable decision-maker could ever have come to it and/or the decision-maker took into account irrelevant matters and/or failed to consider relevant matters in reaching its decision.
At the time of the Braganza decision there was much speculation as to whether this case would have a broader impact on the ability of an employee to challenge the exercise of contractual discretion by his/her employer. However, in this case the High Court expressed caution about the import of public law concepts into employment law. It noted that the fundamental basis of public law meant that public authorities only had the powers conferred by law, private employers and businesses would not necessarily have the same duties to act in the public interest.
Pensions and Lifetime Savings Association (formerly the NAPF) publishes revised Guidelines
The Pensions and Lifetime Savings Association (PLSA) has updated its Guidelines for 2016 AGM season
The changes do not impact significantly on remuneration, although as well as the existing requirement for companies to articulate how their pay policies meet the PLSA's "Remuneration principles for building and reinforcing long-term success" in a manner that is most appropriate to them, the guidelines now provide that the PLSA also expects remuneration committees to take ownership of the design and implementation of remuneration policy. In addition, companies should be mindful of the negative impact of ever widening pay gaps.
The Guidelines continue to list the circumstances in which PLSA members will vote against a shareholder resolution to approve the directors' remuneration policy and /or a resolution to approve the directors' remuneration report.
A copy of the revised Guidelines can be found here.