The Prudential Regulatory Authority has produced a paper which marks a step change in “clawback” in the UK.

It actively proposes for the first time that key bank employees in the large banks currently caught by the toughest provisions of the Remuneration Code would have to return bonuses or other variable pay in the event of personal or corporate underperformance in certain cases.  In contrast, clawback rules under both UK regulatory and institutional investor guidelines have so far just required banks to reduce or forfeit executive bonuses or awards which have not yet paid out (so called “unvested” awards), but have not sought to recoup amounts paid out.

The PRA has produced this paper in the light of prevailing political and media opinion which continues to favour tougher rules which delay rewards being received and require clawback of any rewards retrospectively shown not to have been earned. CRD IV last year also moved the debate forward requiring additional consideration to be given by firms to clawback, and the PRA also produced a paper setting out its expectations on how clawback of unvested awards should be implemented reflecting the increased regulatory interest in this, though the FCA has not published as much material on this. Click here to read the PRA’s paper last year on clawback of unvested remuneration.

The PRA suggests that the conditions in which an employee could be made to repay amounts are the same as where unvested awards can currently be forfeited or reduced (though it invites comment on whether they should be the same) are:

  • There is reasonable evidence of employee misbehaviour or material error,
  • The firm or relevant business unit suffers a material downturn in its financial performance, or
  • The firm or relevant business unit suffers a material failure of risk management.

The proposed regime is to come into place on 1 January 2015, but, controversially, there will be no grandfathering for existing awards which vest after that date (or for events which cause clawback which have occurred before that date), and so the regime is in effect introduced retrospectively. Payouts will have to be at risk for up to six years after payment has occurred. However, there will not be compulsory clawback in any case: only employees (or former employees) who are “culpable” or have shown or are responsible for management or risk failings would be affected.

Other initial comments are:

Who is affected? This will only affect Code Staff, i.e. key and very well-paid employees in large banks, which are caught in Levels 1 and 2 (though the scope of employees to be caught by Remuneration Code rules is increasing – click here to see our previous Law-Now on this). It will not affect smaller banks, others caught by CRD IV or AIFMs who are currently grappling with implementation of the AIFM Remuneration Code and where employment may for relevant people be more attractive without the fear of repayment hanging over them. Nonetheless, the trend is only one way in this area and in due course they and listed companies will no doubt come under increasing pressure to copy these provisions, at least where there is personal culpability.

What will this apply to? The proposals only apply to variable pay which has vested, although existing rules on clawback will continue to apply as well. Fixed pay (salary and similar arrangements) is not covered by these proposals, which makes fixed pay more attractive and may indeed lead to even greater pay inflation in time as individuals look to keep short-term pay at a constant value.

When will this take effect? Awards (including existing awards) will need to be revised by the end of this year (which raises interesting issues for non-calendar year end companies), and the issue of whether compensation for this is permitted will be an interesting one. While it is likely that these proposals will not be automatically unfair as a matter of UK law, where firms are required to implement them in respect of their overseas Code Staff, local employment law may not be so supportive. Other EU countries are thinking about similar proposals, but the UK will have one of the toughest regimes if this is implemented.

What is the tax treatment of clawback? No proposals have been announced to address the UK tax system which at the moment is unclear about whether tax relief is available for amounts which have to be repaid (there is a case currently being fought on this). The UK’s recent changes to partnership taxation have been helpful for LLPs caught by the AIFMD deferral rules and so there is a precedent for some kind of assistance, but the idea of the UK tax system mitigating the effect of clawback may be politically too difficult to implement.

What next? The PRA is later this year going to consult on delaying vesting periods further, and the 6 year clawback period may well be on top of this. If there were therefore a ten year delayed vesting period (and the implication from a recent PRA speech is that it would prefer vesting to be at the end of that 10 year period rather than the beginning), there would then, potentially, at its most extreme, be a 16 year period while remuneration is at risk.

Click here to read the PRA’s recent paper on this.

The proposals are open for comment until 13 May 2014.