On 13 January 2016 the Prudential Regulation Authority (PRA) issued CP2/16 Buy-outs of variable remuneration.
This consultation paper follows on from earlier consultations of both the PRA and Financial Conduct Authority (FCA) on remuneration in which the regulators promised to give further thought to bought-out variable remuneration. This consultation paper is the fruit of that deliberation.
Previously, the regulators had noted that buy-out of variable remuneration posed a threat to the effectiveness of the malus provisions (which allow firms to reduce the amount of deferred and as yet unpaid bonuses) - and the clawback provisions of the remuneration regime. This is because staff who were recruited by a new employer after their bonus had been declared were able to negotiate that their bonuses were "bought-out" by the new employer. Thereby such employees were effectively insulated against the risk that their previous employer could use the malus and clawback provisions of the remuneration regime.
In the view of the PRA this practice undermines the remuneration rules that it and the FCA had put in place and therefore it is proposing a new rule to strengthen the malus and clawback provisions in relation to such buy-outs.
In short, the new rule would allow for malus and clawback to be applied to bought-out bonuses. It is intended that the new rule will operate in practice via a contract between the new employer and the employee, which would provide for the possibility of malus and clawback to be applied on the basis of a determination notified by the old employer. It would involve the old employer notifying the new employer of such a determination that a certain amount should be applied to the employee's deferred variable remuneration by way of malus and/or clawed back where the variable remuneration has already vested. In order to make a determination to apply malus or clawback, the old employer would have to rely on certain grounds such as (at a minimum) misconduct or failures of risk management on the part of the employee. On the face of it, that could require the old employer to share potentially sensitive confidential information with the new employer who may be a competitor.
However, the grounds would not need, or be expected, to include a material downturn in the financial performance of the old employer, since this could be regarded as too open to misuse by the old employer.
Responsibilities of the old employer
The PRA recognises that it is important to the integrity of the malus and clawback framework that the old employer should be subject to a clear duty to act fairly and reasonably in making the determination. In order to meet this standard, the old employer should be able to demonstrate that it has acted consistently in relation to current and former employees, and previous or concurrent cases of malus or clawback. Further the former employer needs to comply with certain procedural obligations such as notifying the new employer in writing within 14 days of making such a determination and providing the former employee with reasons as to why such a determination has been made. The former employee also has a right to make representations to the old employer disputing any determination made by the old employer.
To reinforce the obligations on the old employers, the PRA proposes to provide in the new rule a private right of action for damages under section 138D of the Financial Services and Markets Act 2000 in the event of a failure by a firm to comply with the rule. This would leave the old employer open to a damages claim by former employees on the basis that the old employer had not acted "fairly or reasonably" in making the determination. Further the old employer will need to report to the PRA on any malus or clawback determinations on at least an annual basis.
Responsibilities of the new employer
The new employer would be expected to act on receipt of a notification from the old employer, except to the extent that the awards concerned had already been subject to malus or clawback. Where clawback is sought, the new employer would act as the claimant in a contractual claim against their employee, supported by the old employer's notification, for those sums already vested.
The proposed rule would also provide scope for new employers to apply for a waiver where they have reason to believe an old employer's decision to apply malus or clawback has been manifestly unfair or unreasonable. The PRA suggests that the grounds for seeking such a waiver could include apparent severity of treatment by the old employer to its former employee on the basis of the information provided in its determination and a pattern of determinations suggesting that the old employer is not acting fairly and reasonably toward its former employees. However, the new employer may well be reluctant to get involved in a dispute between an existing employee and their old employer, which may leave the employee having no remedy other than potentially expensive litigation.
Scope of the rule and proportionality
The rule will apply to all material risk takers at PRA-authorised banks, building societies and designated investment firms. However, in line with the PRA's existing approach to proportionality, it will only apply to firms that fall within level one and two of the proportionality framework.
Responses to the consultation paper need to be submitted by 13 April 2016. The PRA will then consider the responses received. While the FCA recognises the risk that buy-outs pose to the remuneration regime, it is not currently consulting on buy-outs itself in order to maintain a consistent approach across dual regulated firms.
If you require further information on anything covered in this briefing please contact Fiona Lowrie (email@example.com ; 020 3375 7232), Eleanor Rowswell (firstname.lastname@example.org ; 020 3375 7111) or your usual contact at the firm on 020 3375 7000. Further information can also be found on the Commercial and Regulatory page on our website.
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