In a July 2010 consultation, the FSA outlined its proposals to amend the Remuneration Code (“the Code”). The consultation contained a number of proposals which will bring more financial firms, and more highly paid employees, under its regime and seek to further promote an underlying principle of “effective risk management” throughout the financial sector.
The consultation refers to the pending implementation of the latest amendments to the Capital Requirements Directive (“CRD3”), stating that although the Code in its current form is “substantially consistent with CRD3”, the Code will require amendment “to ensure it is fully in line with the Directive”.
In terms of domestic legislation, the consultation states that the implementation of sections 4 to 6 of the Financial Services Act 2010 which empower the FSA to require the disclosure of certain executives remuneration packages, and to regulate their remuneration “in accordance with a remuneration policy”. These provisions will also require the FSA to “consult on changes to the Code.”
The consultation proposes a number of alterations to the Code by way of general application to firms, staff and groups, including the following:
- Application to firms
The implementation of CRD3 on 1 January 2011 will require the Code to widen the definition of firms which fall under its regime to include “all banks, building societies and certain investment firms including asset managers.” This will “significantly increase” the number of firms subject to the Code to “over 2,500”.
- Application to staff
The definition of the staff to whom the Code will apply is also proposed to widen from the “P8 employee” definition to a new group referred to as “Code staff”. This new group will include the following:
a) A person who performs a significant influence function for a firm;
b) A Senior Manager; and,
This definition is significantly wider than the definition of “P8 employee”, the previous definition being:
1) A person who performs a significant influence function for a firm; and,
2) An employee whose activities have, or could have, a material impact on the firm’s risk profile.
Under the P8 definition, the FSA “reviewed the deferral arrangements for 4,300 P8 employees.” The widened “Code Staff” definition will, one would think, place more staff within the scope of the Code. The consultation also proposes that firms “compile a list of Code staff ahead of the bonus allocation period” and make this list available to the FSA for review.
- Application to Groups
The territorial scope of the Code is proposed to extend as follows:
- UK groups should apply the code globally to all their regulated and unregulated entities; and,
- UK subsidiaries of third country groups must apply the Code in relation to all entities within the subgroup, including the entities based outside the UK.
In addition to widening the scope of the Code, the consultation also proposes a new set of 12 Remuneration Principles:
- Risk management and risk tolerance,
- Supporting business strategy, objectives, values long term interests of the firm,
- Avoiding conflicts of interest,
- Risk and compliance function input,
- Remuneration and capital,
- Exceptional government intervention,
- Profit based measurement and risk adjustment,
- Enhanced discretionary pension benefits,
- Personal Investment Strategies,
- Avoidance of the Code, and
- Remuneration structures.
By addressing issues such as “risk management and governance” and “rules on capital, government intervention, pensions, hedging and avoidance” the Code incorporates Principles which are ostensibly designed to alter the business practices of financial firms in the longer term, but it is Principle 12 which is most likely to cause concern for those expecting to continue to benefit from the now ubiquitous bonus payment. Principle 12 is accompanied by further guidance designed to reign in a firm’s ability to pay cash bonuses. The guidance includes:
- Deferral of at least 40% of a bonus “vesting over a period of at least 3 years for all Code Staff”, with a suggested 60% deferral in the case of “particularly high” amounts.
- A rule requiring “at least 50%” of a bonus to be paid by way of “shares, share-linked instruments, or other equivalent non-cash instruments of the firm”.
- A performance adjustment provision – providing that a reduction is made to a deferred bonus award for poor performance.
- A rule preventing firms from guaranteeing bonuses of more than one year except to new employees in their first year of service, and in other exceptional circumstances.
- A de minimis provision – the Code proposes that Code staff earning less than £500,000 a year and whose bonus is less than 33% of their total remuneration would be exempt from the above provisions.
Breaching the Remuneration Principles
Section 6 of the Financial Services Act provides the FSA with “express powers” to:
- Prohibit a firm from remunerating its staff in a specified way;
- Render void any provision of an agreement that contravenes such a prohibition; and,
- Provide for the recovery of payments made, or properly transferred in pursuance of a void provision.
The consultation notes that these measures “are only likely to be effective where the effect of the prohibition can be clearly ascertained in advance.” For this reason, the consultation proposes to use the section 6 provisions only in relation to deferral arrangements, and guaranteed bonuses.
The policy statement and final rules are expected to be published in mid-November 2010, with the rules expected to come into effect from 1 January 2011.
 The final text of CRD3 is expected to be published towards the end of 2010. CRD3 will amend the EU Banking Consolidation Directive (2006/48/EC) and Capital Adequacy Directive (2006/49/EC). http://www.fsa.gov.uk/pubs/cp/cp10_19.pdf