UK: Revising The Remuneration Code - How Will This Impact Your Firm?

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.

Bonuses

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.

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.