UK: PRA Crack-down on Buy-out awards

The Prudential Regulation Authority (PRA) has published its latest policy statement on remuneration, focussing on buy-out awards granted to employees who move between banks, building societies and PRA-designated investment firms, including UK branches of non-EEA headquartered firms. The new rules will apply to buy-outs agreed from 1 January 2017.

Policy statement PS26/16

The policy statement on buy-outs, which includes the PRA's final rules which amend the Remuneration Part of the PRA Rulebook, follows a consultation which we described in a previous briefing. The stated aim of the policy statement is to ensure that the practice of buy-outs does not “blunt the beneficial incentive effects of the existing rules on malus and clawback, or allow employees to avoid the proper consequences of their actions”. Although the FCA had indicated that it would closely follow feedback on the PRA's consultation, nothing has yet been proposed on buy-outs by the FCA in respect of solo FCA-regulated firms.

New requirements

The PRA's new rules impose a requirement on the new employer to:

• agree a buy-out for an employee who was a material risk taker (MRT) in the previous firm only following receipt from the new employee of a “remuneration statement” (see below);
• ensure that any buy-out does not exceed the amount of unvested variable remuneration set out in the remuneration statement; and
• operate malus and clawback to buy-out awards on the basis of a determination notified by the previous employer to the new employer (such notification is to be known as a “reduction notice”).

Enforcing malus and clawback

In order to be able to enforce malus and clawback (which in this context is limited to employee misbehaviour or material error, or a material failure of risk management), the new employer is required to include in the buy-out contract a provision under which, following receipt of the reduction notice from the previous employer, the new employer is able to reduce the employee’s buy-out through malus or clawback, by the amount set out in the reduction notice.

No discretion is given to the new employer as to whether malus and clawback should apply, as the rules will require the new employer simply to execute the terms of the reduction notice. As such, the PRA indicates that it is unlikely that firms would be able to obtain any waiver from the PRA to depart from these arrangements. The only time that malus or clawback need not be operated following receipt of the reduction notice is where the buy-out has already been subject to malus or clawback by the new employer.

Remuneration statements

In order to ease the administrative burden on new employers, the PRA will require that employers (and previous employers) must provide to their employees (or former employees), within 14 working days of a request, a remuneration statement containing details regarding unvested variable remuneration which would be forfeited on leaving (or which was forfeited on leaving). This remuneration statement is then available to be provided to the new employer.

The information which must be included in the remuneration statement includes details of any period during which the employee was categorised as an MRT; the amount of unvested variable remuneration applicable to periods during which the employee was an MRT; and the duration of retention, deferral, performance adjustment and clawback arrangements which apply to this unvested variable remuneration.

Buy-out notices

In order for the previous employer to be able to enforce malus and clawback by issuing a reduction notice, the new employer is required to inform all relevant previous employers of the buy-out by issuing a “buy-out notice” which details the amount of the buy-out and the terms on which it has been offered. 

Comment

Buy-out arrangements are generally agreed in advance of the employee agreeing to commence employment with the new employer. On the face of the new rules, no buy-out will be able to be agreed before the new employer (or prospective employer) has been provided with a remuneration statement by the employee. Employees are unlikely to leave it to chance as to whether their new employer will be generous in buying our forfeited remuneration which it is not contractually obliged to do. Consequently, employees may need to request remuneration statements during the period in which they are negotiating their new terms. Employees will, however, be keen to avoid alerting their current employer of an impending departure. The likely consequence of this is that, where such remuneration statements are not prepared by the employer on a periodic basis, employees are likely to make annual requests for such statements so that they have them to hand in the event that they decide to leave; resulting in potential significant additional administration for the firm. This could be avoided if the PRA confirms that conditional buy-outs could be agreed in advance and only finalised once the remuneration statement has been provided.

The prohibition on buy-outs without a remuneration statement will apply to all banks, building societies and PRA-designated investment firms. Although the PRA's consultation paper referred to the proposed arrangements not applying to Level 3 firms, this statement has not found its way through to the policy statement or final rules. Without further guidance, this means that an employee who is an MRT in a small bank which, as a Level 3 firm, takes advantage of the PRA's proportionality guidance not to apply malus or clawback, would still be required to obtain a remuneration statement in order to seek a buy-out from a new employer of any forfeited deferred bonus (i.e. where deferral by the previous employer has been implemented on a voluntary basis, rather than due to the strict regulatory requirements). This would be the case even though there is no possibility of the new employer having to operate malus or clawback on the buy-out amounts. It also means that Level 3 firms will be required to apply malus and clawback to buy-outs, even though they are not required to do so in relation to their own remuneration arrangements.

It will also be the case that the requirement not to offer a buy-out without seeing a remuneration statement will apply only in respect of employees who move between PRA-regulated firms. It would not, therefore, apply where an employee moves, for example, to a bank from an FCA-regulated asset management firm (as the previous employer would be under no obligation to provide the remuneration statement to the employee) or vice versa.

Although new employers will continue to be able to agree guaranteed remuneration in the first year of service, the new rules include avoidance provisions which state that any remuneration agreed with a new employee cannot be structured in a way which characterises a buy-out as something else. There will, therefore, be a fine line for employers who do not offer to buy out remuneration, but instead offer a first year guarantee.