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.
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.
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.
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.
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!