Has the regulator implemented rules in relation to remuneration paid by banks to its staff?
The UK Financial Services Authority (FSA) (the predecessor of the Financial Conduct Authority (FCA)) was the first major financial regulator to respond to the financial crisis with the introduction of a remuneration code. This covered the UK’s largest banks, building societies and broker dealers and came into force on January 1, 2010. The code has been subsequently revised to meet the requirements of the Capital Requirements Directive III (CRD III) and later the Capital Requirements Directive IV (CRD IV) which came into effect on January 1, 2014. The UK now has one code in place for banks (the Remuneration Code). Following legal cutover, the Prudential Regulation Authority (the PRA) has taken the lead on implementing the remuneration rules, working closely with the FCA. The text of the Remuneration Code that applies to banks is set out in chapter 19A of the PRA / FCA Senior Management Arrangements Systems and Controls sourcebook (SYSC 19A). The Remuneration Code forms part of both the FCA and PRA Handbooks. In reality the PRA and FCA share responsibility for assessing compliance with the Remuneration Code as the PRA looks at remuneration from a prudential perspective and the FCA considers it from a conduct perspective. The PRA has also adopted a number of legacy FSA policy publications relevant to the advancement of its objectives.
The key principle from the Remuneration Code is that all firms subject to it must ensure that their remuneration policies and practices are consistent with and promote sound and effective risk management.
What categories of staff are caught by the regulator’s rules?
The Remuneration Code applies to firms and as such many of the rules will apply to all staff. However, certain rules only apply to staff that are classified as “Code staff” (also known as Identified staff). Code staff are those whose activities have a material impact on the risk profile of the firm. Code staff may include those who are senior managers, “material risk takers”, individuals engaged in control functions and any individual whose total remuneration takes them into the same remuneration bracket as senior managers.
On June 6, 2014, regulatory technical standards were published in the Official Journal of the European Union that set out criteria identifying an individual as a material risk taker. The purpose of the RTS is to create a harmonized approach across the EU. As the RTS have direct effect firms are expected to comply with the criteria. The European Banking Authority (the EBA) has also published FAQs on the RTS. The impact of the RTS is that more individuals have been classified as Identified staff or Code staff (for UK purposes).
If an individual is classified as Code staff but satisfies a de minimis concession, certain requirements of the Remuneration Code can be relaxed.
An individual satisfies the de minimis concession for a performance year if both of the following conditions are satisfied:
- his or her total remuneration for that performance year does not exceed £500,000; and
- his or her variable pay for that performance year is not more than 33% of his or her total remuneration.
What are the key regulatory rules?
The Remuneration Code contains 12 Remuneration Principles which are based on related articles in the CRD IV and related standards in the Financial Stability Board’s Principles for Sound Compensation Practices.
Such Remuneration Principles include:
- Principle 1: A firm must ensure that its remuneration policy is consistent with and promotes sound and effective risk management and does not encourage risk-taking that exceeds the level of tolerated risk of the firm;
- Principle 2: A firm must ensure that its remuneration policy is in line with the business strategy, objectives, values and long-term interests of the firm;
- Principle 3: A firm must ensure that its remuneration policy includes measures to avoid conflicts of interest;
- Principle 4: A firm must ensure that its management body in its supervisory function adopts and periodically reviews the general principles of the remuneration policy and is responsible for overseeing its implementation;
- Principle 8: A firm must ensure that its remuneration is principally based on profits and may be adjusted to take into account current and future risks; and
- Principle 11: A firm must ensure that variable remuneration is not paid through vehicles or methods that facilitate non-compliance with the Remuneration Code.
The requirements in the Remuneration Code are subject to a proportionality rule. This rule provides that when establishing and applying the total remuneration policies for its Code staff, a firm must comply with the requirements in a way and to the extent that is appropriate to its size, internal organization and the nature, scope and complexity of its activities.
To help firms understand how the PRA and FCA expect them to apply the proportionality rule they are categorized into three levels based on their ‘relevant total assets’:
- level 1 – total assets exceeding £50 billion (averaged over three years). Firms in this level will need to apply all the Remuneration Code’s rules and are subject to an annual supervisory process which involves pre-approval of remuneration awards;
- level 2 – total assets exceeding £15 billion, but not exceeding £50 billion (averaged over three years). Firms in this level will need to apply all the Remuneration Code’s rules, but are reviewed at supervisory discretion; and
- level 3 – firms with total assets not exceeding £15 billion (averaged over three years). Firms in this level may dis-apply the ‘pay-out process rules’ and the bonus cap.
Further guidance for banks on the proportionality principle can be found in PRA Supervisory Statement 8/13: Remuneration standards: the application of proportionality.
However, the PRA intends to review its proportionality guidance following the issue of the EBA’s revised remuneration guidelines (see further below).
Are bonuses subject to the regulator’s rules?
Yes, the Remuneration Code contains rules implementing the CRD IV requirements regarding variable remuneration (bonuses). In particular, under CRD IV firms are required to comply with a bonus cap. All firms within proportionality levels 1 and 2 are required to implement the cap on variable pay. PRA regulated firms in proportionality level 3 should be able to dis-apply the cap but they may be asked formally to justify their decision to the regulator. Where a level 3 firm dis-applies the bonus cap it is still required to ensure that it maintains an appropriate balance between fixed and variable remuneration.
The Remuneration Code implements the CRD IV “hard” limits to the relationship between the variable component of remuneration and the fixed component (for further information please refer to the European Union submission on remuneration). It is worth noting that in
What is the position concerning role based allowances
The use of role based allowances came to the attention of the regulators as some firms were trying to minimize the impact of the CRD IV bonus cap by increasing basic pay and/or using role based allowances. This led the European Commission to instruct the EBA to investigate the use of role based allowances.
As mentioned in the European Union submission of this comparative analysis, the EBA published a report on role based allowances in October 2014. The report mentioned that, where Member State competent authorities were aware of role based allowances in their jurisdictions which did not have the “necessary characteristics”, appropriate supervisory action should be taken to ensure that:
- firms’ remuneration policies are updated to ensure that these allowances are correctly classified as variable remuneration; and
- payment of these allowances does not cause firms to contravene the bonus cap and other requirements laid down in the CRD IV.
Further guidance on the nature of fixed and variable remuneration is set out in the draft EBA guidelines (see further below).
Do the regulator's rules on remuneration have extraterritorial effect?
UK corporate groups must apply the Remuneration Code to all their regulated and unregulated entities wherever they are situated. UK subsidiaries of third country groups also must apply the Remuneration Code to all entities within their subgroup, including those based outside the UK.
The Remuneration Code applies to UK branches of third country firms. In relation to branches of EEA firms, the Remuneration Code does not apply but they would be subject to equivalent rules in their home Member State.
Do you anticipate further reform in this area?
In July 2014 the FCA and PRA jointly published Consultation Paper 15/14: Strengthening the alignment of risk and reward: new remuneration rules. In this consultation the FCA and PRA set out proposals to strengthen the alignment between risk and reward. The proposals will cover all banks and building societies as well as PRA designated investment firms. The proposals are fairly wide ranging covering: deferral, claw-back, bailed-out banks, buy-outs, risk adjustment and the remuneration of non-executive directors. The consultation closed on October 31, 2014. A Policy Statement with final rules has not yet been published.
The FAQs on the RTS concerning material risk takers also mentioned that the EBA is currently reviewing the existing Committee of European Banking Supervisors (the predecessor of the EBA) guidelines on remuneration policies and practices. An EBA consultation paper on draft guidelines on sound remuneration policies was published on March 4, 2015. The draft guidelines clarify the process for identifying those categories of staff whose professional activities have a material impact on the firms’ risk profile, and do so on the basis of the criteria that were defined in the EBA RTS on identified staff (see question 2). The draft guidelines also give guidance on how the ratio between the variable and the fixed components of remuneration should be calculated, taking into account specific remuneration elements such as allowances, sign-on bonus, retention bonus and severance pay.
The draft guidelines also address the issue of proportionate application of the rules. The EBA, following consultation with the European Commission, follow a legal reading of the CRD IV, and provide that the rules on remuneration in CRD IV have to be applied to all institutions as a minimum and cannot be ‘neutralized’(i.e. disapplied). The EBA is of the view that specific exemptions could be introduced for certain firms that do not rely extensively on variable remuneration and, if confirmed by further analysis, also for Identified staff that receive only a low amount of variable remuneration. In this regard, the EBA intends to send advice to the European Commission suggesting legislative amendments that would allow for a broader application of the proportionality principle and is, therefore, asking stakeholders for input on this aspect. This will not impact level 1 or level 2 firms but is likely to have an impact on level 3 firms that currently dis-apply the pay-out process rules and the bonus cap. The EBA also confirmed that the rules in CRD IV should be applied on an EU consolidated level.
The deadline for comments on the consultation is June 4, 2015.
Must an institution’s remuneration policy be disclosed to the regulator?
The previous CRD III introduced requirements for Member States to collect data on remuneration practices and remit it to the EBA. In the UK, these requirements were implemented by the Capital Requirements (Amendment) Regulations 2012. Policy Statement 12/18: Data collection on remuneration practices set out the FSA’s rules for remuneration data reporting requirements.
In July 2014, the EBA published revised guidelines on both the data collection exercise regarding high earners and the remuneration benchmarking exercise. In addition, the EBA’s guidelines on high earners were updated to take into account changes introduced by CRD IV. The FCA and PRA jointly consulted on changing their approach to data collection on remuneration practices and the reporting requirements in September 2014. A subsequent joint Policy Statement was published in December 2014.
In general, firms that are subject to the Remuneration Code are required to ensure that their remuneration policies, practices and procedures are clear and documented. They are also required to complete an annual remuneration policy statement which records those policies, practices and procedures and assesses compliance with the Remuneration Code. However, how much detail an annual remuneration policy statement should cover varies depending on the proportionality level of the firm. Firms are also required to keep a record of their Code staff for each performance year. Template annual remuneration policy statements and Code staff lists can be found on the PRA website. Firms that are within proportionality level 1 are also required to undertake certain specific steps prior to awarding any bonuses.
There are also certain requirements to make public disclosures in relation to remuneration as required in Article 450 of CRD IV.