The UK Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) (jointly, the Regulators) are proposing to remove the bonus cap for banks, building societies, and PRA-designated investment firms. The consultation is underway and closes on 31 March 2023. If the bonus cap is scrapped, it will likely affect remuneration referable to performance periods commencing from 2024. In-scope firms should keep this development under review so they can swiftly respond to any increased flexibility in employee remuneration arrangements.
In the September 2022 mini-budget, former Chancellor of the Exchequer Kwasi Kwarteng proposed to scrap the bonus cap. While Mr Kwarteng has since been replaced by Jeremy Hunt, who reversed many of Mr Kwarteng’s proposals, Chancellor Hunt has stuck by the plan to remove the bonus cap on the basis that, in his view, “it didn’t work.”
On 19 December 2022, the Regulators published a joint consultation paper proposing the removal of the bonus cap and setting out, in their view, the merits of doing so (CP15/22/CP22/28). Those merits (considered further below) centre on strengthening the effectiveness of the remuneration regime by eliminating, as a corollary of the current bonus cap, an undesirable pressure to award higher fixed remuneration.
WHAT IS THE BONUS CAP?
Under existing remuneration rules, banks, building societies, and PRA-designated investment firms must ensure that, when setting remuneration, the level of any potential variable pay (e.g., bonuses) does not exceed 100% of fixed pay (or 200% of fixed pay where shareholder approval has been obtained). This ratio, which limits variable pay, is known as the bonus cap. The cap does not, however, impose any limit on the total remuneration that can be paid.
The cap was introduced as a measure to curb excessive risk-taking by employees pursuing short-term financial incentives.
WHAT ARE THE KEY PROPOSED CHANGES?
The Regulators propose
- to remove the limits on the ratio between fixed and variable remuneration;
- to remove related provisions regarding the need to obtain, and the process for obtaining, shareholder approval to increase the ratio to 200% of fixed pay (which would become redundant by removal of the cap); and
- other consequential amendments to ensure alignment throughout the remuneration regime.
WHY REGULATORS PROPOSE REMOVING THE CAP
In the consultation paper, the Regulators flag several perceived disadvantages of the bonus cap. These mainly relate to the bonus cap driving up fixed pay, leading to
- higher fixed costs for firms, leaving firms less agile and potentially less resilient; and
- a higher proportion of pay being placed out of reach of adjustment, including (for example) adjustments for actual performance, malus, and clawback.
The Regulators have also flagged the lack of evidence that the bonus cap has in fact curbed excessive risk-taking.
The Regulators also note that the scrapping of the bonus cap would enable firms to set their own fixed-to-variable pay ratios, tailoring variable pay offerings to reflect their financial situation. Such discretion, however, will not be unfettered. Firms will still need to ensure that the ratio is appropriately balanced, and that fixed pay remains a sufficiently high proportion of total remuneration (see PRA Rulebook, Part Remuneration, Rule 15(9); FCA Handbook SYSC 19D.3.48R). Variable pay will also continue to be subject to requirements relating to deferral, payment in instruments, and malus and clawback.
The Regulators have highlighted a range of other potential benefits of scrapping the bonus cap, including
- attracting highly skilled staff from other jurisdictions and sectors (e.g., technology)—candidates who may currently view the bonus cap as discouraging;
- smaller firms with fewer financial resources being able to share greater risk with employees and explore new opportunities; and
- advancing the United Kingdom’s international competitiveness in financial services.
RISK OF INCREASING GENDER PAY DISPARITY
The Regulators acknowledge, however, that the removal of the bonus cap may have inadvertent consequences in terms of gender pay equity. In the consultation paper, the Regulators consider their duties under the Equality Act 2010 and the equality and diversity issues that may arise because of the removal of the bonus cap. Evidence suggests that bonus pay gaps are typically larger than fixed pay gaps between the genders.
The banking sector already has a higher gender pay gap than a number of other sectors, and the removal of the bonus cap may exacerbate the gender pay gap if firms do not take mitigating action. The Regulators highlight the requirements for dual-regulated firms to have gender-neutral remuneration practices and will revisit any equality and diversity implications before publishing the final policy statement.
WHEN WOULD ANY CHANGES TAKE EFFECT?
The Regulators anticipate that the proposed changes “would come into force the next calendar day after the publication of the final policy – anticipated for Q2 2023,” so quite quickly. Any such changes would apply with immediate effect to the next performance period, which the Regulators believe would not start until 2024 for most firms. Therefore firms will have some time to consider and amend their remuneration arrangements.
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