Removal of the Bankers’ Bonus Cap

Following receipt of responses to their joint consultation paper issued last December (PRA CP15/22 and FCA CP22/28), the PRA and the FCA have now published a policy statement (PS9/23) confirming that the bankers’ bonus cap will be removed. This means that firms will now be able to pay bonuses exceeding 100% of fixed pay (or 200% with shareholder approval). This change has been introduced more quickly than expected - it will apply from 31 October 2023 and applies to performance years ongoing on that date, as well as to future performance years. The main rationale for the quicker than expected implementation is that it allows firms to restructure pay faster, gives them further flexibility over their cost base to deal with downturns, and gives firms the ability to restructure more quickly to allow for a greater proportion of total pay to be subject to incentive setting tools. Firms may, if they wish, choose to wait before making any change to their remuneration structures.

The changes described in the policy statement affect banks, building societies and PRA-designated investment firms that are subject to the Remuneration Part of the PRA Rulebook and the Dual-regulated firms Remuneration Code (SYSC 19D) in the FCA Handbook.  The changes do not affect FCA solo-regulated investment firms that are subject to other Remuneration Codes; however they will be of interest to investment firms that are members of a group to which the Dual-regulated firms Remuneration Code applies on a consolidated basis.

This Law-Now is the ninth in our executive remuneration series, which summarises the key points arising from the policy statement, their impact, and sets out a suggested ‘to do’ list for firms.

Background

The bonus cap was introduced in 2014 as part of a suite of EU rules aimed at deterring excessive risk taking by more closely aligning reward with risk. The cap has been unpopular with the investment banking sector, and in particular with US and Asian investment banks operating in London, who found themselves unable to align London pay practices with those in other global centres such as New York or Tokyo. Whilst the theory behind the bonus cap was generally considered to be sound, many considered it to be an ineffective blunt instrument – not least because the industry reacted by adopting ‘role-based allowances’ to mitigate the impact of the rules.

Last December, the PRA and FCA published a consultation paper on the possibility of removing the bonus cap. On 24 October 2023, the PRA and the FCA published a policy statement setting out their final proposals in response to the feedback received during the consultation.

The reason for removing the bonus cap remains unchanged – the PRA and the FCA are concerned that, rather than limiting bonus payments to manage excessive risk-taking, in practice fixed pay was increasing (as a proportion of total remuneration). This was seen by the PRA and the FCA as something to avoid, because:-

• fixed pay is not linked to longer-term performance and is not subject to malus and clawback;
• the increase in fixed pay meant that firms found it difficult to adjust remuneration costs downwards in leaner years.

Another reason for removing the bonus cap is to increase labour mobility and the UK’s competitiveness (given that bonus caps are uncommon outside of the EU).

Summary

Here is a summary of the main points in the policy statement:-

• Firms are no longer required to apply the limit on the maximum ratio between fixed and variable remuneration (the bonus cap) for material risk takers (MRTs). 
• The key change from the proposals in the consultation paper is that the bonus cap is being removed with effect from 31 October 2023. This means that firms will not need to wait until their next performance year and the  transitional provisions that were suggested in the consultation paper are not required. Firms can therefore choose for themselves how and when they change their remuneration structures to deal with the removal of the cap.
• Although the bonus cap will be removed, firms will still be required to set appropriate ratios between the fixed and variable components of total remuneration  The PRA and FCA have issued some guidance on how to do this (in SS2/17 and in SYSC 19D.3.48AG), which is based on the provisions in the MIFIDPRU Remuneration Code (SYSC 19G).
• Existing requirements will continue to apply in relation to deferral, payment in shares or other non-cash instruments, and risk adjustment (ie. malus and clawback).
• Firms must continue to ensure that fixed and variable components of total remuneration are appropriately balanced. The level of fixed pay must represent a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable pay, including the possibility of no variable pay.
• The PRA and the FCA say they may look more broadly at the rules around remuneration (including deferral periods), with a view to streamlining those rules and making them more effective and proportionate. It is possible that the PRA and the FCA may also look at the interaction between those rules and the Senior Managers and Certification Regime (SM&CR).

‘To Do’ List

Firms that are thinking about removing the bonus cap have a number of things to consider. We have set out a few in our “To Do” list below.

• Determine the “appropriate” ratios. This is likely to require a lot of thought.  Firms will need to think about the circumstances in which they can depart from their existing remuneration structures, which would of course have been designed when the cap was in place. Firms must:
  • Consider all relevant factors, including their business activities and associated prudential and conduct risks.
  • Consider whether there should be different ratios for different roles - firms may set different ratios for different categories of staff (SYSC 19D.3.48A (2)).
  • Look at benchmarking, ie. keep an eye on market practice over time. Firms will not want to be out of step with their competitors.
  • Think about how to incentivise MRTs to agree to change their remuneration structures to adapt to higher ratios, which by necessity will mean lower fixed pay and the possibility of higher variable pay. It is likely that the maximum total remuneration on offer will need to be higher before MRTs will agree to changes. No doubt there will also be a lot of discussion over the KPIs/metrics applying to variable pay to justify bigger ratios.
• Think about how to vary employment contracts. If the ratios are to be changed, fixed pay will almost certainly need to be reduced. Reducing salary will require consent. Removing role-based allowances may be easier if there is an express contractual right to do so, but, where there is not, firms will need to obtain consent. Firms may choose to phase in changes, eg by offering bigger ratios to new hires (where there is no requirement to vary an existing contract) or at the time of a promotion (where consent may be easier to get), but this could lead to disharmony if it creates a two (or multi)-tier workforce.
• Remuneration policies will need to be amended and this may need shareholder approval.
• Consider equality and diversity risks. The policy statement says there is evidence that gender pay gaps in bonuses/variable pay are typically larger than in fixed pay, and that the banking sector may have high gender pay gaps. Firms will need to ensure that any changes to ratios are not discriminatory. The PRA and FCA expect firms to take care to avoid adverse impacts on pay gaps when changing ratios.