UK: Regulations On Remuneration - Cracking The Code

The scope of UK remuneration regulations is extending.

The European Commission has made a significant amendment to the Capital Requirement Directive (CRD) in the form of CRD3 adopted in April 2009. CRD3 makes binding the principle of the recommendation on remuneration policies in the financial sector (reflecting the Financial Stability Board (FSB) principles for sound compensation practices which was endorsed by G20 members).

Further amendments, more prescriptive than the FSB Principles, were made in July 2010. CRD3, however, introduces an element of proportionality (i.e. firms might apply some requirements in a way and to an extent that is appropriate to their size, scope and complexity). CRD3 needs to be implemented by each member state from 1 January 2011.

In the UK, this (excluding the CRD3 disclosure requirements) is done via the FSA Remuneration Code. The FSA had already implemented a Remuneration Code in August 2009 that applied to 26 large banks, building societies and broker dealers. Changes to CRD3 have led the FSA to issue a draft Code incorporating the more stringent requirements and widening the scope of application of the Remuneration Code significantly.1

All banks, building societies and Capital Adequacy Directive investment firms (which include a large number of asset management firms including most hedge fund managers and all UCITS investment firms plus some firms which engage in corporate finance, venture capital, the provision of financial advice, brokers, several multilateral trading facilities and others); in all, over 2,500 FSA-authorised firms now fall within the Code's scope. The Alternative Investment Fund Managers Directive has been adopted in November and is broadly consistent with the FSA code. Note that the Code applies to UK firms as well as UK subsidiaries of non EEA firms.

The Code applies to categories of staff, including senior management, risk takers, heads of support and control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the firm's risk profile. These are referred to as "Code Staff".

The Code does not cover the disclosure requirements set out in CRD3. The FSA published proposed amendments to BIPRU via a consultation paper in November 2010 which implements these requirements.

Both the Code and the disclosure requirements are applicable for firms from 1 January 2011 and extended scope firms have until July 2011 for some provisions and disclosure has to be made by 31 December 2011.

Remuneration requirements can be divided into three blocks: risk alignment, governance and disclosure.

Risk alignment, including notably requirements on:

  • Risk measurement: Institutions should take into account all risks when assessing performance for variable remuneration whether on or off the balance sheet, differentiating between risks affecting the institution, business units and individuals.
  • Performance measures in variable remuneration: The risk alignment process should use a mix of quantitative (financial) and qualitative (non-financial) approaches. Variable remuneration should be subject to malus features (i.e. reduction in case of material error or misconduct or material downturn in financial performance or significant failure in risk management).
  • Payout: (i) at least 40% of a bonus must be deferred over a period of at least 3 years for all Code Staff. At least 60% of the bonus must be deferred when it is more than £500,000. (ii) at least 50% of any variable remuneration components must be made in shares, share-linked instruments or other equivalent non-cash instruments of the firm. These shares will need to be subject to a minimum retention policy.

Governance, including notably requirements on:

  • approval and oversight of the remuneration policy;
  • remuneration of the risk and control functions; and
  • input from risk and control functions (including statement that the internal audit function should periodically carry out an independent audit of the design and implementation of the remuneration policy).

Disclosure, including notably information for Code Staff relating to:

  • the decision making process for determining the remuneration policy including information about composition of a remuneration committee if applicable;
  • the link between pay and performance;
  • performance measurement and risk adjustment, deferral policy and vesting criteria;
  • performance criteria on which entitlement to shares, options or variable components of remuneration is based;
  • the main parameters and rationale for any variable component scheme and non-cash benefits; and
  • aggregate quantitative information on remuneration broken down by business area and by senior management and members of staff whose actions have a material impact on the risk profile of the firm.

Proportionality

Firms

When issuing its consultation document on disclosure in November, the FSA has clarified its approach to proportionality with regards to disclosure and stated that it is intended to be broadly in line with its general approach to proportionality with regards to the Code.

Tier 1 firms − Full disclosure of all items under CRD3: Banks and building societies with capital resources in excess of £1bn, and Full Scope BIPRU Investment €730K firms with capital resources in excess of £750m. The FSA expects this category to include around 26 very significant groups.

Tier 2 firms – Disclosure of most qualitative items (including design characteristics of remuneration) and selected quantitative items: Banks and building societies with capital resources between £50m and £1bn, and Full Scope BIPRU Investment €730K firms with capital resources between £100m and £750m. The FSA expects this category to include some 200 firms.

Tier 3 firms − Disclosure of most qualitative items (excluding design characteristics of remuneration systems) and selected quantitative items: Banks and building societies with capital resources of less than £50m, Full Scope BIPRU Investment €730K firms with capital resources less than £100m. The FSA expects this category to include around 300 firms.

Tier 4 firms – Disclosure of basic qualitative and quantitative items only: All BIPRU Limited Licence and Limited Activity firms. The FSA expects this category to comprise over 2,000 firms.

Staff

Rules on deferral, performance adjustment, proportion of remuneration paid in shares and guaranteed bonuses do not need to apply to Code Staff whose variable remuneration is < 33% of total remuneration and total remuneration is <£500,000.

Deloitte credentials

  • Deloitte risk, regulation and executive compensation teams comprise over 170 professional staff.
  • Within Deloitte there are HR remuneration specialists, financial risk modellers and risk managers, actuaries, lawyers, accountants and chartered tax advisors. Deloitte can provide the joined-up expert advice to help you demonstrate that remuneration in your firm is genuinely informed by sound risk management practices.
  • We have deep expertise in the Financial Services sector, advising a significant number of the UK's largest FS organisations, giving us sound knowledge of the issues impacting financial services pay.
  • We are Remuneration Committee advisors to around a third of the FTSE as well as a broad range of other listed and non-listed companies.
  • We have a track record for implementing bespoke incentive arrangements for companies, tailored to their strategy and business circumstances.

How Deloitte can help

General code compliance

  • Provide information on the Code and its developments (e.g. paper, presentation, training).
  • Review a firm's compliance with the Code.
  • Assist firm draft its response (i.e. define what is right for them, how they might want to apply the proportionality principle for example).
  • Assist firm in assessing the differences between the draft Code and the final Code in readiness for the 1 January 2011 deadline.

Governance & policies

  • Assist firm prepare its Remuneration Policy Statement.
  • Draft internal communication material (e.g. draft remuneration policies and processes; communication to employees on any changes in the package).
  • Advise on how remuneration can help to embed sound risk management within remuneration practices.

Risk adjusted performance metrics

  • Review performance measures used in incentives plans and review their alignment with the Code.
  • Assist firm in improving its remuneration arrangements including risk adjustment of bonus pools to ensure appropriate linkage with capital.
  • Design and implement deferral and share schemes (including possibilities for operations outside the UK).
  • Develop both quantitative and qualitative measures.
  • Appropriate performance reporting is key, and we can assist to scope and develop. Reports must include the risk profile changes in the period, note any tail risk building up and contextualise the return generated against the risk profile.

Footnote

1 The final Code and amendments to BIPRU relating to disclosure requirements are expected to be published mid December following publication of the Committee of European Banking Supervisors' (CEBS) final Guidance on implementation of CRD3 expected early December

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