Executive Compensation and Investment
Management Alert
21 December 2010
Authors:
Ian Fraser
ian.fraser@klgates.com
+44.(0)20.7360.8268
Victoria Green
victoria.green@klgates.com
+44.(0)20.7360.8202
Philip Morgan
philip.morgan@klgates.com
+44.(0)20.7360 8123
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
FSA: Revised Remuneration Code Issued
17 December 2010
On 17 December, the UK’s Financial Services Authority published the final text of
its revised Code of Practice on remuneration. The Code will apply from 1 January
2011 onwards to all FSA-regulated banks, building societies and investment firms
that fall within the scope of the EU's Markets in Financial Instruments Directive
(MiFID), including most banks, building societies, investment advisers, fund
managers and broker-dealers (including branches and subsidiaries of Non-EU
firms) except, broadly, those that do not hold client money and only provide advice
and arrange deals.
The Code has been drafted to implement recent amendments to the EU Capital
Requirements Directive (CRD III) and also to reflect the Guidelines issued by the
Committee of European Banking Supervisors (CEBS) on remuneration policies
and practices under CRD III which were released on 10 December. The Code has
the following main implications:
•
The approximately 26 biggest banks, building societies and broker-dealers
operating in the UK continue to be subject to the Code but have new reporting
and public disclosure obligations;
•
Another approximately 2,500 financial services firms, including investment
advisers, fund managers and smaller banks and broker dealers, will now be
subject to the Code. However, for most of these firms a "proportionality
principle" should mean that some of the Code's provisions can be "neutralised"
and that lower levels of reporting and public disclosure should apply.
For the full background to the Code, please see our earlier alerts on (i) the draft
Code (Link1), (ii) CRD III (Link2), (iii) the CEBS Guidelines (Link3), and (iv) the
disclosure requirements under the Code (Link4). If you would like to discuss how
the Code may affect your business, please contact any of the authors.
The key points to note from the Code are:
1. Proportionality
The FSA has now provided guidance on how it intends to apply the
"proportionality principle" to the Code. It has created a framework of 4 tiers and
specified a different level of expected compliance for each tier. The tiers are not
rigid, and the FSA is prepared to accept a degree of flexibility in the boundaries so
that firms are assessed on their specific risk characteristics. Broadly speaking, tiers
1 and 2 will apply to the larger banks, building societies and broker dealers and
tiers 3 and 4 to investment firms and fund managers. The tiers are as follows (NB:
BIPRU means the Prudential Sourcebook for Banks, Building Societies and
Investment Firms):
1
FSA Consults on Amendments to the Remuneration Code and Extension of its Scope
Changes to EU Regulation of Bonuses paid by Banks and Investment Firms in CRD III
3
CEBS Guidelines on Remuneration Policies and Practices under CRD III
4
Disclosure Requirements under the FSA's Remuneration Code
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Executive Compensation and Investment Management Alert
a.
Proportionality tier one firms: Banks
and building societies with capital
resources exceeding £1bn; BIPRU €730k
firms that are full-scope BIPRU
investment firms with capital resources
exceeding £750m; and all third country
BIPRU firms with total assets (for the
branch) exceeding £25bn. These firms
have the highest compliance
requirements, and are expected to
comply with all of the Code's rules with
the possible exception of the requirement
to establish a remuneration committee, if
the firm has an overseas parent.
b. Proportionality tier two firms: Banks
and building societies with capital
resources between £50m and £1bn;
BIPRU €730k firms that are full scope
BIPRU investment firms with capital
resources between £100m and £750m;
and all third country BIPRU firms with
total assets (for the branch) in excess of
£2bn. These firms are expected to
comply with all of the Code's rules with
the possible exception of the requirement
to establish a remuneration committee, if
the firm has an overseas parent. In
addition, unlisted firms may be able to
demonstrate that it is inappropriate for
them to use alternative instruments
to shares.
Proportionality tier one and tier two
firms are intended to include larger
banks and building societies, as well as
broker-dealers that engage in significant
proprietary trading or investment
banking activities.
c.
Proportionality tier three firms: Any
bank, building society and full scope
BIPRU investment firm that does not fall
within proportionality tiers one or two;
and all third country BIPRU firms that
do not fall into proportionality tiers one,
two or four. This tier includes small
banks and building societies and firms
that may occasionally take over-night or
short-term risk with their balance sheet.
These firms are generally able to
disapply (subject to proportionality) the
rules regarding the deferral of variable
awards, retention of equity awards,
malus/clawback of deferred awards, and
the requirement to establish a
remuneration committee.
d. Proportionality tier four firms: All
limited licence and limited activity firms
(including third country BIPRU firms
with equivalent permissions). This tier
contains firms that generate income
from agency business without putting
their balance sheets at risk. These firms
are generally able to disapply (subject to
proportionality) the rules regarding the
deferral of variable awards, the
requirement to fix a maximum ratio
between fixed and variable
remuneration, the retention of equity
awards, the malus/clawback of deferred
awards, and the requirement to establish
a remuneration committee. They can
also take into account the specific
features of their types of activities when
considering the requirement to assess
performance in a multi-year framework
and in particular the accrual and
performance-related adjustment
elements of making awards.
2. Scope: Groups
•
The Code is aimed at all FSA regulated
banks, building societies and investment
firms that fall within MiFID, except for
"exempt CAD" firms that only provide
advice and arrange deals and do not hold
client money.
•
UK branches of firms whose home state is
outside the EEA are within scope, but UK
branches of EEA firms are not, as they
should be covered by their home state's
implementation of CRD III.
•
For groups with UK parents, the Code
applies on a group wide basis and therefore
would, in principle, include all branches and
subsidiaries worldwide (subject to
proportionality).
•
For groups with non-EEA parents and with
subsidiaries within the UK, the Code applies
to all branches and subsidiaries of the UK
authorised entity, irrespective of where they
are located.
3. Scope: Individuals
•
As with CRD III and the CEBS Guidelines,
the general principles of the Code apply to
all staff working at an in-scope firm/group,
but certain specific provisions on
remuneration policies apply only to "Code
Staff" (referred to as "Identified Staff" under
the CEBS Guidelines). Code Staff include
senior management, risk takers, staff
21 December 2010
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Executive Compensation and Investment Management Alert
engaged in central functions and any
employee receiving total remuneration that
takes them into the same remuneration
bracket as senior management and risk takers
whose professional activities have a material
impact on the firms risk profile. It is now
clear that individuals are not considered
"Code Staff" simply by virtue of being highly
paid, as they must also have a material
impact on the firm's risk profile.
•
•
Firms will be expected to compile a list of
"Code Staff" before making bonus awards for
2010.
•
Awards should be subject to "malus"
performance adjustments which can be used
to prevent vesting of all or part of the
deferred payments, and "clawback"
provisions, under which firms can demand
payback of previously vested awards to take
account of developments after vesting. In
the CEBS Guidelines, this would be in the
case of fraud or misleading information, or
where remuneration is received in breach of
CRD III.
•
Guaranteed Bonuses can only be offered in
exceptional circumstances to new hires for
the first year of service. The payments
should be subject to performance adjustment
and should not be more generous in either
amount or term than the variable
remuneration awarded or offered by the
previous employer. These requirements
apply to all staff and not simply Code Staff.
•
Code Staff whose total remuneration does
not exceed £500,000 and whose variable
remuneration is less than 33% of total
remuneration are not subject to the rules
relating to deferral, performance adjustment,
proportion of remuneration paid in shares,
retention and guaranteed bonuses.
•
For the most highly remunerated Code Staff
in large firms, severance payments must
reflect performance over time and must not
be an award for failure, and enhanced
discretionary pension contributions (i.e.,
one-off payments, not standard pension plan
contributions) must take the form of shares
or share-linked instruments and be held for
at least five years.
As with the CEBS Guidelines, limited
partners and general partners of limited
partnerships and individual proprietors are
within the scope of the Code (subject to
proportionality).
4. Remuneration Design
The following principles only apply to Code Staff
(with the exception of the comments relating to
guaranteed bonuses which apply to all staff):
•
•
•
The Code has followed the CEBS Guidelines
by requiring explicit maximum ratios of
fixed/variable compensation to be set,
although these can vary between staff. This
is a change from the draft Code.
The Code has also set deferral requirements
that broadly follow the CEBS Guidelines. At
least 40% of variable remuneration must be
deferred, rising to 60% if variable
remuneration exceeds £500,000. The
deferral period must be at least three to five
years. Vesting can be pro rata, but not more
frequent than annually, and cannot start
earlier than one year after the date at which
performance is measured to determine the
amount of the award.
At least 50% of variable remuneration must
be delivered in shares or share-linked
instruments and must be applied equally to
the upfront and deferred part of awards. This
is a change from the draft Code, but reflects
the CEBS Guidelines. Shares or share linked
instruments delivered as upfront or deferred
awards must be subject to a further retention
period. Share-linked instruments are not
identified in the Code, but in the CEBS
Guidelines they include stock appreciation
rights (SARs) and phantom options.
5. Voiding Power
Breaches of the Code can render contractual
provisions void and/or require recovery of
payments made to Code Staff. However, this is
only likely to be applied to provisions that
clearly breach the rules on bonus deferral or
guaranteed bonuses. For 2011, voiding will only
apply to firms which are within the scope of the
current Code. During 2011, the FSA intends to
extend this provision so that voiding will apply
to firms broadly equivalent to proportionality
tier one.
21 December 2010
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Executive Compensation and Investment Management Alert
6. Reporting and Disclosure
Firms within the scope of the Code will be
required to report to the FSA on compliance with
the Code, and they will also be required to make
public disclosures regarding their remuneration
policies. The reporting and disclosure
requirements are being implemented taking into
account "proportionality" principles so that larger
firms have greater reporting and disclosure
requirements. All in scope firms will be required
to make public disclosure regarding their
remuneration policies at least in respect of:
•
corporate governance relating to
remuneration policy;
•
information on the link between pay and
performance; and
•
aggregate quantitive information on
remuneration, broken down by (i) business
area and (ii) senior management and
members of staff whose actions have a
material impact on the firm's risk profile.
For more information on the new public
disclosure requirements, see our earlier alert5 on
5
Disclosure Requirements under the FSA's Remuneration
Code
the draft rules, which remain unchanged in the
final Code except that the requirement for public
disclosure to be made in a firm's annual financial
statements or a stand alone document has been
relaxed and disclosure can now be made in any
appropriate way as long as it cross refers to other
disclosures required under the Pillar 3 capital
adequacy disclosure regime.
7. Timing
The Code applies to remuneration awarded on or
after 1 January 2011 and to payments made after
1 January 2011 that relate to contracts concluded
or services provided in 2010 or earlier.
However, firms that were not within the scope of
the Code in 2010 can rely on proportionality
principles to justify less than full compliance by
1 January 2011, although they must take
reasonable steps to comply as soon as possible
and in any event before 1 July 2011 so that the
2011 bonus round (i.e., bonuses paid in 2012) is
compliant. Firms that were within the scope of
the 2010 Code that are not listed on a stock
exchange or are not part of a group which have
shares listed on a stock exchange may also be
able to justify not paying 50% of variable
remuneration in equity if they are not able to
comply with this provision by 1 January 2011.
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GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
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This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied
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©2010 K&L Gates LLP. All Rights Reserved.
21 December 2010
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