FCA Remuneration Code Guide

  1. Introduction
  2. Overview of the Code
  3. The Code applies to
  4. Who is affected?
  5. What are the key provisions of the Code?
  6. Code principles which apply to Code Staff remuneration
  7. The Code and Termination of Employment
  8. What are the consequences of breaching the Code?
  9. Capital Requirements Directive

Introduction

The FSA introduced the Remuneration Code in 2009. Originally, it only applied to the largest banks and building societies and broker dealers that met certain financial thresholds. The FSA published a revised Remuneration Code (the “Code”), which came into effect on 1 January 2011. The Code is now contained in Senior Management Arrangement, Systems and Controls (SYSC) 19A of the FCA Handbook. The Code is principally concerned with the risks created by the way remuneration arrangements are structured, not with the absolute amount of remuneration, which is generally a matter for firms’ remuneration committees. By limiting risk – the Code seeks to create stability and confidence in financial services markets and protect consumers.

The Code is enforced by the PRA and what is now the FCA.

Overview of the Code

All firms that have to meet the Code are required to ensure that their remuneration policies and practices are consistent with and promote sound and effective risk management. The Code covers all aspects of remuneration including salaries, bonuses, long-term incentive plans, options, hiring bonuses, severance packages and pension arrangements. Some of the main features of the Code or its application include:

  • Who it applies to ­ the Code applies to senior management, risk takers and staff in control functions, collectively known as Code Staff.
  • Deferral – at least 40% of a bonus must be deferred over a period of at least three years for all Code Staff. At least 60% must be deferred for the most senior management or when an individual’s bonus is more than £500,000.
  • Proportion in shares ­ at least 50% of any bonus must be made in shares, share-linked instruments or other equivalent non-cash instruments of the firm. These shares should be subject to an appropriate retention period.
  • Guarantees ­no guaranteed bonuses of more than one year. Guarantees may only be given in exceptional circumstances to new hires for the first year of service. The amount should not exceed the remuneration (in terms or amount; including any deferral or retention periods) from the previous employer. It should also be subject to appropriate performance adjustment requirements. This applies to all employees.
  • Disclosure – of fraud or significant Code breaches to the FCA. Some firms (those subject to BIPRU) must disclose details of firm’s remuneration policies at least annually.
  • Application of Code on proportionate basis – The FCA applies the Code taking account of an institution’s size, internal organisation and nature and complexity of their activities. Depending on which one of 4 tiers an organisation falls into, minimum expectations of compliance apply.

The Code applies to

The Code has been extended to apply in some form to all banks, building societies and investment firms, which are within the scope of the Capital Adequacy Directive (2006/49/EC) (CAD). CAD has been amended by the Capital Requirements Directive, known as CRD 3 (2010/76/EU), the remuneration provisions of which have been incorporated by the Code (and other parts of the FCA Handbook). The Code also incorporates remuneration provisions of the Financial Services Act 2010. The Code applies to some 2,700 firms, hedge fund managers and Undertakings for Collective Investments in Transferable Securities (UCITS) including firms which engage in corporate finance, stockbrokers and the provision of financial advice.

Applicable to:

  • UK firms within the scope of CAD;
  • If the Code applies to a UK firm, the FCA takes the stance that it applies to employees and directors worldwide within group entities;
  • UK branches of firms which are based outside the EEA.

The Code sets out the rules and associated guidelines which will deal with remuneration but also covers governance and the methods of performance measurement used to determine performance related bonuses. The core principle remains that a firm “must establish, implement and maintain remuneration policies, procedures and practises that are consistent with and promote effective risk management” (SYSC 19A.2.1 R).

Who is affected?

Overall, all employees will be subject to the Code, however there are specific requirements which primarily affect the remuneration of two categories of employees, namely Code Staff and Code Staff engaged in “controlled functions”.

The concept of “Code Staff” has been introduced by the Code and includes employees who perform a significant influence function for the firm ¬ this will include senior partners of support and control functions, who could have a material impact on the firm’s risk profile, senior managers, all staff whose total remuneration takes them into the same bracket as senior staff; and risk takers, whose professional activities have a material impact on the firm’s risk profile.

The definition of Code Staff may also include consultants and advisors who may fall within the category by virtue of their level of remuneration or because their role could materially impact the firm’s risk profile. Under SYSC 19A 3.5 a firm must maintain a record of its Code staff and must take reasonable steps to ensure they understand the implications of their status as such.

Exclusion from Code based on level of pay

Generally, the FCA will not consider it necessary for a firm to apply the Performance Principles below where a staff member has total remuneration of under £500,000 and whose variable remuneration is less than 33% of the total remuneration.

  1. Guaranteed variable remuneration
  2. Retained shares or other instruments
  3. Deferral
  4. Performance adjustment

What are the key provisions of the Code?

The Code does not apply to all firms in the same way and smaller ones are not subject to all the requirements of larger ones. In accordance with guidelines of the FSA (now FCA) and the European Banking Authority (which has replaced the Committee of European Banking Supervisors), requirements concerning deferral and variable remuneration, and the payment of a proportion of variable remuneration in an appropriate non-cash form, may be applied proportionately.

The FCA’s approach to proportionality

The Remuneration Code (SYSC 19A) & Pillar 3 disclosures on remuneration (BIPRU 11) create four different proportionality “tiers” for an FCA regulated entity, each with different minimum requirements depending on their size and scope. : Firms within the same tier may apply aspects of the Code with different degrees of sophistication depending on the complexity of their businesses:

Tier one ­ larger banks, building societies (with capital resources of over £1 billion) and broker dealers (with capital resources of over £750 million) that engage in significant proprietary trading/investment banking activities and firms with branches outside the EEA where total assets for UK branch is over £25 billion. Comply with Code in full.

Tier two ­ larger banks, building societies ( with capital resources between £50 million and £1 billion) and broker dealers that engage in significant proprietary trading/investment banking activities (with capital resources of between £100 – £750 million) and those with and branches outside the EEA with total assets for UK branch of over £20 billion. Comply with Code in full except the requirement that at least 50% of variable remuneration should be in an appropriate non-cash form (ie. shares, or other securities) and subject to a retention period.

Tier three ­ consists primarily of small banks and building societies and firms that may occasionally take overnight/short-term risk with their balance sheets. Comply with Code, but no need to: have a remuneration committee, deliver at least 50% of variable remuneration in an appropriate non-cash form (ie, shares, or other securities) subject to a retention period, or defer a proportion of Code Staff variable remuneration, adjust/reduce deferred variable remuneration to reflect performance.

Tier four ­ firms that generate income from agency business without putting their balance sheets at risk. Firms will be expected to comply with the Code as for tier three, except that tier four will also generally: not be required to specify appropriate limits for the proportion of variable remuneration, and will be able to take into account their specific activities when applying rules on profit-based measurement and risk adjustment of variable remuneration, and multi-year performance periods for the assessment of variable remuneration.

However the FCA propose to amend the ‘General Guidance on Proportionality’, which sets out the proportionate approach to implementing the Code and the Pillar 3 remuneration disclosure rules. The proposed new framework would replace the current four-tier structure (based on capital resources) with three new ‘levels’ (based on total assets). The proposed approach would allow the FCA to focus its resources on the most significant firms who pose risks to financial stability.

Code principles which apply to Code Staff remuneration

  • Set “appropriate ratios” between the fixed and variable components of total remuneration; fixed percentage to represent “a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable remuneration components, including the possibility to pay no variable remuneration component”.
  • At least 50% of any variable remuneration as a whole should consist of shares, share-linked instruments or other equivalent non-cash instruments (in the case of a non-listed credit institution).
  • At least 40% of the variable remuneration component of an individual’s remuneration must be deferred, with vesting over a period of three to five years and no faster than on a pro-rata basis. The first vesting of deferred remuneration should be no sooner than one year after the award.
  • At least 60% of all variable remuneration must be deferred when variable remuneration is £500,000 or above.
  • Firms should retain the ability to make adjustments to an individual’s unvested deferred amounts of variable remuneration, after the amount has been communicated to the employee, to reflect actual outcomes as they materialise over time. This means that further assessment will need to be made immediately prior to vesting or pay out in order to determine whether the relevant conditions have been met.
  • Guaranteed bonuses should be exceptional and should occur only in the context of hiring new Code Staff and will be limited to the first year of employment (not only Code staff).
  • Payments in connection with the early termination of a contract should reflect the performance achieved and should not reward failure.

The Code and Termination of Employment

SYSC 19A 3.45 requires a firm to ensure that payments related to early termination reflect performance and do not reward failure. The guidance suggests that payments should only be made where they are necessary and consistent with the Code’s general requirements.

The FCA consider performance adjustments to be an essential requirement.

What are the consequences of breaching the Code?

Certain contractual provisions which contravene the provisions of the Code would be rendered void. The firm would be under an obligation to recover any sums paid, or property transferred to an individual under such contractual provisions, and would additionally be restricted from paying the relevant employee variable remuneration for the same performance year, unless it has a legal opinion to state that an award complies with the Code.

As the Code consists of rules in the FCA’s Senior Management Arrangements, Systems and Controls sourcebook (SYSC), any breach will be a breach of SYSC rules. Serious breaches might also breach the FCA’s Principles for Businesses and significant breaches are likely to lead to the FCA taking disciplinary action against the firm.

In order to establish whether a firm is complying the Code, the FCA can ask a firm’s remuneration committee to provide evidence of how well its “remuneration policies” comply with the Code’s principles.

SYSC 19A 3.32 states that a firm must ensure variable remuneration is not paid through vehicles or methods that facilitate the avoidance of the Code.

The Code is enforced by both the FCA and PRA.

Capital Requirements Directive

CRD IV

On 16 April 2013, the European Parliament adopted CRD IV. This includes a cap on bankers’ bonuses of one times salary. There is provision to increase to two times salary with shareholder approval, provided at least 25% of any bonus in excess of one times salary must be deferred for at least five years.
The cap will apply to:

  • Banks, building societies and some investment firms within the scope of the CRD.
  • Staff of the above who are material risk takers (referred to as Code Staff under the FCA’s Remuneration Code)
  • In respect of Code Staff, the ratio of “variable pay” to “fixed pay”. Variable pay is remuneration which reflects “a sustainable and risk adjusted performance as well as performance in excess of that required to fulfil the employee’s job description as part of the terms of employment”. Fixed pay is remuneration which “primarily reflects relevant professional experience and organisational responsibility as set out in an employee’s job description as part of the terms of employment”.

If the legislation is published in the EU Official Journal before 1 July 2013, the cap will apply to remuneration for services and performance on or after 1 January 2014. If the legislation is published on or after 1 July 2013, the cap is only likely to apply to remuneration awarded for services and performance on or after 1 July 2014.

CRD IV is currently being challenged.
 

This publication is intended for general summary guidance. It is not and should not be considered legal advice. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.