I am putting pen to paper (so to speak) off the back of hosting a breakfast session attended primarily by wealth managers and private banks at which we considered the effect of the Remuneration Codes on their businesses and in particular how changes to remuneration (designed of course to discourage excessive risk taking and focus on short-term returns) were affecting recruitment and retention of key staff. Many of the financial institutions did not fall within proportionality levels 1 and 2 and therefore some of the more onerous rules within the Remuneration Codes can often be disapplied in relation to them. However, the rules are still complex and often confusing and there was a general consensus that even those firms not affected by more onerous requirements can still potentially be adversely affected by some of the practices which have developed over time at larger firms in response to the impact of the Remuneration Codes.
This short blog is not the place for a detailed account of the rules (this would require several pages rather than a few paragraphs!). However, by way of reminder, we now have six different Remuneration Codes (all slightly different and with the devil in the detail). All firms subject to one or more Codes must ensure that their remuneration policies and practices are consistent and support sound and effective risk management, and are clear and documented. Templates are available on the FCA and PRA websites to assist firms in completion of an annual remuneration policy statement to record their policies and assess their compliance.
Some of the detailed rules in the Codes only apply to “material risk takers” (or Code staff) assessed by way of qualitative criteria (relating to seniority and role) and quantitative criteria (relating to remuneration in the previous year). Still more confusing is that some material risk takers may be exempted from certain requirements if a de minimus exemption applies (ie very broadly, where total remuneration for that year is no more than €500,000 and variable pay is not more than 33% of remuneration).
The PRA and the FCA have both issued guidance (updated this month: here) that confirms that smaller firms may not need to comply with certain remuneration rules, including some of the rules relating to the specific ratio between fixed and variable pay (the “bonus cap”), rules on payment in instruments, and requirements on deferral of variable pay and the application of malus and claw-back in relation to variable pay.
One might have thought that the potentially less onerous requirements on smaller firms might give them a competitive advantage to the larger firms as they have (potentially) more flexibility in pay arrangements. However, as a result of practices which have developed at larger firms, including, importantly, the need to drive up fixed pay in order to counteract the effect of the bonus cap (sometimes by way fixed pay allowances), ironically smaller firms can find it more difficult to compete with larger firms, certainly in terms of base-line fixed pay. That seems to me to be a shame and certainly not the intended effect of the policy behind the bonus cap.
The other change early this year of some interest (to me at least) is the introduction of new rules for Code staff in PRA regulated firms on buy-outs of variable remuneration: see guidance here. These rules ensure that buy-outs of deferred variable remuneration by a new employer are still subject to the conditions of malus and claw-back on which the original award was made. This requires information sharing between the old and new employer (often an alien concept between competitors), including the provision of a remuneration statement from the old employer to the new employer. There is also a subsequent obligation on the old employer to issue a reduction notice to a new employer if they conclude that they would have sought to exercise malus or claw-back in relation to the bought out award if the employee had not left the firm. It is probably too early to say what the overall effect of these rules will be on the prevalence of buy-outs. My personal view is that market forces will continue to play a significant role and it will continue to be necessary for firms to offer significant buy-outs to key members of staff in order to attract them in a competitive environment, although I have heard other commentators indicate that buy-outs may wither on the vine as a consequence of the new rules.
As a final reflection, one area in which I haven’t yet seen significant focus from the regulators is in relation to termination payments. The rules state that firms must ensure that termination payments reflect:
- performance achieved over time; and
- are designed in a way to avoid rewarding failure or misconduct.
EBA guidance effective 1 January 2017 also suggests that severance pay should not be awarded where there is an obvious failure that allows for the summary termination of the employee's contract or where an employee resigns voluntarily in order to take up a position elsewhere. One can see that this is an area where firms could potentially be challenged by regulators in due course, perhaps where settlement payments are offered for commercial reasons in order to avoid unfair dismissal claims. That is a bit of crystal ball gazing but I can see there may be more focus on termination payments in the future. Certainly the rules (and consequently practices) in pay in financial services are constantly evolving and I don’t see that changing in the immediate future.