On 12 August 2009, the FSA published the final version of its proposed Handbook Rule and supporting Code on employee remuneration for large companies in the financial services sector. These will take effect on 1 January 2010 in time for payments of bonuses next year based on this year's financial performance.
The final version of the Code is substantially the same as the draft produced in March in terms of the processes which those companies affected by the Code must follow, but is accompanied by a detectable change of tone. The FSA appears less likely to be prescriptive on the types of remuneration arrangements that companies should put in place. Nonetheless, there still remains an expectation that at least two thirds of sizeable bonuses should be deferred and there is a new insertion that it is expected that guaranteed bonuses for more than one year will not be risk-compliant.
The FSA has said that this Code will apply from the end of this year but now only apply to the top 26 not the top 47 institutions as had previously been proposed. The FSA will report in October this year on its consultation on whether and to what extent the Code should apply to other FSA-regulated businesses.
Those 26 affected by the Code this year will shortly be contacted by the FSA on the report which will be expected in October this year on how they are proposing to implement the Code.
Click to view the revised Code and the accompanying press release.
To view the article in full, please see below:
Full Article
In March this year, the FSA proposed a draft Handbook rule change requiring relevant financial institutions to ensure that their employee remuneration structures adequately reflected the risk inherent in the activities being conducted and did not incentivise excess risk to be taken. A draft Code was produced which went into some detail recommending the procedures and corporate governance affected companies should adopt and particular types of remuneration practices that were encouraged and discouraged. There was then a consultation period on the contents of the Code and which financial institutions should have to comply with it.
We issued a Law-Now at the time on these proposals. Click here to read that Law-Now.
Since then, there have been many developments in this area including:
- European Commission recommendations on listed company director pay and remuneration in the financial services sector as well as proposals for capital sanctions for companies that breach remuneration rules.
- Lord Turner and Sir David Walker have written reports on the UK financial services industry. Sir David Walker made a number of proposals affecting remuneration (click here for our Law-Now on the Walker recommendations)
- Banks have returned to pre-credit crunch areas of profitability in some areas generating sizeable bonus pools, which were not expected earlier this year.
- Political pressure for bonus capping and calls for sensitivity to pay have increased as the recession has taken further grip in other areas of the economy.
- Guaranteed bonuses for more than one year (so called multi-year bonuses), which were not referred to in the March draft of the Code, have come to the fore of the debate.
Amendments To The Code
In the revised Code published on 12 August, which takes account of consultation responses and developments since March, the proposed Handbook rule on remuneration has not been changed, but there have been a number of changes to the detail of the Code and its application. Relevant points are set out below.
Who Will The Code Apply To?
Although the FSA never named those companies to whom it proposed the Code would automatically apply, it suggested that about 47 companies would be involved. Now only the 26 largest UK companies will be caught because non-UK firms will be removed from the scope unless they are part of a group that contains UK banks or building societies that have total regulatory capital exceeding £1 billion or BIPRU 730k firms that have total regulatory capital exceeding £750 million.
The FSA will report in October on whether other financial services companies should have some express remuneration-related rules applied to them.
Corporate Governance And Relevant Procedures
There are no significant changes here as to the way that companies will have to achieve and monitor compliance with the Code. The FSA has confirmed that reports to it on how risk etc have been addressed in remuneration will be confidential and reports to shareholders and employees can be separate – although it advocates that relatively full disclosure is publicly made to comfort investors and other stakeholders.
Implementation Date
The implementation date for the Code has been delayed by a couple of months from 6 November 2009 to 1 January 2010. However, as the Code will still be in force for the next bonus year, this will probably not make a great deal of difference to those payments but at least it means that companies will not have to undertake unnecessary formal compliance reviews for just a few months in 2009.
There is also an extension given to deal with Code non-compliant terms in employment contacts which were entered into before the March draft Code was published. Where a firm can amend them itself, they should be amended by 31 March 2010, but in any event offending practices should cease by 31 December 2010.
Employees Caught By The Code
The Code now makes clear that the only employees specifically covered by the Code are those with a "significant influence function" or an employee whose activities have, or could have, a material impact on the firm's risk profile. This makes the Code more proportionate. The Code also now says that bonus deferral issues and subjecting the deferral to a long-term performance requirement only arise where a significant part of total remuneration (whether by proportion or in absolute terms) is performance-related.
Detail Of Remuneration
Here is where the main changes have been made. However, it is more a question of tone than substance.
There is now just to be one principle (not 3) requiring that remuneration for relevant employees individually caught by the Code should be consistent with risk management. The previous proposals on how long-term bonuses should be determined and paid, the proportion between bonus and salary and bonus deferral are now relegated to guidance.
However, in essence the guidance remains the same as the previous principles (including the controversial recommendation as to deferral of at least two thirds of bonuses, although this is now referred to as merely a "reasonable starting point") but at least companies will have greater ability to justify why any particular proposals are consistent with risk management.
Guaranteed bonuses were not covered in the March draft Code. Since then, however, occasional use and intense discussion of guarantees spanning more than one year (so-called "multi-year" bonuses) has meant that the Code could not ignore them. The FSA indicated last month that in its view there was a presumption that guaranteed bonuses for more than one year were inconsistent with good risk management, but in the Code itself (see 19.3.17(7)) the FSA restrict their comments to guidance only and so companies should be able to put up a good defence for them in appropriate cases by demonstrating that "risk" is taken into account in other ways.
There is an element of compromise to all of this, and only time will tell if this formula will allow banks to offer these deals in rare circumstances without having to offer up extra regulatory capital, which is what the FSA is saying will be required if non-compliant deals are offered. However, by the time a guarantee has been reported and discussed with the FSA, it may be too late for any effective action to be taken.
Going Forward
The Code is now in final form and is being put forward for implementation.
The relevant 26 companies will soon be contacted with details of what should be contained in reports which they are being asked to submit in October on their compliance with the proposed Code. However, while this may mark the final regulatory pronouncement on pay for the top 26 companies for some time (other financial services companies need to await an announcement scheduled in October for how they will be affected) there is likely to be continuing wide debate, both in the UK and globally, as to the way forward on pay in the financial services sector and additional informal guidance is likely to emerge.
References:
FSA Renumeration Code
Press release
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 12/08/2009.
