Following completion of its consultation on proposals to implement a code of practice on remuneration policies, the FSA has published the responses received and the decisions that it has taken on the application of the Code. The full response can be found here.
Scope of the new rule
In a change from the terms of the consultation (see our previous briefing available here), the new code will not now apply to non-UK firms unless they are part of a group that contains one of the larger UK banks, building societies or firms. As a result, the new Code will apply to only around 26 firms rather than the 47 under the proposals set out in the consultation. Although the new rule now applies only to the largest banks, building societies and broker dealers in the UK, the principles will be of interest to all FSA regulated entities as the FSA has stated that "the proposals we have set out indicate our thinking on what we view as good practice".
A further announcement is to be made in October in relation to extending the Code generally to FSA regulated firms.
The new code (which will now apply from 1 January 2010, rather than 6 November 2009 as previously proposed) is designed to achieve two objectives: firstly, that boards focus more closely on ensuring that the total amount distributed by a firm is consistent with good risk management and sustainability; and, secondly, that individual compensation practices provide the right incentives. Non-compliant firms could face enforcement action or ultimately be forced to hold additional capital should their remuneration practices be found not to avoid risky practices.
New rule adopted in FSA Handbook
The adopted new rule on remuneration is unchanged from that on which the FSA consulted. It states that "A firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management."
Changes to evidential provisions
Whilst the rule remains unchanged, there have been a number of variations made to the evidential provisions which accompany the new rule. These were made in order to take into account the responses to the consultation, and in particular the concern with the perceived "one size fits all" approach, and also more recent developments relating to the progress in the international implementation of remuneration principles.
In particular, the more prescriptive provisions which were contained in evidential provisions 8, 9 and 10 (fully flexible bonus policies, deferment of the majority of any significant bonus, and linking deferred elements to the firm's future performance) have been replaced with a single new evidential provision (principle 8) headed "Remuneration structures" which simply states that "A firm should ensure that the structure of remuneration for a person to whom this evidential provision applies is consistent with and promotes effective risk management." The terms of the previous evidential provisions remain, however, but as guidance to this new principle. This should therefore give firms more flexibility in assessing whether their remuneration structures meet the new requirements.
As was indicated in the most recent "Dear CEO letter", the guidance accompanying principle 8 now includes a reference to guaranteed bonuses. The FSA considers that guaranteed bonuses which run for a period of more than one year and similar payments in addition to salary are unlikely to be consistent with effective risk management. This is not an absolute prohibition, but firms will need to be able to justify such arrangements when questioned by the FSA.
In relation to the supervision of the new rule, the FSA has explained in the guidance to principle 1 that there may be a distinction between the content of the "statement on remuneration policy" which will be required by the FSA, and what it considers would be good practice for the firm to disclose publicly to its shareholders and other stakeholders. This addresses a concern which may have troubled those caught by the new rule in relation to the issue of commercial confidentiality.
The FSA's policy statement also gives clarity as to how it expects firms to implement the new rule, and in particular what should be in place by the new 1 January 2010 implementation date. Essentially, changes to policies and procedures should be fully in place by 1 January 2010, and changes to remuneration structures and contracts should be implemented with effect from 1 January 2010. Implementation of risk-adjustment techniques (principle 4) should take effect from 1 January 2010.
Where shareholder approval for changes to a firm’s remuneration policy is required, this approval should be sought at the earliest possible opportunity.
The FSA has requested that the firms within the scope should communicate their first remuneration policy statement to the FSA by the end of October this year, and the FSA has confirmed that it proposes to give further detail on the content of such statement directly to those firms affected.
In relation to the measurement of performance for long term incentive plans (principle 7), the FSA expects firms to be reviewing how well their long-term incentive plans take account future risks by 1 January 2010 (although full implementation of necessary changes as a result of such review will not be required by this date).
Where firms are able to unilaterally amend employment contracts/agreements, the FSA requires amendments to ensure compliance with the new rule to be effected by 31 March 2010. For other types of employment contract or agreement, the relevant amendments, or the termination of those arrangements, must be effected by 31 December 2010.