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

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

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:

1. 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;
2. 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;
3. where an unvested, deferred sum is converted from equity to other instruments, the relevant post-vesting retention requirements should remain unchanged;
4. 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;
5. 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
6. 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