The new FSA Remuneration Code came into effect on 1 January 2011 and applies to all banks and building societies, firms subject to the Capital Adequacy Directive (CAD) and UK branches of firms headquartered outside the EEA. It replaces the previous code which only applied to the 26 largest UK banks, building societies and broker-dealers. Over 2,500 firms will be subject to the new Code and those which fall within its scope for the first time must comply by 1 July 2011.
Pay in the EU is now more restricted than the rest of the world, with the UK leading the pack. This could make recruitment and retention of top talent problematic for UK banks. Those operating in Asia, South America and the USA will be at a competitive disadvantage, particularly as there are no restrictions on pay in the USA.
Scope of the Code
The Code applies to all banks and building societies, CAD firms and UK branches of firms headquartered outside the EEA. CAD firms include investment banks, UCITS investment firms, most asset managers, some brokers and some corporate finance and VC firms. Many asset managers will escape the Code because they are “exempt CAD” or “MiFID exempt” firms. The Code also applies to all branches of a firm in any jurisdiction in the world and all members of a “UK consolidation group” and a “non-EEA sub-group.”
Remuneration at a glance
You should apply the following principles in the packages of staff to whom the Code applies:
- Individual, business unit and firm-wide performance must be taken into account. At least 40 per cent of any bonus must be deferred over at least three years and for staff whose total remuneration exceeds £500,000 the deferral rate rises to 60 per cent.
- At least 50 per cent of any bonus must be paid in shares, share-linked instruments or other equivalent non-cash instruments. This should be applied equally to the deferred and undeferred portions of the bonus. Guaranteed bonuses must be exceptional and limited to new hires for the first year of service.
- Unvested, deferred bonuses must be reduced if the firm or business unit suffers a downturn in its financial performance or a failure of risk management. The same applies in cases of misbehaviour or material error on the part of the employee.
A proportionate approach
The Code identifies four tiers of firm. For those in Tiers 1/2, all rules in the Code apply and Tier 1 firms are subject to an annual FSA review. Most of the rules in the Code do not apply to firms in Tiers 3/4.
Code Staff are defined as those who have a material impact on the firm’s risk profile, including risk-takers, staff who perform a “significant influence function”, senior managers, staff whose total pay takes them into the same bracket as senior management and risk-takers, heads of support and control functions, including compliance, legal and investment research. The category could also include risk-takers and SIFs in overseas parents.
Code Staff whose total pay is less than £500,000 and for whom no more than 33 per cent of that total is bonus will not be subject to the rules on bonuses (including deferral, payment in kind and guaranteed bonuses). For example, the Code will not apply to an employee earning £100,000 (including pension and benefits) with a bonus of £25,000.
Potential employment disputes
Many existing employment contracts do comply with the new Code, so firms are required to establish appropriate contracts by the end of 2011. The FSA can treat as void any bonus arrangements agreed after 1 January 2011 which are not Code-compliant – an issue that could lead to disputes between firms and staff.
Unfortunately, the FSA has provided little detail about whether the Code will apply to carried interest and how certain vehicles (such as LLPs and unlisted companies) can meaningfully pay Code Staff in membership interests and unlisted shares which present valuation difficulties. The FSA is continuing to consult with industry bodies, so further details will emerge.