The PRA has published a Policy Statement, which includes feedback on the responses it received to its summer consultation on its proposed implementation of the remuneration provisions of the revised Capital Requirements Directive (referred to as CRD5), which will apply in the UK and the EU from 29 December 2020.
As more fully set out in in our previous briefing, the PRA and FCA’s implementation of CRD5 will impact on the remuneration provisions which apply to banks, building societies and a limited number of large investment firms, for remuneration paid in respect of performance years starting on or after 29 December 2020; so, for the majority of UK banks, this will mean that the new rules will apply from 1 January 2021. The changes will be particularly significant for banks that currently fall within Proportionality Level Three.
As expected, the Policy Statement largely affirms the proposals made by the PRA and FCA in the summer, with some minor concessions. There is some helpful clarity on how the requirements should be complied with following the end of the Brexit transitional period, but a few points of uncertainty remain outstanding.
Reminder of the main CRD5 changes
The key changes that will apply from the 2021 performance year onwards are:
- the bonus cap, and malus and clawback will apply to all banks and CRD investment firms irrespective of size;
- deferral and payment in instruments will apply subject to a revised proportionality threshold, which is likely to extend the provisions to a number of previously Level 3 banks and CRD investment firms;
- the minimum deferral period is to increase to four years;
- the ‘de minimis’ provisions which apply to individuals is to be limited to employees earning bonuses of less than £44,000, which represent no more than one-third of their total annual remuneration; and
- new UK-specific categories of material risk takers to be subject to gold-plating in excess of the CRD5 requirements: “Higher Paid Material Risk Takers” with total annual remuneration of £500,000 where variable remuneration represents more than one-third of that amount and those performing an SMCR “senior management function”.
Proportionality and complexity introduced by the new requirements
Many of the responses to the Consultation related to the complexity being introduced by the new rules. Respondents raised concerns around the additional costs and administrative burden of implementing and operating incentive arrangements which are compliant with multiple deferral and clawback requirements for different categories of MRT. Other respondents raised level playing field and competition concerns in relation to Asset Management subsidiaries and EEA-based branches being required to comply with the bonus cap and the PRA’s gold-plating respectively.
As expected, the PRA appears to have limited sympathy for these concerns. The Policy Statement suggests that where administering incentive arrangements would be overly complex due to a firm having numerous categories of staff, the firm is welcome to over-comply and apply the strictest obligations to all affected staff. Equally, the PRA’s view is that Asset Management subsidiaries and EEA-based branches can have an impact on the risk profile of the consolidated group, and there is therefore no justification for excluding them from the rules.
Part-year MRTs and the De Minimis Exemptions
The PRA have softened the part-year MRT proposals made in the summer, by allowing the new individual de minimis exception to be applied to part-year MRTs without requiring time pro-rating. Under the de minimis exception, deferral and payment in instruments do not have to be applied to MRTs with variable remuneration of less than £44,000, where that amount represents no more than a third of total remuneration. As a result, if an individual becomes an MRT for only a few months in a performance year the firm may not need to apply these requirements to them for that period. This concession has been made in recognition of concerns regarding hiring locum / fixed-term MRTs and making promotions during a performance year.
Higher Paid MRTs and Gold-Plating
The revised rulebook and guidance retains the concept of Higher Paid MRTs introduced in the summer; these individuals will continue to be subject to the PRA’s more onerous requirements, rather than the minimum standards applicable under CRD5. The definition of a Higher Paid MRT is very similar to the existing CRD4 individual de minimis test used by the PRA to disapply pay-out process rules. However, as the new definition is used to apply more onerous requirements, whilst the existing test is used to disapply requirements, significantly fewer MRTs should be captured by the new definition:
- The existing test allows for disapplication where:
- variable remuneration represents no more than one-third of total remuneration; and
- total remuneration is no more than £500k.
- Under the new test, an individual will be a Higher Paid MRT (such that the additional provisions apply), only if:
- variable remuneration represents at least one-third of total remuneration; and
- total remuneration is at least £500k.
By way of example, if an employee had total pay of £400k, of which £200k was variable, they would not meet the test under the current CRD4 regime for disapplication of the pay-out process rules (as their variable pay represents more than one-third of total pay). However, they would seemingly not be treated as a Higher Paid MRT under the new CRD5 regime, as their total pay is less than £500k. It is unclear if the PRA intended to make this distinction (indeed the phrasing in the Policy Statement appears to indicate that they did not, notwithstanding the clear drafting in the rulebook and supervisory statement). The PRA may clarify this prior to the new rules coming into effect.
Application of Clawback for Level 3 Firms
The PRA’s revisions to the rulebook dealing with the application of clawback to Level 3 firms (or “small CRR firms” using the new terminology) may need to be further clarified. The new rules specifically state which clawback triggers should apply to Level 3 firms, but by omission fail to state the period for which clawback must be operable. Rather than leaving individual firms to determine their own clawback terms, it is likely that, in line with the requirements which will apply to non-deferred remuneration paid by other firms, the PRA intends for Level 3 firms to apply clawback for at least one year following the grant of variable remuneration (and so clawback may not be required in relation to any variable remuneration paid by a Level 3 firm which is deferred for at least one year), but this needs to be clarified. The PRA may rectify this omission, and provide further guidance, before the revised rules come into force on 29 December.
The Policy Statement helpfully clarifies how firms should convert other currencies into sterling for compliance purposes. Firms should either use their internal exchange rate, or the Bank of England’s daily exchange rate averaged over the relevant performance year. Whilst not expressly stated, it appears the PRA’s preference is for firms to use the performance year average rate, to smooth any substantial foreign exchange rate fluctuations and to better mirror the remuneration round. Using a 12 month averaged rate is a departure from the current EBA guidelines, which suggest using a monthly rate for conversion purposes.
In addition to the above specific points, the Policy Statement also confirms that:
- those MRTs who earn more than £440k and more than the average remuneration of the management body and senior management will only be subject to the minimum four year deferral requirement, rather than the five years that was proposed in the summer; and
- no de minimis will be applied to the buy-out rules, notwithstanding that this may be challenging for smaller firms who had suggested a carve-out for small awards.
The PRA intends to publish updated template RPS tables and is considering whether its current approach to data collection for benchmarking and high earner reporting remains beneficial on a single country level.
The PRA will consider whether any further updates to the remuneration supervisory statement are required once the EBA’s current consultation on revisions to its guidelines on sound remuneration policies has completed (on which, see our briefing here). For now, firms should fully comply with UK requirements and, to the extent possible, the EBA’s 2015 guidelines.
The Policy Statement and revised rules and guidance are available here. The PRA should publish a final binding version of the rules on 28 December, which will come into effect from 29 December.
In the meantime, all firms should be reviewing their MRT lists and broader remuneration practices to ensure they will be compliant with the new regime.