On 31 July 2020, the PRA issued consultation paper CP12/20 amending the remuneration part of the PRA Rulebook. Shortly after, on 3 August 2020, the FCA issued consultation paper CP20/14 amending its dual-regulated firms Remuneration Code (SYSC 19D) and relevant non-handbook guidance.

The changes to the PRA and FCA remuneration rules, as set out in the Consultation Papers, are required as a result of the latest iteration of the EU’s Capital Requirements Directive (CRD V) which must be transposed into UK law by 28 December 2020. As the Brexit transition period will not have ended by that date, the UK is required to implement CRD V domestically.

The proposed changes to the remuneration rules in the consultation papers will be of interest to “class 1 firms” and “class 1 minus firms” (i.e. investment firms that have dealing on own account and/or underwriting/firm placing permissions but do not meet the €30bn asset threshold for Class 1 firms). The types of firms that typically fall within these categories are:

  • credit institutions (banks and building societies);
  • PRA-designated investment firms (those designated for prudential regulation by the PRA);
  • third-country firms that carry out activities from a subsidiary in the UK that otherwise would be a credit institution or PRA- designated investment firm if they were a UK domestic firm; and
  • firms in the same group as at least one of the types of firm.

FCA-authorised investment firms (class 2 firms) will remain subject to the existing rules in the IFPRU Remuneration Code (SYSC 19A) or BIPRU Remuneration Code (SYSC 19B), as appropriate, until the new UK prudential regime for MiFID investment firms comes into effect in June 2021. This new regime will replace the IFPRU and BIPRU Remuneration Codes with a new remuneration code that will be based on the Investment Firms Regulation and Directive (IFR/IFD). We have previously commented on the new investment firm regime in our June article.

Overview of proposed changes

The proposed new rules will affect both who will be subject to the remuneration rules and also the way in which those rules apply to them.

In particular, the draft rules change the way in which proportionality applies to firms and individuals with the effect CRD that more firms and individuals will become subject to some or all of the remuneration rules for the first time. It is, however worth noting that the remuneration rules in CRD V are not materially different from the remuneration rules in the current CRD IV and so the Consultation Papers are not proposing radical changes to the substance of the regulatory framework.

Changes to proportionality

The current guidance on the application of proportionality allows firms with total assets below £15bn to disapply certain onerous remuneration structure rules, namely those requiring firms to apply deferral, payment in retained shares or other instruments, performance adjustment (malus and clawback) and a maximum ratio between fixed and variable pay (typically referred to as the bonus cap).

The existing proportionality guidance will be replaced by a new proportionality regime prescribed by CRD V and which covers both firms and individuals.

Firm-level proportionality

Under CRD V, firms with total assets equal to or less than €5bn can disapply requirements relating to deferral, payment in retained share or other instruments and holding and retention periods for discretionary pension benefits. However, importantly, the application of firm-level proportionality does not allow firms to disapply the requirements relating to performance adjustment and the bonus cap in respect of variable pay paid to “material risk takers” or “MRTs” (this concept is explained further below).

The €5bn asset threshold can be increased to €15bn by Member States - and the PRA and FCA propose to implement such an increase (which will be converted into a £13bn threshold under the proposed rules) - provided the relevant firm has:

  • no obligations, or is subject to simplified obligations, for recovery and resolution planning purposes;
  • a small trading book (i.e. traded business ≤ 5% total assets and < €50 million); and
  • traded derivatives positions ≤ 2% of its total on- and off-balance sheet assets, and the total value of its overall derivatives positions ≤ 5%.

Despite the proposed £13bn threshold being near the existing £15bn limit, it is important to bear in mind that the application of proportionality does not allow firms to disapply the rules relating to performance adjustment and the bonus cap. This means that a number of firms that have been able to avoid malus and clawback and the bonus cap will now have to apply such requirements for the first time.

Individual-level proportionality

Under existing rules, individuals whose variable pay is not more than 33% of total pay and whose total pay is not more than £500,000 (de minimis MRTs) do not have to apply the remuneration rules relating to deferral, payment in retained shares or other instruments, performance adjustment and the bonus cap.

However, under the new proportionality rules relating to individuals, only individuals with variable pay equal to or less than €50,000, and where such variable pay represents not more than one-third of total pay, are outside the scope of the remuneration rules. In addition to significantly lowering the threshold for de minimis MRTs, the new proportionality rules does not allow individuals to escape the rules on performance adjustment and the bonus cap which will apply to all MRTs.

Changes to remuneration rules

Deferral periods

The PRA and FCA intend to amend the minimum deferral periods in current rules to align them with those in CRD V. Currently, MRTs that are not de minimis MRTs are subject to minimum deferral periods of 7 years (for MRTs who perform a PRA-designated senior management function (SMF)) and 3 to 5 years for all other MRTs. De minimis MRTs do not have to apply deferral.

As the minimum deferral period under CRD V is 4 years for MRTs that are not members of the management body and senior management of firms, the Consultation Papers provide a new, more nuanced, deferral framework for MRTs which takes into account both the type of MRT and the total remuneration received. The table below sets out an overview of the minimum deferral periods as set out in current rules and what these will look like once the new rules come into effect.

Clawback periods

Although CRD V requires variable pay for MRTs to be subject to clawback, it does not prescribe the period during which clawback may be applied. Currently, the PRA and FCA require variable pay to be subject to clawback for a period of at least 7 years from the date of award (which may be extended to 10 years in certain circumstances). As this period applies from the date of award, it does not take into account the length of any deferral and retention periods (which in practice can mean a particularly long clawback period for variable pay which is not deferred).

Under the proposed new rules, the applicable clawback period will be determined by reference to the relevant deferral and retention periods (which in turn are determined by reference to the type of MRT and total remuneration received as set out above). As with the new deferral period, this results in a more nuanced approach.

For MRTs who receive total remuneration of £500,000 or below and whose variable pay is not subject to deferral, the PRA and FCA are proposing a minimum clawback period of one year which is equal to the applicable retention period. The table below sets out an overview of the minimum clawback periods as set out in current rules and what these will look like once the new rules come into force.

Minimum clawback periods may be extended to at least 10 years in certain circumstances

Payment in instruments

In line with CRD V, both regulators propose to permit firms whose shares are listed on a stock exchange to award variable pay in the form of share-linked instruments and equivalent non-cash instruments to satisfy the requirement that at least 50% of an MRT’s variable remuneration must be awarded in certain instruments. This aims to recognise that these instruments are as effective as shares in aligning the interests of the individual with those of the firm and that the use of such instruments can also achieve equivalent prudential benefits.

Gender neutral remuneration policies

CRD V requires firms’ remuneration policies to be “gender neutral”. It also requires there to be data collection on remuneration, including on the gender pay gap, and for that information to be used to benchmark remuneration trends and practices. HM Treasury is consulting on its proposed approach to transposing these requirements. The PRA will determine if further changes are needed in light of HM Treasury’s approach and, if necessary, intends to consult on any such changes in autumn 2020.

The FCA, on the other hand, propose to include a specific rule on gender neutrality in its Handbook and will require firms to ensure and be able to show that their remuneration policies and remuneration practices are gender neutral. The FCA also intends to include a guidance provision which reminds firms of their existing obligations as employers to ensure that their remuneration policies and practices do not discriminate against applicants and employees on the grounds of any of the protected characteristics under the 2010 Act. The aim of introducing such rules is to drive healthy purposeful cultures in firms, which includes developing an inclusive and diverse workplace. It will also support the FCA in supervising the extent to which firms are meeting these standards and holding them to account if they fail to do so.

Identification of MRTs

CRD V updates the basis for identifying certain categories of MRTs, specifying certain categories of staff whose professional activities have a material impact on the firm’s risk profile. The PRA and FCA therefore propose to replicate CRD V’s revised approach to identifying MRTs in the updated PRA Rulebook and Dual-regulated firms Remuneration Code. CRD V’s revised approach will also extend to MRTs in subsidiaries of third-country firms that are established in the UK.

The relevant rules will also refer to the EBA’s final draft regulatory technical standards (RTS) where certain terms and definitions are set out.

Next steps

In scope firms are required to apply the revised remuneration requirements to any remuneration awarded in relation to the first performance year starting after 29 December 2020. For remuneration awarded on or after 29 December 2020 in respect of earlier performance years, firms should continue to apply the existing rules.

Both consultations close on the 30 September.

The PRA intends to publish a second consultation in the Autumn on matters related to CRD V that are not covered by the PRA Consultation Paper (in particular those that will be implemented by HM Treasury), as well as amendments to the Capital Requirements Regulation under CRR II (Regulation (EU) 2019/876), which will also apply from 28 December 2020.