18 November 2020

The Financial Stability Board (FSB) has published its annual report on the implementation and effects of the G20 financial regulatory reforms that followed the 2008 financial crisis. The report considers the impact that the COVID-19 pandemic has had on the implementation of reforms and how effective the reforms have been. The FSB concludes that the reforms have “served the financial system well during the pandemic” but that there has been limited additional progress in implementing the reforms this year due to the pandemic. The report includes some comments on the FSB’s remuneration reforms, which we have summarised below.

Background

Following the 2008 financial crisis, the FSB was called upon to develop and co-ordinate a comprehensive framework for global financial services regulation, as well as to provide oversight of the global financial system and increase international financial stability. The reforms included the regulation of remuneration within ‘significant’ financial institutions and resulted in the publication of the FSB’s ‘Principles for Sound Compensation Practices’ and the related ‘Implementation Standards’ (the ‘Principles and Standards’), which were intended to align compensation with prudent risk-taking and develop good compensation practices. The Principles and Standards form the basis of many of the remuneration rules that regulate financial services firms around the world, including, for example, the remuneration rules set out under the EU’s Capital Requirements Directive.
 
As part of their oversight role, the FSB produces an annual report reviewing the implementation and effects of the financial regulatory reforms. In this alert, we have summarised the key remuneration-related points noted in the 2020 annual report. The implementation of the remuneration reforms is judged by how far the Principles and Standards have been implemented for all banks considered to be ‘significant’ in this context.

Key remuneration-related points:

• In line with the 2019 report, as of October 2020, the Principles and Standards had been implemented in full for significant banks by 18 FSB jurisdictions, with 6 FSB jurisdictions (Argentina, Brazil, China, Russia, South Africa and the US) having implemented all except a few (three or less) of the Principles and Standards. There were no jurisdictions that had not implemented the Principles and Standards at all.
• Fewer jurisdictions have implemented the Principles and Standards for the insurance and asset management sectors but the FSB did not provide further detail on this in the report.
• Authorities in some jurisdictions have introduced new prohibitions or set supervisory expectations on remuneration to address COVID-related risks, including to ensure that banks preserve the capital needed to support lending. In line with the Principles and Standards which expect remuneration actions to be risk-aligned, some jurisdictions have asked banks to consider prudential risks when taking remuneration actions.
• The FSB intends to conduct a country peer review of the UK’s compensation practices and expects to publish this in Q1 2021.
• More generally, the FSB will undertake further work to identify potential lessons learned from the COVID-19 pandemic in relation to international standards.

Tapestry comment  

It is not surprising that the COVID-19 pandemic is a topic that the FSB has focussed on in this year’s annual report. The FSB’s financial regulatory reforms, including those relating to remuneration, were intended to ensure that the financial system would remain sufficiently robust during periods of market instability and shock. The COVID-19 pandemic is probably the first time that the effectiveness of the reforms has been tested globally in this way and the FSB will be keen to identify what has worked well, what did not work well, and where further international standards will be required, which could include further remuneration reforms.

This year’s report did not identify any major changes in how the Principles and Standards have been applied globally, which appears to have remained largely unchanged against last year with the exception of the general comments on the approach to remuneration in consideration of the COVID-19 pandemic. That said, the report only gives a high-level overview of whether the Principles and Standards have been applied and not necessarily how they have been applied or whether a jurisdiction has implemented more stringent requirements than those expected under the Principles and Standards.

Firms should look out for the FSB’s country peer review on the UK’s compensation practices when this is published in Q1 2021. The UK has implemented stringent remuneration rules for significant banks, going much further than the Principles and Standards in some places, and so it will be interesting to see the comments and any recommendations coming from the review.

If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do let us know.
 
Matthew Hunter

17 November 2020

The UK’s HM Treasury, Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) have published a short joint statement on planned timelines for introducing the UK’s Investment Firms Prudential Regime (IFPR) (which will establish a new prudential regime for MiFID investment firms in the UK) and the implementation of Basel reforms which make up the UK equivalent to the outstanding elements of the EU’s Capital Requirements Regulation II. The authorities had originally intended to implement these regimes in summer 2021 but, due in part to concerns from industry about the volume of regulatory reform in 2021, the targeted implementation date has been pushed back to 1 January 2022.

Tapestry comment
The delayed implementation should be welcomed by those firms that are already stretched with managing the impact of Brexit and a range of other regulatory reforms. From a remuneration perspective, the delay should also be welcomed by those firms that currently comply with existing remuneration requirements in a proportionate manner but which may be required to materially change their remuneration structures once the IFPR comes into effect, given that the IFPR is anticipated to contain a more stringent and less subjective concept of proportionality. The delay will give those firms more time to prepare for the changes and to communicate with impacted staff. It is likely that the new IFPR remuneration rules will be applied to remuneration related to performance years beginning on or after 1 January 2022, although this will need to be confirmed by the authorities.

It is worth noting that there is no indication that the implementation of the Capital Requirements Directive V (CRD V) (as covered in our alerts on the FCA and PRA consultations), including the material changes to the remuneration rules impacting credit institutions and designated investment firms, will be delayed. As CRD V must be implemented by EU member states by 28 December 2020 and applied from 29 December 2020 (that is, during the Brexit transition period during which the UK must continue to implement and apply EU laws), the UK must implement the CRD V remuneration rules in line with the EU requirements.

If you have any questions on this alert, or on your remuneration compliance generally, please do let me know.
 
Matthew Hunter

4 November 2020

The European Banking Authority (EBA) has published a discussion paper on the management and supervision of Environmental, Social and Governance (ESG) risks for credit institutions and investment firms, providing a comprehensive proposal on how ESG factors and risks could be included in the regulatory and supervisory framework for credit institutions and investment firms. Responses to this discussion paper will influence the report on ESG risks that the EBA is mandated to develop under the latest iteration of the Capital Requirements Directive (CRD V) and the Investment Firms Directive (IFD). The consultation runs until 3 February 2021 and a final report is anticipated to be published by June 2021.

The discussion paper is fairly extensive and includes an explanation of what ESG factors and risks are, how and through which transmission channels they materialise, why they matter from a financial point of view and what can be done to support their full incorporation by firms and supervisors to enhance the resilience of the financial sector. Of particular interest to us, the EBA identifies a need to incorporate ESG risks into each firm’s internal governance arrangements and supervisory framework in a proportionate manner, including through the firm’s remuneration policies and practices. This alert summarises the comments relating to remuneration.  

Remuneration

Chapter 6 of the discussion paper outlines a number of perceived shortcomings in how firms currently incorporate ESG risks into their internal governance practices, including an assessment that remuneration policies are generally not integrated with the relevant firm’s business strategy, core values and long-term interests so as to account for ESG risks, to ensure sound risk management and to mitigate excessive risk taking in this area. This is despite the fact that firms that are currently regulated under the fourth iteration of the Capital Requirements Directive (CRD IV) should already ensure that remuneration policies are consistent with and promote sound and effective risk management and not encourage risk-taking that exceeds the firm’s level of tolerated risk.

 The discussion paper notes that: 

• a robust and appropriate incentives-based mechanism is important to support the achievement of an appropriate risk culture and should account also for ESG risks;
• aligning the remuneration policy with the firm’s ESG objectives, e.g. long-term resilience of the business strategy under ESG considerations and risk appetite, is important to avoid conflicts of interest when business decisions are taken;
• remuneration policies that create appropriate incentives for staff members to favour decisions in line with the firm’s ESG considerations would facilitate the implementation of ESG risk-related objectives as the staff members would benefit from meeting the long-term ESG risk-related objectives for the business activities of the firm, e.g. in the context of ‘green credit-granting’ or reducing exposures highly affected by transition risk; and
• the impact of the remuneration policies on the achievement of sound and effective long-term risk management objectives from the point of view of ESG considerations may be especially relevant when it comes to the variable remuneration of staff who are ‘material risk takers’. 

The discussion paper then makes the following policy recommendations: 

• for firms that have set ESG risk-related objectives and/or limits, they should consider implementing a remuneration policy that links the variable remuneration to the successful achievement of those objectives, while ensuring that ‘green-washing’ and excessive risk-taking practices are avoided;
• firms should establish a framework to mitigate and manage conflict of interest which incentivise short-term-oriented undue ESG-related risk-taking, including ‘green-washing’ or mis-selling of products;
• firms should consider ESG indicators when taking into account the long-term interests of the firm in the design of their remuneration policies and its application; and
• in Chapter 7, the EBA recommends that an assessment of the ESG risks, including an assessment of how ESG risks are incorporated into a firm’s remuneration policies and practices, should also be incorporated in the supervisory review for credit institutions.

The EBA recognises that some aspects of the points listed above may not be fully applicable for the economic activities of investment firms, as opposed to credit institutions, but notes that the need to capture the ESG risks in the internal governance and risk management of investment firms, reflecting the specificities of their activities, is equally valid.

Timing

• The EBA is holding a public hearing via webinar on 26 November 2020.
• The deadline for consultation responses is 3 February 2021. A consultation response can be submitted on the webpage that can be found here.
• The responses to the discussion paper will influence the EBA’s final report on the management and supervision of ESG risks for credit institutions and investment firms that they intend to publish in June 2021. The final report may lead to future legislative changes and guidance / standards.

Tapestry comment
The recommendation that firms take steps to incorporate ESG risks into their remuneration policies and practices and align ESG objectives with the remuneration policy reflects a general trend towards linking ESG risks and objectives to pay. Regulators, investors and other stakeholders are all increasingly concerned with how companies approach and integrate ESG considerations into their remuneration strategies, particularly at the executive level.
 
We recently conducted a review of the remuneration reports published by the UK’s FTSE 100 companies. This review included an analysis of if and how those FTSE 100 companies incorporate ESG metrics into their executive remuneration. We found that a majority of those companies do now incorporate a broad range of ESG metrics into their executive remuneration. This is particularly the case for financial services firms, which we identified in our review as being a leading sector for incorporating ESG targets into executive compensation.
 
The EBA’s recommendations are not, however, limited to executive compensation. Once the final report is published and legislative or guidance changes are implemented, market practice will develop over time and the regulatory expectations will become clearer. In any event, it is clear that the EBA will expect ESG risks and objectives to be incorporated into the remuneration policies and practices on a wider basis than just to executives, where proportionate.
 
It is notable that the discussion paper and its recommendations constitute only one aspect of the European Union’s focus on ESG and financial services. For example, the EBA recently closed a survey on ESG disclosures and the upcoming Disclosure Regulation, which is anticipated to apply from 10 March 2021, will require certain firms to include in their remuneration policies information on how those policies are consistent with the integration of ESG risks and publish that information on their websites. Firms should take note of the continuing focus on this area and stay aware of future developments in this space and the impact that these may have on remuneration.
 
If you would like to discuss this update, or anything else, please do contact us. 
 
Matthew Hunter

30 October 2020

The European Banking Authority (EBA) has published a consultation paper in connection with proposed changes to its guidelines on sound remuneration policies under the Capital Requirements Directive (CRD). The consultation focusses only on changes against the existing guidelines and a track changes version has been published. The consultation runs until 29 January 2021 and the guidelines, once finalised, are expected to apply from 26 June 2021.

1. Background
   
   The EBA first published its guidelines on sound remuneration policies under the CRD in December 2015, in line with a mandate under the fourth iteration of the CRD, CRD IV. The guidelines apply to CRD firms and seek to harmonise the remuneration policies of CRD firms across Europe, in line with the CRD remuneration rules. The latest iteration of the CRD, CRD V, expands on this and includes a mandate for the EBA to issue guidelines on gender neutral remuneration policies for CRD firms. 
   
   The EBA’s proposed revisions to the guidelines are intended to reflect the amendments to the rules regulating the remuneration policies of CRD firms that were introduced by CRD V and, in particular, the requirement that those remuneration policies should be gender neutral.
   
   
2. Revisions
   
   The proposed revisions to the guidelines impact the following topics:

• Gender neutral – many of the changes relate to the requirement under CRD V that remuneration policies and practices are ‘gender neutral’, meaning that there must be equal pay for male and female workers for equal work or work of equal value. These changes to the guidelines are reasonably wide-ranging. For example, the guidelines expect firms to demonstrate how each aspect of the remuneration policy is gender neutral and undertake specific additional record-keeping, and expects that all employment conditions that may impact remuneration are gender neutral (including recruitment policies, career development and succession plans, access to training and the ability to apply for internal vacancies). The guidance also expects the supervisory function / remuneration committee review of the remuneration policy to include analysis of whether the policy is gender neutral and, as part of the review, consider the overall gender pay gap and calculate specific gender pay gap ratios.
• Remuneration policy – amongst other existing factors, a firm’s remuneration policy for all staff should also be consistent with the firm’s ‘risk culture’, including with regard to environmental, social and governance (ESG) risk factors.
• Material risk taker identification – updates have been made to reflect the CRD V changes to the process of identifying material risk takers and also the new regulatory technical standards on identifying material risk takers.
• Group consolidation – revisions have been made to the guidelines to clarify how CRD firms should apply the remuneration rules on a consolidated basis for their non-CRD subsidiaries, including investment firms and others financial institutions that are subject to a specific remuneration framework (such as UCITS, AIFMD and MiFID firms).
• Proportionality – the new CRD V rules will materially impact the concept of proportionality. Proportionality will now comprise of specific firm-level and individual-level proportionality thresholds, under which certain remuneration rules can be waived. This is as opposed to the existing, more discretionary, concept of proportionality. The EBA has provided procedural requirements and expectations for the application of these new thresholds and waivers, including the method of calculating the firm’s average assets when applying firm-level proportionality and calculating individual remuneration when applying individual-level proportionality.
• Retention bonuses – the guidance on retention bonuses has been heavily revised, including to ensure that retention bonuses are only awarded where properly justified and to clarify that retention bonuses must be taken into account when calculating the ‘bonus cap’. The EBA notes that this has been revised based on supervisory experience regarding cases of circumvention.
• Severance payments – the guidance on severance payments has been revised, including to clarify which payments can properly be regarded as severance payments and those which cannot, and also when severance payments can be excluded from the scope of certain remuneration rules. As with retention bonuses, the EBA notes that this has been revised based on supervisory experience regarding cases of circumvention.
• Disclosure – the existing guidelines provide guidance on the remuneration disclosure requirements that apply under the Capital Requirements Regulation. This guidance has now been removed as it has become superseded by the draft implementing technical standards on disclosure, including remuneration disclosure, published by the EBA in June.
• Clawback – the EBA has removed the recommendation that clawback should, in particular, be applied when a “staff member contributed significantly to the subdued or negative financial performance” of the firm. The EBA has, however, added an expectation that where the application of malus is not possible in connection with an award due to the deferral requirement being disapplied using proportionality, firms should ensure that clawback can be applied.

3. Timing

• The EBA is holding a public hearing on the draft guidelines on 13 January 2021.
• The deadline for consultation responses is 29 January 2021. A consultation response can be submitted on the webpage that can be found here.
• The EBA expects to publish the final guidelines in the first half of 2021 and the guidelines are then expected to apply from 26 June 2021, at which point the revised guidelines will replace the 2015 guidelines. 

Tapestry comment
The track changes version of the guidelines contains extensive mark-up throughout. That said, there does not appear to be many major surprises in here. As the EBA notes, the majority of the changes reflect the CRD V changes and, in particular, the new ‘gender neutral’ requirement, and so should align with what CRD firms were expecting. The changes relating to remuneration policy, retention bonuses, severance payments and clawback are the notable exceptions.
 
Although many firms will already consider their remuneration policies and practices to be ‘gender neutral’, the more granular expectations set out under the guidelines, for example, relating to record-keeping and supervisory function / remuneration committee oversight, as well as a focus on wider policies (such as recruitment policies and succession plans), will give firms an opportunity, and a regulatory driver, to ensure that this is truly the case. These new expectations will, however, need to be administered and firms should work through the practicalities of doing so.
 
Except where noted above, or where minor changes have been made to reflect CRD V (e.g. changing references from 3 to 5 year deferral periods to the 4 or 5 years required under CRD V; referring to listed firms being able to offer share-linked instruments), much of the existing guidance remains unaffected, particularly with regard to structural elements of remuneration, such as in relation to the award, pay-out and risk adjustment processes. This is generally positive news.
 
Firms should take the time to review the proposed revisions to the guidelines in detail, understand exactly how the changes will impact existing practice and, where appropriate, respond to the consultation process. Firms should note that the EBA has clearly stated that comments are only invited on the proposed amendments and not the existing text of the guidelines so, unfortunately, this is not a chance to try and delete any existing guidelines that you do not like!

If you would like to discuss these changes, or anything else, please do contact us. 
 
Matthew Hunter

18 September 2020

The EU has been looking to increase good practice and reporting on Environmental, Social Impact and Governance (ESG) for some time.  With a specific focus on the financial services sector, the European Banking Authority (EBA) has published an online survey asking for input from credit institutions on their practices and views on the disclosure of environmental social governance (ESG) risks. The survey is addressed large credit institutions that will be required to make Pillar 3 disclosures on ESG risks under the Capital Requirements Regulation (CRR).
 
The survey consists of three main parts: general questions on the current status of ESG disclosures, the interaction between Pillar 3 disclosures and policy initiatives and the implementation of the upcoming disclosure requirements of Article 449a of the CRR.

The survey can accessed either via the webpage or responses can be submitted via this online tool. Questions can be submitted to ESG.disclosure@eba.europa.eu.

The deadline for submission is 18:00 CEST on 16 October 2020.
 
Background
 
Pillar 3 disclosures are seen as critical in the promotion of transparency and disclosure of the prudential risks across the market. Pillar 3 disclosures are made in a harmonised and universally accepted format. This provides for the information on the risk profiles of institutions to  be comparable and comprehensive. This is key as Pillar 3 disclosures are made in relation to multiple areas which go beyond ESG risks and includes amongst others, those disclosures related to remuneration policies.
 
The views collected from the survey will be used to assist in the development of the Pillar 3 framework. Specifically, to aid the EBA’s work in developing draft implementing technical standards on Pillar 3 disclosure of prudential information on ESG risks by institutions and to monitor the short-term expectations mentioned in the EBA Action Plan on Sustainable Finance.
 
Tapestry comment
In addition to the disclosure of ESG risks forming part of the Pillar 3 and sustainable finance framework, investors and other stakeholders are all increasingly concerned with how companies approach and integrate ESG considerations into their strategies. The results of this concern and the importance attached to ESG are evident in the number of companies that have taken action to incorporate ESG targets into their executives’ compensation structures. This is particularly true for financial services firms, who we identified in our recent FTSE100 review as being a leading sector when incorporating ESG targets into their executive compensation structures.
 
We will be discussing the inclusion of ESG targets and risks into executive compensation structures at our FTSE100 virtual roundtables. 
 
I will also be hosting a GEO session on 22nd September at 16.20 (GMT) “A little less conversation...a bit more action”, with Louise Sutton from Unilever and Anna Fletcher from Rentokil, where we will be talking about the key developments in the use of ESG targets in reward. 
 
If you have any questions about this alert, or if you would like to discuss your remuneration structures generally, please do let us know.
 
Janet Cooper OBE

10 August 2020

The UK's Financial Conduct Authority (FCA) has published a consultation paper on the implementation of the EU Capital Requirements Directive V (CRD V) for UK banks, building societies and designated investment firms. The consultation paper includes appendices which set out the proposed changes to the FCA’s Dual-regulated firms Remuneration Code (SYSC 19D) and related guidance. The FCA’s approach closely aligns with the approach taken by the UK’s Prudential Regulation Authority in its recent consultation paper on CRD V and so many of the key points covered in this alert align with the key points in our alert on the PRA’s consultation paper.

Background

CRD V, published back in June 2019, is the latest iteration of the EU’s Capital Requirements Directive. EU Member States are required to implement CRD V locally by 28 December 2020. As the Brexit transition period will not have ended by that date, the UK is required to implement CRD V locally. 
 
This implementation process will have a material impact on the way in which firms caught by the rules can operate their remuneration policies and practices. In particular, CRD V will impact how firms identify their Material Risk Takers (MRTs), extend the duration of the minimum deferral period for certain of those MRTs and materially change the way in which the ‘proportionality’ principle applies to remuneration rules, both on a firm and individual basis.

Key points from the consultation paper

• Identification of MRTs: CRD V updates the basis for identifying MRTs, specifying certain categories of staff whose professional activities have a material impact on the firm's risk profile. The FCA proposes to implement CRD V's revised approach to identifying MRTs, including the revised list of categories of staff who must be included as MRTs.
• Minimum deferral period: CRD V increases the 3 to 5 year minimum deferral period for variable remuneration to a minimum of 4 years for all MRTs and to 5 years for members of management bodies and senior management of firms that are 'significant' in terms of their size, internal organisation and the nature, scope and complexity of their activities. The FCA proposes to lengthen the minimum deferral period in line with the CRD V requirements, but where the FCA's current minimum deferral periods are longer, these will not be changed.
• Payment in instruments: CRD V will permit listed firms to offer share-linked instruments to satisfy the requirement that at least 50% of an MRT's variable remuneration must be awarded in certain instruments. The FCA will change their rules to permit this. 
• Gender neutral remuneration: the FCA proposes a new requirement that firms must ensure their remuneration policies and practices are gender neutral, as required under CRD V. The FCA also proposes to include related guidance provisions, including provisions which remind firms of their existing legal obligations to ensure that their remuneration policies and practices are not discriminatory.
• Proportionality: the FCA currently applies a flexible approach to proportionality which allows firms, either on a firm or individual basis, to disapply certain remuneration requirements, including rules on pay-out in retained shares or other instruments, deferral, performance adjustment (malus and clawback), and the variable remuneration ‘bonus cap’. CRD V requires that these requirements apply to all firms and all MRTs, except, for some requirements, where limited exemptions apply (see below). In line with CRD V, the FCA intends to remove its flexible proportionality threshold and apply these remuneration rules to all firms and MRTs.
• Firm-level exemptions: consistent with CRD V, the FCA will introduce a rule to exempt certain firms from applying the remuneration rules on pay-out in retained shares or other instruments, deferral, and certain requirements for discretionary pension benefits. Exemptions will be available for firms that are not considered a ‘large institution’, as defined in the Capital Requirements Regulation, whose total assets average EUR5bn (c. GBP4bn) or less over the previous 4 years (or EUR15bn (c. GBP13bn) where certain other criteria are also fulfilled). The FCA also intends to revise the criteria for assessing whether a UK branch of a third country firm is in scope of SYSC 19D. 
• Individual-level exemptions: in line with CRD V, the FCA will also introduce a rule to exempt certain individuals from applying the remuneration rules on pay-out in retained shares or other instruments, deferral, and certain requirements for discretionary pension benefits. Exemptions will be available to individuals whose annual variable remuneration does not amount to more than one-third of the individual’s total remuneration, and does not exceed EUR50,000 (c. GBP44,000). 
• Clawback: currently, the FCA requires that all variable remuneration is subject to a clawback period of at least 7 years. In light of the CRD V revised minimum deferral periods, the FCA will make changes to the minimum clawback period. The FCA proposes that firms must apply whichever is the longer period of the minimum clawback period set out in their rules, or the period equal to the sum of the deferral and retention period the firm chooses to apply to the individual. The FCA also proposes to apply a more proportionate approach to those employees with total remuneration of GBP500,000 or below, whereby a shorter clawback period may apply, including a one-year clawback period for non-deferred variable remuneration.
• Remuneration guidance: the FCA will update their remuneration guidance to reflect the amendments proposed in their consultation paper. They also propose creating a second version of the guidance to apply solely to SYSC 19A and firms in scope of the IRPRU Remuneration Code (The Prudential Sourcebook for Investment Firms). The substance of the Guidance for SYSC 19A would remain unchanged. Only amendments to references to SYSC 19D and dual-regulated firms, and to the UK’s exit from the EU, would be made.  
• The UK’s exit from the EU: the consultation paper also sets out proposals for further amendments to  SYSC 19D that would enter into force at the end of the transition period following the UK’s exit from the EU on 1 January 2021. The proposals will make minor amendments to address exit-related deficiencies in the text of SYSC 19D, for example changing references to CRD to the UK legislation that will implement CRD.
• Application: the FCA is only seeking to implement the CRD V remuneration requirements for dual-regulated firms. Solo-regulated CRD firms that are not subject to SYSC 19D should continue to comply with the relevant existing rules until a new UK prudential regime for these firms is introduced. 
• Timing: the FCA intend to consider all feedback received and publish their final rules and guidance before the CRD V transposition deadline on 28 December 2020. The FCA proposes that firms will need to apply the amended remuneration requirements from the next performance year that begins on or after 29 December 2020. For remuneration awarded on or after 29 December 2020 in respect of earlier performance years, firms must comply with the rules as they applied immediately prior to the amendments. 

The consultation period closes on 30 September 2020. If you would like to provide feedback on the consultation, you can address any comments or enquiries to cp20-14@fca.org.uk.

Tapestry comment  
It is important to note that these changes will not affect solo-regulated CRD firms, that is, firms that are currently regulated under the IFPRU Remuneration Code (SYSC 19A) or the BIPRU Remuneration Code (SYSC 19C). There had been some uncertainty as to whether solo-regulated CRD firms would be expected to implement the CRD V rules before moving onto the UK’s new prudential regime for investment firms, but the FCA has clarified that those firms will continue to apply the existing rules. HM Treasury had previously indicated that this would likely be the case but the clarification is helpful.
 
As with the corresponding PRA proposals, the FCA’s proposed changes are not extensive and generally reflect the final text of CRD V which firms will already be familiar with. That said, all dual-regulated banks, building societies and designated investment firms will be affected in some way by these changes and so firms should take steps now to understand the impact of the proposed remuneration changes before they come into effect.
 
Like the PRA proposals, the proposed date of 29 December 2020 to apply the amended rules is not far away. Firms should ensure that they are clear on the remuneration structures that will need to be applied after this date and be prepared to communicate any changes to any affected employees. The clarification that remuneration for performance years beginning prior to this date will be subject to the previous rules will be welcomed by firms.  
 
Although there may be little room for the FCA to move from the proposals that they have stated in their consultation paper, given that these changes implement CRD V, the consultation process still serves as an opportunity to clarify issues and guidance where necessary. We encourage firms to use this process to clarify those issues that are genuinely unclear. If we can assist you with this, please do let us know.

If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do contact us.
 
Matthew Hunter

31 July 2020

The UK's Prudential Regulation Authority (PRA) have today published a consultation paper on the implementation of the EU Capital Requirements Directive V (CRD V) for UK banks, building societies and PRA-designated investment firms. The consultation paper includes appendices which set out the PRA’s proposed changes to the Remuneration Part of the PRA Rulebook (Remuneration Part) and the PRA’s ‘Remuneration’ Supervisory Statement (SS2/17).

Background
CRD V, published back in June 2019, is the latest iteration of the EU’s Capital Requirements Directive. EU Member States are required to implement CRD V locally by 28 December 2020. As the Brexit transition period will not have ended by that date, the UK is required to implement CRD V locally. 
 
This implementation process will have a material impact on the way in which firms caught by the rules can operate their remuneration policies and practices. In particular, CRD V will impact how firms identify their Material Risk Takers (MRTs), extend the duration of the minimum deferral period for certain of those MRTs and materially change the way in which the ‘proportionality’ principle applies to remuneration rules, both on a firm and individual basis. There are also changes to remuneration disclosure requirements under the related Capital Requirements Regulation II, although those are not covered by the PRA’s consultation paper.

Key points from the consultation paper

• Identification of MRTs: CRD V updates the basis for identifying certain categories of MRTs, specifying certain categories of staff whose professional activities have a material impact on the firm's risk profile. The PRA proposes to implement CRD V's revised approach to identifying MRTs, including MRTs in branches of third-country firms. The PRA also clarifies that it is consulting on the basis of the EBA's draft regulatory technical standards for identifying MRTs and that if these are adopted and operative in EU law before the end of the Brexit transition period, the standards will be 'onshored' in UK legislation. 
• Minimum deferral period: CRD V increases the 3 to 5 year minimum deferral period for variable remuneration to a minimum of 4 years for all MRTs and to 5 years for members of management bodies and senior management of firms that are 'significant' in terms of their size, internal organisation and the nature, scope and complexity of their activities. The PRA proposes to lengthen the minimum deferral period for remuneration from 3 years to 4 years for MRTs that are not already subject to the longer deferral periods that already apply under the PRA rules. 
• Payment in instruments: CRD V will permit listed firms to offer share-linked instruments to satisfy the requirement that at least 50% of an MRT's variable remuneration must be awarded in certain instruments. The PRA will change their rules to permit this. 
• Gender neutral remuneration: CRD V requires firms' remuneration policies to be 'gender neutral', for there to be data collection on remuneration, including on the gender pay gap, and for that information to be used to benchmark remuneration trends and practices. HM Treasury is consulting on its proposed approach to transposing these requirements. The PRA will determine if further changes are needed in light of HM Treasury's approach and, if necessary, intends to consult on any such changes in autumn 2020. 
• Proportionality: the PRA currently applies a flexible approach to proportionality which allows firms, either on a firm or individual basis, to disapply certain remuneration requirements, including the variable remuneration ‘bonus cap’, the prohibition on guaranteed variable remuneration, requirements relating to buy-outs of variable remuneration, and malus and clawback, in certain circumstances. CRD V requires that these requirements apply to all firms and all MRTs, except, for some requirements, where limited ‘derogations’ apply (see below). The PRA intends to align with the CRD V approach and apply these requirements to all firms and MRTs.
• Firm-level derogation: CRD V introduces explicit derogations under which the requirements for payment in instruments, minimum deferral and discretionary pension benefits are not applied to small, less complex firms. The PRA will apply these derogations and has indicated that, for certain firms that meet the criteria set out in the consultation paper, the assets threshold that cannot be exceeded for a firm to be able to rely on the derogation will be increased from EUR5 billion (c. GBP4 billion) to EUR15 billion (c. GBP13 billion). The PRA has also explained how they propose that these rules will apply to branches of third-country firms.
• Individual-level derogation: the PRA proposes to amend its approach to the proportionate application of remuneration requirements to individuals in line with CRD V. The PRA proposes to clarify that remuneration requirements for payment in instruments, minimum deferral of variable remuneration, and discretionary pension benefits do not apply to individuals with annual variable remuneration equal to or less than EUR50,000 (c. GBP44,000) and which represents no more than one-third of total remuneration. For MRTs whose variable remuneration is no more than a third of total remuneration and their total remuneration is no more than GBP500,000, the PRA proposes to apply deferral periods of either 4 years or 5 years, subject to the MRT’s role, and clawback periods of either 1 year, 5 years, 5.5 years or 6 years, depending on whether the remuneration is deferred or not and the MRT’s role.
• Timing: the amendments to the Remuneration Part and SS2/17 will apply to any remuneration awarded in relation to the first performance year starting after 29 December 2020. For remuneration awarded on or after 29 December 2020 in respect of earlier performance years, firms must comply with the rules as they applied immediately prior to the amendments. 

The consultation period closes on 20 September 2020. If you would like to provide feedback on the consultation, you can address any comments or enquiries to CP12_20@bankofengland.co.uk. 

Tapestry comment 
The PRA’s proposals show a clear intention to implement the key CRD V remuneration changes in full. For the larger ‘proportionality level one’ firms, the changes will require some action to be taken, such as changes to MRT identification, the revised application of individual proportionality and the extension of the deferral period for some MRTs. These changes will not, however, reflect a significant change to the remuneration structure of those firms. It will be those ‘proportionality level three’ firms that can currently benefit from the PRA’s application of proportionality which will see the most material changes to their remuneration structures. For example, such firms may have no bonus cap, no malus and clawback, and deferral and payment in instruments structures that are significantly less onerous than the PRA requirements. The implementation of some or all of these requirements will reflect a significant change in the remuneration structures of those firms.
 
The key message, however, is that all PRA-regulated banks, building societies and designated investment firms will be impacted in some way by these changes and firms should take steps now to understand the impact of the proposed remuneration changes. It is important to note the timing of the proposed changes. The PRA has stated that it intends to apply the amended rules and supervisory statement to remuneration awarded in relation to the first performance year beginning after 29 December 2020. This is not far away and firms should ensure that they are clear on the remuneration structures that will be applied to remuneration for any performance year starting after that date and be prepared to communicate any changes to impacted employees.
 
As these changes will implement CRD V, there will be little (if any) room for the PRA to move from the proposals that they have stated in their consultation paper. That said, the consultation process serves as an opportunity to obtain further clarification on any issues that you consider would benefit from additional clarity and guidance. We encourage firms to use this opportunity to obtain clarity on issues that are genuinely unclear. If we can assist you with this, please do let us know.

If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do let us know.
 
Matthew Hunter

24 July 2020

Earlier this week, the Financial Conduct Authority (FCA) published a letter (also sent to firms' remuneration committee chairs) setting out its finding from the 2019/20 remuneration year and how it plans to assess firms' remuneration policies and practices for the 2020/21 remuneration year. 

In the letter the FCA confirmed that culture in financial services remains a key area of focus. They commented on the risk that firms may deprioritise their focus on culture as they redirect resources in response to immediate risks presented by Covid-19. The FCA stated that a continued focus on maintaining a healthy culture and driving the right behaviours during this time of uncertainty is needed. They believe it can help to reduce the potential for harm and make firms more resilient. 

In addition to the importance of culture, firms' remuneration and recognition practices remain a key focus for the FCA. They will continue to assess the extent to which firms' approaches to rewarding and incentivising staff promote healthy cultures and minimise harm. 

Findings for 2019/20 and future approach

• Accountability: the FCA expect firms to ensure remuneration policies and practices remain aligned with long-term business plans and continue to support and reinforce healthy cultures at the firm. Supervisors will continue to assess how policies may have evolved in response to Covid-19 including the impact on bonus pools and individual remuneration outcomes. The FCA expect firms to consider how their remuneration policies promote equality of opportunity and ensure that diversity and inclusion is embedded within firms' approaches to rewarding individuals, avoiding unconscious bias. 
• Ex-post risk adjustments: during the 2019/20 review, supervisors focused on how firms had responded to major risk and performance issues, including adjustments made to bonus pools and individual remuneration outcomes. The review found that some firms were slow in concluding investigations and failed to demonstrate how they aligned levels of adjustment with what they knew about individuals' conduct. The FCA expects Remuneration Committee Chairs to oversee how their firm makes consistent and timely judgements on the level of adjustments made. 
• Diversity and inclusion: a firm's approach to diversity and inclusion is an important part of a healthy culture. Firms should assess the extent to which a remuneration policy positively promotes diversity and inclusion across all protected characteristics and take appropriate steps to address areas of weakness or concern. Firms should be aware of the risks that may have a negative impact on diverse and inclusive cultures. They should proactively recognise particular issues that some people may face and take action. The review showed that gender and BAME pay gaps provide a quantitative window into inequalities and the FCA expect firms to consider the analysis from those reports and use them to address inequalities. 

The letter also confirms, in line with last year, which supporting information should be provided alongside the Remuneration Policy Statement. 

Tapestry comment 
It is not surprising that the FCA's review of the latest remuneration year primarily focuses on risk and firms' abilities to be accountable for that risk. Whilst Covid-19 was unexpected and unprecedented, recent notable case law has shown firms that they should be adaptive and quick to respond to risk and performance issues. This letter demonstrates that firms may still have a way to go to ensure they are prepared for any event which may impact performance and pose a risk. 

A focus on diversity and inclusion fits in with many trends we have seen, and we expect this will be a focus for some time. As demonstrated in our FTSE review last year (and being updated this year), diversity is being embedded within remuneration practices. Financial services companies are taking the lead for pushing the Gender Agenda forwards. With firms getting prepared for the updated CRD V / CRR II and IFD / IFR legislative packages, we expect to see a bigger push on diversity and inclusion to comply with gender and diversity requirements under the legislation. As a result, we may see the 2020/21 review find the progression on diversity and inclusion to be impressive. 

FCA supervisors will continue to assess firms' remuneration policies and the outcomes they drive, and we will of course keep you appraised of any changes and how they may impact your current policies and practices. 
 
If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do let us know.
 
Carla Walsham

21 July 2020

Last week, the UK’s Treasury published a consultation paper on updating the UK's prudential regime before the end of the Brexit transition period, focusing on the UK implementation of the Capital Requirements Directive V (CRDV).

Background

We previously reported on the reforms proposed by CRDV as well as the changes under the Capital Requirements Regulation II here.

The Capital Requirements Directives impact how remuneration in banking firms is structured. Broadly, they require certain portions of remuneration to be deferred; remuneration to be paid in certain instruments, such as shares; for malus and clawback provisions to be implemented and, the rules also contain a ‘bonus cap’. CRDV implements various changes, including the requirement for remuneration policies and practices to be ‘gender neutral’.

The Capital Requirements Directives work alongside the Capital Requirements Regulations, which set out various remuneration disclosure requirements.

Key points

The consultation asks for comments on the areas which will require legislation. This includes the Treasury’s proposals relating to its intention to exempt from its scope those investment firms prudentially regulated by the Financial Conduct Authority, as well as making amendments to the list of exempted entities under CRDV, the macro-prudential tools available to the Prudential Regulation Authority (PRA) relating to capital buffers, and increasing the supervision of holding companies and their management. The full consultation paper can be accessed here.  

Specifically, relating to remuneration, the Treasury does not intend to introduce new requirements to implement the CRDV measures requiring gender neutral remuneration policies and practices or the reporting of firms’ gender pay gaps, as the government is satisfied that the existing framework meets the objectives of CRDV. However, equality law, covering gender neutrality and gender pay gap reporting, is a devolved power to Northern Ireland and the government is considering these requirements and their application in Northern Ireland.

Responses to the consultation paper are requested by 19 August 2020.
 
Responses can either be sent electronically to CRDVConsultation@hmtreasury.gov.uk, or posted to: Prudential Banking Team, HM Treasury, 1 Horse Guards Road, London SW1A 2HQ. Responses should state whether the views are your own or are representing an organisation. If the latter, it should be clear who the organisation represents and, where applicable, how the views of the members were assembled.
 
Tapestry comment 
We will be providing a more detailed analysis of the proposals shortly.  With this newsletter we wanted to let you know the consultation is now open.

The intention of the Treasury is to implement CRDV using secondary legislation to update the existing framework which implemented the previous Capital Requirements Directives. This includes providing the PRA with new or updated powers, to implement CRDV and to ensure that the PRA can update its rulebook as needed. We will update you when any such updates take place. It is anticipated that information relating to CRDV’s implementation will increase in the build up to the UK’s firm deadline to transpose CRDV by 28 December 2020.

In addition, to further prepare the UK’s financial services regulatory regime for application following the end of the transition period, the Treasury has released a statement on the provisions of the EU’s Covid-19 CRR ‘quick fix’ amendment package into UK law which it intends to retain. We previously reported on the impact of these changes here.
 
If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do let us know.
 
Janet