Consultation Paper 10/19
On July 29, 2010, the United Kingdom’s Financial Services Authority (“FSA”) promulgated “Consultation Paper 10/19 – Revising the Remuneration Code” to greatly expand the number of financial services firms who will need to comply with its provisions.
The prior version of the Remuneration Code (“Code”) applied to a relatively limited group of firms in the UK (essentially 30 or so of the largest British financial institutions). Now the Code will apply to all institutions falling within the scope of UK capital oversight, including banks , asset managers, hedge fund managers, UCITS (Undertakings for the Collective Investment of Transferable Securities) and investment firms as well as some firms that engage in corporate finance, venture capital, the provision of financial advice and stockbrokers.
Personnel Subject to Compensation Restrictions
The Code will limit the remuneration to be paid to so-called “Code Staff” of covered firms. These comprise any staff which "have a material impact on a firm's risk profile". The FSA expects the definition to apply both with respect to employees and to most partners with limited liability, including members of English limited liability partnerships (LLPs).
The FSA's proposed guidance suggests Code Staff should include:
(i) a person who performs a significant influence function, as defined in the FSA's rule
(ii) a Senior Manager, defined as "an individual employed by the firm to whom the governing body (or a member of the governing body) of the firm has given responsibility for management and supervision, and who reports directly to the governing body, a member of the governing body, the chief executive, or the head of a significant business group"; and
(iii) all staff whose remuneration takes them into the same bracket as senior management and "risk takers", whose professional activities could have a material impact on a firm's risk profile.
Restrictions
The following are some of the significant restrictions on Code Staff compensation.
- Deferral – At least 40 percent of any Code Staff bonus must be deferred, vesting over a minimum three-year period. The deferred portion of a bonus exceeding £500,000 must be at least 60 percent. Firms that operate long‑term incentive plans will need to structure them so that half of the award vests after not less than three years and the remainder after five years
- Payment of Bonuses in Kind - At least 50% of variable remuneration will have to be paid in shares, non-cash instruments or other share-equivalent instrument subject to a minimum retention policy
- Guaranteed bonuses can only be offered in exceptional circumstances to new hires for the first year of service. The payments should not be more generous in either amount or term than the variable remuneration awarded or offered by the previous employer and should be subject to performance adjustment.
- A current de minimis level which exempts from deferral requirements staff whose bonus forms less than 25% of their total remuneration, and whose total remuneration is less than or equal to £500,000 will be extended to Code Staff whose variable pay is up to 33% of total remuneration. It is proposed that such staff would not be subject to rules relating to deferral, performance adjustment, proportion of remuneration paid in shares, and guaranteed bonuses.
Proportionality
The FSA will have a degree of flexibility in implementing the Code so that smaller firms only need to be subject to the remuneration requirements in a ”proportionate manner” —although at the present time it is not clear what this will mean for hedge fund managers.
The Consultation Paper proposes the following structure of application of the Code's provisions to reflect the proportional approach:
i. minimum requirements that all firms would be expected to comply with. These requirements are mainly the high-level principles that form part of the Code in its current version, including the requirement to ensure variable and fixed components of remuneration are appropriately balanced;
ii. rules which could be applied proportionally in line with a firm's nature, scale, scope and complexity; and
iii. rules which could be applied on a "comply or explain basis" (which includes the requirements relating to bonus deferrals, guaranteed bonuses, severance pay, share-based awards, performance adjustment, discretionary pension benefits, and voiding and claw-back, as discussed below). A firm will have the option whether or not to implement such rules, but if it decides not to implement them, it must provide acceptable reasons for its decision.
Furthermore, a firm may be able to rely on the proportionality provisions in the Code and the FSA Handbook as a justification for not complying with the Code's requirements relating to remuneration structures by January 1, 2011, provided that it takes reasonable steps to comply as soon as is reasonably possible, and in any event by July 1 2011.
Effective Dates
The finalized rules will apply to:
- remuneration awarded on or after January 1, 2011;
- remuneration due on the basis of contracts concluded before January 1, 2011 which is awarded or paid on or after that date; and
- remuneration awarded, but not yet paid, before January 1, 2011, for services provided in 2010.
USA Law On Incentive Compensation
Section 956 of the Dodd Frank Act takes a principles based view of incentive compensation in the financial services industry. More specifically Dodd Frank grants the appropriate federal regulators rule making authority to prohibit any type of incentive-based payment arrangement, or any feature of such an arrangement, that the regulators determine encourages inappropriate risks by a covered financial institution, either by providing excessive compensation, fees, or benefits or by potentially leading to material financial losses to the institution. Section 956 requires the federal banking agencies, the SEC, federal credit union authorities, and federal housing finance authorities to jointly develop, no later than April 21, 2011, regulations or guidelines implementing these disclosures and prohibitions concerning incentive-based compensation at "covered financial institutions" with at least $1 billion in assets. That seems to be a much higher threshold than the UK Remunerations Code for smaller firms looking for relief.
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Robert Kiggins, Esq. of McCarthy Fingar LLP, is author of the blog, and may be reached at (914) 385-1024 or rkiggins@mccarthyfingar.com. Nothing in this blog is legal advice and readers should not rely on anything in this blog as being legal advice.
