In August 2009, the FSA published a rule and ancillary code (its Remuneration Code), requiring the 26 largest banks, building societies and broker-dealers to operate remuneration policies, procedures and practices that are consistent with and promote effective risk-management practices. To coincide with the G20 summit in Pittsburgh on 24-25 September 2009, the FSB issued implementation standards which prioritised those areas of its Principles for Sound Compensation Practices (issued in April 2009) that should be addressed by firms and supervisors to achieve effective implementation of its Principles.
The Financial Services Act 2010 requires the FSA to draw up general rules governing remuneration policies (with the Remuneration Code now fulfilling this role) and provides for new disclosure rules in the light of the Walker Review recommendations – click here to read a full analysis of the remuneration provisions in the Act and the related Walker
recommendations on remuneration, including an early draft of new-style executive remuneration reports to be voted on by shareholders in relevant quoted companies.
At the European Level, amendments to the Capital Requirements Directive (CRD III) are almost finalised, containing provisions relevant to remuneration at all credit institutions and MiFID investment firms (with the exception of non-exempt CAD firms which may only carry on MiFID business of receiving and transmitting orders and giving investment advice). These cap upfront bonuses at 60% of total variable pay and to 40% for particularly large amounts. The balance must be deferred for at least 3 years and may be recovered if investments do not perform as expected. Moreover at least 50% of variable remuneration will have to be paid as shares or contingent capital. The ratio between variable and fixed remuneration will also need to be set at an “appropriate” level to be established by each affected institution on the basis of guidance still to be issued. Extra capital requirements for risky remuneration are also proposed.
It is anticipated that similar restrictions will be incorporated into the AIFM Directive, UCITS IV and Solvency II Level 2 Directive. To read a fuller discussion of recent EU developments please click here.
On 29 July 2010 the FSA released a consultation paper containing proposed revisions to its Remuneration Code affecting pay in the financial services sector due to take effect from 1 January 2011 implementing the CRD III changes. The FSA had always intended to conduct a review one year after the Remuneration Code was put in place so as to take account of the Walker report on corporate governance and the Financial Services Act. However, it is CRD III which has had the greatest impact on its proposals, which extend application of the Remuneration Code to approximately 2,500 firms. The revised Remuneration Code also contains provisions relating to deferral of variable remuneration, payment in shares and other remuneration matters. For a fuller discussion of the consultation paper and the FSA’s proposals please click here.
Ceding to political pressure, the then Government introduced a new one-off Payroll Tax on bonuses in December 2009. This tax originally applied to a very broad range of financial institutions, but was revised to apply only to UK and foreign-domiciled banks and companies in “banking” groups who are deposit-taking or who are full-scope BIPRU 730k firms with £100 million or more of regulatory capital requirements. Insurance and asset management groups are, broadly, excluded. The tax is payable by the taxable company, not the employee, at a rate of 50% on relevant remuneration awarded to each of its “relevant banking employees” above £25,000 in the period between 9 December 2009 and 6 April 2010. Click here to read a full analysis of this tax framework. The tax is payable on 31 August 2010.
In April 2010 the IMF published a report, commissioned as a technical paper by the G20, proposing new global taxes on financial institutions. The first, a “financial stability contribution”, would be levied on bank balance sheets, specifically their liabilities. The IMF suggested the G20 nations initially apply the levy as a flat rate tax and later adjust the rate to reflect the risk. If additional taxation is desired, the IMF recommended a “financial activities tax” on profits above “normal” levels as well as high pay. However, at the G20 summit in Toronto in June 2010 these proposals for a worldwide levy on banks were dropped in the face of heavy opposition led by Canada.
The UK has, however, acted unilaterally and in an emergency Budget on 22 June 2010 the Chancellor of the Exchequer announced the introduction of a bank levy based on balance sheet liabilities (excluding retail deposits) from 1 January 2011. The rate is proposed to be set at 0.04% in 2011 rising to 0.07% in later years. There will be a reduced rate for longer-maturity wholesale funding liabilities of 0.02% and 0.35% respectively. Consultation on the details of the proposed bank levy began on 13 July 2010 and is due to close on 5 October 2010.
The Government has also announced that the costs and benefits of a financial activities tax, on profits and remuneration, will be explored as part of its action to tackle bank bonuses. Additionally, the Government plans to consult on a remuneration disclosure regime (separate from the disclosure regime in relation to executives’ remuneration planned in the draft regulations published in March this year under the Financial Services Act 2010).
The FSA rule and Remuneration Code currently only apply to the 26 largest banks, building societies and broker dealers in the UK. As stated above, its application is to be extended to approximately 2,500 firms from 1 January 2011. This extension of the regime poses significant challenges for firms (and their HR, risk and compliance divisions). REMCOs will have a much bigger/broader role. One big change is the move towards incentives that are risk-adjusted and with greater deferral (and which need not be paid if longer-term performance criteria are not met). There will be a need for much more comprehensive policy, procedure and transparency across HR, particularly where it may be relevant to risk. An increasing number of asset management houses are encouraging portfolio managers to invest their bonuses in the funds they run. A transition plan is also required.
For the 26 major firms, the new rule and Remuneration Code came into effect on 1 January 2010 and employment contracts for relevant employees needed to be amended by 31 March 2010 (or terminated by 31 December 2010 if they cannot be amended unilaterally).
At European level, CRD III is almost finalised, and implementation is supposed to be 1 January 2011. CEBS is to produce guidelines on the implementation of CRD III and these are expected in October 2010.
Consultation has begun in relation to the FSA’s review of its Remuneration Code in response to these changes. The consultation period ends on 8 October 2010, and finalised provisions are expected in November 2010 ahead of the rules coming into effect on 1 January 2011 for the 2010 remuneration of relevant firms. Some transitional rules are intended.
The FSB has launched a peer review of compensation on the basis of the assessment methodology for the FSB principles and Standards, and IOSCO is due to integrate compensation design characteristics and disclosure of compensation decision-making into its Principles for Periodic Disclosure by Listed Entities. The FSB was asked by the G20 to monitor the implementation of its standards and propose any additional measures. In its report in March 2010, the FSB concluded that while relevant frameworks had been agreed, they still needed to be fully implemented. A further review is due in the second quarter of 2011.
The AIFM Directive is currently expected to be voted on in Parliament in October. Although the final specifics of the Directive have not yet been agreed on, fund managers to which it applies will be required to implement policies, which currently include rules on deferral of payments, to some staff. Meanwhile, for the insurance sector, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) has advised the European Commission to include remuneration requirements into the Solvency II Directive regime. These provisions are expected to be in place by the end of 2012.
The previous Government said that the regime for executive remuneration reports will come into force for annual reports in respect of 2010 issued in early 2011. The new Government has not yet pronounced on this but there have been suggestions that this will now slip.
There is ongoing consultation as regards the proposed UK bank levy which is due to close on 5 October 2010. It is proposed that draft legislation will be published in the autumn. Final draft legislation for inclusion in the 2011 Finance Bill will be published towards the end of this year, ahead of implementation of the levy from 1 January 2011.