Labour and Employment Client Service Group FSA: final UK Remuneration Code From Bryan Cave, London 20 December 2010 This is our final briefing on the Financial Services Authority s (FSA) new Remuneration Code (the Code ), which was published on 17 December 2010 and which will come into operation on 1 January 2011. Background In July 2010 the European Parliament approved changes to the Capital Requirements Directive (CRD3). After a short period of consultation, the Committee of European Banking Supervisors (CEBS) published its Guidelines on Remuneration Policies and Practices on 10 December 2010. These guidelines are directed to national regulators, such as the FSA. Consequently, the FSA has now published its revised Code, reflecting CEBS guidelines. The FSA has also published its revised rules on the disclosure of remuneration information. The Code will be implemented by amending the FSA s Senior Management Arrangements, Systems and Controls sourcebook (SYSC), and (in respect of disclosure) the Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU). HR action items If it has not already been attended to, HR at in-scope firms should undertake the following: Seek confirmation from compliance/risk, as to which tier the firm falls into; Identify those staff who are Code Staff; Prepare remuneration policies that reflect the requirements of the Code (summarised below) to the extent appropriate to the firm s tier, taking into account the de minimis concession; and Be prepared to implement new Code-compliant remuneration policies as soon as possible after 1 January 2010 but in any event no later than 1 July 2011. This Client Bulletin is published for the clients and friends of Bryan Cave LLP. Information contained herein is not to be considered as legal advice. This Client Bulletin may be construed as an advertisement or solicitation. Bryan Cave LLP. All Rights Reserved.
Who does the Code affect? The Code will apply to approximately 2,700 FSA regulated firms, which incorporates banks, building societies and Capital Adequacy Directive (CAD) investment firms. A large number of asset managers, hedge fund managers, UCITS investment firms, firms which engage in corporate finance, venture capital and the provision of financial advice, brokers and multilateral trading facilities are in-scope. Those firms already within the scope of the FSA s Remuneration Code are required to comply with the Code from 1 January 2011. Firms that are coming within scope for the first time will be subject to transitional rules, but must comply as soon as reasonably possible, and at the latest by 1 July 2011. Following lobbying by relevant industry groups, CEBS and the FSA have now clarified that certain key principles relating to compensation and benefits structuring, can be disapplied by firms such as hedge funds/asset managers (see further, below). Territorial scope of the Code The scope of the Code has not changed since the original proposed text. It will apply to the following: CRD entities within UK-headquartered groups, including overseas branches of such entities; and UK-based CRD entities (including branches) and sub-groups, belonging to groups headquartered outside the EEA (EEA-headquartered groups will not be required to apply the Code, as such groups home EEA states will be required to apply equivalent CRD3 provisions instead). Identifying Code Staff The types of staff who will be considered in-scope for the Code (Code Staff) have not changed significantly since the draft Code was published. New rule 19A.3.4R of the Code identifies Code Staff as being: categories of staff including senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration brackets as senior management and risk takers, whose professional activities have a material impact on the firm s risk profile. More guidance can be found at Code rule 19A.3.6G. As foreshadowed in the original draft Code, staff who are identified as Code Staff but who fall within the de minimis concession, are excluded from the operation of certain remuneration principles. A person will fall within the de minimis concession if he or she earns total remuneration of no more than 500,000 p.a. and his or her variable remuneration is no more than 33% of total remuneration. Special rules apply in respect of identifying staff who are Code Staff for only part of a year. 2
Proportionality Both CEBS and the FSA accept that the CRD3 guidance on remuneration should be applied on a proportional basis, taking into account the type of organisation, its business and the specific duties of the individual. For this purpose, four tiers of organisation have been identified: Tier 1: banks and building societies with capital resources exceeding 1bn; BIPRU 730k firms that are full scope BIPRU investment firms with capital resources exceeding 750m; and all third country BIPRU firms with total assets (for the branch) exceeding 25bn. Tier 2: banks and building societies with capital resources between 50m and 1bn; BIPRU 730k firms that are full scope BIPRU investment firms with capital resources between 100m and 750m; and all third country BIPRU firms with total assets (for the branch) between 2bn and 25bn. Tier 3: any bank, building society and full scope BIPRU investment firm that does not fall within proportionality Tiers 1 or 2; and all third country BIPRU firms that are not in proportionality Tiers 1, 2 or 4. Tier 4: all limited license and limited activity firms (including third country BIPRU firms with such permissions). This will include most hedge funds/asset managers. Remuneration principles There are 12 remuneration principles that in-scope firms will need to comply with. These have not changed significantly from the consultation draft of the Code, but some points of detail have been clarified. The 12 principles are all set out below (some of which are generic mission statements rather than containing rules, as such). Principle 12 is likely to be the most important for most firms. The annotation FW means that the principle applies on a firm-wide basis (i.e. not just to Code Staff). Principle 1: Risk management and risk tolerance FW The firm s remuneration policy must be consistent with and promote sound and effective risk management. Principle 2: Supporting business strategy, objectives, values and long-term interests of the firm FW The firm s remuneration policy must align with the business strategy, objectives and long-term interests of the firm. Principle 3: Avoiding conflicts of interest FW The firm s remuneration policy must contain measures to avoid conflicts of interest. 3
Principle 4: Governance FW The firm s remuneration policy must be periodically reviewed (at least annually) by the firm s governing body (i.e. the board or equivalent). Tiers 1 and 2 firms must normally have a formal Remuneration Committee; Tiers 3 and 4 firms need not establish a Remuneration Committee (though the FSA recommends they do so if possible). Principle 5: Control functions Employees engaged in control functions (risk and compliance) must be independent, have appropriate authority in respect of the business lines they oversee, and be remunerated appropriately (including not being remunerated according to the performance of their business lines). Principle 6: Remuneration and capital The total variable remuneration paid by a firm must not threaten its capital base. Principle 7: Exceptional government intervention State-funded firms must adhere to stricter principles (as set out in more detail in the Code). Principle 8: Profit-based measurement and risk adjustment FW Variable remuneration should be determined according to profit, not merely revenue/income, and should be able to be adjusted for current and future risks to profitability. In the event of subdued or negative financial performance, variable remuneration must be able to be severely curtailed. Principle 9: Pension policy FW Pension payments for staff leaving the firm (due to retirement or otherwise) should be consistent with the other principles set out in the Code. Where variable remuneration must be awarded partly in the form of instruments (see further, below), discretionary pension payments should be made in the same manner. Principle 10: Personal investment strategies FW Firms must take steps to ensure that staff do not enter into third-party arrangements intended to hedge against the risk of the Code adversely affecting the personal remuneration streams (though as a general principle, this will not normally be deemed to apply to mortgage/healthcare insurance arrangements). Principle 11: Avoidance of the Remuneration Code Firms must not take steps to deliberately avoid the operation of the Code. 4
Principle 12: Remuneration structures This is the most detailed and the most substantive of the 12 principles. The key points are set out below. An annotation of 3 indicates principles that Tier 3 firms may avoid completely; similarly, an annotation of 4 indicates principles that Tier 4 firms may avoid completely. An annotation of DM indicates principles that de minimis staff need not have to comply with. Assessing performance. Individual performance (and related variable remuneration decisions) must be assessed taking into account personal, business-line and firm-wide performance. This must include financial as well as non-financial metrics (such as attitude to risk management) and extend to performance in a multi-year context (for example, using moving averages) to avoid distortions through business performance peaks-and-troughs. Guarantees and retention awards FW, DM. Firms must not offer guaranteed variable remuneration except in the case of new hires, for exceptional reasons, and for no more than the first year of service. Any guaranteed variable remuneration should be delivered in the same manner as non-guaranteed variable remuneration. For existing staff, guarantees should not be given, except in rare circumstances as retention awards where a firm is undergoing a major restructuring. Leverage 4. Firms must set out in a policy the normal maximum leverage between fixed and variable remuneration. Golden parachute payments FW. Early termination payments should not reward failure, nor contradict the general principles set out in the Code. Proportion in shares 3, 4, DM. At least 50% of variable remuneration will need to be made in shares, share-linked instruments or other equivalent non-cash instruments, which should be subject to an appropriate retention period (which is no longer set but which individual firms must determine). This rule applies to both deferred and un-deferred elements of variable remuneration equally (e.g. 50% of deferred variable remuneration and 50% of immediate variable remuneration to both be awarded in stock). Deferral 3, 4, FW, DM. Firms must establish a firm-wide/group-wide policy setting out its deferral mechanism. The policy must comply with the following minimum requirements: at least 40% of variable remuneration must be deferred over a period of 3-5 years. For high bonus earners (which automatically includes any staff earning variable remuneration of more than 500,000 p.a.) and executive directors of large firms, the deferral portion must be at least 60% of the variable remuneration. Performance adjustment (malus and claw-back) 3, 4, DM. Variable remuneration paid or awarded to an individual must be subject to potential claw-back arrangements (if the remuneration has already been paid out) or downward malus adjustments (for awarded remuneration that has not yet been paid or vested). Such adjustments are to be made in the event of individual misconduct/material error, or a material financial downturn/risk management failure suffered by the firm or business unit. Voiding provisions. The FSA has the power to render "void" any agreement which contradicts the revised Code, and to require the relevant firm to take action to recover any payments made in contravention of the Code. 5
New disclosure requirements The FSA s new disclosure requirements will currently only apply to BIPRU firms (i.e. UK-based firms, not UK branches of non-eea firms). This may change during 2011 following further consultation. The new disclosure requirements cover both qualitative and quantitative data on a tiered approach. Tier 1 firms have the most onerous disclosure obligations. Tier 4 firms will have to disclose the least data, however this will include aggregate quantitative remuneration data applicable to Code Staff, broken down by business line, and by members of senior management vsother Code Staff. To discuss any of these issues further, please direct your queries to your Bryan Cave contact or: Darren Isaacs Office: London Direct Dial: (+44) 20 3207 1171 Email: darren.isaacs@bryancave.com Rachel Lewis Office: London Direct Dial: (+44) 20 3207 1229 Email: rachel.lewis@bryancave.com Bryan Cave's Briefings are available online at www.bryancave.com/bulletins. This bulletin is published for the clients and friends of Bryan Cave LLP. To stop this bulletin or all future commercial e-mail from Bryan Cave LLP, please reply to: opt-out@bryancave.com and either specify which bulletin you would like to stop receiving or leave the message blank to stop all future commercial e-mail from Bryan Cave LLP. Information contained herein is not to be considered as legal advice. Under the ethics rules of certain bar associations, this bulletin may be construed as an advertisement or solicitation. 6