Executive Remuneration updates - Tapestry - Global Legal Compliance Partners

Tapestry Alert - Malaysia - Salary deductions - restrictions expanded

16 February 2023

Recent changes to employment legislation in Malaysia mean that the approval of the Director General of Labour (DGL) is now required for an employer to make deductions from an employee’s salary to pay contributions towards an employee share plan.

Background
Under the Malaysian Employment Act (the Act), an employer is only permitted to make specified lawful deductions from the wages of all employees. The Act exempts additional specific deductions which can be made at the written request of the employee. In all other cases, the permission of the DGL is required prior to making any salary deductions. Before the recent amendments, the Act only applied to employees whose wages were below MYR 2,000 (around GBP380) per month or who worked in manual labour. Given this limited scope, the Act usually did not cover participants in global employee share plans and consequently no DGL approval was required for salary deductions for contributory share plans.

Amendments to the Act
Following wide ranging amendments to the Act, which came into effect on 1 January 2023, the scope has been extended to cover all private sector employees who enter into a service contract with an employer. As a result, the Act now applies to participants in global share plans who would not previously have been caught by the salary deduction restrictions.

Employee share plans
As noted above, the Act includes exemptions for specific deductions which can be made at the request of the employee and without the need for approval from the DGL. One of the specific deductions is in respect of payments for shares in the employer’s business. Unfortunately, this exemption has been drafted and construed very narrowly and only applies to shares in the actual employer, which is usually the local entity rather than the parent company. In the view of local counsel, this exemption cannot be relied upon for deductions to make payments for shares in the parent company, meaning companies will need to re-evaluate the operation of share plan related salary deductions. The Act provides for employers to apply to the DGL for approval to make salary deductions for a purpose that is not otherwise permitted under the Act. It would be theoretically possible to apply for a general approval to extend this exemption to cover offers made by a parent company to purchase its shares. However, it is not possible to say how long it would take to get a response or whether the response would be favourable.

What can companies do now?
Unless the exemption is extended to cover a foreign share plan, for companies offering contributory share plans in Malaysia, the choices are suddenly more restricted. The local employer can apply for permission from the DGL to take deductions in respect of payments to a third party on behalf of the employee, which would include payroll deductions under a share plan offered by a parent company (this is different from an application to extend the exemption, as discussed above). This is a potentially lengthy process and requires an application to the employer’s local Labour Department branch (or each branch if there are multiple employers). The employer will be required to complete a prescribed application form and file detailed documentation. A response is likely to take at least 10 weeks. An alternative is for the employee to make the contribution directly to the company once they have been paid, either by setting up a standing order or a direct debit.

Date of implementation
The amendments to the Employment Act came into force on 1 January 2023.

Tapestry comment
This is a surprising change and seems to go against the general trend to simplify the process for employees to participate in employee share plans. For example, Singapore recently removed the requirement to obtain regulatory approval for salary deductions. It is disappointing to see Malaysia move in the opposite direction. As the Employment Act includes a specific exemption for employee share plans, it is particularly frustrating that the exemption is considered not to apply to employee share plans offered by foreign companies to employees in Malaysia. Although we can all understand the desire of regulators to protect employees from fraudulent or unscrupulous behaviour, making it more difficult for companies to include Malaysian employees in global share plans is unfortunate. We hope that the DGL will consider extending the share plan exemption to include offers to Malaysian employees under global share plans.

If you want to discuss any of the points above or want help with your share plans or other incentive arrangements, please do contact us.

Rebecca Perry & Sharon Thwaites

Tapestry Alert: India - Major reform of foreign investment rules

13 December 2022

As of 22 August 2022, India has a new set of foreign investment rules. The new rules were issued to liberalise India’s regulatory framework and replace the existing regulations facilitating overseas investment by Indian residents. The new rules are wide ranging and this alert will focus on how the new rules affect offers to Indian employees under global employee share plans (ESOPs).

Where are the new rules?
Overseas investment in India is regulated under the Foreign Exchange Management Act 1999 (FEMA) and is implemented by the Royal Bank of India (RBI). The new rules are contained in the Foreign Exchange Management (Overseas Investment) Rules 2022, the Foreign Exchange Management (Overseas Investment) Regulations 2022 and the Foreign Exchange Management (Overseas Investment) Directions 2022 (collectively, the OI Regime).

How do the new rules apply to share plans?
As a general rule, for Indian residents to participate in an ESOP, the individual has to obtain RBI approval or come within an exemption. This chart gives a high level overview of the key features under the old and new rules from a share plan perspective:

ESOP under the previous rules
Under the previous rules, the relevant exemptions for an ESOP were: the General Permission for offers to Indian employees and directors of a foreign entity; cashless employee share plans (i.e. plans with no outward remittances from India); and, the Liberalised Remittance Scheme (LRS). Each of these exemptions is discussed in more detail below. The local employer had to make an annual ESOP report in Annex IV to the RBI. The General Permission did not provide an exemption from the strict repatriation rules which require repatriation of the proceeds of sale of shares within 180 days and repatriation of dividends within 90 days of receipt. This meant that it was not possible to operate a DRIP (dividend reinvestment programme) for Indian employees without approval from the RBI.

ESOP under the new OI Regime
Under the OI Regime, Indian individuals who invest in foreign shares will be making either an Overseas Direct Investment (ODI) or an Overseas Portfolio Investment (OPI). In the case of a foreign ESOP, employees will usually be treated as making an OPI. The OI Regime sets out detailed descriptions of both ODIs and OPIs, but in brief (and for most ESOPs), an OPI is an investment where an individual acquires foreign securities that represent less than 10% of the foreign entity’s share capital.

General Permission: under the OI Regime, all ESOPs must come within the revised General Permission. There are no other exemptions. The main terms of the General Permission are unchanged, apart from a new semi-annual reporting obligation. To come within the General Permission, the ESOP must comply with the following:

The individual must be an employee or a director of:
- an Indian office, or branch of the foreign entity, or
- a subsidiary in India of the foreign entity, or
- an Indian company in which the foreign entity has direct or indirect equity holding.
The shares offered under the ESOP must be offered by the foreign entity globally on a uniform (i.e., non-discriminatory) basis.
Outward remittances must be made through an authorised bank.
The local employer must make prescribed semi-annual filings.

Cashless ESOP: The specific exemption for cashless ESOPs has been removed. Such plans must comply with the revised General Permission and must be reported in the semi-annual filing.

Liberalised Remittance Scheme (LRS): Under the LRS, Indian residents are permitted to send up to USD250,000 offshore each year without seeking RBI consent. Subject to compliance with strict rules and reporting obligations, the LRS allows flexibility in sending funds offshore. Previously, the LRS did not mention ESOPs, and local counsel generally advised against using the LRS for an ESOP, one reason being the need to ensure that the LRS limit was not exceeded. To align the LRS with the OI Regime, the LRS has been amended to state that the acquisition of foreign shares comes under the OI Regime. Any amounts invested in foreign shares under an OPI, including under an ESOP, must come within an individual’s LRS limit.

ESOP reporting by employer: Under the old rules, employers made an annual filing on Annex IV (ESOP Reporting Statement). Under the OI Regime, this single filing is replaced with semi-annual filings on Form OPI (here). The form includes details of share plan investments held abroad and any changes (investments and sales) since the last report, as well as any amounts remitted and repatriated in the previous six months. The local employer must declare the percentage interest and the shares allotted and repurchased and the number of employees who acquired and sold shares during the period. The forms are filed by the local employer with the RBI through an authorized dealer within 60 days of each of 31 March and 30 September and late filing fees apply. As the first filing was due on 28 November this year, many companies have been caught out and local counsel advise that the filing should be made as soon as possible. Reporting companies should discuss how to complete the report with their authorised dealer.

Repatriation of funds: One advantage of the OI Regime is that it appears to permit employees in India to participate in a DRIP. The strict repatriation requirements for share proceeds will not apply so long as the funds (proceeds of sale and dividends) are reinvested under the terms of the General Permission within 180 days. If this deadline cannot be met, the funds must be repatriated to India within180 days of receipt.

Date of implementation
The OI Regime took effect on 22 August 2022. Due to the extent of the changes, local advisers have been working with the regulators to clarify the application of the changes to ESOPs. This has a caused a delay in news of the OI Regime being circulated, although, frustratingly, no delay in the implementation of the new reporting requirement.

Application of the OI Regime to previous overseas investments
Any overseas investments made prior to 22 August are deemed to have been made under the OI Regime. As a result, any plans that were offered on the basis of the previous rules or which have received RBI approval, must now comply with the OI Regime.

Tapestry comment
Foreign exchange rules in India continue to be complex. To some extent, the OI Regime appears not to have made significant changes to the operation of global employee share plans in India, but there are important updates that companies will need be aware of - in particular, the new twice yearly reporting system. Other changes are more subtle and companies will need to review their share plans to ensure that they comply with the revised General Permission. If your plan does not currently permit employees in India to participate in a DRIP, this may be something to investigate in more detail. The key takeaway is that the OI Regime is a major overhaul of the FX rules and it will take a bit of time for advisers, local teams and employees to adjust to these changes.

We would like to thank our local counsel Roshnek Dhalla at Khaitan & Co for her assistance with the information for this alert.

If you want to discuss any of the points above or want help with your share plans or other incentive arrangements, please do contact us.

Sally Blanchflower, Rebecca Perry, Sharon Thwaites

Executive Remuneration updates / Financial Services updates / Global updates / Newsletter - 12/14/2022

UK: The IA Principles of Remuneration 2023

10 November 2022

The Investment Association (IA) yesterday released its updated Principles of Remuneration, with the usual accompanying letter to Remuneration Committee Chairs setting out member expectations for the 2023 AGM season.

Full copies can be found here: 2023 Principles and Remco Chair letter.

Whilst the IA notes it has not made significant changes to its Principles, there are specific areas with notable updates as set out below. The IA’s previous guidance for addressing the impact of the Covid-19 pandemic has also now been withdrawn.

Windfall gains
The guidance continues to provide that companies should scale back the quantum of awards at grant, following a substantial fall in share price, to reduce the risk of windfall gains. Further guidance has now been added, stating that shareholders expect remuneration committees to consider adjusting vesting outcomes where awards were not scaled back at grant. In the Remco Chair letter, the IA indicates that remuneration committees should clearly articulate to shareholders how they have considered the impact of potential windfall gains when determining vesting outcomes and why any reduction is appropriate. If no reduction is made, they should explain and disclose the rationale.

Pay restraint
Companies are warned to be mindful of widening inequality and making excessive awards to executives at a time when many lower-paid employees are forced to make significant sacrifices due to cost-of-living constraints. In the Remco Chair letter, the IA points out that most companies exercised good levels of restraint in relation to executive pay through the pandemic and should continue to be mindful of this in the current economic context. In particular:

Remuneration outcomes should be commensurate with company performance and not excessive – the guidance now states outcomes should also be commensurate with the experience of key stakeholders.
Remuneration committees should consider the overall quantum paid to executives in the context of pay levels and conditions across the entire workforce.
Remuneration committees should generally not increase executives’ salaries at a level greater than inflation or the increase awarded to the wider workforce. In the Remco Chair letter, the IA indicates a need to consider the impact of inflationary salary increases on overall remuneration (given that variable pay is often linked to a salary multiple) and encourages any increases to be below those given to the rest of the workforce.

Discretion
The guidance on remuneration committee use of discretion remains. The changes this year add a focus on ensuring remuneration outcomes reflect the performance of the executives and their contribution to overall corporate performance – as well as the experience of shareholders, wider stakeholders and general market environment.

The Remco Chair letter states that the IA encourages remuneration committees to be clear on disclosing issues and the different drivers they have considered when judging overall performance, and to put outcomes in the context of wider stakeholder experience.

Performance measures
The guidance continues to suggest the inclusion of strategic or non-financial performance measures, but now clarifies that this should be in addition to financial performance measures and should promote long-term value creation.

Remuneration committees should consider the collective impact of performance targets to ensure they lead to a balanced assessment of the company’s performance and that there is ‘appropriate natural tension’ between the metrics chosen.

Where ESG measures are used, there is now express guidance to state that they should be suitably stretching. In particular, they should not provide reward for ‘business as usual’ activity or be used as essentially a ‘soft target’ to increase overall quantum. Remuneration committees should explain how progress against the targets will be measured and how performance against them will be disclosed.

The Remco Chair letter provides some potentially helpful flexibility, suggesting that given wider economic uncertainties, it may be appropriate to consider wider performance ranges and discretion may be needed to ensure appropriate outcomes are achieved.

Non-executive directors (NEDs)
Recognising the increased complexity and time commitment associated with the NED role, the guidance now states that NEDs should receive fees commensurate with their duties, but that any increases in fees should be properly explained. Guidance on encouraging ownership by NEDs of shares in the company is retained, with a new acknowledgement that the number of companies introducing a minimum shareholding guideline for NEDs is increasing.

Pensions
The Remco Chair letter includes a statement that IVIS will red top any remuneration policy or report where executive pension contributions are not aligned to the majority of the workforce, reflecting the previous guidance that such alignment should be achieved by the end of 2022.

Tapestry Comment
The annual update to the IA Principles provides a useful barometer of investor views and key focus areas in relation to executive pay, and the changes are unsurprising given the wider economic outlook. These focus areas will be an important factor for companies in considering their executive pay structures for the year ahead. Whilst much of the guidance remains unchanged, the changes made will potentially be significant for those companies impacted, in a year where many will be renewing remuneration policies, managing the vesting of “Covid grants” under their LTIPs, and considering pay in the context of the current economic climate.

In addition to the IA’s update, LGIM has also published remuneration guidance, and the ISS has published its 2023 benchmark policy consultation. The FRC’s annual review of corporate governance reporting also contains some useful observations. We will be considering all of the updates in our Q1 webinar on Investor Expectations – look out for details to follow!

As always, if you have questions about any of the content of this alert, or there is any assistance you need in relation to your incentive plans, do not hesitate to contact us.

Hannah Needle, Suzannah Crookes and Sally Blanchflower

Executive Remuneration updates / Global updates / Newsletter - 11/11/2022

UK: The Government's "mini-budget" - a new broom sweeps clean

19 October 2022

As previously reported (see our alerts of 7 October and 14 October), the UK government’s “Special Fiscal Event” (or “mini-budget”) on 23 September sent major shockwaves through the UK economy. In an attempt to stabilise the continuing market turbulence, on Monday the newly appointed Chancellor of the Exchequer, Jeremy Hunt, scrapped most of the tax cutting measures remaining from the mini-budget.

A further statement is expected on 31 October, providing detail on some of the other (non-tax) proposals in the government’s Growth Plan, as well as a forecast from the Office for Budget Responsibility.

Where are we now on the key tax changes?

For reward and share plan professionals, the following points are of particular relevance:

Some changes are staying:

The cut in the rates of national insurance contributions (NICs) by 1.25% from 6 November, and the abolition of the proposed new Health & Social Care Levy, will proceed.
The proposed changes to the Company Share Option Plan (CSOP) also remain “on the table” at this stage (see HMRC’s Employment Related Securities Bulletin (45)).

And some are abandoned or amended:

The additional 45% rate of income tax is retained.
The recent 1.25% increase in the dividend rates will remain (even though this was originally introduced to align with the now cancelled increase in NICs).
The proposed reduction to the basic rate of income tax from 20% to 19% in April 2023 (bringing it forward from 2024) is now postponed "indefinitely".
The off payroll working rules (IR35) will remain unchanged, with the obligations around determining employment status and paying the appropriate PAYE and NICs will remain, as now, with the service recipient.
The previously planned and then cancelled corporation tax rise from 19% to 25% is back on track and will take effect on 6 April 2023.

What about the bankers’ bonus cap?

HM Treasury has confirmed that the proposal to remove the cap on bankers’ bonuses remains and it is expected that the Prudential Regulation Authority will be consulting on this in the autumn. A package of regulatory reforms is also expected on this timescale, which may give further insight into any other changes in the pipeline for remuneration regulation in the UK following Brexit.

Tapestry comment
The new Chancellor’s extensive tearing-up of the tax measures in the mini-budget has restored a degree of stability for UK plc. However, the government must clear more hurdles to restore confidence with the markets, businesses and the public. Generally, the messaging seems to be that the current administration will defer most tax cutting measures until the economy is in a better shape, but at this stage they still have the appetite to continue with reducing regulation.

From a share plans and reward perspective, it’s largely back to the “status quo” as far as tax rates are concerned, with some slight reduction in participant costs through the changes to NICs from 6 November. We are pleased to see that the increase in the CSOP limits has (so far) survived the bonfire.

However, this is a fast-moving situation, and we are now awaiting the release of the further fiscal statement on 31 October. Given it coincides with Hallowe’en, we hope that it will not present an opportunity for too many scary surprises!

As always, if you have questions about any of the content of this alert, or there is any assistance you need in relation to your share incentives, do not hesitate to contact us.

Suzannah Crookes and Sharon Thwaites

Executive Remuneration updates / Financial Services updates - 10/20/2022

Irish Revenue issues Employer Notice
to share scheme registered employers

25 August 2022

The Irish Revenue recently sent a communication to employers who have indicated that they operate share-based scheme(s) for their employees, as reported on Form RSS1 (for reporting option plans) and/or Form ESA (for reporting other share-based remuneration). The Employer Notice in respect of unapproved (i.e. not tax-qualified) share options was issued to such employers on 12 August 2022 (here).

The Irish Revenue notes that employees may not be fully aware of their tax obligations where they are engaged in a share-based remuneration scheme(s), for example, where they exercised, assigned or released share options, and/or disposed of shares. As such, the Irish Revenue is requesting that all employers operating share-based remuneration scheme(s) circulate the information provided in the Employer Notice to all employees to inform them of their tax obligations under sections 128 (the charging provision) and 128B TCA 1997 (which sets out that the tax is to be paid on the Form RTSO1). Employers should be able to access this notice through their ROS (online reporting) inbox.

Remember that in Ireland, employees are actually responsible for reporting (on Form RTSO1) and paying any taxes arising upon exercise of their share options (which must be reported and paid within 30 days of exercise).

Our counsel in Ireland is aware that, in some cases, employers are operating payroll when their employees exercise share options but, by doing so, employers are inadvertently creating tax issues for employees. It is clear that the Irish Revenue are cross-checking information provided on the Form RSS1 and reaching out to employees who they have been notified have exercised share options but who have not filed a Form RTSO1.

It is important that employers and employees are aware of and adhere to their obligations under Irish tax law in respect of share awards, and in particular, share options.

We would like to thank our relationship law firm in Ireland McCann FitzGerald for providing us with the information in this alert.

Tapestry comment: this intervention by the Irish Revenue demonstrates a very real concern that employees are not aware of their reporting and tax payment obligations in respect of share options. The system in Ireland is unusual in requiring employer withholding for some types of employee share plan but not for plans that are treated as options for Irish tax purposes. This is not always straightforward as, depending on the terms of the plan, this may include a share purchase plan. If the plan is treated as a share option, the employee is responsible for declaring and paying any taxes, including social security, on the benefit. It goes without saying that employees do not want to be in default in their tax obligations and employers may want to take extra care to ensure that the obligations are explained. Employers will also want to make sure that their payroll is aware that withholding does not apply to option plans.

Please let us know if you have any questions about the share plan reporting obligations, whether in Ireland or elsewhere.

Sharon Thwaites and Matthew Hunter

Executive Remuneration updates / Financial Services updates / Global updates / News / Newsletter / Press Releases - 08/26/2022

Financial Services: EBA Benchmarking and High Earners Report for 2019 and 2020

12 August 2022

The European Banking Authority (EBA) has published its report on benchmarking of remuneration practices in the EU for the 2019 and 2020 and high earners data for 2020.

The Capital Requirements Directive (CRD) mandates the EBA to benchmark remuneration trends in the EU and to publish data on staff whose pay is at least EUR 1 million per year (high earners). The report sets out the EBA’s findings and compares the data collected for 2020 with 2019 and, with regard to high earners, also 2018. The EBA’s main findings are set out below.

Key points:

The number of high earners fell from 4,963 in 2019 to 1,383 in 2020, mainly due to the fact that the 2020 figures no longer include data for high earners in the UK, who accounted for 71% of all high earners in 2019.
The weighted average ratio of variable to fixed remuneration for all high earners fell from 129% in 2019 to 86.4% in 2020. Again, the decrease is mainly due to the fact that the 2020 figures no longer include data reported by UK firms for high earners who, on average, received a higher portion of variable remuneration relative to their fixed remuneration.
When comparing the 2019 and 2020 data for the remaining EEA countries, that is, with the UK removed from the 2019 data, then:
- the number of high earners decreased from 1,444 in 2019 to 1,383 in 2020. The decrease was mainly caused by the reduction of the variable remuneration for certain staff in the context of the COVID-19 pandemic in 2020 and in line with the EBA recommendation to set variable remuneration of identified staff at a conservative level;
- a small increase of the weighted average ratio of variable to fixed remuneration for all high earners from 85.9% in 2019 to 86.4% in 2020 was observed, which was mainly caused by severance payments;
- the number of staff whose professional activities have a material impact on their firm’s risk profile (i.e. identified staff) included in the benchmarking exercise increased from 1.76% in 2019 to 1.84% in 2020. This is expected to increase further following the updates to identification practices in line with the requirements of the revised CRD and revised regulatory technical standards on material risk taker identification; and
- the average ratio of variable to fixed remuneration for identified staff decreased from 53.7% in 2019 to 49.7% in 2020. The ratio of variable to fixed remuneration for staff that were not identified staff decreased from 13.5% in 2019 to 12.3% in 2020. This reduction is due to the overall reduction in variable remuneration due to the COVID-19 pandemic as institutions followed the recommendation of the EBA and competent authorities to apply conservative remuneration policies and practices.
The regulatory framework for remuneration practices still appeared to not be sufficiently harmonised across member states and firms. In particular, the application of deferral and pay-out in instruments requirements differs significantly among member states and firms, mainly in relation to differences in the national implementation of CRD. CRD V implemented specific criteria which allows derogation from these requirements, which is expected to enhance the harmonisation for these requirements for 2021 onwards.
The EBA will continue to benchmark remuneration trends biennially and publish data on high earners annually, to closely monitor and evaluate developments in this area.
The EBA has stated that when collecting data for 2022, the data will be collected separately for credit institutions and investment firms and will include also a benchmarking of the application of derogations on the requirements to pay out a part of the variable remuneration in instruments and apply deferral arrangements, the gender pay gap and, for certain firms, the features of approved higher ratios (up to 200% with shareholders’ approval) between the variable and fixed remuneration.

Tapestry comment

Although the report looks at data from 2019 and 2020 and so may not be an accurate reflection of the current market position, it is useful to review the historic data when considering the trends that have impacted remuneration across the EU.

It is no surprise that the data in the report has been heavily impacted by the UK’s exit from the EU and the onset of the COVID-19 pandemic, given the impact that both events had and continue to have on the market. It will be interesting to see the future data to more fully understand the impact of the COVID-19 pandemic and Brexit on pay in EU credit institutions and investment firms.

Further, the separate collection of data from credit institutions and investment firms should provide an interesting comparison between institution types, and it will be interesting to see the impact that the introduction of more consistent derogations under CRD V will have on the structure of variable remuneration within the EU. It will, however, take a few years for these factors to be fully reflected in the data for future reports.

If we can assist you with your incentive arrangements, please do get in touch. We would be delighted to help.

Matthew Hunter and Lewis Dulley

Executive Remuneration updates / Financial Services updates / Newsletter - 08/12/2022

Financial Services: UK FCA publishes 'Dear Chair of Remuneration Committee' letter

3 August 2022

The UK Financial Conduct Authority (FCA) has published a letter addressed to the Chair of the Remuneration Committee of proportionality level one banks, building societies and PRA designated investment firms. The letter sets out the FCA’s expectations for the Chair as they determine their firm’s remuneration outcomes for the year and highlights a number of focus areas that they expect the Chair to take into account, and which the FCA may focus on in any firm-specific engagement during the year.

Key points:

Culture and accountability – firms are expected to continue to focus on driving positive cultural change. Remuneration policies should be risk-focused, helping to identify and manage risks and promoting a strong risk culture in the firm. Through the Senior Managers and Certification Regime, individuals should be held accountable for their conduct and competence with a clear, strong, and evidenced link between behaviours and remuneration outcomes. Where there is evidence of regulatory failings, the Chair is expected to oversee and challenge the process to ensure appropriate, timely and transparent adjustments to remuneration are made, including for individuals and Senior Managers, and the FCA may ask to see evidence of this. The FCA aims to embed Environmental, Social and Governance, and Diversity and Inclusion considerations into firms’ functions and will, later this year, consult on measures to promote diversity and inclusion in the financial services sector, including proposals to change the responsibilities of the Remuneration Committee.

Consumer duty – the FCA recently published the final rules and guidance for a new Consumer Duty which sets higher and clearer expectations for the standard of care and customer service that firms give consumers at each stage of the product lifecycle. The firm’s approach to supporting consumers in the current economic environment should be aligned with the firm’s business strategy. The firm’s remuneration policies should be designed to support the expectations set by the Consumer Duty when it comes into effect.

Rising cost of living – the current economic environment is both a current and future risk that the FCA expects the Chair to take into consideration when designing and reviewing the remuneration policies and practices and the incentives created.

Operational resilience – operational resilience is the ability of firms, financial market infrastructures and the financial sector as a whole to prevent, adapt and respond to, recover and learn from operational disruption. Continuing to strengthen firms’ operational resilience and minimise the impact of operational disruptions is one of the FCA’s key priorities. In the event of service disruptions, data breaches or other interruptions, the FCA would expect firms to respond appropriately, such as making remuneration adjustments where appropriate.

Environmental, Social, Governance (ESG) – the FCA is committed to consulting on a new regulatory framework for ESG. As firms respond to evolving regulatory, societal and customer expectations in this area, firms may wish to review whether incentives for their senior leadership and other material risk takers are aligned to these wider ESG risk factors. Firms may wish to use remuneration and incentive programmes as a lever to align incentives with ESG commitments. The FCA believes that linking progress against these commitments to a measurable proportion of pay could be effective in encouraging individuals to take accountability for change. Firms may want to consider the short and long-term milestones towards achieving these goals. If asked, the Chair should be able to explain the approach that the firm has taken to assess the outcomes of these measures to the usual FCA supervisory contact.

Diversity and Inclusion – the FCA published a discussion paper on diversity and inclusion in 2021 and are looking to consult on a new package of measures later this year. Pending that consultation and its outcomes, the FCA believes that remuneration and incentives have a part to play in supporting diversity within firms. As Chair, oversight of the link between the performance management framework and incentives is critical and the Chair may wish to review how remuneration policy takes into account some of the risks that an employee’s working preferences negatively influence their remuneration.

Remuneration approach for 2022/23 – in line with previous years, firms with an accounting reference date of 31 December should submit their Remuneration Policy Statement (RPS), Annex 1: malus and RPS tables 1a, 2 and 8 by 31 August 2022. Firms with an accounting reference date later than 31 December should submit their RPS no later than 8 months after the end of the preceding financial year. Firms are asked to also send:

(a) a short summary of the key points in the RPS with cross-references to the full RPS, including any key changes made in the last year;

(b) an explanation of how the Chair remains assured that the firm’s remuneration policies motivate and drive the purpose, long-term strategy and values of the firm, and how the Chair will hold employees to account if these are not met. This includes how the firm will take into account the impact of the current economic environment on bonus pools and individual outcomes; and

(c) where these exist, details of how the firm's ESG commitments are linked to remuneration policy, including any metrics and targets.

Tapestry Comment

This letter will be helpful for the relevant firms to understand some of the regulatory priorities impacting remuneration. This letter does not appear to contain any expectations that should come as a surprise for a relevant firm. The majority of the topics covered, and the interaction with a firm’s remuneration, have been areas of focus for the UK regulators for a number of years, particularly culture and accountability, operational resilience and diversity and inclusion. The other topics, being the new Consumer Duty, rising cost of living and ESG, are not surprising and align with areas of regulatory focus outside of the remuneration context. Firms should ensure that they have taken note of these expectations and take steps to address any possible improvements to the firm’s approach. Firms should also note the references to possible future changes to remuneration expectations, particularly in relation to ESG and diversity and inclusion.

Matthew Hunter and Lewis Dulley

Executive Remuneration updates / Financial Services updates / Newsletter - 08/04/2022

FS: PRA publishes consultation on changing variable pay instruments for MRTs seeking public appointment

18 July 2022

The UK’s Prudential Regulation Authority (PRA) has published a consultation paper setting out their proposed expectations on how existing unvested and deferred financial instruments awarded to Material Risk Takers (MRTs) as part of their variable pay should be dealt with where, in particular, a change to those instruments is appropriate to manage a conflict of interest arising from a MRT seeking a senior public appointment linked to financial policy or financial services regulation. The consultation will end on 19 September 2022.

The proposed expectations would apply to PRA-authorised banks, building societies, and PRA-designated investment firms, including third country branches, that are subject to the Remuneration Part of the PRA Rulebook and would result in changes to the PRA’s ‘Remuneration’ Supervisory Statement (SS2/17). The proposed changes are shown in the appendix to the consultation paper.

Background

Except where certain derogations are available, firms that are subject to the Remuneration Part of the PRA Rulebook will generally be required to: (a) ensure that a substantial portion, which is at least 50%, of any variable remuneration payable to a MRT consists of an appropriate balance of permitted instruments, including shares or share-linked instruments (non-cash requirement); and (b) defer a substantial portion, which is at least 40%, of variable remuneration for a period varying between at least 4 and 7 years.

The PRA has indicated that they are aware that an unvested, contingent claim to equity (or other instruments) arising from these requirements could create a conflict of interest, or a perception of the same, in particular where a MRT or former MRT seeks to take up a senior public appointment linked to financial policy or financial services regulation. In such situations, it may be appropriate to change the instruments that are comprised in the award to other instruments or cash. Those situations are the focus of the consultation paper.

Whether or not a firm wishes to explore if a change to the instruments underlying unvested, deferred variable pay is appropriate to manage a conflict of interest is a matter for the firm and the PRA sets no expectations in such cases. Where a firm believes that such a conflict could not be managed by means other than changing the underlying instruments, the PRA’s proposed expectations will apply.

Key proposals

The key proposed expectations, which would be set out in a new section 4A to SS2/17, are as follows:

in general, all unvested, deferred variable pay for MRTs, including any amounts above the minimum set out in the Remuneration Part of the PRA Rulebook, should not be converted from an equity claim into a claim on other instruments, or vice versa, after an award has been made;
in exceptional circumstances, it may be appropriate for a conversion of the instruments into other instruments to occur and, where that is the case, the firm should seek the prior non-objection of the PRA. When considering whether its non-objection is appropriate, the PRA will be guided by certain considerations, including whether it would not be appropriate or sufficient for a potential conflict to be avoided or mitigated through other means;
where an unvested, deferred sum is converted from equity to other instruments, the relevant post-vesting retention requirements should remain unchanged;
in wholly exceptional circumstances, where conversion to an award that comprises other instruments is not sufficient to mitigate conflicts, conversion to a cash award may be appropriate. Where conversion to a cash award would breach the minimum non-cash requirement, this would require a waiver or modification from the PRA. The proposals set out multiple features which, if satisfied, would mean that a successful waiver or modification request would be more likely, including: (a) where the individual is due to join a public-sector employer in a senior capacity and where their financial services experience is directly relevant to the role; and (b) where the cash award would replicate the deferral, malus and clawback provisions that applied to the original award and no early payment takes place;
in cases where a firm is seeking the PRA’s prior non-objection to a conversion or makes a request for a waiver or modification, the PRA should be presented with a reasoned case outlining why this, together with other measures, would be appropriate and sufficient to address the conflict of interest identified; and
where a public sector employer’s conflict of interest policy can address a potential conflict of interest without need for any alteration of variable remuneration, that route should be pursued instead.

Next steps

The consultation closes on 19 September 2022. Consultation responses can be sent by email to CP8_22@bankofengland.co.uk and there is also a mailing address for responses within the consultation paper linked above.

The PRA proposes that the implementation date for the changes would be 12 December 2022.

Tapestry comment
The PRA’s proposals with regard to changing the instruments underlying a variable remuneration award are not strictly limited to situations where a MRT is moving to a senior financial services public sector role but that is clearly the focus here. The proposed expectations are intended to mitigate the conflicts that may arise in such scenarios in a proportionate manner.

The proposals do not appear to materially increase the regulatory burden on firms and instead give firms avenues to explore when navigating these scenarios. This will likely be welcomed by firms. That said, firms should carefully consider the proposals and provide feedback to the PRA if the proposals would cause any problems.

Please do reach out if we can assist you with your remuneration arrangements. We would be delighted to help!

Matthew Hunter

Executive Remuneration updates / Financial Services updates / Newsletter - 07/18/2022

UK - Bonuses to return for SAYE contracts? New developments!

What is happening?

HMRC, the UK tax authority, has announced that it will be reviewing how it could simplify the mechanism for calculating the bonus rate applicable to a UK tax advantaged SAYE plan (sometimes called Sharesave, or Save as you Earn).

Remind me - what is the ‘bonus rate’?

Essentially, it’s interest.

Individuals who wish to participate in a UK SAYE must enter into a linked savings arrangement with an authorised savings carrier to save a specified amount per month. It is possible for the linked savings arrangement to provide that the participant will become entitled to a tax-free bonus - essentially this is interest which accrues on their savings, and is paid at maturity of the contract. The bonus is calculated based on a rate which is fixed at the start of the savings contract.

Why is this happening now?

The bonus rate is currently nil and has been set at this level for many years (since 2014). The bonus rate is set in accordance with an automatic mechanism, linked to market swap rates.

Whilst the announcement by HMRC does not specifically confirm that bonuses will become payable in future, in the current economic climate, this is something which seems more likely than in recent times. The timing of the review of the mechanism for calculating the bonus rate may not be coincidental.

What are HMRC actually reviewing – and when do we hear more?

HMRC are reviewing the mechanism for calculating the bonus rate. In HMRC’s ERS Bulletin 43, HMRC note that the current mechanism is “extremely complex”. The aim of the review will therefore be to simplify the method of calculating the applicable bonus rate.

In the meantime, HMRC have issued a new prospectus (the document which governs the terms of the savings contracts), which comes into effect for savings contracts entered into from 30 June onwards. The reference to the current bonus rate mechanism has been removed from this new savings prospectus.

HMRC have said they will provide an update (in a further bulletin) by the end of the summer. In the meantime, bonus rates are being held at nil.

If bonuses do become payable, what will this mean for UK SAYE?

The obvious implication is that, going forwards, participants will normally become entitled to receive interest on their savings, in the form of a tax-free bonus.

However, there is another potential benefit too. Where a bonus is payable, it can also be included in the amount of the savings the participant will make over the life of the savings arrangement. This amount is called the ‘expected repayment’. The ‘expected repayment’ is used to calculate the number of shares subject to the SAYE option. A bigger expected repayment therefore ultimately increases the number of shares subject to an SAYE option. This means a participant can buy more shares and maximise the value they are receiving from the SAYE plan.

Tapestry comment
A simplification of the bonus rate calculation mechanism is likely to be seen as good news. However, for SAYE participants, this may be tempered in the event that any change reduces the bonus rate which would otherwise have been due under the current mechanism.

There will be a number of things to think about in this context:

Will HMRC apply the change to existing SAYE contracts, or only those entered after the change takes effect? Generally, a change will only apply to savings contracts entered into on or after the date on which it comes into effect. Any change in the mechanism for calculating the bonus rates will not of itself impact existing contracts in any case, as the rate has already been specified at nil. If there is an increase in the rate itself (calculated under the new mechanism), we anticipate this is likely only to apply to savings contracts which are entered into after a further new savings prospectus, which specifies the new rates, takes effect.
Will a company need to amend its plan rules? A company would not normally need to amend its UK SAYE plan rules in relation to any change in bonus rate calculation, as this is not generally set out in the rules. Again, amendments are unlikely to be needed if bonuses start becoming payable, as rules are usually drafted flexibly to accommodate payment of bonuses, in line with the legislation. However, it will depend on exactly what has been included on certain points – so specific advice should be taken. A company may also need to update its pro-forma grant minutes (e.g. to allow bonus to be included in the ‘expected repayment’ to maximise the number of shares employees can buy). Given the early stages of this review, it’s probably too early for companies to make any updates just yet – but it is one to keep on the radar.
Will the employee communications need updating? If bonuses become payable again, then almost certainly, yes. Given there has been no bonus payable for many years, plan communications such as brochures, FAQs and invitation documents/application forms are unlikely to cater for this adequately at the moment. As rates are being held at nil whilst HMRC undertakes its review of the calculation, companies and administrators may want to wait and see whether HMRC’s further update later in the summer gives any indication of when rates may rise above nil before putting pen to paper on this. However, in an economic context where a rate rise is perhaps anticipated, companies and administrators may want to plan ahead.
What do companies need to do about their international SAYE arrangements? Whilst it does depend on how the plan rules are drafted, any change in UK SAYE bonus rates may not automatically apply to an international SAYE plan. A company which wants to track its UK SAYE plan will therefore need to check its plan rules and savings paperwork for the international arrangement, to see whether changes would need to be made. Legal advice would be needed – the position will be company specific.

Watch this space!

If you have any questions, please do contact us and we would be happy to help.

Suzannah Crookes and Emma Parker

Executive Remuneration updates / Global updates / Newsletter - 06/24/2022

UK: The Government's "mini-budget" - a new broom sweeps clean

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