Any person in the Finance Sector designing pay packages, incentives or settling enhanced payments on termination should be aware of the restrictions which are coming into force by virtue of an updated FSA Remuneration Code (the 'Code').
The Code is intended to disincentivise employees in the financial sector from taking risks in return for short term rewards. In theory, by deferring pay and linking it to the long-term performance of both the business and employees, employees will be more likely to consider the long-term implications of their actions. However, the new voiding provisions and tight confines within which affected firms will be required to remunerate their staff will require consideration of a greater number of factors than ever before and smaller firms without large HR departments might find applying the new rules a big departure from their current mode of operation.
Doesn’t the Code apply to just a handful of banks? Why do we need to know about it now?
The first version of the Code, which was introduced earlier this year, applied to 26 of the UK’s largest banks, building societies and broker dealers. The Code is being amended in order to anticipate new EU rules on financial sector bonuses which are currently in the pipeline. The EU's new pay rules are intended to deal with perceived excesses in risk-taking in the financial sector at large and so the new Code is expected to cover over 2,500 FSA authorised firms.
At the moment, the new Code is only in draft and the final form is expected to be published in December 2010. However, it is important to be aware of the likely content of the new rules now because the new Code will come into effect on 1 January 2011 and will apply to pay on or after that date for services performed in 2010.
Will our firm be affected by the Code?
The Code will apply to certain credit institutions, investment firms, hedge funds, all banks and building societies, and the UK branches of any firm whose home state is outside the European Economic Area (the 'EEA'). UK branches of firms whose home state is within the EEA are not required to apply the Code as their home state will be required to apply equivalent provisions under the EU pay rules.
What are the key proposals?
- Code Staff
This is a new defined group of employees whose pay packages will be subject to specific principles under the Code. Code Staff includes senior management and anyone who could have a material impact on a firm’s risk profile. Firms will be responsible for identifying their Code Staff in the first instance, but their lists can be challenged by the FSA.
- Compulsory bonus deferral
At least 40% of a bonus must be deferred over a period of at least three years for all Code Staff. At least 60% must be deferred when the bonus is more than £500,000.
- Non-cash proportions
At least 50% of variable pay to Code Staff must be made in shares or 'share-like' instruments. These shares will need to be subject to a minimum retention policy. Even though the Code currently permits that the entire cash portion of a bonus (i.e. the other 50%) may be paid upfront, the Committee of European Banking Supervisors subsequently published draft guidelines on remuneration which indicate that only 20% of a bonus can be paid upfront in cash. The final form of the Code may well take this into account.
- Golden handshakes
Sign on or buy out bonus guarantees may only be given in 'exceptional' circumstances when hiring new Code Staff and for the first year of service only. Further, they should not be more valuable than the terms offered by a previous employer which the new employer is seeking to buy out. Finally, the guarantee will have to be made subject to performance adjustment requirements and the same compulsory deferral requirement above will apply.
- Capital base considerations
Firms should be able to demonstrate that their assessment process considers their current and future capital needs. Firms should ensure their remuneration policies do not limit their ability to strengthen their capital base if and when this becomes necessary.
- Termination payments
Payments related to the early termination of a contract must reflect performance achieved over time and not 'reward failure'. This might have a significant impact on some firms’ current approach to negotiating compromise agreements.
- Voiding powers
Contracts that breach pay arrangements under the Code can be rendered void, and the FSA will be able to recover payments made. Firms would not be able to make further variable pay awards to the individual in respect of the same performance year unless they have legal advice that the award complies with the Code.
- Pensions payments
The Code applies to enhanced pension benefits granted on a discretionary basis to an employee as part of that employee’s variable pay package (rather than accrued benefits under a company pension scheme). When an employee leaves a firm before retirement, any discretionary pension benefits will have to be held by the firm for a period of five years in the form of share or 'share-like' instruments.
I think the Code affects our firm – what is our next step?
Look at the full text of the Code on the FSA website – if there is any confusion as to whether your plans to compensate your employees might contradict the principles within the Code, your firm should seek advice. The hrlaw.co.uk team would be happy to help!