Although approximately 2,500 financial services firms are caught by the Remuneration Code, a number of its key features only apply to larger and more complex firms.

The FSA's approach to date when categorising firms for this purpose has been to divide relevant firms into four tiers.

Firms in tiers 1 and 2 have the most onerous obligations. Firms in tiers 3 and 4 are not required to adopt many of the Remuneration Code's toughest structural requirements for pay.  Categorisation is also relevant to the amount of public disclosure required, as well as the information which must be privately submitted to the FSA and the level of general FSA supervision. However, there is not a great deal of practical difference between falling into tiers 3 and 4.

In this Law-Now, we set out by way of reminder the current position and then the proposed changes.

Current position

To determine which tier a firm falls into, UK BIPRU firms are judged on the basis of their activities as well as their capital resources (where relevant) at the most recent accounting date. Third country BIPRU firms are also assessed on their activities but their financial test (where relevant) looks at the relevant total assets related to the branch's UK activities rather than their capital resources.

In more detail, the current position regarding proportionality is as follows:

  • BIPRU limited licence or limited activity firms fall within tier 4. This accounts for the vast majority of firms caught by the Remuneration Code. Of the remainder:
    • UK banks and building societies are in tier 1 if they have capital resources exceeding £1 billion, as are BIPRU 730k firms that are full scope BIPRU investment firms if they have capital resources exceeding £750 million;
    • UK banks and building societies are in tier 2 if they have capital resources of between £50 million and £1 billion, as are BIPRU 730k firms that are full scope BIPRU investment firms if they have capital resources of between £100 million and £750 million; and
    • Any other UK bank, building society or full scope BIPRU investment firm falls within tier 3.
  • Third country BIPRU firms which are limited licence or limited activity firms also fall within tier 4. Again, this accounts for the vast majority of relevant non-UK firms. Other third country BIPRU firms are in tier one if they have relevant total assets for their UK branch exceeding £25 billion, tier 2 if they have relevant total assets between £2 billion and £25 billion and tier 3 in other cases.
  • The position for groups with more one than one firm caught by the Remuneration Code is more complicated. Here the starting point is that all firms in the group fall within the most onerous tier which applies to any member of the group, a so-called levelling up approach, but concessions can be obtained from the FSA.

Proposed changes

The FSA is proposing to simplify the position as follows:

  • It proposes that the financial tests for both BIPRU and third country BIPRU firms be the same, looking at relevant total assets rather than capital resources and a three year historic average will also be used instead of the most recent position which is currently used.  In the case of a non-UK firm, this will continue to look at the UK branch's position. 
  • "Tiers" are being renamed "levels" and tier 4 is now being abolished as a separate tier with members of tier 4 now effectively becoming level 3 members.

However, the key change is that financial limits will now increase significantly. 

In the new regime, UK banks, building societies and BIPRU 730k firms that are full scope BIPRU investment firms will be in level 1 if their average relevant total assets exceed £50 billion and level 2 if their average relevant total assets are between £50 billion and £15 billion. Other UK banks, building societies and full scope BIPRU investment firms will join all limited licence and limited activity firms in level 3. Non-UK firms will value their relevant total assets by reference to their UK branch as is currently the case.

Some firms previously within tier 2 will now be in level 3 which they will generally welcome as this distinction is a significant one because it marks the dividing line between compulsory deferral into shares etc. and more intrusive supervision of pay. It is possible, however, that the change in financial limit tests may cause some firms to move to a more onerous category which will be less welcome for them.

The group test remains as before.

The FSA has not provided any detailed press release on why it is making these changes but a cover announcement refers to a more risk-based approach and a desire to simplify the structure of its categorisation system. 

The FSA is consulting on these proposals until 6 September 2012.  No implementation date is given, but our understanding is that it may be as early as September 2012.

To read the consultation paper, click here.