14 February 2023
On 10 February 2023, the UK’s Prudential Regulation Authority (PRA) published a Policy Statement containing the final PRA policy 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 Policy Statement follows the PRA’s consultation from July 2022 and contains the PRA’s feedback to consultation responses.
The new policy applies 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. The new policy took effect from 10 February 2023 and a revised ‘Remuneration’ Supervisory Statement (SS2/17) has been published to reflect the new policy.
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 indicated that they were aware that an unvested, contingent claim to equity-based instruments (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 Policy Statement.
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 new policy will apply.
Key features of the new policy
The final policy is the same as the proposed approach that was set out in the consultation paper but with a small number of changes to clarify the position, as summarised in the Policy Statement. There were no significant changes.
In summary, the key features of the new policy are as follows:
- in general, the instruments that comprise 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 changed after the relevant award has been made;
- in exceptional circumstances, it may be appropriate for equity-based instruments to be converted into other instruments (or vice versa) 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 an equity-based instrument to other instruments, the relevant post-vesting retention requirements should remain unchanged;
- in wholly exceptional circumstances, where a change in the 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 new policy sets out circumstances 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
- it is the responsibility of a potential public sector body looking to employ a MRT to consider what mechanisms may be available to it under its own code of conduct to address any conflict of interest arising from unvested remuneration. 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.
In the PRA’s Policy Statement, the PRA notes that most respondents welcomed the proposals or viewed them as helpful, although further clarification was requested on certain aspects. The new policy is materially the same as the proposed policy covered by the consultation and the additional clarifications (including the insertion of descriptive footnotes) are helpful.
Although the Policy Statement sets out reasonably clear expectations, whether a non-objection, waiver or modification will be granted by the PRA will be determined based on the specific facts of a potential conflict scenario, and the new policy does not set out clear circumstances when such a non-objection, waiver or modification will definitely be granted.
Where a potential conflict scenario of the kind covered by this Policy Statement arises for a firm, a careful review of the facts should be undertaken. The review should first consider whether the potential conflict can be mitigated in a way that does not involve the alteration of variable remuneration. If the firm is satisfied that an alteration to variable remuneration will be necessary, the firm should then consider if a change to the underlying instruments will be appropriate and justifiable, and, if not, whether a modification or waiver will be needed instead to convert the award to a cash award. In each situation, a reasoned case must be presented to the PRA.
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