Amendments have been made to the FCA’s Dual-Regulated firms Remuneration Code under SYSC 19D and the Remuneration Part of the PRA Rulebook (together the “Remuneration Codes”) to implement the remuneration aspects of the EU Capital Requirements Directive V (“CRD V”). CRD V builds on CRD IV and introduces additional measures to reduce risks in the banking sector, including amending the requirements which apply to remuneration policies. For those firms already subject to the Remuneration Codes – namely banks, building societies and PRA-designated investment firms – the changes came into force on 29 December 2020, just before the end of the Brexit transition period, and apply in respect of performance years beginning on or after 29 December 2020. So for firms with calendar performance years, the changes kicked in on 1 January 2021 and will impact bonus payments in Q1 2022. So what do firms subject to the Remuneration Codes need to know now?
On 17 December 2020, the FCA published Policy Statement 20/16: Updating the Dual-Regulated firms Remuneration Code to reflect CRD V. This Policy Statement sets out the FCA’s final rules on remuneration for dual-regulated firms and the revised versions of the relevant guidance documents. While the changes are generally aligned with those of the PRA, the FCA’s Policy Statement should be read together with the PRA’s Policy Statement 26/20 also published in December 2020 with what are now the finalised changes to the PRA’s Rulebook on remuneration.
As expressly set-out in the Remuneration Codes, the purpose of the remuneration requirements is to promote the sound and effective risk management of systemically important financial institutions, by aligning the long-term interests of those institutions and their staff whose professional activities have a material impact on the institution’s risk profile, i.e. material risk takers or “MRTs” (also referred to as “Code staff”). Implementing higher levels of individual accountability and better incentivising staff to make sound decisions for the long-term benefit of the institution furthers the aim of improving positive conduct and behaviours that drive healthy cultures.
Key takeaways from the changes
1. Material Risk Takers (MRTs)
The definition of MRTs has changed. Firms have re-assessed or are in the process of re-assessing which staff are MRTs. The changes are likely to mean that more individuals will be categorised as MRTs and therefore subject to the remuneration provisions under the Remuneration Codes. The European Banking Authority (“EBA”) has produced the final draft of its revised Regulatory Technical Standards (“RTS”) on the criteria to identify MRTs (see here). The purpose of the RTS is to define and harmonise the criteria for identification of MRTs and to ensure a consistent approach across the EU. While based on qualitative and quantitative criteria (which was the case before the current changes), an MRT now includes:
- All members of the firm’s management body and senior management (this criteria has not changed);
- Staff members with managerial responsibility over the firm’s control functions or material business units. “Managerial responsibility”, “control function” and “material business units” are further defined in the EBA’s RTS and while it is likely to still capture the heads of legal, internal audit etc., it may capture a larger number of individuals; and
- Staff members entitled to significant remuneration in the preceding financial year provided that the following three conditions are met:
- the staff member’s remuneration is equal to or higher than £440,000;
- the staff member’s remuneration is equal to or higher than the average remuneration awarded to the members of the firm’s management body and senior management; and
- the staff member performs the professional activity within a material business unit and the activity is of a kind that has a significant impact on the relevant business unit’s risk profile.
- Code staff no longer need to be within the top 0.3% of staff awarded the highest total remuneration in the preceding financial year, and the reference to being awarded remuneration at least equal to the lowest total remuneration awarded to senior management or risk takers is no longer a criteria.
2. Bonus cap
No CRD firm, irrespective of size, can disapply the “bonus cap” in respect of its MRTs. This clearly has a significant impact on those smaller firms previously in Proportionality Level 3 and necessitates significant changes to the remuneration of MRTs to now apply the bonus cap.
Certain firms (see further below under Proportionality) can disapply the rules relating to pensions holding/retention periods, deferral and the need to retain shares or other instruments.
4. Deferral periods
Under CRD V, the minimum deferral period for variable remuneration (typically shares) was increased from three to four years. The FCA and PRA have aligned the minimum deferral periods with CRD V, with the result that for many MRTs the deferral periods have increased.
In summary, the length of time for deferring shares has changed for those Code staff who: (a) are a “higher paid MRT”, i.e. a Code staff member whose total remuneration exceeds £500,000 and whose annual variable remuneration exceeds 33% of that total remuneration; and (b) perform a PRA-designated senior management function or an FCA-designated senior management function.
Higher paid MRTs must defer a proportion of their variable compensation awards for 7 years if they perform a PRA-designated senior management function, 5 years if they perform a FCA-designated senior management function, and 4 years for all other Code staff. In relation to MRTs who are not higher paid MRTs the deferral period is 5 years for those who perform either a FCA-designated senior management function or a PRA-designated senior management function, and 4 years for all other code staff. This can be contrasted with the period under CRD IV which ranged from 7 to 3 years: 7 years for Senior Managers, 5 years for risk managers and 3 years for all other MRTs.
No CRD firm, irrespective of size, can disapply malus and clawback in respect of MRTs.
The clawback/malus requirements may potentially now apply for a shorter minimum period for some Code staff depending on whether they are: (a) a “higher paid MRT”; and (b) whether they perform a PRA-designated senior management function or an FCA-designated senior management function (see above). In summary:
- Variable remuneration for higher paid MRTs is subject to clawback for at least 7 years from the date on which awarded.
- Variable remuneration for MRTs who are not higher paid MRTs but who are either PRA-designated senior management function holders or FCA-designated senior management function holders at a significant firm, is subject to clawback for a period of at least 6 years from the date awarded.
- For other code staff, the deferred element of variable remuneration is subject to clawback for a period of at least 5 years from the date awarded; the undeferred component of variable remuneration is subject to clawback for a period of at least 1 year from the date awarded.
This can be contrasted with the clawback period under CRD IV which was for a period of 7 years. As under CRD IV, the period of clawback can be extended from 7 to 10 years in certain circumstances.
These requirements apply to the MRTs of all "large institutions" and all other CRD firms with total assets in excess of the £4bn threshold (see further below under “Proportionality”).
The proportionality rules for firms and individuals have changed. For firms to benefit from a relaxation of the rules that can be disapplied (as referred to above) they need to meet certain criteria, including (a) not being a “large institution” and (b) having an average of total assets equal to or below £4bn over the four years preceding the current financial year (or £13bn if certain other conditions are met). The Proportionality Level needs to be understood by reference to other companies within the group, which may mean that Code staff who would otherwise be exempt from the rules because they are de minimis are in fact caught. UK branches of EEA firms may benefit from temporary transitional relief in relation to the changes until 31 March 2022.
Even if the firm does not satisfy the criteria to fall within a lower Proportionality Level, certain MRTs may be exempt from the rules on pensions holding/retention periods, retained shares, and deferral if they meet minimum thresholds (previously referred to as “de minimis MRTs”). Fewer MRTs are likely to be exempt as so-called de minimis MRTs as the threshold now includes annual variable remuneration being no more than £44,000 (under CRD IV a de minimis MRT was an individual whose total remuneration was not more than £500,000 for the relevant financial year, and whose variable pay was not more than 33% of total remuneration). The upshot is that there will be a significant increase in the number of employees whose remuneration now needs to be deferred and paid in shares (or other instruments) rather than in cash.
While the remuneration rules are complex in part and the changes may take some time to get used to, the overall framework has remained the same, which should mean that for those firms who were already subject to the bulk of the provisions, thankfully remuneration policies will not need a complete overhaul. However, there are significant changes embedded in the updated Remuneration Codes. In particular, for smaller CRD firms, there have been significant changes requiring the imposition of the “bonus cap”. To the extent not already underway, the starting point for firms is to review their MRT populations to ensure that the correct MRTs caught by the expanded remuneration provisions have been identified.