The Financial Services Authority (FSA) has announced plans to update its Remuneration Code to take on board remuneration rules required by the Capital Requirements Directive (CRD 3) and the Financial Services Act 2010 (FS Act).
The FSA also reports on the implementation of the code so far, lessons learned from last year’s implementation and discusses progress made in achieving international alignment.
The FSA’s current code applies to the largest banks, building societies and broker dealers. However, CRD3 will bring over 2,500 firms within the scope of the code. These include all banks and building societies, asset managers, hedge fund managers, UCITS investment firms as well as some firms that engage in corporate finance, venture capital, the provision of financial advice and stockbrokers.
The FSA does not intend the final rules to be super-equivalent to the CRD3 requirements unless required to do so by UK legislation.
The existing code requires that firms apply ‘remuneration policies, practices and procedures that are consistent with and promote effective risk management’. Although the code is broadly consistent with CRD3 provisions and the FS Act, the FSA is required to make some changes to ensure full alignment. In particular, the code will be strengthened in the following ways:
- Scope of the code – as the scope of the code is expanded, the FSA is committed to applying a proportional approach to implementation and will ensure that ‘institutions shall comply with the principles in a way and to the extent that is appropriate to their size, internal organisation and the nature, the scope and the complexity of their activities’.
- Application – the FSA is consulting on the group of employees to which the code applies (code staff). These will include senior management and anyone whose professional activities could have a material impact on a firm’s risk profile. The consultation paper sets out examples of the key positions in firms that the FSA believes should be subject to the code. The onus will be on firms to identify their code staff in the first instance, but their lists will be subject to review and challenge by the FSA.
- Deferral – at least 40% of a bonus must be deferred over a period of at least three years for all code staff. At least 60% must be deferred when the bonus is more than £500,000.
- Proportion in shares – at least 50% of any variable remuneration components must be made in shares, share-linked instruments or other equivalent non-cash instruments of the firm. These shares will need to be subject to a minimum retention policy.
- Guarantees – firms must not offer guaranteed bonuses of more than one year. Guarantees may only be given in exceptional circumstances to new hires for the first year of service.
- Strengthening of capital base – firms must ensure that their total variable remuneration does not limit the ability to strengthen their capital base. Total variable remuneration must be significantly reduced in circumstances where the firm produces a subdued or negative financial performance.
- Voiding provisions – a new rule will be introduced which defines instances where breaches of the code may render a contract void and/or require recovery of payments made.
- Severance payments – should reflect performance over time and failure must not be rewarded.
- Pensions – CRD3 states that enhanced discretionary pension benefits should be held for five years in the form of shares or share-like instruments.
While it will take time to assess the full impact of the code in contributing to effective risk management, all firms within scope that have paid bonuses since 1 January 2010 have adhered to the FSA’s code.
The consultation period closes on 8 October 2010. The FSA intends to issue a policy statement in November 2010 with rules effective from 1 January 2011.
In response, the British Bankers’ Association (BBA) released a statement that reiterates the need for a globally co-ordinated response. “UK banks recognise that reform of pay structures plays a significant part in restoring confidence in the industry. Banks link pay and bonuses to the long term success of the business and do not reward staff in ways which encourage undue risk taking. Indeed, for the past year, pay and bonus policies have been regulated by the FSA. Banks have also paid additional tax on bonuses, and the government has closely monitored individual policies at state-supported banks.
“The UK has moved further and faster on reform of pay and bonuses than any other country. The proposals from the FSA represent the UK’s contribution to levelling the playing field for all EU financial institutions, as they will implement the EU-wide rule changes which will come into force next January.
“The BBA maintains that reform of the bonus system in financial services must be globally co-ordinated. A global industry needs to conform to global standards, as any country that takes a lighter approach will prove to be a magnet for business. We now need other countries to co-ordinate their reforms with the UK and EU rules. We will work with the FSA to ensure rule changes do not damage the banks ability to recruit and retain staff in the UK.”
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