The main headline is that the EBA says that bonuses received in 2018 and in subsequent years by senior staff in all firms caught by CRD4 whatever their size will be required to be subject to the bonus cap imposed by CRD4. This prevents bonuses exceeding 1 x salary unless shareholder approval has been received, in which case they may be up to 2 x salary. At the moment, the UK only requires CRD4 firms in Levels 1 and 2 of its proportionality framework to apply a bonus cap – Level 3 firms do not have to, and so this application of a bonus cap to all senior staff in CRD4 firms would be a major change in the UK and the firms would have to start applying bonus cap rules in the same way that larger firms have had to apply them over the past two years.
At the same time, the EBA accepts that the pay-out rules (the requirement to defer a percentage of bonuses, and partially pay in shares or other instruments which must be retained for a period and the imposition of malus and clawback arrangements) should be remain capable of being disapplied by small and non-complex CRD4 firms (which are not defined), although the remaining CRD4 firms will have to apply these rules for their senior staff. Little detail is provided on the cut-off point between small and non-complex and other firms – at the moment the UK puts many smaller banks into the “small and non-complex” category (currently Level 3), but it is not clear if in future the EBA equivalent of Level 3 would exclude banks altogether and just include investment firms. The EBA recommends that the underlying legislation in CRD4 is amended to make clear that the disapplication of the pay-out rules can occur.
Background to EBA announcements
By way of background, the European institutions have been wrestling for some years on whether existing legislation permits the EBA’s current guidelines to let some banks and investment firms off applying rules affecting senior staff bonus deferral, paying bonuses in shares, malus/clawback as well as not applying the bonus cap to them. The UK has vigorously taken advantage of these exemptions to date and so would feel any loss keenly. The EBA’s interpretation of existing legislation is hotly debated but part of this revolves around whether proportionality as set out in CRD4 allows complete neutralisation or disapplication.
The EBA is still of the view that existing legislation does not allow any concessions on the bonus cap and is unclear on the other concessions, but it is proposing that legislation is amended so that small and non-complex CRD4 firms may expressly disapply rules on deferral, paying in shares and malus/clawback. No CRD4 entity will be able to disapply the bonus cap, however. The Commission was already consulting on changing legislation in 2016 and so this will no doubt form part of that.
The EBA’s existing guidelines will stay in force until the end of 2016 and so permit the continuation of existing practices in the interim in the hope presumably that new legislation can come in in time so that the new guidelines and the amended legislation will dovetail.
There are some other changes in the guidelines (although minor in comparison with these bigger proposed changes). Among other things, there is a tightening up of when guaranteed bonuses and retention bonuses can be paid, for example, and expressly allowing cash arrangements linked to share price instead of shares (which is welcome). Bonus deferral will also be required over a five year period rather than just three years for larger firms, though the UK has led here and is already imposing this requirement. A subsequent retention period of one year (rather than 6 months which is permitted in the UK) for shares is also proposed once they have vested. De minimis individual exemptions are also put forward.
What will PRA and FCA do next?
The next stage is for the PRA and FCA to review the changes to the guidelines (though the proposed legislative changes are strictly not part of this process). They have two months from the publication of translations in all EU languages (which has not yet occurred) in which to make up their mind whether they are going to comply. It is not a foregone conclusion that they will agree with the EBA legislative interpretations and guidelines and so may continue to permit UK existing practice on the bonus cap to continue until there is specific legislation to the contrary. It is expected in due course that the PRA and FCA will consult on some of the proposals.
The FCA has already confirmed no firm need change any pay arrangements for 2016. The PRA has not made any public comment, but it is assumed that it does not disagree that no immediate change is needed.
The PRA and FCA have been concerned for some time that buy-outs by new employers of remuneration forfeited by Code staff when they leave their old firms has the potential to subvert the overall operation of the Remuneration Code. While the employee would where he was a Code staff member at a Level 1 or 2 bank have had his original remuneration subject to malus and clawback by the old employer, bought-out remuneration was in practice immune from recovery by the old employer for obvious reasons. On 13 January 2015, the PRA issued a consultation paper on how it proposes to deal with this issue.
After some 18 months deliberation, the PRA proposes that where a malus or clawback event has occurred in relation to an employee’s employment with the old employer (of personal misconduct nature as material downturn of the financial performance of the old employer is excluded), the old employer acting fairly and reasonably must approach the new employer with the amount of malus and/or clawback that is to be applied, and the new employer would recover those amounts for the old employer. In order to allow the system to operate, the new employer will have to identify buy-out remuneration to the old employer when awarded so that the old employer knows that it can apply to the new employer for recovery.
Considering that one of the earlier proposals the PRA had was to ban buy-outs altogether, this may not be the worst outcome, but the documentation and paperwork around these awards (from both the old employer and new employer) will, if implemented in the proposed form, be extremely cumbersome.
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