UK: Bankers' Bonuses Back In The Spotlight

Last Updated: 21 May 2014
Article by Bradley Rice

Summary and implications

The issue of bankers' pay has been a "hot potato" ever since the global financial crisis hit our shores. Since then a raft of legislation and rules has been introduced, both domestic and international, to govern the policies and procedures of financial services firms in setting the remuneration packages of their top earners and risk takers.

In 2010, the Financial Services Authority (the predecessor to the Financial Conduct Authority (the FCA)) introduced the Remuneration Code (the Remuneration Code) setting out rules on remuneration for the 26 largest banks, building societies and broker-dealers in the UK. Originally the Remuneration Code required these 26 firms to have and maintain a remuneration policy that promoted effective risk management and discouraged excessive risk taking.

Since then the Remuneration Code has been substantially revised and widened in scope to cover a wider category of firms, such as fund managers, as well as introducing more detailed rules on the amount of bonus that can be awarded, how that bonus can be paid and which staff the Remuneration Code provisions apply to. Many of the revisions to the Remuneration Code originate from European legislation, including the Capital Requirements Directives, the Solvency II Directive regulating insurers and the Alternative Investments Funds Managers Directive setting out rules for fund managers.

Now that the provisions of the Remuneration Code have had time to become integrated with the policies and procedures of regulated firms, the Prudential Regulation Authority (PRA) has issued a number of supervisory statements setting out its expectations relating to some of the provisions in the Remuneration Code. Amongst these have been supervisory statements on the application of proportionality under the Remuneration Code and how the PRA expects firms to apply the concept of malus to employees' bonus payments (malus being an arrangement that permits a firm to withhold all or part of any remuneration due under deferred remuneration provisions as a result of poor performance of the firm or a risk management failure, amongst others). The PRA has continued this trend with the publication of a consultation paper on the clawback provisions of the Remuneration Code, discussed further below.

Latest consultation

The PRA published a paper in March 2014 (CP6/14) announcing the launch of a consultation on rules for extending the Remuneration Code. Under the extended rules, all PRA supervised firms would need to amend staff employment contracts to include clawback provisions in relation to the bonus elements of an employee's pay package. 

Clawback has been clearly distinguished from the concept of malus as being the contractual agreement under which the staff member agrees to return some or all of a bonus payment to the firm in certain circumstances. 

CP6/14 suggests that clawback should apply as a minimum in circumstances where:

  1. there is reasonable evidence of employee misbehaviour or material error;
  2. the firm or business unit suffers a material downturn in its financial performance; or
  3. the firm or business unit suffers a material failure of risk management. 

If adopted, the proposed rule will come into force on 1 January 2015.  The PRA expects that the clawback provisions will apply to bonuses awarded prior to that date but suggests that there is a time limit to the clawback of six years from the date the bonus was awarded.  

The proposed clawback rules do not simply apply to those employees who were directly culpable but also to those who "could have been reasonably expected to be aware of the failure or misconduct at the time but failed to take adequate steps to promptly identify, assess, report, escalate or address it [...] or by virtue of their role or seniority could be deemed indirectly responsible or accountable for the failure or misconduct, including senior staff in charge of setting the firm's culture and strategy".

The PRA has correctly identified that there must be a clear contractual right to clawback either in an employee's service contract or in a document referred to in it, such as the bonus policy, which is why it anticipates that employment contracts will need to be renegotiated with many senior employees of PRA authorised firms. 

In practice this simply tightens an existing rule of the Remuneration Code. But it is not without its practical difficulties for implementation. 

Amending employment contracts involves tricky negotiations with members of the workforce. This can pose diplomatic issues between enforcing the legal requirements and keeping those that it affects motivated, engaged and secure in their employment.  Those that will be affected by these rules tend to be senior in the management structure of the firm, many of whom have a great degree of geographic mobility. 

Similarly, once the employment contracts have been amended there are practical questions on the enforcement of a clawback provision that need to be considered before a firm's policy on the issue can be updated. For example:

  1. How will employee performance be monitored to ensure that clawback provisions are invoked in the right circumstances? 
  2. Who will make the decision to enforce clawback provisions?
  3. How far is the firm willing to go to enforce clawback provisions (unlike the rules on malus, the bonus payments that are subject to the clawback provisions will already have been paid at the time of enforcement and, so, if an employee doesn't pay back the amount voluntarily, a court order for recovery may be required)?
  4. What value will the firm seek to claw back particularly when the bonus has been awarded in shares (e.g. when there has been an increase in the value of the shares since the date they were awarded).

This is definitely one to watch.  No firm wants to be more heavy-handed than is necessary when it comes to the packages it can offer its employees, particularly when the global financial marketplace is an increasingly international one. More importantly, it will be interesting to see where firms draw the line on enforcement of a clawback provision. 

UK Government's legal challenge on remuneration rules

At the same time as the PRA is pushing forward with the implementation of ever stricter rules on bonuses, the UK Government is launching a quiet fight back against Europe.  In September last year, the UK Government submitted a legal challenge to the bonus cap provisions contained in Capital Requirements Directive IV (CRD4). The UK's application has now been published in the Official Journal. 

The UK Government argues that the bonus cap was introduced without any assessment of its impact and will undermine other developments that have been introduced on remuneration in the financial sector. The UK Government further submits that the remuneration provisions in CRD4 have, amongst others, an inadequate Treaty legal basis, are disproportionate and infringe the principle of legal certainty.

Indeed the UK Government suggests that as a result of the cap on bonuses in CRD4, it is likely that in practice there will simply be an increase in bankers' fixed salaries, contrary to the intention of the rules. 

Despite the challenge, the UK will still implement CRD4 in its current form including those remuneration provisions that it is challenging. However it will now be for the European Court of Justice to rule on the legality of the CRD4 provisions. Unfortunately, it is unlikely that the UK's legal challenge will be resolved before the 2015 round of bonuses which is when the cap will first be introduced. Businesses need to continue to plan for the application of CRD4 but should monitor the outcome of the UK's legal challenge. 

It's also interesting to see the UK Government take such an aggressive stance with Europe on bankers' pay. The UK Government has clearly understood the mobility of the bankers in the City of London and the need to preserve the delicate balance between consumer protection and international competitiveness. It's clear from this action that the UK Government thinks that in this respect the EU has gone too far. 

This is a reproduction of an article by Brad Rice and Lorraine Johnston from Nabarro's financial regulatory team published in the Company Secretary's Review on 23 April 2014.  This article examines the current position on UK bankers' pay, the consultation on clawback provisions and the UK Government's challenge to the remuneration provisions in the Capital Requirements Directive IV.

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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