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.
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 email@example.com.
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.