FSA issues final form remuneration code

On Friday 17 December 2010, the FSA issued its revised Remuneration Code (the "Code") containing its interpretation of the remuneration principles contained in the amendments to the Capital Requirements Directive ("CRD III"). The FSA Code takes into account a number of the principles set out in the Guidelines issued by the Committee of European Banking Supervisors on 10 December 2010 (the "CEBS Guidelines").

The approach taken by the FSA is in line with the CEBS Guidelines and broadly addresses a number of key concerns raised in the consultation process. In particular there is additional clarification provided on the application of the proportionality principles to extended scope firms, including limited licence and limited activity firms. This briefing highlights some of the key provisions on the revised Code and will be discussed further in our client webinar on 11 January 2011.

Implementation

• The Code will come into force on 1 January 2011.
• A six month transitional period will apply in relation to extended scope firms and to firms which would not be in a position to issue shares in time for the 1 January deadline. However, by 1 July 2011 all in scope firms must ensure that their remuneration structure is fully compliant with the requirements of the Code, which, for most firms, is likely to become effective in relation to bonus payments in 2012 in respect of the 2011 financial year.

Proportionality - four-tier system introduced

• One of the ways in which the FSA deals with the issue of proportionality is in introducing a four-tier system which establishes different minimum standards for compliance with the Code for different types of firms. The system, which puts firms into one of four tiers according to certain regulatory capital or asset based criteria, is intended to take into account the need to focus on systemic importance and the risk posed by different business model types. The Code contains helpful tables which set out the rules which the FSA considers would 'normally' apply to firms in each of the four tiers, a summary of which is set out in the table further below. Whilst a firm will still need to consider the application of the proportionality principles to its individual circumstances, the table can be used as a helpful starting point when considering how proportionality might properly be applied.  In practice, we imagine that there will be a considerable degree of variation among firms falling in any given tier as they apply the informal guidance set out in the table to their own individual circumstances.  This reflects the FSA's clear statement that there is no 'one size fits all' approach to compliance with the Code.
• Where one or more firms form part of a group, an assessment will need to be made as to which tier each group entity would fall into if considered on an individual basis. If, on this assessment, the group entities fall into different proportionality tiers, the primary position seems to be that the group entity should, as a whole, be treated as falling within the highestapplicable proportionality tier. However, the FSA has provided some flexibility in this regard; if a firm believes that an individual group entity or the group as a whole should fall into a lower tier than determined by the general guidance, it may be possible to make representations to the FSA setting out its reasons for taking a different approach.  The FSA has also said that it is willing to give individual guidance to firms in relation to their compliance with the requirements of the Code.
• The FSA has adopted an 'all or nothing' approach to certain aspects of proportionality set out in the CEBS Guidelines. Therefore, where the requirement to defer and/or to make awards in instruments cannot be completely neutralised, it is not possible to apply proportionality at an institution-wide level to reduce the periods or percentages specified. If there is insufficient justification for complete neutralisation of any of these specific requirements, the relevant minimum criteria will apply. In other words, it will not be possible to argue for a relaxation of criteria in order to defer a percentage of variable remuneration lower than 40%, defer for a shorter period than three years or to pay less than 50% in instruments where complete neutralisation has not been achieved. If complete neutralisation can be justified, firms will be able to apply their own internal requirements on deferral which may be more lenient than the minimum requirements.
• In circumstances in which complete neutralisation is not possible at the institution-wide level, it may still, however, be possible to justify a proportionate application of these rules at the level of individual Code Staff, where the relevant individual or group of individuals has a less material impact on the risk profile.

Code staff

• In-scope firms must collate their Code Staff list annually and update it as appropriate.
• The de minimis concession would apply in the same way as previously proposed, namely:

• Secondees and part-year Code Staff - the Code contains particular rules in respect of secondees and individuals who have not been Code Staff throughout the relevant year. In particular, if the role of a relevant secondee involves material risk taking for the in-scope firm, the Code will apply, but firms are referred to the specific guidance provided in relation to part-year Code Staff in respect of secondments for less than 12 months. This guidance provides that, where an employee has been Code Staff for no more than three months, the rules on deferral, issuance in shares and performance adjustment would not be expected to be applied in relation to that year. However, if an employee has been Code Staff for more than three months, the requirements of the Code will apply, subject to any de minimis concession (as applied on a pro-rata basis).  This means that the rules on deferral, issuance in shares and performance should be applied, although only on the relevant portion of variable remuneration for that year.
• Staff of non-EEA based parent - CEBS confirmed that, in its view, no automatic exemption would apply in respect non-EEA based staff who perform services or duties for an EEA institution (the default position in such circumstances, seemingly, would be that the remuneration requirements of the jurisdiction of the relevant EEA institution should be followed). The FSA has, as hoped, provided some additional clarity. It has confirmed that, whilst it will "have close regard for cases of possible avoidance", firms will have the opportunity to put forward a case for exemption of the application of the rules where the individual has global responsibilities and where a group's UK entities form only a part of those responsibilities. In general terms, in relation to overseas based senior managers employed by a non-EEA based parent entity, a two stage approach should be applied to determine whether or not they are Code Staff. Consideration should first be given to the extent to which the risk pertaining to the in-scope entity can affect the risk profile of the group as a whole and, second, to the significance of the in-scope entity within the context of the overall responsibilities of particular parent level senior managers.

Remuneration rules

Variable remuneration

• The FSA has (somewhat surprisingly, given the European Parliament's Q&A response issued with CRD III) confirmed that commission would be included in the definition of variable remuneration for the purposes of the Code. However, it also expects that this will not apply to large numbers of sales staff, who would not be deemed to be Code Staff in the first place.

Deferral

• Although complete neutralisation would normally be applicable in respect of firms in tiers three and four, firms are encouraged to consider applying deferral on a firm-wide basis in any event (although the FSA has confirmed that, where deferral is applied to non-Code Staff, the 40% minimum requirement would not apply).
• Where the requirements in relation to deferral are not completely neutralised, the £500,000 threshold for deferral of 60% of variable remuneration would apply as previously proposed. In addition, executive directors of tier one firms are expected to apply the deferral requirements to 60% of variable remuneration, notwithstanding the 'large bonus' threshold, subject to any applicable de minimis concession.

Award in instruments and retention periods

• The FSA has followed the CEBS Guidelines that 50% of variable remuneration must be paid in instruments and 50% in cash and that these proportions apply both to the deferred and non-deferred components. This is expected to apply to firms in tiers one and two. For firms in tiers three and four, this requirement will not normally apply, subject to such firms providing suitable justification. For firms subject to the requirement but which would not currently be in a position to issue shares, the applicable six-month transitional provisions will apply and the FSA will engage with the relevant firms and trade associations during the transitional period in this regard.
• For firms in tiers one and two, at least, there will therefore be a de facto limit on up-front cash bonuses for Code Staff of 20% - 30% on the assumption that such firms will not be able to completely neutralise the relevant requirements.
• The FSA has followed CEBS in not setting a minimum retention period for variable remuneration issued in shares or other instruments, we understand from the FSA that, provided there are adequate risk adjustment procedures in place, a retention period of not less than six months is likely to be appropriate in most cases.
• The issues relating to tax are not dealt with directly in the guidance to the Code (as highlighted in our previous briefings). However, we understand from the FSA that the retention period which must be imposed can apply to the net number of shares or other instruments after a sale of sufficient shares/instruments in order to realise funds to cover any tax liability arising.

Maximum bonus ratio

• The Code confirms that firms (save normally for tier four firms) should set out in their remuneration policy a maximum ratio (or ratios) of the variable component in relation to the fixed component. Within a group structure, this ratio could vary between firms and/or between different categories of Code Staff.

Avoidance and voiding provisions

• Structures devised to avoid the rules will be scrutinised, although the FSA proposes to apply the relevant voiding provisions only to firms already in scope, with the application of such provisions to extended scope firms being introduced on a transitional basis during 2011. In any event, the FSA proposes to apply the voiding provisions only to a limited number of rules, relating to: (i) the use of certain prohibited forms of remuneration; (ii) the restrictions on guaranteed bonuses; and/or (iii) the requirements in relation to deferral. The FSA will also have powers to replace payments and/or recover property transferring under void agreements.
• In response to potential avoidance techniques, the FSA has stated that it does not expect firms to offer non-recourse loans to staff or to set up other structures through which remuneration can be paid in an attempt to avoid the application of the Code.

Guaranteed and retention bonuses

• Rules in relation to guaranteed minimum bonuses (which can be awarded only in exceptional circumstances, when hiring new staff and in respect of the first year of employment) apply on a firm-wide basis and, not only to Code Staff. However, employees who fall within the de minimis threshold (whether or not Code Staff) would be excluded from this restriction (please see the text box above in relation to the application of de minimis). Guaranteed buy-out bonuses should be no more generous, in terms or amounts, than the previous employer’s arrangements and should be subject to the relevant performance adjustment provisions.
• Retention bonuses may be permitted, but only in "exceptional circumstances" and where compatible with the Code.

Disclosure requirements

• Firms will have to submit an annual data return, containing aggregate data and a certification of compliance with the Code based on 2010/2011 awards, where relevant. The deadline for submission is still to be determined but it is likely to be during the second half of 2011.
• In addition, all firms will have to submit a Remuneration Policy Statement ("RPS") or equivalent questionnaire at the same time which will record the self-assessment process in relation to compliance with the Code (although the RPS for tier two, three and four firms will be shorter than that for tier one firms). Template documentation will be issued by the FSA in due course in 2011.
• A table setting out the applicable disclosure requirements for each of the four tiers is set out in Appendix 2 to the Code. This confirms that the approach to be taken in relation to firms in tiers three and four will be less stringent, although these firms will still be required to disclose quantitative information on an aggregate basis.