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).
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.
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.