The FSA has today released a Consultation Paper, which contains
proposed revisions to its Remuneration Code affecting pay in the
financial services sector. The revisions are proposed to take
effect from 1 January 2011 and will mean far more firms are brought
within its ambit.
The FSA had always intended to review the Remuneration Code in any
event one year after it was formally put in place in August 2009 so
as to take account of subsequent developments in the Walker report
and the Financial Services Act, but it is recent changes at the
European level which have had most impact on its proposals.
The Consultation Paper discusses three main areas:
Extending the scope of the Remuneration Code to more
firms
Currently the Remuneration Code only applies to the top 26 banks
and building societies. The FSA says that the recent CRD3 changes
give it no choice but to extend the Remuneration Code to
approximately 2,500 firms including all banks and building
societies, most hedge fund managers and all UCITS investment firms,
as well as others including some firms which engage in corporate
finance, venture capital or the provision of financial advice,
brokers and multilateral trading facilities (CAD investment firms).
UK branches of EEA firms will still be excluded.
The FSA has said that it will look sympathetically at how firms are
brought into the scope of the Remuneration Code with the
possibility of flexible transitional provisions (with compliance in
some areas possible to be delayed until July, or late, 2011).
It also proposes a lighter touch or proportionality in many other
areas for firms brought within the Remuneration Code. While some
principles will be of universal application, others will only be
applied depending on the type of firm and its scale and complexity
etc, while other provisions will only have to be commented upon if
relevant in a "comply or explain" approach. The
Consultation Paper sets out some suggested proposals in Annex
5.
Going forward, it separates firms into:
- high impact groups (broadly, those subject to "close and
continuous" supervision) who will need to prepare a
remuneration policy statement ahead of the end of the financial
year, have a specific remuneration meeting with the FSA and may not
be able to pay bonuses without FSA agreement. This year, general
considerations will be separated from particular remuneration
decisions. Governance and controls will be discussed in Q4 2010,
with specific decisions being reviewed against the new Remuneration
Code in early 2011. This should make the process smoother than last
year;
- medium high or medium low groups or firms will have to prepare a report which will be inspected as part of the ARROW review;
- low impact firms will only need to prepare a report if they are part of a thematic review. However, there will inevitably be a de minimis set of remuneration provisions for all firms (who will have to include some remuneration information in their GABRIEL regulatory returns).
The FSA is conscious of giving a competitive advantage to
smaller firms over larger ones. The revised draft which is agreed
this year is also not necessarily the final position as European
Directives covering other areas of financial services, and with
remuneration provisions of their own, are expected over the next
few years.
Clarifying which employees are targeted by the Remuneration
Code
Where the Remuneration Code applies, some employees'
remuneration is subject to particularly close regulation. These are
currently known as "Principle 8" or "P8"
employees. Due to some confusion over the scope of the definition,
the FSA gave further clarification as part of the supervisory
framework issued to firms in December 2009. It now proposes to use
the term "Code staff". The FSA has published a table of
key positions which it believes should be subject to the
Remuneration Code provisions on Code staff (see page 20 of the
Consultation Paper) in addition to staff whose remuneration takes
them into the same pay bracket. Those who hold SIF positions
(e.g. directors, partners and senior managers) are automatically
included.
Changing to the Remuneration Code itself
Many of the changes are to comply with CRD3, although in most cases
these changes are simply making express what would have been
implied anyway. There is a general escalation of what was
previously guidance into rules although the FSA has comfortingly
said that it does not generally expect firms to have to breach
contractual obligations to comply with the changes. Of particular
interest are some provisions on remuneration structures:
- Deferral – at least 40% of variable remuneration for Code staff should be deferred over a period of at least 3 years, rising to 60% where annual total remuneration is more than £500,000 or in other appropriate cases. However, Code staff whose bonus is less than 33% of their total remuneration and whose annual total remuneration is £500,000 or less are not caught (and also would not be caught by some other rules e.g. guaranteed bonuses or payment in shares). The FSA recognises that this may not be aligned with some other jurisdictions and so could be perceived to be uncompetitive. It is notable though that the FSA does not seem to recommend extending the three year deferral period to five, as had been feared.
- Payment in shares – at least 50% of variable remuneration should be paid in shares or other equivalent non-cash instruments (by building societies, for example). The current Remuneration Code is not so prescriptive here. The FSA recognises that the relevant European legislation is ambiguous and so the up-front bonus can be paid in cash subject to the overall limit. It also recognises that firms not currently caught by the Remuneration Code and in particular non-listed firms will need time to implement this and firms currently in scope may also be able to justify not complying with this provision for 2011 awards so long as they can show that by 1 July 2011 they are compliant.
- Performance adjustment – tougher rules are proposed on employee misbehaviour, employee material error, firm/business unit material downturn or material failure of risk management requiring reduction of variable remuneration in some form.
- Voiding of provisions – currently breach of the Remuneration Code still allows the employee to be paid the relevant remuneration or sue for its non-payment and the FSA has no power to order its recovery. The FSA proposes to introduce relevant provisions to deal with deferred remuneration and guaranteed bonuses for Code staff which breach the Remuneration Code.
The deadline for consultation ends on 8 October 2010 with final
FSA proposals due to be published in November 2010 for
implementation as of 1 January 2011. Although transitional
provisions apply, the revised Remuneration Code catches all
remuneration after that date even if awarded previously. This tight
timetable is driven by CRD3 which requires Member States to
implement the remuneration-related provisions by 1 January 2011.
The FSA is separately conducting a cost-benefit analysis of these
changes and will issue this in September 2010 having collated the
necessary information by early August (relevant firms were sent
questionnaires in early July).
Firms should also be aware that many details, such as the numerical
relationship between fixed and variable pay, are primarily to be
supplied by the Committee of European Banking Supervisors (CEBS)
which is not due to report until later in the autumn. There is
therefore a very tight timetable for compliance as this means that
what has to take effect from 1 January 2011 may not be known until
November at the latest.
In particular, firms which are going to be caught by the
Remuneration Code for the first time are therefore advised to start
putting in place review and compliance programmes as soon as
possible anticipating that at least some changes to their processes
will be necessary by year end.
Click here to link to the consultation
paper.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
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The original publication date for this article was 29/07/2010.