21 March 2019 - Article
Even if your firm falls into Tier 4, the FSA Remuneration Code will still apply to you.
From 1 January 2011 all MiFID investment firms (except for those exempt under the Capital Adequacy Directive) fell within the scope of the FSA’s revised Remuneration Code, SYSC19A (the ‘Code’). The FSA estimates that this will catch around 2,600 firms.
After a certain amount of panic about how the Code would be applied following last minute changes to the Capital Adequacy Directive, many partnerships, hedge funds and alternative investment managers were (finally) able to breath a sigh of relief when the FSA published its policy statement PS 10/20 on 17 December 2010, setting out the FSA’s proportional approach to the implementation of the Code. However, although many firms will now escape the more onerous requirements of the Code (for 50% of bonuses to be in shares and deferral of bonuses over at least three years), there are still important elements of the Code that all firms will have to comply with as soon as possible.
Determining which Tier your firm falls into
The FSA has adopted a ‘tiered’ approach to implementing the Code, with varying degrees of implementation for different categories of firm. As a general guide, if a firm either:
- does not have FSA permission to carry on the regulated activity of dealing in investments as principal (this can be quickly checked by looking at the firm’s permissions on the FSA’s online register) (a so-called ‘limited licence firm’); or
- only has exercises such permission on an execution-only basis for clients or for being able to use a clearing and settlement system (a so-called ‘limited activity firm’),
then it will fall within Tier 4 of the Code (the lowest category for implementation of the rules). A firm will have had to make this assessment of its business anyway for its Pillar 3 disclosure requirements.
However, if your firm is part of a group, within which several firms are subject to the Code or equivalent EEA regulations implementing the third Capital Requirements Directive, then the FSA has said that the firm will generally fall within the highest proportionality tier to which any group member belongs. However, firms can try to justify to the FSA why they should be in a lower proportionality tier than the general guidance would suggest, and the FSA may authorise such treatment.
The FSA also has a discretion to move firms into a higher proportionality tier than the general guidance would suggest, based on their individual risk characteristics.
Applying the principles of the Code by no later than 1 July 2011
If you have determined that your firm is Tier 4, that does not mean that you can simply sit back, relax and count yourself lucky that you didn’t take that job at a bank! Your firm must still have a written remuneration policy that is consistent with the following numbered principles of the Remuneration Code in place by 1 July 2011:
1. the policy must be consistent with sound and effective risk management and must not encourage excessive risk-taking;
2. it must be aligned with the long-term interests of the firm;
3. it must include measures to avoid conflicts of interest;
5. it must ensure that people performing control functions are remunerated adequately to attract qualified and experienced staff and in accordance with the achievement of their functions’ objectives (independent of the performance of their business areas);
6. it must ensure that the total amount of bonuses awarded does not limit the firm’s ability to strengthen its capital base;
8. it must allow adjustment of awards for all types of current and future risks;
9. the pension policy must also be consistent with the business strategy, objectives, values and long-term interests of the firm;
10. the remuneration policy must ensure that employees undertake not to use personal hedging strategies or insurance to off-set the risk in their remuneration arrangements;
11. it must ensure that remuneration is not paid through vehicles that facilitate avoidance with the Code;
12(a) the structure of an employee’s remuneration must be consistent with and promote effective risk management;
12(b) when assessing an individual’s performance, non-financial criteria (such as good risk management) should form a significant part of the performance assessment. Total performance related remuneration must be based on the performance of (a) the individual, (b) the business unit concerned and © the overall results of the firm. Assessment of performance must be set in a multi-year framework to ensure that it is based on long-term performance;
12© no guaranteed bonuses must be awarded unless all of the following conditions are met:
- it is exceptional;
- it occurs in the context of hiring a new Code Staff member; and
- it is limited to the first year of service, and
12(e) the policy must ensure that payments related to early termination of a contract reflect performance achieved over time and do not reward failure.
Although the other principles of the Code may be disapplied by all Tier 4 firms (such as the requirements to pay at least 50% of bonuses in shares and defer payment over at least three years), the FSA has said that firms voluntarily adopting certain of those principles in their remuneration policies may be desirable, taking into account the size of the firm and promotion of effective risk management. For example, a large hedge fund may consider it worth while setting up a remuneration committee in line with Principle 4 of the Code. Other firms may consider that, in the light of their risk profile, it is appropriate for their Code Staff to have a proportion of the bonuses which they pay deferred over a number of years.
In addition, the FSA has said that it is the responsibility of firms to assess their own characteristics when developing their remuneration policies. Firms should clearly demonstrate in their remuneration policies not only the analysis that they are Tier 4 but also a rationale why the firm has made the choice to disapply certain principles with reference to its business model and risk management.
Transparency and internal disclosure
According to the FSA’s policy on disclosure of remuneration policies (PS10/21) the remuneration policy should be accessible to all staff members of that institution. Firms should ensure that the information regarding the remuneration policy disclosed internally reveals at least the details which are disclosed externally to the FSA in its regulatory returns (the first such disclosure must be made by all firms by no later than 31 December 2011). Staff members should know in advance the criteria that will be used to determine their remuneration. The appraisal process should be properly documented and should be transparent to the member of staff concerned, although confidential quantitative aspects of the remuneration of staff members shall not be subject to internal disclosure.
Important steps to be taken without delay
Get independent confirmation that your firm does fall into Tier 4
If the FSA conclude that your firm falls into a higher tier then your firm could be in breach of the FSA’s remuneration principles and, to the extent that the firm has already paid bonuses out in breach of the Code, be required to claw the bonuses back. This is even more important if the firm is part of a group structure, regulated at different levels or in different EEA member states.
Identify who is ‘Code Staff’ and notify them
All firms are required to make and maintain a list of their Code Staff (this rule cannot be disapplied). ‘Code Staff’ comprises categories of staff including senior management, risk takers, staff engaged in control functions and any employee receiving a total remuneration package that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the firm’s risk profile.
Firms are under an obligation to make Code Staff aware of the fact that they are Code Staff and what the implications of this are. It would be worth the firm holding training sessions for its Code Staff once it has determined who they are and what its remuneration policy will say (bearing in mind the staff must be able to see the policy) to ensure compliance with this requirement.
Drafting a code-compliant remuneration policy
The FSA has said that firms are expected to put in place remuneration policies consistent with the Code as soon as possible, and in any event by no later than 1 July 2011. The firm’s compliance and HR functions should be closely involved in drafting a code-compliant policy as soon as possible. Input will also be needed from the firm’s management to consider the rationale behind the policy, with reference to the firm’s long-term objectives, values, business strategy, performance metrics and risk profile and the reason why the firm has chosen to disapply any of the principles.
- The firm should consider consulting employment lawyers to advise on how the firm can use this opportunity to develop a remuneration policy that not only complies with the code, but also delivers a competitive remuneration package which will attract, incentivise and retain high-quality staff (bearing in mind that the policy will have to be disclosed to all staff).
- The firm should also consider taking specific advice on the tax implications of how and when to pay bonuses, particularly if planning to introduce some form of deferral.
Review and renegotiate non-compliant arrangements
Firms are under an obligation to take reasonable steps to bring existing contracts into line with the code as soon as possible. If particular employees’ contracts are not code-compliant (for example because they contain guaranteed bonus provisions) then these will need to be amended or terminated. If the contract contains a provision which allows the firm to vary any part of it in order to comply with relevant legal requirements then the FSA would expect this to be activated (otherwise the firm may be accused of not taking ‘reasonable steps’). If it appears that there may be difficulty in renegotiating contracts with particular employees, employment lawyers should be consulted at the earliest opportunity.
Remuneration can be a touchy subject for many people. A good remuneration policy handled well can produce a vibrant and motivated workforce who are engaged and committed to the success of their firm. Handled badly, the results can be disastrous, with suspicion of favouritism or prejudice over the level of some bonuses, demoralisation and the loss of key individuals. In an increasingly competitive marketplace it is important that firms dedicate adequate time and resources to getting the right policy in place as soon as possible. This will make compliance with the closely similar remuneration provisions annexed to the recently adopted Alternative Investment Fund Managers directive all the easier, once that directive is implemented come 2013.