On 18 March 2009, the FSA published Consultation Paper 09/10: Reforming remuneration practices in financial services (CP09/10). In CP09/10 the FSA provides an update on its proposals to incorporate the Code of practice on remuneration policies (the Code) into its Handbook and to apply it to large banks, building societies and broker dealers.

A draft version of the Code was first published on 26 February 2009. Significant revisions have since been made to the Code, and the new version is set out in Annex 2 of CP09/10.

The FSA is encouraging firms to use the Code as a benchmark to compare their remuneration practices.  

Proposals  

The FSA proposes that the Code’s general requirement (A firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management) should become a Handbook rule.  

The FSA also proposes that the remaining ten specific principles should be put into the Handbook as “evidential provisions” or, where appropriate, as guidance to support the general requirement. Contravention of an evidential provision may be relied on by the FSA as tending to establish a contravention of the underlying rule. CP09/10 provides further guidance on how firms can comply with these in Chapter 5, Annex 2 and Appendix 1.  

The Senior Management Arrangements, Systems and Controls (Remuneration Code) Instrument 2009 will implement the Code into the Handbook. A draft of this instrument is set out in Appendix 1.  

Who does the Code apply to?

  • The FSA states that the Code would apply to large banks, building societies and broker dealers, defined as:
    • FSA-regulated banks and building societies which meet either of these criteria:
    • total regulatory capital in the UK banking entities in excess of £1 billion; or
    • are part of an international financial group whose regulatory capital is in excess of £20 billion or the equivalent amount in another currency.
  • FSA-regulated BIPRU 730k firms which meet either of these criteria:
    • total regulatory capital in the UK authorised entity is in excess of £750 million or its equivalent amount in a foreign currency; or
    • are part of a financial group (UK or international) whose regulatory capital is in excess of £5 billion or the equivalent amount in another currency.

Therefore, UK branches of EEA firms would be excluded, but overseas branches of UK firms (both EEA and non-EEA) would be caught.

The FSA is inviting discussion on whether the Code should be applied to all other FSA-authorised firms, in the same way as proposed for banks, building societies and large broker dealers.

Implementation of the Code

The FSA suggests that the Code will be implemented in a principles and risk-based way. This would mean that every principle would not be applied in the same way to every firm. Principles would be applied in light of the size and type of regulated firm.  

Levels of remuneration

The FSA states that whilst it is concerned with remuneration policies and practices, setting levels of remuneration is a matter for firms’ boards and shareholders. The intention of the Code is to increase understanding of the link between remuneration policies and risk, and to encourage firms to implement better practices. The Code will not prevent firms awarding employees large remuneration packages if they can be justified by reference to the success of the firm, and if they have been adjusted appropriately for risk.  

Supervisory programmes

The FSA intends to take steps to ensure that the potential risks posed by inappropriate remuneration policies of authorised firms are examined closely within supervisory programmes. The FSA intends to make follow-up visits to a number of major banks and broker dealers during April and May 2009 in order to review their progress in aligning remuneration and risk management. It will also incorporate remuneration risk into ARROW programmes, and into ICAAPS and SREPs as part of the Pillar 2 process. These steps do not require consultation, and will be put into practice as soon as possible.  

CP09/10 warns that all firms should expect greater supervisory focus and potential supervisory action if their remuneration practices pose unacceptable risks. However, the primary focus is to be on high impact UK-incorporated banks and broker dealers.  

Next steps

There will be a two month consultation period on implementing the Code for the larger banks and broker dealers, and a three month feedback period for the possibility of extending the Code to other regulated firms. It is intended that the new rules will be published, as well as feedback, in early August 2009.  

The FSA intends to bring the Code into effect from early November, in time for firms’ 2009 remuneration reviews.  

In implementing the proposals, the FSA intends to consider the views of international bodies to ensure consistent implementation. International cooperation on principles relating to remuneration is essential to avoid regulatory arbitrage. International bodies such as the FSF and CEBS have been preparing high level principles relating to remuneration and the FSA, as a participant in their working groups, has been working closely with them.