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Hello and welcome to our latest employment video. My name is Paul Griffin and I’m Head of the Norton Rose Fulbright Employment team in London. 

Over the past few years, a number of wide-ranging reforms regulating the financial services industry have been implemented, in particular relating to pay and bonuses paid by banks, building societies and certain investment firms. In today’s video I’m going to look at the latest developments in this area regarding the payment of bonuses.

Don’t forget to have a go at answering our quiz question at the end of the video for the chance to win a bottle of champagne.

Bonus caps

First of all I’m going to look at the subject of bonus caps.

Recent reforms implemented by the EU relating to the financial services industry are set out in the CRD IV Directive and Capital Requirements Regulation of 2013, which are known together as CRD IV.

Member states were required to implement CRD IV, which contains various provisions relating to remuneration and bonuses paid by banks, building societies and certain investment businesses, by the 1st of January 2014.

In particular the CRD IV reforms require financial institutions to impose a cap on bonuses of one year’s basic pay, except where the regulators in the member states permit this to rise to two years’ basic salary with shareholders’ consent.

The relevant regulators in the UK are the PRA – the Prudential Regulation Authority – and the FCA – the Financial Conduct Authority. So far as the UK is concerned, the PRA and the FCA have confirmed that they will allow the cap on bonuses to be increased to two year’s basic pay with shareholder consent.

The first bonuses to be affected by this new rule are those to be paid this year in respect of performance in 2014. This will affect not only new contracts entered into since the implementation date of 1st January 2014, but also those contracts in place before that date.

In September 2013, the UK Government announced the launch of a legal challenge to the new bonus cap provisions in the European Court of Justice, stating that they considered the legislation was not fit for purpose and would not improve stability across the banking system.

However, in November last year, the Government announced that it would no longer be pursuing its challenge. This followed publication of an Advocate General’s opinion that all grounds for the challenge should be rejected and that the ECJ should dismiss the action.

As a result the new provisions on bonus caps stand, and will impact bonuses paid by the relevant firms this year.

Bonus clawback

The second area I’m going to look at is bonus clawback. As you’ll be aware, this is where an employer claims repayment of a bonus which has already been paid in certain circumstances.

By way of background, in March last year the PRA issued a consultation paper on bonus clawback. It set out its proposals to require all PRA-authorised firms to amend their employment contracts to ensure that bonuses which have been paid can be clawed back from employees in certain circumstances. These were:

  • firstly, where there is reasonable evidence of misbehaviour or material error by the employee;
  • or, secondly, where the firm, or relevant part of the firm, suffers a material downturn in its financial performance;
  • or, finally, where the firm or relevant part suffers a material failure of risk management.

The British Bankers’ Association criticised some of these proposals as unfair and potentially unenforceable. In particular they argued that amending employment contracts retrospectively would be in breach of employment law in many countries in which UK banks operate. In addition, they considered that bonus clawback would discourage results-based pay, which would result in increased pay overall.

In July last year the PRA issued its final policy statement on the matter. As a result, PRA-authorised firms must ensure that bonuses are subject to clawback for a period of up to 7 years after vesting.

However, this clawback requirement will only apply in relation to bonuses awarded on or after the 1st of January this year. It won’t apply to past bonuses.

In addition, the grounds for clawback have narrowed – firms won’t have to claw back bonuses in the event of a material downturn in financial performance – only on the other grounds of employee misbehaviour or material error – or where the firm has suffered a material failure of risk management.

From the 1st of January this year, PRA-authorised firms will have to amend their employment contracts so that they have the right to claw back bonuses from individual employees in accordance with these new rules.