24 May 2023

The UK’s Financial Conduct Authority (FCA) has published a consultation paper proposing changes which would apply more proportionate remuneration rules to certain firms subject to the FCA’s Dual-regulated firms Remuneration Code. The proposed changes cover: (a) the criteria for determining when a firm may benefit from more proportionate and less restrictive remuneration requirements; (b) the removal of malus and clawback for those firms; (c) other minor changes to the FCA’s Handbook to address some differences between the FCA’s Handbook and the Prudential Regulation Authority’s (PRA) Rulebook; and (d) consequential changes to FCA’s non-Handbook guidance.

These proposals are relevant to credit institutions (banks and building societies), PRA designated investment firms and firms from overseas that carry on activities from an establishment in the UK that mean they would be a credit institution or designated investment firm if they were a UK domestic firm. The deadline for consultation responses is 9 June 2023.

Background

As a consequence of the latest iteration of the EU’s Capital Requirements Directive (CRD V) which took effect in 2020, when the UK remained subject to EU law, the FCA was required to change the criteria which were used to determine the remuneration rules that applied to certain firms, including a reduction in the financial thresholds.  

The firms that meet the new criteria are currently not subject to some requirements, such as deferral and payment in instruments requirements, but are subject to other requirements, including malus, clawback and bonus cap requirements. Prior to the CRD V changes, these requirements did not apply to such firms.
 
The FCA has seen evidence that these additional remuneration requirements have been burdensome for small firms and they are reviewing the rules to create a more proportionate remuneration regime. As we have reported on separately: (a) the PRA has also issued a consultation on the remuneration regime for small firms; and (b) the PRA and the FCA have issued a consultation paper on the removal of the bonus cap.

Proposals

1. Proportionality criteria. The criteria that are used to determine which firms can disapply certain remuneration requirements will be loosened, with the intention that more firms will meet the criteria. The proposals align with those set out in the related PRA consultation.
 
Under the proposals, a UK bank, building society or UK designated investment firm needs to meet either condition 1a or 1b set out below to be exempt from certain remuneration rules (e.g. deferral and payment in instruments requirements). The criteria outlined in 1b will cross-refer directly to the corresponding wording set out in the PRA Rulebook to ensure consistency in the future.

Where the firm is part of a group containing another firm subject to the FCA’s Dual-regulated firms Remuneration Code on an individual basis, both firms must meet the criteria on an individual basis, consolidated basis and sub-consolidated basis. This means that there cannot be a group where one firm benefits from the proportionality-based exemptions and another does not; all dual-regulated firms within a group must be subject to the same remuneration rules. The consultation paper also provides detail on how overseas firms would apply the criteria.

2. Removal of malus and clawback requirements for small firms. Firms that meet the amended proportionality criteria set out above will no longer be required to apply the rules on malus and clawback. The proposals align with those set out in the related PRA consultation.

3. Alignment with the PRA Rulebook. The FCA’s Dual-regulated firms Remuneration Code will be amended to align with the PRA’s Rulebook. The most substantive change will be to align the FCA’s approach to the identification of material risk takers with the PRA’s approach by cross-referring directly to wording set out in the PRA Rulebook, although there are other minor wording changes to align the rules in the FCA Handbook with their equivalent in the PRA Rulebook.
 
4. Updated non-Handbook guidance. Consequential amendments will be made to the FCA’s non-Handbook guidance to reflect the changes outlined above. The specific guidance that will be amended is set out in the consultation paper.
 
The impacted guidance includes guidance on proportionality, FAQs on remuneration for dual-regulated firms (including guidance in relation to who can be excluded as a material risk taker) and the FCA’s general guidance on the application of ex-post risk adjustment to variable remuneration, which will, in particular, clarify that dual-regulated firms must ensure that variable remuneration is only awarded on the basis of risk-adjusted performance set in a multi-year framework. This means that all firms should continue to consider, and make adjustments to, in-year variable remuneration at firm, business unit and / or individual level to reflect ex-post risk.
 
5. Timing. The proposed changes on the proportionality criteria and on the removal of malus and clawback for impacted firms would come into force on the next calendar day after the publication of the final policy statement, which is anticipated for Q4 2023, and would apply to firms’ performance years starting after that. The FCA and PRA intend to align the timing of the final rules and guidance. The proposed changes to ensure alignment with the PRA Rulebook will come into force and apply immediately following the publication of the final policy statement.

Next steps

The proposed changes are subject to consultation and so the final policy changes may differ to those set out in the consultation paper. The consultation closes on 9 June 2023. Comments or enquiries should be sent to cp23-11@fca.org.uk, using the form on the FCA’s website or to: Governance & Cross-Cutting Standards team, Financial Conduct Authority, 12 Endeavour Square, London E20 1JN. If a firm has already responded to the PRA’s consultation, firms can respond to the FCA’s consultation by sharing that response with the FCA.

Tapestry comment
The proposals set out in this consultation paper are broadly consistent with the PRA's proposed changes in its consultation paper on enhancing proportionality for small firms and similarly aim to provide increased flexibility for dual-regulated firms that meet the new, less restrictive criteria. The new criteria, and the removal of malus and clawback requirements for impacted firms, seek to ensure that the remuneration framework is more proportionate for smaller and less complex firms and will be welcomed by those firms.
 
The proposals to more closely align the FCA Handbook to the PRA Rulebook, particularly in relation to material risk taker identification, will also be welcomed as it will help to reduce some of the unnecessary complexity that was created by having overlapping (yet sometimes misaligned) FCA and PRA rules applying to the same firms and staff members.
 
It is anticipated that these changes will go ahead as consulted upon, with the proportionality changes taking effect for the first performance year starting on or after the final policy statement is published, which is anticipated for Q4 2023. It should be noted that the proposed removal of the bonus cap would also take effect around this time. Firms should consider whether they will be impacted by the new, less restrictive proportionality criteria and, if so, consider how and when the changes will be reflected in the firm’s remuneration structures. For firms that will be able to benefit from the new proportionality criteria, it may be that material risk takers may no longer be subject to, in particular, deferral, payment in instruments, malus, clawback or bonus cap requirements.  

Please do let us know if you have any questions or comments on this, or if we can assist you with your remuneration regulation compliance.

Matthew Hunter & Lewis Dulley

15 March 2023

The UK’s Prudential Regulation Authority (PRA) has published a consultation paper proposing changes which would apply more proportionate remuneration rules and expectations to small CRR firms and small third-country CRR firms (together, ‘small firms’). The proposed changes will impact: (a) which remuneration rules small firms will have to apply; and (b) which firms qualify as a small firm.

These proposals are relevant to PRA-regulated banks, building societies and PRA-designated investment firms, including third-country branches which are subject to the Remuneration Part of the PRA Rulebook. The deadline for consultation responses is 30 May 2023.

Background
As a consequence of the latest iteration of the EU’s Capital Requirements Directive (CRD V) which took effect in 2020 when the UK remained subject to EU law, the PRA was required to change the conditions which were used to determine the remuneration rules that applied to certain firms, including a reduction in the financial thresholds.  

The firms that meet the new conditions, being small firms, are currently not subject to some requirements, such as deferral and payment in instruments requirements, but are subject to other requirements, including malus, clawback, buyout and bonus cap requirements. Prior to these changes, these firms would not have been subject to malus, clawback or bonus cap requirements.

The PRA has received feedback and seen increasing evidence that these additional remuneration requirements have been ‘costly or burdensome’ for small firms and, as we are now in the post-Brexit world, they are reviewing the rules to create a more proportionate remuneration regime. As we have reported on separately, the PRA and the UK Financial Conduct Authority have already separately issued a consultation paper on the removal of the bonus cap.

Proposals

1. Broader definition of a small firm. The conditions that are used to determine which firms qualify as small firms will be loosened, with the intention that more firms will meet the conditions. The aim is to align the conditions with the proposed criteria in the recent Simpler-regime consultation, where possible, although more firms will qualify as small firms under the amended remuneration rules than under the Simpler-regime. 
   
   To benefit from the small firm remuneration regime, UK banks, building societies and UK designated investment firms will need to meet the following conditions: (a) either conditions 1a or 1b, as set out below; and (b) condition 2, as set out below:

The consultation paper provides further detail as to how third country CRR firms would apply the conditions which take into consideration the status of such entities as branches of overseas firms.
 
2. Fewer remuneration rules that apply to a small firm. Any firm that qualifies as a ‘small firm’ under the new definition will no longer be required to apply the rules on malus, clawback and buyouts. As noted above, there is a separate consultation in process in relation to the removal of the bonus cap.
 
3. New disclosure obligations. Small firms will be subject to a new expectation to disclose any material changes to their remuneration structures to their supervisors, especially on: (a) the ratio of the maximum payout of bonus and executive incentive schemes when compared to fixed remuneration; and (b) the performance measures and the risk adjustment used to determine whether and how much their bonus schemes and executive incentive schemes will pay out.
 
The PRA has also proposed to remove certain disclosure expectations from its guidance and has indicated that they intend to consult on their approach to remuneration disclosure requirements in the near future.
 
4. Timing. The proposed changes would come into force on the next calendar day after the publication of the final policy, which is anticipated for Q4 2023, and would apply to firms’ performance years starting after that. For most firms, this would likely be performance years starting in 2024.

Next steps
The proposed changes are subject to consultation and so the final policy changes may differ to those set out in the consultation paper. The consultation closes on 30 May 2023. Comments or enquiries should be sent to CP5_23@bankofengland.co.uk or to: Governance, Remuneration and Controls Policy Team, Prudential Policy Directorate, Prudential Regulation Authority, 20 Moorgate, London EC2R 6DA.

Tapestry comment
The proposals set out in this consultation paper, coupled with the existing consultation on the removal of the bonus cap, show the PRA’s willingness to scale back some of the more unpopular remuneration rules where it is proportionate to do so. There is also an indication that remuneration disclosure requirements will be reviewed. A more proportionate remuneration regulation regime will likely be welcomed by many firms. 

The PRA states that a simpler prudential regime would facilitate effective competition, thereby supporting its existing secondary competition objective. The PRA also notably states that these proposals will facilitate compliance with the new secondary objective that the PRA will become subject to under the proposed Financial Services and Markets Bill 2022-23, which, at a high-level, will require the PRA to act in a way that facilitates: (a) the international competitiveness of the economy of the UK; and (b) its growth in the medium to long term.

The PRA considers that these proposals would facilitate competitiveness and growth as they would support the attractiveness of the UK as a place to do business by reducing the regulatory burden on firms. The more proportionate approach may also facilitate growth by reducing ongoing implementation costs and the greater flexibility offered to small firms in how they design their remuneration structures may also support them in their competition for talent with businesses within and outside of the UK, and within and outside of financial services (e.g. with technology firms).

It is important for firms to remember, however, that these proposals do not remove all of the remuneration requirements for impacted firms and firms will still be required to ensure that a prudent approach is taken to aligning risk and reward. The PRA considers that risks to safety and soundness for the proposed firms in scope can be mitigated sufficiently by other remuneration rules that the PRA is not proposing to modify.

It should be noted, however, that the recent shock to the financial services industry globally, triggered by the collapse of Silicon Valley Bank in the US, may lead the PRA and other policy makers to reassess whether now is a sensible time to be loosening remuneration regulations. We will have to wait and see if there is any change in direction.

Firms should assess if and how they will be impacted by the proposed changes and consider whether to respond to the consultation process.

Please do let us know if you have any questions or comments on this, or if we can assist you with your remuneration regulation compliance.

Matthew Hunter & Becky Moore

30 January 2023

The EU’s European Banking Authority (EBA) has published its report on high earners data at EU-regulated banks and investment firms as of the end of 2021. The report also compares the data for 2021 against the data for 2020.

Background
The Capital Requirements Directive (CRD) and Investment Firms Directive (IFD) require the EBA to publish aggregated data on staff members remunerated at EUR 1 million or more for the previous financial year. These staff members are known as ‘high earners’.  

The data is collected by the national regulators and then forwarded to the EBA. The data gathered includes the business areas involved and the main elements of salary, bonus, long-term awards and pension contributions.

The EBA will continue to publish data on high earners annually, with the data for 2022 being collected based on revised guidelines. Future iterations of the reporting will include a benchmarking of the derogations from requirements to pay variable remuneration in instruments and on a deferred basis, the gender pay gap and, as relevant, of approved increases in the ‘bonus cap’.

Key points
The key findings of the report include the following:

• The number of high earners increased by 41.5% to 1,957, the highest number for the EU/EEA (excluding the UK) since they began collecting data in 2010. 70% of the increase came from institutions located in Italy, France and Spain.
• The increased number of high earners is linked to: (a) good institution performance, in particular in investment banking and trading and sales; (b) further relocations of staff from the UK to the EU post-Brexit; and (c) overall salary level increases. Inflation, and associated increases in labour costs, contributes to an increased number of high earners over time, especially in the EUR 1 million to EUR 2 million bracket.
• High earners were reported in 26 of the 30 in-scope EU/EEA member states and so 4 member states reported no high earners. Most high earners fell within the EUR 1 million to EUR 2 million bracket and the highest bracket was EUR 14 million to EUR 15 million, which was for 1 person (with a significant amount of this relating to one severance payment).
• The percentage of variable remuneration that was deferred increased from 50.1% in 2020 to 56.4% in 2021, and the part of variable remuneration paid out in instruments increased from 43.5% in 2020 to 51.5% in 2021. This is despite the introduction of specific derogations from deferral and payment in instruments requirements.
• The weighted average ratio of variable to fixed remuneration for all high earners increased from 86.4% in 2020 to 100.6% in 2021, driven by: (a) increased institution performance; (b) relief from Covid-19 restrictions on bonuses; and (c) further relocations of staff to the EU post-Brexit.
• 81.8% of the 2021 high earners were ‘identified staff’ (also known as material risk takers), representing a decrease of 3% from 84.8% in 2020. This decrease is linked to: (a) changes in how staff in asset management companies and investment firms are identified within banking groups; (b) many reported high earners having only exceeded the monetary identification threshold to be identified as ‘identified staff’ for the first time (and so would not be identified as such for 2021); and (c) an increase in the monetary threshold for identifying staff from EUR 500,000 to 750,000 in some cases.
• In 2021, 143 high earners received significant severance payments with an average amount of EUR 1,328,048, compared with an average of EUR 1,171,943 across 181 high earners for 2020.

Tapestry comment
This report considers data from 2021 and 2020, both of which were exceptional years due to the impact of, and initial recovery from, the Covid-19 pandemic during that period. It can be useful to consider the trends shown in this report, particularly around the increased concentration of high earners in particular jurisdictions (Germany continues to have the most but others, e.g. Italy, France and Spain, are catching up), the concentration of high earners in particular business lines and the impact that inflation has on high earner data.

Given the sharp change in market conditions over the last year, with increasing inflation and interest rates and declining financial performance within investment banking leading to job losses, it will be interesting to see what the report for 2022 will look like when it is published in 2024. That report may, for example, show increased severance payments (and an increased number of high earners who are only high earners due to large severance payments) and an increased number of high earners due to increasing labour costs in the current inflationary environment.

Please do reach out if you would like any support with your incentive arrangements. We would be delighted to help.

Matthew Hunter