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Financial Services Reward

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PRA Consultation Paper – ‘Remuneration: Enhancing proportionality for smaller firms’– March 2023

On 27 February 2023, the Prudential Regulation Authority (PRA) published for consultation proposed changes to the current rules and expectations to enhance the proportionality of the remuneration requirements which apply to “small firms” (Remuneration: enhancing proportionality for small firms – CP 5/23). This consultation was published in parallel to another consultation setting out proposals for simplifying certain other aspects of the prudential regime applicable to smaller banks and building societies (The Strong and Simple Framework: Liquidity and Disclosure requirements for Simpler-regime Firms – CP 4/23).

Impacted firms: The Consultation Paper on the proposed changes to the remuneration rules and regulatory guidance is relevant to banks, building societies and PRA-designated investment firms that are subject to the Remuneration Part of the PRA Rulebook, including third-country branches.

Timing: Responses to the Consultation Paper need to be submitted by 30 May 2023. The proposed changes to the PRA’s remuneration rules would come into force the day after the publication of the final policy and would apply to remuneration awarded in relation to performance years starting after that. For most firms, this would be likely to be the performance year starting in 2024. The PRA is proposing to insert a specific rule to make clear that the current remuneration rules must be applied to remuneration awarded in respect of a performance year starting before that date.

The PRA does, however, encourage firms which consider that they may be disproportionately disadvantaged by the timings of the final Policy Statement, on account of their specific year-end, to raise this within their response to the Consultation Paper.

Key provisions: The PRA is proposing to remove some of the current remuneration requirements applicable to smaller firms, with the aim of reducing the regulatory burden on such firms to a level that is considered to be more appropriate. This is as part of a broader simplification to the prudential regime for smaller banks and building societies.
The PRA notes that, since the implementation of the changes under the EU Capital Requirements Directive (CRD V), which brought smaller firms into scope of the bonus cap and the rules on malus (if the firm chooses to apply deferral) and clawback, there has been increasing evidence that the application of these rules has been costly or burdensome for some small firms, including through the submission of waiver applications.

Definition of “small firm”
The PRA proposes to amend the definitions of “small CRR firm” and “small third-country CRR firm” for the purposes of the remuneration rules. Under the proposals, such firms will be defined with reference to selected criteria which have been proposed for the purposes of identifying smaller firms under the new simplified prudential regime (the “Strong and Simple framework”).

In many areas, the proposed criteria are aligned, meaning that firms that meet the simpler-regime criteria under the new Strong and Simple framework (“Simpler-regime Firms”) should also benefit from the proposed simplifications to the remuneration requirements. However, the PRA proposes that the simplified remuneration rules apply beyond those firms which qualify for the simpler prudential regime.

To benefit from the simplified remuneration requirements as a “small firm”, firms will need to meet the following conditions:

  • Condition 1: size threshold and criteria
    Condition 1(a) – The firm must have average total assets of less than or equal to £4 billion (calculated on a three year average using the calculation methodology within the proposed Strong and Simple framework); OR
  • Condition 1(b) – The firm must have average total assets (calculated as above) over £4 billion but not exceeding £20 billion, and must be subject to all the following Simpler-regime criteria:
    • The firm’s trading book business must be less than or equal to both 5% of the firm’s total assets and £44 million*;
    • The firm’s overall net foreign exchange positions must not exceed 3.5% of its own funds and must not exceed 2% of its own funds on average*;
    • The firm must have no commodities or commodity derivatives positions;
    • The firm must not provide clearing, transaction settlement, custody or correspondent banking services to a UK bank or building society, or non-UK credit institution, including by acting as an intermediary for a UK bank, building society or such a credit institution to access certain facilities. (Firms can meet this criterion if the only entities to which they provide these services are within their immediate group and the services are in GBP); and
    • The firm must not be an operator of a payment system.

*Specific provisions within these criteria can be disapplied where the UK firm or third country branch was not a “firm” on the last day of the preceding month and/or was not a “firm” on the last day of each of the preceding six months.

Condition 2: level of application

  • The firm must not be part of a group containing another firm which: (a) is subject to the Remuneration Part of the PRA Rulebook on an individual basis; and (b) exceeds £20 billion in average total assets (as calculated above) on an individual basis, consolidated basis or sub-consolidated basis (assessed at the level of the UK consolidation group).**

**If the firm has not yet been required to report its total assets, the calculations in respect of the average total assets can be done on the basis of the firm’s reasonable forecast.

The PRA proposes to allow branches of third country CRR firms also to benefit from the simplified remuneration rules, provided that the average total assets relating to their branch operations also fall below £4 billion or, if their assets are between £4 billion and £20 billion, they satisfy the criteria of Condition 1(b) above, assessed on the basis of the branch’s operations in the UK.

As drafted, the amended remuneration rules would be expected to apply to a wider range of firms than those expected to satisfy the criteria for the simplified prudential regime. For example, the simplified remuneration rules will not be limited to UK-headquartered firms. Similarly, the PRA is not proposing to require all banks and building societies within a firm’s group to meet all the Simpler-regime criteria in order for the firm to benefit from the simplified remuneration rules.

Disapplication of additional remuneration rules by small firms

Under the PRA’s proposals, if a firm satisfies the “small firm” definition, it would be allowed to disapply the following remuneration requirements, in addition to continuing to be able to disapply the rules on deferral, payment in instruments and discretionary pension benefits:

  • Malus (where deferral is applied voluntarily) and clawback, as set out in Rules 15.20(2) and (3A) and Rules 15.20A to 15.23;
  • Buy-outs, as set out in Rule 15A.

In addition, as set out in its Consultation Paper from December 2022 (CP 15/22, found here), the PRA proposes to remove the bonus cap in relation to all firms, including small firms.

The PRA emphasises that small firms will continue to remain subject to all other remuneration requirements, including in relation to the identification of Material Risk Takers (MRTs), performance assessment, consideration of capital and liquidity and the application of risk adjustment, and the rules relating to guaranteed variable remuneration. Small firms will also continue to be subject to the requirement to submit a High Earners Report.
Small firms should note that, under the draft amended rules, Rule 15.20(1) is not proposed to be disapplied, meaning that such firms would remain subject to the requirement to ensure that any variable remuneration is paid or vests only if it is sustainable according to the financial situation of the firm as a whole and justified on the basis of firm, business unit and individual performance.

Additional reward regulatory guidance for small firms

The PRA notes that, while it proposes to be less prescriptive on the requirements that apply to MRT remuneration in small firms, it continues to be important that small firms ensure that they do not engage in remuneration practices that could cause harm to their safety and soundness.

The PRA therefore proposes to incorporate into its Supervisory Statement on remuneration (SS 2/17) a new paragraph 5.48 that sets out its expectation that small firms would report to their supervisors “any material changes to their remuneration structures, especially on: the ratio of the maximum payout of bonus and executive incentive schemes when compared to fixed remuneration; and the performance measures and the risk adjustment used to determine whether and how much their bonus schemes and executive incentive schemes will pay out”.

The PRA considers that this would be consistent with the regulatory obligation on firms to deal with the regulators in an open and cooperative way, and to disclose anything relating to the firm of which the PRA would reasonably expect notice.

The PRA also notes that it will continue to review and monitor small firms’ compliance with all applicable remuneration rules, and any effects on incentives and behaviours, through requests for completed Remuneration Policy Statements (RPS), noting that it will take supervisory or enforcement action if required.

Remuneration disclosures

The PRA is proposing to remove in its entirety the guidance in its Supervisory Statement relating to remuneration disclosures under Article 450 of Chapter 4 of the Disclosure (CRR) Part of the PRA Rulebook. This would include the removal of Table D, which currently sets out remuneration disclosure requirements by proportionality level.

Noting that it is proposing changes to Pillar 3 disclosure requirements under the separate Consultation Paper (CP 4/23), the PRA highlights that it will consider further its position on remuneration disclosures and consult on potential changes in the near future.

A link to the Consultation Paper on remuneration can be found here.

A link to the Consultation Paper on the simplified prudential regime can be found here.


Quarterly Update - February 2023

We are pleased to share our summary of key reward regulatory developments impacting firms in the financial services sector in recent months. Our update covers the following:

  • Joint Consultation Paper on the removal of the limit on variable remuneration (‘bonus cap’) for banking sector firms;
  • FCA observations on approaches to Diversity & Inclusion (D&I) in financial services;
  • FCA letter to the Chief Executive Officers (CEOs) of wholesale broker firms;
  • Thematic feedback on the PRA’s supervision of climate-related financial risk and the Bank of England’s Climate Biennial Exploratory Scenario exercise;
  • Financial Services: Edinburgh Reforms;
  • PRA’s supervisory priorities for UK deposit-takers and international ‘Banks operating in the UK;
  • FCA sector letters on the implementation of the Consumer Duty;
  • Publication of the European Banking Authority (EBA) roadmap on sustainable finance;
  • EBA Report on incorporating ESG risks in the supervision of investment firms;
  • EBA Report on High Earners Data.

You can read our quarterly summary here.

New PRA Policy Statement and updated Supervisory Statement on MRTs and public sector appointments – February 2023

On 10 February 2023, the Prudential Regulation Authority (PRA) published a new Policy Statement and updated its Supervisory Statement on remuneration (SS2/17), to set out its expectations for firms where a Material Risk Taker (MRT) who holds unvested deferred instruments awards is looking to be appointed to a senior public sector role. This follows the consultation on this topic published by the PRA on 15 July 2022.

Impacted firms: The Policy Statement and updated Supervisory Statement are relevant to banks, building societies and PRA-designated investment firms that are subject to the Remuneration Part of the PRA Rulebook, including third-country branches.

Timing: The updated Supervisory Statement came into effect immediately on publication.

Key provisions: The updated guidance has been included as a new section 4A within the Supervisory Statement and addresses the circumstances in which an MRT may be appointed to a senior public sector role linked to financial policy or financial services regulation and the outstanding, unvested deferred equity awards held by the individual could potentially cause a conflict of interest to arise.

The PRA confirms that, in general, unvested deferred awards over instruments held by MRTs should not be converted into awards over other instruments and/or cash after an award has been made. This expectation applies to all unvested deferred awards and does not exclude amounts above the regulatory minima.

However, the PRA indicates in the updated guidance that, in exceptional circumstances, such as where there are potential conflicts of interests arising from a proposed public sector appointment that cannot be otherwise sufficiently mitigated through other means, it may be appropriate for a conversion of the award to occur, subject to prior engagement with the PRA, and provided that the relevant retention period continues to be applied.

In the updated Supervisory Statement, the PRA distinguishes between where a firm is proposing to convert an equity award into an award over other instruments and where a firm is proposing to convert an equity/instruments award into an award over cash.

  • Where a firm is proposing to convert an unvested equity award into an award over other instruments, the firm should seek the PRA’s prior non-objection. The PRA cites the factors that it will take into account when considering such requests as including whether it agrees that a conflict of interest could arise, whether other means could be employed to avoid or mitigate the risk of such conflict of interest arising and whether the conversion of the award would be consistent with the aims of the remuneration requirements. The same retention period would need to be applied to the new award.
  • In “wholly exceptional cases”, a firm may apply to the PRA for a waiver or modification of the relevant remuneration rules to convert a deferred instruments award into an award over cash. In this scenario, the PRA will consider additional factors in considering such a request, including that the new contractual arrangements replicate the features of the original instruments award (e.g. with a write-down feature at the relevant Common Equity Tier 1 (CET1) trigger) and that the firm can demonstrate how the alignment of interests between the firm and the MRT that arises from the retention period can be replicated contractually (e.g. by extending the vesting period).

A link to the Policy Statement can be found here and a link to the updated Supervisory Statement can be found here.

Quarterly Update - September 2022

We are pleased to share our summary of key reward regulatory developments impacting firms in the financial services sector in recent months. Our update covers the following:

  • The Financial Conduct Authority’s (FCA) new Consumer Duty rules;
  • The Prudential Regulation Authority (PRA) Consultation Paper on deferral arrangements for Material Risk Takers (MRTs) seeking senior public sector appointments;
  • The Financial Reporting Council (FRC) position paper on restoring trust in audit and corporate governance;
  • The FCA’s annual letter to Remuneration Committee Chairs;
  • Potential developments in FS Reward: the PRA’s Discussion Paper on its future approach to policy and new speculation over the banking sector bonus cap;
  • The European Banking Authority’s (EBA) final guidelines on remuneration and gender pay gap benchmarking under the Capital Requirements Directive (CRD V) and the Investment Firm Directive (IFD);
  • The EBA’s final guidelines on high earner data collection under CRD V and IFD; and
  • The Basel Committee on Banking Supervision’s (BCBS) final principles for the effective management and supervision of climate-related financial risk.

You can read our quarterly summary here.

Key considerations for firms in relation to the lifting of the bonus cap - September 2022

Earlier this morning, during the Mini Budget, the Chancellor announced that the Government is planning on reforming the UK financial services sector remuneration rules. One of the main proposals is the removal of the bonus cap which applies to staff identified as Material Risk Takers (MRTs) under the Capital Requirements Directive (CRD V).

This update focusses on some of the key considerations for firms and Remuneration Committees if the bonus cap were to be amended or removed.

You can read our update here.

Financial Conduct Authority (FCA) letter to Remuneration Committee Chairs

On 2 August 2022, the FCA released its annual letter to the Remuneration Committee Chairs of proportionality Level 1 banks, building societies and PRA-designated investment firms. The letter outlines the FCA’s views and expectations on key topics for Remuneration Committees to consider as firms determine their year-end remuneration outcomes over the coming months. While addressed to Level 1 firms, the FCA publishes this letter on its website so that other Financial Services firms can see its supervisory priorities.

The key topics include a focus on culture and accountability and the new FCA Consumer Duty, as well as the rising cost of living, operational resilience, Environmental, Social and Governance (ESG) considerations and Diversity and Inclusion (D&I).

Overview of key areas

  • In relation to culture and accountability, the FCA reminds firms that, where there is evidence of regulatory failings, there should be appropriate, timely and transparent adjustments to remuneration, including that of Senior Managers. The FCA notes that “where appropriate” it may follow-up with the firm to request evidence for this.
  • The FCA highlights its recent publication of rules and regulatory guidance around a new Consumer Duty, which is intended to set higher and clearer expectations for the standard of care and customer service that firms should give to consumers at each stage of the product cycle. The FCA notes that firms’ remuneration policies should be designed to support the expectations set by the new Consumer Duty when it comes into effect from July 2023.
  • With the rising cost of living in the UK, the FCA has also highlighted the need for Remuneration Committee Chairs to be mindful of this when reviewing workforce remuneration, as well as to consider it from a risk perspective (as both a current and future risk) when designing and reviewing remuneration practices and policies.
  • Noting the importance of operational resilience for firms more broadly, the FCA makes clear that, in the event of service disruptions, data breaches or other interruptions to a firm’s operations, it expects firms to respond appropriately, including in the making of remuneration adjustments where appropriate.
  • The FCA highlights ESG as a continuing area of regulatory focus, with firms expected to consider whether incentives for senior leadership and other Material Risk Takers are aligned with wider ESG risks. The FCA also expects firms to consider whether linking progress against ESG commitments (from both a short-term and long-term perspective) to a “measurable proportion of pay” could be effective in encouraging individuals to take accountability for change.
  • The FCA references the Consultation Paper on D&I that is expected to be published later this year (following the publication of the Discussion Paper in July 2021), which will consult on a package of measures to promote D&I within the Financial Services sector. Within this consultation, it is expected that there will be proposals to update the responsibilities of the Remuneration Committee to reflect the importance that the UK regulators attribute to the Remuneration Committee in establishing the right conditions for a healthy firm culture.

Submission of Remuneration Policy Statement (RPS) by Level 1 firms

In addition to highlighting these key themes, the FCA has also specifically requested that Level 1 firms, when submitting their RPS, also provide an explanation of how the firm will take into account the impact of the current economic environment on bonus pools and individual outcomes. Level 1 firms are also now asked to provide details of how the firm’s ESG commitments, where these exist, are linked to the firm’s remuneration policy, including any metrics and targets.

A link to the full letter can be found here. Firms should also note that the FCA has updated its main Remuneration webpage content to align with its focus on culture.

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