UK: Financial Services and Markets Group Bulletin - The Shape Of Things To Come - Winter 2010

Last Updated: 6 January 2011
Article by Smith & Williamson


By Natasha Lee

As part of our continued commitment to the financial services industry we are conducting our 13th (but not unlucky) annual survey at a time of cautious growth across the sector.

Last year's annual survey revealed a feeling of optimism with 62% of respondents believing the UK economy to be either stable or improved on the previous 12 months. During the past year this optimism has borne fruit, although probably not as much as everyone had hoped for, if not expected, but we will know more once the results of this year's survey are received.

London's reputation as a major financial centre continued to suffer from the fall out of the 'credit crunch', with New York still representing the biggest threat. It will be interesting to see if this sentiment is held, in light of the FSA's intensive supervisory approach as well as time being a great healer.

94% of respondents to last year's survey were expecting turnover to remain stable or increase in the forthcoming 12 months, and given the increased activity in the market this expectation is likely to have materialised. Conversely, 44% of respondents to last year's survey had experienced a decline in profit margins as pricing pressures took hold. Will this trend continue?

Unsurprisingly, 2009 was the year of redundancies but our respondents were not expecting this trend to continue in 2010 and based on evidence in the market place, this hope will convert into actual results in this year's survey.

Tax and regulatory changes were reported to have had an adverse impact in last year's survey and this sentiment is expected to continue in light of proposed changes, and consequently increased costs, in both areas.

Are we in for another tough year as fears of a double-dip recession circulate? We would like to hear your thoughts.

Our survey is a reliable source of information relevant to your sector and highlights key areas affecting your market and business. We would like to invite you to participate by completing the enclosed survey questionnaire, and would be grateful if you could return this to us by 9 December. All participants will receive a full summary of our survey findings which we hope will provide a useful benchmark of industry sentiment.

Individual responses are treated as confidential.


By Inez Anderson and Marco Bragazzi

The remuneration code is being revised; its remit will now be extended to include a wider scope of firms and individuals. You should review your remuneration policies to avoid being penalised by the FSA for noncompliance.

From 1 January 2011, detailed new compliance requirements are coming into effect for financial services firms in respect of their remuneration policies; in particular, variable pay practices. As a result of the proposed changes to the FSA's remuneration code, which are still in consultation, companies may have to radically alter their remuneration structures, in particular for high-level variable pay arrangements for key staff. The changes were required following the Financial Services Act 2010 and amendments to remuneration in the Capital Requirements Directive 3.

Scope of the changes

The code will be extended to all CAD investment firms, not just large banks, building societies and broker dealers. In all, over 2,500 authorised firms will be caught within the code's scope.

There is now a much wider application to individuals within these firms. The remit will now cover people who perform significant influence functions for a firm; senior managers; or any staff whose remuneration takes them into the same bracket as senior management and risk takers and whose professional activities could have a material impact on the firm's risk profile. This could extend to staff working in areas such as compliance, internal audit, IT and similar functions.

The new rules require that there be an appropriate ratio between fixed and variable remuneration. It should be possible for the individual not to receive any variable remuneration at all.


Where bonuses are paid, at least 40% of a bonus should be deferred for at least three years, and if the amount concerned is over £500,000, then at least 60% should be deferred. At least 50% of a bonus must be in shares, share-linked instruments or other non-cash equivalent instruments of the firm. Guaranteed bonuses will only be permitted for new joiners, and they will be limited so that they are not more generous than arrangements already entered into by the employee with his/her last employer.

An important aspect is that there should be a performance adjustment both at the grant of the bonus and through its life to adjust for risk. Employees whose total pay is less than £500,000, with variable pay which does not exceed 33% of the fixed pay, will be excluded from these general arrangements on the basis of proportionality. This is an important concept for the FSA, as it attempts to ensure that heavy regulation only applies to high-risk category firms with a lighter touch applying to less risky organisations.

Calculating risk

For remuneration policies to support effective risk management, firms need to ensure that their techniques for assessing variable remuneration take account of all risks. Historically, the FSA has looked at how firms adjust for risks after the payout of bonuses, 'ex-post-risk adjustment', but it is now going to review techniques used to calculate risks before bonuses are paid out, 'ex-ante risk adjustments'. This will be relevant for all companies. The revised code includes detailed provisions concerning pension benefits and the personal investment strategies of the individual employees to ensure that they do not avoid the rules.

How will the new rules be regulated?

Firms will see an increase in corporate governance; they will be required to establish detailed arrangements to ensure that rules are met, including establishing remuneration committees and policy. There may also be potential for additional reporting to the FSA on remuneration via GABRIEL.

The level of compliance required will vary, depending on the perceived impact the firm could have in the eyes of the FSA. The revised code defines three categories which firms would fall into: high impact, medium high and medium low impact, and low impact. High impact firms will be supervised on a close and continuous basis with medium high and medium low firms being subject to ARROW or ARROW liked reviews, while low impact firms will be covered via the thematic review process.

Firms will be penalised if they fail to comply with the rules. These penalties include disallowing a firm from remunerating its staff in a specified way as well as providing for the recovery of payments made where the remuneration is deemed to be void by the code.

Time frame for implementation

The FSA is not expecting to publish the final revised remuneration code until mid-December. It is expected that firms which are already within the scope of the current remuneration code will need to implement the revised code from 1 January 2011, in respect of the 2010 bonus round. For other capital adequacy directive investment firms now caught by the revised code, the FSA is not expecting an implementation of the new remuneration structures until later in 2011, particularly due to the delay in publishing the final code. As a result transitional provisions will be in place from 1 January, with full implementation required by 1 July 2011.

Next steps

It will now be an important compliance function for all code firms to satisfy these rules. When the rules are finalised you should seek advice. We can assist with this and can also help with redesigning remuneration policies and appropriate structures. If you would like advice on the tax risks associated with deferred pay, or wish to find out more about tax planning to minimise tax leakage for both employer and employee, please get in touch.


By Colin Aylott

We review taxes which have been proposed for the financial services sector following extensive G20 discussions.

Several new taxes are currently being considered with the aim of ensuring that the financial sector makes a greater contribution to public finances. The most relevant potential changes to the financial services sector are the proposed bank levy, financial activities tax, and financial transactions tax.

Bank levy

A levy on banks' balance sheets is due to come into force on 1 January 2011. This is being introduced along with similar levies in Germany, France and the US (Hungary and Sweden have already introduced a similar tax), though the scope and cost of the tax is/will be different in each location. Dubbed a 'financial stability contribution', the levy is intended to both create tax revenue and discourage highrisk funding profiles.

The levy will apply to UK banks and building societies, and to branches of foreign banks operating in the UK, where their relevant short-term and long-term liabilities amount to £20bn or more. The definition of bank is the same as that used for the much maligned bank payroll tax so it can apply to certain financial businesses that are not banks, though the size requirement will exclude many of these businesses.

The rate of levy has still to be set, but if the June 2010 Budget proposals are accepted the initial levy will likely be set at 0.04% of equity and liabilities for 2011, expected to rise to 0.07% for subsequent years. The June Budget also proposed reduced rates for certain funding, starting at 0.02% for 2011 and rising to 0.035%. HMRC will collect the levy, which is not deductible for corporation tax. There are complicated rules concerning what is included as a liability.

The effect on individual institutions will vary, but the impact of the levy will be partly offset by the proposed reduction in the rate of corporation tax from 28% to 24% over the next few years. Some analysts have suggested that some of the largest banks operating in the UK will be better off under the 2011 taxation regime, though this remains to be seen.

Although some other countries have introduced or committed to a similar levy, concerns will remain about the competitiveness of the UK within the global banking market. Most countries outside of the EU have stated their intention not to impose similar charges. Despite possible tax savings by banks from the corporation tax reduction, the introduction of another tax charge may well be damaging to the UK's reputation within the global banking market. Financial activities tax In April, the International Monetary Fund released a report to the G20 proposing a financial activities tax (FAT) to be levied on the profits of financial institutions and potentially from high remuneration levels. Financial institutions are currently undefined although it is expected that it would be widely drawn.

On 7 October the EU published a report supporting the implementation of a FAT at EU-level. If introduced, it is argued that revenues from the FAT could reach €25bn annually across the EU, based on a tax rate of 5%. The report notes that the FAT could offset the VAT exemption that financial services institutions currently benefit from for certain transactions, since the FAT effectively acts as a tax on value added.

Implementation of the FAT is not intended to directly alter the structure of the markets where financial institutions operate, since income would be taxed regardless of how it is generated. Similarly, since the FAT applies to the profits and/or remuneration from financial activities, the prices of specific financial instruments are not intended to be directly affected and the market structure not directly altered. A stated aim of the tax is to discourage risky investment practices so it could be targeted more at such transactions. If so, there may be indirect changes in the market structure as financial institutions seek to minimise their tax burden while still maximising revenue.

The European Commission has noted the probable ineffectiveness of a FAT at a national level, due to the mobility of multinationals. Indeed, the UK Government has stated that it is unlikely to implement the FAT without international agreement. Accordingly, without EU agreement the FAT looks unlikely to come into practice. If it is implemented within the EU, it remains to be seen if it will encourage businesses to move activities outside the EU to avoid the tax.

Financial transactions tax

A financial transactions tax (FTT) would be a tax on the value of individual transactions. If implemented it would most likely apply to a wide range of transactions in order to raise the most revenue. Much like the FAT, the FTT would need international agreement so as not to encourage financial institutions to relocate. It should be noted that the UK Government has not indicated that it is in favour of such a tax so it is perhaps less likely to be implemented than the other taxes.

While the bank levy is likely to come into effect as proposed, implementation of the FAT and the FTT appear doubtful at this stage. However, discussion surrounding them creates uncertainty regarding the tax position for financial services businesses, which may prove damaging to their respective positions within the global financial market and encourage them to consider relocating.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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