On Tuesday, 23 June 2015, the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA) announced new remuneration requirements that will apply to U.K. banks and investment firms.

These requirements are a regulatory response to essentially avoid reward for failure. The build up to the release of the new rules has been long and complex, with input from various parties. The new rules follow the publication of a joint consultation in June 2014 in which both regulators proposed a number of changes to the FCA Handbook and PRA Rulebook. This was a response to the final report of the Parliamentary Commission on Banking Standards (PCBS), established in July 2012 in the wake of the LIBOR fixing scandal, on their inquiry into professional standards and culture in the U.K. banking sector, and subsequent recommendations for legislative and other action. Allied with the requirement to propose binding remuneration policy votes for U.K.-incorporated companies, and the Europe-wide CRD IV regulatory regime for EU banks (see the 2015 ISS United Kingdom Voting Season Preview Report for more information), the new regulatory environment for bankers’ pay in the U.K. presents further matters to be considered by remuneration committees and their advisers when drafting remuneration packages.

Andrew Bailey, chief executive of the PRA said, “Our intention is that people in positions of responsibility are rewarded for behaviour which fosters a culture of effective risk management and thus promotes the safety and soundness of individual institutions.”

Significant Changes under the New Requirements

Deferral Requirements

“Senior Managers,” as defined under the Senior Managers Regime (SMR), must have deferral periods of no less than seven years applied to variable remuneration awards, with no awards able to vest earlier than the third anniversary of the award, and any accelerated vesting only allowed on a pro rata basis. This requirement covers board-level executives. Risk managers at PRA-regulated firms must have deferral periods of at least five years for variable remuneration awards, with vesting no faster than pro rata from year one.

All other “Material Risk Takers” (MRTs) must have at least a three year deferral for variable awards, with vesting no faster than pro rata from year one.

Clawback Arrangements

The PRA previously introduced a rule, from 1 January 2015, requiring firms to apply clawback policies in instances of misconduct or failures in risk management for up to seven years from the date of a variable remuneration award. The FCA will subsequently introduce a new rule requiring a minimum clawback period of seven years from the date of award for all awards made to MRTs.

The seven-year clawback period has the possibility of extension to 10 years for PRA-designated “Senior Managers” where either a firm has commenced its own internal inquiry into a possible material failure which could potentially lead to the application of clawback, or a firm has been notified by a regulatory authority (including an overseas authority) that an investigation has commenced which the firm considers could lead to the application of clawback.

Taxpayer-Supported Institutions

In line with a CRD IV-enshrined principle that no variable remuneration should be paid to the management of a firm in receipt of exceptional government intervention unless justified, the new rules now explicitly state that this presumption extends to all discretionary payments, including payment for loss of office and discretionary pension benefits. It also clarifies that this will not apply retrospectively, even if elements of taxpayer support are still in place. In other words, in the future, management at banks that receive bailouts will not be eligible to receive bonuses.

Non-Executive Director Remuneration

The new rules contain an explicit provision that prohibits variable remuneration for non-executive directors of banks and financial institutions.

Buyouts for New Joiners

The new rules stop short of banning buyouts in the banking industry, as was previously envisaged in the initial consultation paper. The PRA and FCA, however, decided to explore further if variable remuneration for “good-leavers” should be kept in an escrow account. In the meantime, the two regulatory bodies will ensure that clawback provisions are robust.

Performance Measures

Separately, the PRA is also introducing further provisions within its remuneration code, including a prohibition on using single revenue or profit-based measures (like EPS, ROE, and TSR) to determine variable remuneration at either the aggregate or individual level, except as part of a balanced and risk-adjustment scorecard.

Areas for Future Development

It will be interesting to see how the industry responds to this new set of requirements. Some market observers are arguing that this may mean that the fixed element of banker pay in the U.K. will go up further. Remuneration committees and shareholders alike may have a busy lead up to the 2016 AGM season as far as U.K. bank pay is concerned, as this may mean another round of policy proposals with a newer framework coming two years after the CRD IV mandated reworking. The final recommendation of the European Banking Authority rules on the use of fixed share allowances as currently implemented by most of the U.K. banks may also have a significant bearing on the industry’s response.

Additionally, some legal experts in the market have raised questions about how a company will actually be able to recoup money paid as variable remuneration several years after the award was given. This can only be tested in due course of time when such clawbacks have to be applied.

Going Forward

The final provisions on clawbacks and deferrals will apply to variable remuneration awarded for performance periods beginning on or after 1 January 2016. The rest of the requirements will apply from 1 July 2015. –Rachit Gupta, ISS U.K. Research