cp10_19 revising the remuneration code

7/31/2019 Cp10_19 Revising the Remuneration Code

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List o acronyms used in this Consultation Paper 3

1 Overview 52 Why we are revising the Code 11

3 The proposed revisions to the Code 17

4 Implementation 35

5 Next steps 45

Annex 1: Cost beneft analysis

Annex 2: Compatibility statementAnnex 3: Report on the implementation o the Code

Annex 4: International alignment a progress report

Annex 5: Proposed approach to Proportionality

Annex 6: List o questions in this Consultation Paper

Annex 7 : Glossary

Appendix 1: Dra t Remuneration Code rules

Contents

The Financial Services Authority 2010


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The Financial Services Authority invites comments on this Consultation Paper.Comments should reach us by 8 October 2010.

Comments may be sent by electronic submission using the orm on the FSAswebsite at (www. sa.gov.uk/Pages/Library/Policy/CP/2010/cp10_19_response.shtml).

Alternatively, please send comments in writing to:

Lindsey DawkesRemuneration TeamFinancial Services Authority25 The North ColonnadeCanary Whar London E14 5HS

Telephone: 020 7066 9766Email: cp10_19@ sa.gov.uk

It is the FSAs policy to make all responses to ormal consultation availableor public inspection unless the respondent requests otherwise. A standard

con identiality statement in an e-mail message will not be regarded as a request ornon-disclosure.

A con idential response may be requested rom us under the Freedom o In ormationAct 2000. We may consult you i we receive such a request. Any decision we makenot to disclose the response is reviewable by the In ormation Commissioner and the

In ormation Tribunal.

Copies o this Consultation Paper are available to download rom ourwebsite www. sa.gov.uk. Alternatively, paper copies can be obtained bycalling the FSA order line: 0845 608 2372.


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List o acronyms used inthis Consultation Paper

Financial Services Authority 3

AIFMD Alternative Investment Fund Managers Directive

AIFM Alternative Investment Fund Managers

ARROW Advanced Risk-Responsive Operating FrameWork

BCBS Basel Committee on Banking Supervision

BCD Banking Consolidation Directive

BIPRU Prudential sourcebook or Banks, Building Societies and Investment Firms

BTS Binding Technical Standards

CAD Capital Adequacy Directive

CBA Cost Bene it Analysis

CEBS Committee o European Banking Supervisors

CEO Chie Executive O icer

CESR Committee o European Securities Regulators

CP Consultation PaperCRD3 The latest amendments to the Capital Requirements Directive

EEA European Economic Area

EMEA Europe, Middle East and A rica

EU European Union

FAQ Frequently Asked Questions

FS Feedback Statement

FSB Financial Stability Board


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4 CP10/19: Revising the Remuneration Code (July 2010)

FSMA The Financial Services and Markets Act 2000

GABRIEL GAthering Better Regulatory In ormation ELectronically

HR Human Resources

ICAAP Internal Capital Adequacy Assessment Process

IOSCO International Organisation o Securities Commissions

LTIP Long Term Incentive Plan

MFA Market Failure Analysis

MiFID Markets in Financial Instruments Directive

PERG The Perimeter Guidance Manual

PS Policy Statement

RemCo Remuneration Committee

RPS Remuneration Policy Statement

SIF Signi icant In luence Function

SREP Supervisory Review and Evaluation Process

SYSC Senior Management Arrangement, Systems and Controls (sourcebook)

UCITS Undertakings or Collective Investment in Trans erable Securities


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Overview1

PurposeThis Consultation Paper (CP) proposes, and ormally consults on, changes to our1.1Remuneration Code (the Code), as set out in the FSA Handbook (see SYSC 1 19).Chapter 2 sets out the reasons why these changes are required. These include thepassing o the Financial Services Act 2010 in April 2010, and the amendments to theCapital Requirements Directive (CRD3) which come into orce on 1 January 2011. Asits name implies, CRD3 is principally concerned with revisions to capital requirements,but it also contains important provisions relating to remuneration practices. 2

We also report on the implementation o the Code so ar, and on the progress made1.2in achieving international alignment o remuneration principles in the G20 countries

and the EU. These reports are set out in Annexes 3 and 4.

As Chapter 2 explains, agreement on the CRD3 text was only reached in early July,1.3which has given us a tight timetable to consult and prepare a Policy Statement (PS)be ore the rules have to be in orce at the beginning o 2011. The Financial Servicesand Markets Act 2000 (FSMA) requires us to undertake and publish a Cost Bene itAnalysis (CBA) o the CPs proposals. We estimate this process (which involvessurveying a sample o irms) will take about six weeks.

As a result o the timing constraint, we have decided to publish the CP be ore the1.4CBA is completed to give irms in ormation about the prospective changes to theCode, and allow as much time as we can or the consultation. The CBA results,which will orm Annex 1 o this CP, will be published separately in early Septemberand will be ed into the PS. We may then need to revise discretionary aspects o theCode in September i the CBA results indicate this is appropriate. The ull timetableis set out in paragraph 1.19.

The CRD3 text contains several ambiguities that may be resolved during the review1.5which takes place in September and October this year by the Commissions jurist/ linguists process. In addition, a number o key issues have been remitted to the

1 SYSC: Senior Management Arrangement, Systems and Controls (sourcebook).2 The FSA published a CP on 23 July 2010 in order to consult on the capital proposals in CRD3

(CP 10/17: Strengthening Capital Standards 3 eedback to CP09/29), inal rules or CRD2 and urther consultation www. sa.gov.uk/pages/Library/Policy/CP/2010/10_17.shtml .
http://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdf


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Summary of our proposalsWe are consulting on a number o changes to the Remuneration Code, as set out in1.12Appendix 1. Chapter 2 explains that the changes will:

incorporate requirements relating to remuneration in the Financial Services Act,

which received Royal Assent on 8 April 2010. The Act requires us to ensure thatthe Code is consistent with the Implementation Standards set by the FSB. 6 Although the Code is substantially consistent with the FSB standards, we needto make some changes to re lect this requirement. The Act also enables us torender void provisions o remuneration agreements that breach speci iedprovisions o the Code, and changes are required to give e ect to this;

incorporate the remuneration provisions o CRD3. Again, the Code is substantially

consistent with CRD3, but we need to make some changes. We will amend thewording o the Code to ensure it is ully aligned with the Directive, even where

there is no change to the substance o the provision;adjust the Code to re lect experience gained in implementing the Code since its

inception on 1 January 2010; and

incorporate a recommendation o The Walker Review 7 o corporate governancein UK banks and other inancial institutions, published in November 2009.

Signi icant changes that we propose to make to the Code are set out in Chapters 31.13and 4. These include:

Scope o the Code: as required by CRD3, this will include all banks, building

societies and Capital Adequacy Directive (CAD) investment irms. CADinvestment irms includes a large number o asset managers (including mosthedge und managers and all UCITS investment irms), plus some irms whichengage in corporate inance, venture capital, the provision o inancial advice,brokers, several multilateral trading acilities and others. In all, over 2,500FSA-authorised irms will be within the Codes scope.

Recasting o certain existing evidential provisions and guidance into rules, to

re lect the binding nature o the CRD3 provisions once they come into orce.

A commitment to adopt a proportional approach in applying the rules, re lecting

CRD3, which says that institutions shall comply with [..] principles in a wayand to the extent that is appropriate to their size, internal organisation and thenature, the scope and the complexity o their activities.

New rules that require irms to ensure that total variable remuneration does not

limit their ability to strengthen their capital base, and that total variableremuneration must generally be signi icantly reduced in circumstances where the

irm produces subdued or negative inancial per ormance.

6 Chapter 2 sets out details o the work o the Financial Stability Board on remuneration.7 http://webarchive.nationalarchives.gov.uk/


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A new rule to act on the voiding provisions o the Financial Services Act 2010.

This rule de ines instances where breaches o the Code may render a contractvoid, and require recovery o payments to be made.

New rules on remuneration structures, covering the de erral o variable

remuneration, ex-post per ormance adjustment, 8 and guaranteedminimum bonuses.

Changes in the group o employees to which the Principles o the Code apply.

Summary of our reportsThis paper includes two reports. Annex 3 reports on the implementation o the Code1.14since it came into e ect on 1 January 2010. From November 2009 to April 2010we examined the remuneration policies o the irms in scope. It ensured that the

remuneration o irms that distributed awards a ter 1 January 2010 were compliant.It will take time to thoroughly assess the impact o the Code in reducing excessive1.15risk and in contributing to e ective risk management. However we believe that theimplementation o the Code has already led to improvements in remunerationpractices in the London market.

Annex 4 reports on progress in achieving international alignment. Drawing on a1.16review o the implementation o the FSBs Principles and Standards, 9 it notes thatnational supervisors have done much to implement remuneration principles.Although international alignment has increased, it remains inconsistent. A

di erence has appeared between countries that are implementing the FSBsstandards by en orceable rules or regulations, and those who are incorporating itinto supervisory processes via guidance. Further work is underway to increase theconsistency o approach across the G20 countries.

The UK has adopted en orceable rules, via the Remuneration Code, as have many1.17other EU countries. CRD3 will require the authorities to adopt en orceable rulesacross the EU.

Structure of the paper The rest o the CP is set out as ollows:1.18

Chapter 2 explains why we are revising the Code, describing the developments

that have taken place since our PS introduced the Code in August 2009.

Chapter 3 explains the proposed revisions, and gives some guidance on how we

plan to implement them.

8 See Glossary9 www. inancialstabilityboard.org/publications/r_090925c.pd


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Chapter 4 ocuses on implementation. We plan to assess how the irms currently

in scope are complying by using a two stage approach. Firstly, we discuss thequestion o proportionality and indicate how we plan to apply it. We thendiscuss our views on risk adjustment.

Chapter 5 sets out next steps and provides early guidance on what irms should

do to prepare or the introduction o CRD3.

Annex 1 will provide a CBA. This will be published in the irst week o

September 2010.

Annex 2 analyses how our proposals are compatible with our statutory

objectives and the principles o good regulation.

Annex 3 reports on the implementation o the Code since it was incorporated

into the Handbook on 1 January 2010.

Annex 4 reviews the current state o international alignment in remuneration

principles since the publication o our PS in August 2009.

Annex 5 provides our proposals on proportionality.

Annex 6 lists the consultation questions.

Appendix 1 contains the dra t text that is proposed to be used to incorporate

the revised dra t Code into the Handbook.

Next stepsThe timetable or applying the revised Code is as ollows:1.19

29 July 2010: publish CP;

irst week o September 2010: publish Annex 1 o the CP, reporting on our CBA

o the proposals;

8 October 2010: consultation period closes;

November 2010: publish PS;

1 January 2011: Handbook rules come into e ect or remuneration in respecto 2010 per ormance.

Who should read this paper and to whom do our proposals apply?This CP should be read in particular by all FSA authorised banks, building societies1.20and CAD investment irms. This audience corresponds to irms subject to theMarkets in Financial Instruments Directive (MiFID), although exempt CAD irms


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are not caught. 10 The CP will also be o interest or other FSA-authorised irms, asthe scope o the Code will probably extend in uture to other irms via otherDirectives. Shareholders, creditors and other stakeholders o irms covered may also

ind this paper o value.

This paper may also be o interest to trade associations and consumer groups.1.21

10 See PERG 13 or guidance on the scope o a CAD investment irm.


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Why we are revisingthe Code2

In PS09/15 (published in August 2009), we agreed to review our Code, and amend2.1

it as necessary to take account o new developments. These include:the coming into orce (on 8 June 2010) o the provisions relating to

remuneration within the Financial Services Act 2010;

the need to take into account recent international work on remuneration

principles under the auspices o the FSB and at the EU level, most notably theamendments to the CRD3;

Sir David Walkers review o corporate governance in UK banks and other

inancial institutions, published in November 2009;

lessons learned rom our experience in implementing the Code so ar, as set outin Annex 3; and

the need to review whether to extend the Code to other inancial institutions.

We conducted a Market Failure Analysis (MFA) in last years Consultation Paper2.2(CP09/10) when we applied the Code to large banks, building societies andbroker-dealers. We also considered potential remuneration risks at inancialinstitutions in other sectors in our December Feedback Statement (FS). Althoughthere may have been instances o market ailure, we did not deem them to beo su icient magnitude to warrant action ahead o EU legislative changes.

All substantive changes to the Code proposed in this CP are the result o legislative2.3requirements, which are discussed in more detail below. We believe that the MFA hasnot changed undamentally or the large banks, building societies and broker-dealersin scope. Our position on extending the scope to other irms also remains unchanged.


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The UK Financial Services Act 2010The Financial Services Act 2010 was enacted on 8 April 2010. Sections 4 to 6 o the2.4Act contain a number o provisions concerning remuneration. The Treasury can nowrequire regulated irms to disclose remuneration-related matters. We have also beengranted new powers and duties, which came into orce on the same date.

Sections 4 to 6 rein orce the key principles o our Code, notably the need to align2.5remuneration practices with e ective risk management, and generally do not requireus to make changes to the Code. However, there are two provisions within the Actrelating to remuneration, which require us to consult on changes to the Code.

Firstly, we have been given express powers to prohibit employees (or groups o 2.6employees) rom being remunerated in a speci ic way. Remuneration contracts thatbreach prohibitions on orms o remuneration under the Code can be rendered void,and the Act enables us to provide or recovery o any payments made, or other

property trans erred.This CP will consult on how we might apply this voiding power under the Code2.7(Chapter 3). It is likely that we will limit its application to instances where breacheso the Code can be most clearly identi ied and measured.

Secondly, under section 6 o the Act, our rules must ensure that the remuneration2.8policies o irms subject to our Code are consistent with the FSBs implementationstandards. As noted below, the Code is already largely consistent with these standards,but some changes will be needed (and we must also take into account otherinternational standards).

Under the Act, the Treasury has powers enabling it to implement the remuneration2.9disclosure provisions o CRD3. There is also potential or disclosure provisions to beimplemented under the FSAs powers. We are currently considering the appropriateapproach to implementing these requirements.

The FSBs principles and standardsThe FSB published a set o high level principles in April 2009, which were2.10endorsed by the G20 summit meeting in London ( or urther details see Annex 4).These were ollowed by more detailed implementation standards in September, whichwere approved at the G20 meeting in Pittsburgh. The implementation standards weredesigned to prioritise and give more detail on areas that should be addressed by irmsand supervisors so the principles could be e ectively globally implemented.

We were closely involved in discussions which led to the FSBs documents, and our2.11existing Code is largely consistent with the FSBs principles and standards. Thereare, however, di erences between the Code and the implementation standards,which mainly re lect how international thinking has evolved on remunerationprinciples between the publication o the Code in March 2009 and the standards

in September 2009.


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We there ore propose a number o changes to the Code to increase alignment with2.12the FSBs implementation standards; details are set out in the ollowing chapter.

The amendments to the Capital Requirements Directive (CRD3)On 7 July 2010, the European Parliament approved the text o the new EU Directive2.13to amend CRD3. The EU is expected to publish the inal text in its O icial Journaltowards the end o 2010.

Among other things, CRD3 will require irms remuneration policies and practices to2.14take into account several principles covering the structure, amount and timing o bonus payments. Depending on the interpretation o CRD3, these principles couldgo beyond the FSBs standards concerning limits on the cash proportion o bonusesand the composition o payments. 11

Our current Code is generally consistent with the CRD3 text, although in some2.15instances elements o guidance will need to be converted into rules to satis y ourobligations to implement CRD3. This will also, in most cases, satis y our duty tohave rules consistent with FSB Standards.

There is however a major di erence in the scope o application. The current Code2.16(and the FSB Standards) applies to a limited number o large irms. CRD3 appliesto all banks and building societies and investment irms to which the Market inFinancial Instruments Directive (MiFID) rules apply, 12 which is a much largergroup. In Handbook terms, CRD3 remuneration requirements apply to irms towhich the Prudential Sourcebook or Banks, Building Societies and Investment irms(BIPRU)13 applies. We estimate that over 2,500 irms will be subject to CRD3sremuneration requirements.

CRD3 requires us to consider the size, nature and complexity o the institutions2.17within its scope. This proportionality clause is o great importance and will bediscussed in urther detail in Chapter 4.

We are aware o , and are contributing to, urther work that is being carried out by2.18the Committee o European Banking Supervisors (CEBS) to provide guidance onimplementing the text o CRD3. We intend to take account o this guidance when

it is published in line with our duty to comply or explain with CEBS guidelinesunder CRD3.

The Walker Review recommendations on remunerationIn 2009, Sir David Walker conducted a review o corporate governance in UK2.19banks and other inancial institutions ( The Walker Review ) and published his inalrecommendations on 26 November 2009. We believe that our Code is currently

11 See Chapter 3 Proportion in Shares or our proposals12 Excluding exempt CAD irms (see PERG 13).13 CRD3 does not apply to third country irms, but Member States have obligations not to provide more

avourable treatment.


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well aligned with The Walker Review recommendations. The one area wherewe propose to change the Code is in relation to long term incentive plans, whichwe discuss in Chapter 3.

The Walker Review2.20 makes 11 recommendations on remuneration. We believe ourCode is largely aligned with these recommendations, notably: roles and responsibilitieso remuneration committees, skills and experience o members, responsibility orapproving and reviewing remuneration policy; risk management input into theremuneration process; and incentive structures or high end 14 employees.

The Walker Review2.21 states that: Executive board members and high end employeesshould be expected to maintain a shareholding or retain a portion o vested awardsin an amount in line with their total compensation on a historic or expected basis,to be built up over a period at the discretion o the remuneration committee. Webelieve that this recommendation is largely met through the de erral and vestingconditions stipulated under our Code. We are also proposing a rule requiring irms

to have in place appropriate retention policies in place or share-based awards inline with CRD3 and the FSB (see chapter 3).

Experience gained from the 2009 remuneration reviewsAnnex 3 reports on our implementation o the Remuneration Code in respect o 2.22

irms 2009 remuneration arrangements. We gained valuable experience romapplying the Code and have received eedback rom irms which we have consideredas ar as possible in our proposed revisions. We summarise the key points below:

a) For the 2009 reviews, provisions relating to the remuneration structures o Principle 8 15 (P8) employees were expressed as guidance and there was alack o clarity around implementation. For 2010, we propose to convert theprovisions or P8 employees into rules. This will also make the Code consistentwith CRD3.

b) There were di iculties in irms consistently interpreting the de inition o P8employees as set out in the Code. As a result we clari ied this in the supervisory

ramework issued to irms in December 2009. We are proposing additionalclari ication o the P8 de inition in this CP. 16

c) We encountered a number o time pressures during last years assessment o irmsremuneration arrangements. To improve the process this year, we have decidedto separate the assessment process into two stages, with a review o remunerationpolicies occurring or most irms in Q4 2010, and sign-o o the remunerationdata at an appropriate time ahead o irms announcing their awards.

14 Where high end relates to individuals who as executive board members or other employees per orm a signi icantin luence unction or the entity or whose activities have, or could have, a material impact on the risk pro ile o theentity. This de inition is consistent with the classi ication o employees to whom certain parts o the Code appliedlast year.

15 P8 is de ined in the Glossary (Annex 7)16 We are now calling this group Code Sta see Glossary.


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Extending the Code to other parts of the financial sector Last year we explored whether, and i so how, the Code should be extended to other2.23parts o the inancial sector. The results were published in an FS in December 2009(FS 09/5). 17 We concluded that remuneration risks could be ound in other parts o the inancial sector, particularly in larger and more complex irms, but they were noto such seriousness as to warrant action by the UK ahead o internationalagreement. In practice, this meant we would wait or the orthcoming EU Directivesto be implemented so we could move in tandem with other EU member states.

International developmentsTwo other EU Directives are likely to come into e ect in 2012 or 2013 which will2.24deal with remuneration issues: The Alternative Investment Fund Managers Directive(AIFMD) will extend the scope to und managers and the Solvency II Directive willcover insurance companies. Consequently, some irms within the scope o CRD3 willpotentially also be subject to AIFMD, and this question o overlap will needto be addressed as the AIFMD details are inalised. Key details, such as applyingproportionality clauses, have yet to be agreed or both Directives. Overlap withSolvency II may also occur where groups contain irms subject to di erent directives.More in ormation on AIFMD and Solvency II can be ound in Annex 4.

The FSB has recommended that its standards should be applied to all signi icant2.25inancial institutions, but has le t national authorities to determine which

institutions all into that category. Some countries have already included major

insurance companies and asset managers in their implementation o FSB standards.However it is likely that a substantial number o FSB member states in the EU willwait until the introduction o the EU Directives.

Competition between firms in and out of scopeThe irms currently within scope o the Code have expressed concerns about losing2.26their sta to competitors outside the scope o the Code. For example, those irmswith investment banking business are concerned that they are at a competitive

disadvantage relative to hedge und managers. 18 Smaller irms, both retail andwholesale, have complained they will be disadvantaged against competitors that arecurrently out o scope.

The introduction o CRD3, and extending scope to all banks, building societies and2.27certain investment irms including asset managers, will reduce these competitiveconcerns. Applying remuneration rules to the Alternative Investment Fund Managers via AIFMD and the insurance companies via Solvency II will be a urther

17 www. sa.gov.uk/pubs/discussion/ s09_05.pd 18 Although the two types o irms may compete or persons (e.g. traders) with similar capabilities, it does not imply

that the one irm is at a competitive disadvantage relative to the other.


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signi icant step. The policies we adopt on proportionality will need to have dueregard to competitive concerns.

The European Directives will, we hope, ensure consistency in applying remuneration2.28principles within the EU. As noted elsewhere in this CP, there is a wider question o di erences in regulatory approach at the global level creating an uneven playing

ield, and a risk o geographic arbitrage in avour o jurisdictions that are perceivedto be more lenient.

We recognise that the de inition o risk will vary according to the type o irm. For2.29example, or an asset management or investment irm, investment risk is invariablyassumed on an agency rather than a principal basis, as investment decisions made bysta are carried out on behal o clients in line with the mandates they have agreedbetween them. These risks are not taken onto a irms balance sheet as they wouldbe or credit institutions. We believe the key risks a ecting the success or ailure o an asset management irm are typically operational or legal risks arising rom asset

management activities. O course, a key control o legal risk will relate to a irmsability to ensure that investment managers act in line with the mandates they haveagreed with their customers.


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3 The proposed revisionsto the Code

IntroductionThis chapter sets out the proposed changes to the Code and should be read in3.1conjunction with the proposed Handbook text as set out in Appendix 1. Thischapter has two main parts.

Firstly, we revisit the purpose and general requirements o the Code, and outline our3.2proposals or the application o the revised Code to: irms, sta and groups.

Secondly, we set out the proposed new rules, with guidance where appropriate,3.3highlighting any necessary changes to the current Code. The new rules can begrouped as ollows:

risk management and governance (Principles 1 5);

new CRD rules on capital, government intervention, pensions, hedging and

avoidance (Principles 6, 7 , 9, 10 and 11);

risk adjustment the associated guidance can be ound in Chapter 4 (Principle 8);

remuneration structures, such as de erral and guarantees, with additional

guidance (Principle 12); and

e ect o breaches o the Remuneration Principles.

The Handbook text, as set out in Appendix 1, is structured as ollows:3.4application provisions including timing, interpretation and noti ications;

the general rule and guidance;

remuneration principles; and

annex on voiding powers.


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Scope of the Code

Application to firms

The implementation o CRD3 on 1 January 2011 requires us to change the scope o 3.5

the Code to incorporate:all banks and building societies covered by the de inition o credit institutions in

Article 4 (1) Banking Consolidation Directive (BCD); and

all irms within the scope o investment irms to which the CRD3 requirements

apply, as set out in the Capital Adequacy Directive (CAD). 19

In view o this requirement, we propose to replace the current SYSC 19 text with theCRD3 text, as shown in Appendix 1. This also includes some provisions carried over

rom the current Code, additional FSB requirements and provisions relating to thevoiding powers.

CRD3 will signi icantly increase the scope o irms subject to the Code rom the3.6current set 20 to over 2,500 irms. This population will incorporate the ollowingtypes o irm:

all banks and building societies;

all CAD investment irms (as previously explained in paragraph 2.16); and

UK branches o irms whose home state is outside the EEA.

UK branches o irms whose home state is within the EEA are not required to3.7

apply the Code, as their home state will be required to apply equivalent provisionsunder CRD3. 21

Application to individuals

To ensure alignment with the structure o CRD3 text, we need to de ine a group o 3.8employees to whom all the Principles o our Code will apply. We will re er to theseindividuals as Code Sta .

In respect o non-Code Sta , we propose to issue guidance explaining that irms3.9should also give consideration to the Remuneration principles on a irm-wide basisunder the general rule (subject to proportionality discussed later in Chapter 4).

19 Paragraph 3.5 covers all BIPRU irms.20 The scope o the irms subject to the Remuneration Code is currently de ined by three Handbook rules. This means

that the Code currently applies to banks and building societies with total capital resources o 1bn, and BIPRU730k investment irms (as de ined in the FSA Handbook) with total capital resources o 750m. In relation toan overseas irm, the Code only applies in relation to activities carried on rom an establishment in the UK. TheCode does not apply to a irm that is a branch o an incoming EEA irm. Such branches will be subject to therequirements that their home country establishes to implement CRD3. Incoming services are also subject to homestate regulation.

21 We expect CRD3 and the CEBS guidelines to align remuneration rules within the EU.


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In order to identi y Code Sta , we have re erred to the relevant section o CRD33.10text on remuneration policies 22 which states:

When establishing and applying the total remuneration policies, inclusive of salaries and discretionary pension benefits, for categories of staff, including senior management, risk takers, control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as seniormanagement and risk takers, whose professional activities have a material impact ontheir risk profile .

We propose to apply this CRD3 text as a rule (19.2.1 R) that applies the3.11remuneration principles to any sta which have a material impact on a irms riskpro ile. This group will comprise Code Sta .

Building on our experience o implementing a similar de inition or P8 employees3.12or the 2009 remuneration reviews, we propose guidance that we would expect

Code Sta to include the ollowing:

a person who per orms a signi icant in luence unction or a irm (a SIFa) 23);

a Senior Manager;b) 24

all sta , whose total remuneration takes them into the same bracket as seniorc)management and risk takers, whose pro essional activities could have a materialimpact on a irms risk pro ile.

For reasons described below, this group may not match per ectly with the P83.13employees o the 2009 remuneration review. In the 2009 review, the remuneration

structure provisions under Principle 8 only applied to P8 employees, while theother principles were applied more broadly. We propose that or all payments madeon or a ter 1 January 2011, all principles o the Code will apply to Code Sta , andthe term P8 employees will no longer be used.

To ensure a more consistent interpretation between irms o individuals who could3.14have a material risk impact on the irm, the ollowing table provides a non-exhaustivelist o examples o key positions that we believe should be subject to the Code:

22 Re erences to CRD3 are to the text agreed by Coreper (the Permanent Representatives Committee o the Councilo the European Union) on 30 June 2010 . http://register.consilium.europa.eu/pd /en/10/st11/st11527.en10.pd . SeeAnnex 1, section 11, point 23.

23 Signi icant In luence Function as de ined in the Handbook Glossary24 As de ined in the Glossary to this CP
http://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdfhttp://register.consilium.europa.eu/pdf/en/10/st11/st11527.en10.pdf


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Table 3.1 Examples of Code Staff (non-exhaustive)

High-level category Suggested business lines (This list is not exhaustive)

Heads, including regional heads,and any individuals or groupswithin their control who havea material impact on the irmsrisk pro ile.

Fixed Income Commercial BankingForeign Exchange Equities

Commodities Structured FinanceSecuritisation Lending QualitySales Areas Trading AreasInvestment Banking(incl. Mergers &Acquisitions advisory)

Heads o support and control unctions and other individuals

within their control who havea material impact on the irmsrisk pro ile.

Credit/Market/Operational Risk ComplianceLegal Internal AuditTreasury Controls Investment ResearchHuman Resources In ormation Technology

We recognise that irms have di erent organisational structures and use di erent3.15terminology to express seniority. However, when interpreting this guidance, we willexpect all irms to consider how best to overlay the examples provided above totheir own organisational structures. In addition to the individuals shown in thetable, irms may choose to devise their own additional metrics, e.g. based on tradinglimits, to identi y their Code Sta .

We would expect all individuals who have held either a signi icant in luence3.16unction, a senior management position or per ormed a role as a head o a

signi icant business line or support and control unction or all or part o the givenyear to be identi ied as Code Sta in that year.

As mentioned above, irms in scope may ind that their number o Code Sta does3.17not match the number o P8 employees o last years review. 25 This is due to lastyears P8 parameters being a practical, temporary measure ocusing on consistencybetween irms. This year, our rules or Code Sta have been guided by CRD3 withthe intention o tying the de inition more closely to e ective risk management, by

ocusing on individuals who have a material impact on the irms risk pro ile. Webelieve that this de inition will result in a more appropriate application o the Codesgeneral requirement.

We expect irms to compile a list o Code Sta ahead o the bonus allocation period3.18so irms can noti y sta who will be potentially subject to the Codes rules, includingthe voiding provisions. In the event that a Code Sta s bonus is not paid, theindividual would still be considered Code Sta and their remuneration would haveto comply with relevant provisions o the Code.

We also propose that, as a minimum, irms provide an annual attestation via3.19GABRIEL26 regulatory returns that all Code Sta have been identi ied and listed. Atthe same time, we retain the right to challenge a irms list o Code Sta i , in ourview, the list is inconsistent with the rules described above.

25 See Annex 326 See Glossary


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Further work to develop the reporting requirements will be necessary, and we3.20will consult on this later this year.

Q1: Do you agree with our proposed approach to thede inition o Code Sta ?

Interpretation of references to remuneration (Secondees)

We are proposing a new rule (SYSC 19.2.5R) to clari y to whom the re erences to3.21remuneration apply.

Secondees were not mentioned explicitly in the current Code, although the de inition3.22o employee in the Handbook has always been wider than an employment lawinterpretation and extends to secondees. We have sought to clari y this ollowingdiscussions with some o our stakeholders. The proposed guidance (SYSC 19.2.6G)states that remuneration awarded by a bank headquartered outside the UK (not

subject to the Code) to an individual on secondment to a major bank within the UK,would be subject to our Code.

Firms should take this guidance into account when reviewing their 20103.23remuneration arrangements. Firms should also consider whether there are otherpeople whom we might consider to be employees or sta , such as special advisers.

Application to Groups

We propose to adopt the ollowing approach to the territorial scope o the Code:3.24

UK groups should apply the Code globally to all their regulated and unregulated

entities; and

UK subsidiaries o third country groups must apply the Code in relation to all

entities within the subgroup, including the entities based outside the UK (e.g. orseveral irms this will consist o their EEA or EMEA 27 operations).

SYSC 12.1.3R states that irms must ensure that their risk management process and3.25internal control mechanisms at the level o any UK consolidation group or non-EEAsub-group o which it is a member comply with the obligations set out in the Codeon a consolidated or sub-consolidated basis.

As mentioned above, the Code will apply in relation to any entity that is part o a3.26UK group/subgroup that is located outside the UK, including in a non-EEAjurisdiction. We expect in-scope irms to re rain rom:

setting up special group structures or o shore entities, or

allowing or assisting sta to become employed by such structure or entities inorder to circumvent the application o the Code. A irm that is ound to engagein such practices may be ound to be non-compliant with the general rule.

27 Europe, Middle East and A rica.


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As irms develop remuneration policies and practices or subsidiaries, they should3.27consider the nature, scale, scope and complexity o the subsidiarys activities alongwith the level and types o employees working there. I the subsidiary poses a higherrisk to the regulated entity, more robust remuneration policies and practices shouldbe required or that entity.

For irms which engage in more than one type o inancial activity, including inancial3.28conglomerates, consideration should be given to the di erent sectoral requirements onremuneration. For example, where a group contains both an insurance irm which iscovered by the relevant insurance Directive and an investment irm covered by CRD3,remuneration policies should take account o each type o market activity includingany relevant sectoral standards.

Q2: Do you agree with our approach to applying the Codeto irms, individuals and groups, as outlined above?

The general requirement

Remuneration policies must be consistent with and promote effectiverisk management

The general requirement (SYSC19.2.1R3.29 28) that remuneration policies must beconsistent with and promote e ective risk management underlies our work onremuneration and remains the central tenet o the revised Code. We will measureall irms remuneration proposals against this rule and we would expect irms

themselves to use this rule as the irst point o consideration. We expect this ruleto apply in relation to all sta within a irm.

Equality and diversity

As a public authority, we are obliged under equality legislation3.30 29 to consider thepotentially discriminatory impact o our regulatory proposals (the basic duty) and todemonstrate due regard in seeking opportunities to promote equality & diversity (thegeneral duty). The Code (19.2.2G (2)) already reminds irms o their need to complywith equality legislation and requires policies and processes which support equality

and diversity or example, the requirement that remuneration decisions should beproperly documented. Although we ound that most irms that we surveyed monitorsta diversity as standard, we may request evidence rom irms on this subject, in linewith our general duty.

We have judged that the requirements outlined in this CP are non-discriminatory,3.31however we acknowledge that remuneration structures constantly change (due to thecombined impact o the Code, taxation and other external reasons). There ore we

28 See Appendix 129 Currently contained in section 71 o the Race Relations Act 1976, section 49A o the Disability Discrimination

Act 1995 and section 76A o the Sex Discrimination Act 1975. The equivalent duty public sector duty under s149o the Equality Act 2010 will supersede the current duties when brought into orce.


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will monitor whether the proposed changes have a disproportionate impact onspeci ic groups de ined through equality legislation.

Principle 2 o our current Code states that procedures or setting remuneration3.32within a irm should be clear and documented. Although this is not within theCRD3 text, we propose retaining this as guidance in the revised Code (SYSC19.2.4G), with no change o substance. We will expect all irms to demonstratethat robust processes are in place or recording remuneration decisions.

Q3: Do you have any comments on how theproposals contained in this CP a ect equalityand diversity issues?

Conduct risk and remuneration

We will expect irms to avoid remuneration structures which could create incentives3.33

or employees to take excessive risks in order to maximise bonuses, therebyjeopardising the prudential standing o the irm.

Remuneration PrinciplesWith regard to the actors mentioned in Chapter 2 and the changing scope o our3.34remuneration rules, we believe it is necessary to revise and update the Principles o our Code. Our proposed new Principles are outlined below.

Principle 1 Risk management and risk toleranceWe are proposing a new rule (SYSC 19.3.7R) ensuring that a irms remuneration3.35policy does not encourage risk taking that exceeds a irms tolerated level o risk.This is not a signi icant change in substance to our existing rule and means ourCode is aligned with CRD3 and FSB text.

Principle 2 Supporting business strategy, objectives, values andlong-term interests of the firm

We propose that a new rule (SYSC 19.3.8R) is included within the Code to ensure a3.36

irms remuneration policy is in line with its business strategy and long term corporatevalues. This is consistent with the current Code, which states that the assessment o anemployees remuneration should be based on longer-term per ormance, and it isaligned with CRD3 text.

Principle 3 Avoiding conflicts of interest

Con licts o interest are addressed as guidance under Principle 2 o our current3.37Code. We ound that most irms have policies in place to avoid such con licts andpropose that this guidance is converted into a rule (SYSC 19.3.9R) to be aligned

with CRD3. We will expect to see evidence o procedures that contain measures toavoid con licts o interest, including those related to customers interests, in a irmsremuneration policy.


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Principle 4 Governance

Principle 1 o our current Code states that irms Remuneration Committees3.38(RemCos) should exercise independent judgement and have the skills and experienceto do so. RemCos should also be able to demonstrate their decisions are consistentwith a reasonable assessment o the irms situation; and be responsible orapproving and periodically reviewing the irms remuneration policy.

These governance provisions are largely aligned with CRD3 and FSB, however we3.39propose certain changes to re lect the CRD3 text (see SYSC 19.3.12R in Appendix 1).Although the substance o the current provisions is retained, there are several speci icadditional requirements proposed, which are summarised below.

RemCos should be responsible or the preparation o decisions regarding

remuneration, including those with implications or risk management.

The implementation o a irms overall remuneration policy and ramework

should be subject to annual independent internal review.

Firms signi icant in size must establish a RemCo.

The RemCo chair and members must be non-executive directors.

The latter two proposals in particular, are generally acknowledged to be good industry3.40practice or corporate governance and consistent with promoting the independence o the RemCo and its oversight role. We observed that many o the irms in scope or the2009 reviews already had such governance structures in place. Firms should note thatthe rules do not preclude executive directors rom attending meetings and contributing

to the RemCo decision-making process where appropriate. We also deem the input o Human Resources (HR) and Risk to be particularly important.

We recognise that establishing a separate independent RemCo may not be3.41appropriate or smaller irms. This is in accordance with SYSC 19.3.12R (1),which states that only irms signi icant in [...] size, internal organisation and[...] nature [...] must establish a remuneration committee. Further guidanceon proportionality is provided in Chapter 4.

Furthermore, it may not always be necessary or a irm with an overseas parent to3.42establish a RemCo solely or the UK entity. We will however want to ensure that the

UK governing body su iciently oversees the remuneration policies o the UK entitiesand has the capability to act in an independent manner.

Principle 5 Risk and compliance function input

Principle 3 o our current Code states that remuneration or employees in risk and3.43compliance unctions should be determined independently and should be based onachieving the objectives o those unctions.

We propose to make this provision a rule (SYSC 19.3.14R) and amend its wording3.44to align with the CRD3 text. There is no change o substance and the proposedamendments will not a ect our approach to implementation; our ocus will continueto be on risk and compliance. However irms should note that the HR and Legal


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unctions should also be included within the de inition o control unctions. Theindings rom our 2009 reviews suggest that this is an area where irms were already

well aligned with our requirements.

We also propose to retain, as an Evidential Provision, our expectation that irms3.45risk and compliance unctions have appropriate input into setting remunerationpolicy and individual remuneration decisions where appropriate. We consider this animportant indication that irms have remuneration procedures that support e ectiverisk management. Firms should be able to demonstrate that control unction input issought and taken into account as appropriate. This provision links in with severalother areas o our Code, including governance, risk adjustment o bonus pools andper ormance measurement.

Principle 6 Remuneration and capital

CRD3 requires that a irms total variable remuneration should not limit its ability3.46

to strengthen its capital base. We propose including this as a rule (SYSC 19.3.18R)in our Code or all irms.

We plan to assess compliance by the largest irms against this requirement by3.47conducting an annual exercise to review the extent to which remuneration payoutsare consistent with their capital plans. The aim will be to link this into other existingsupervisory work on capital. It is our intention to per orm this assessment on a

orward-looking basis.

Principle 7 Exceptional government intervention

CRD3 places a number o requirements around executive directors o irms in3.48receipt o state aid. We will incorporate these as a rule, but we would normallyexpect appropriate variable remuneration to be capable o being justi ied ordirectors who join a stricken company a ter the crisis occurred (SYSC 19.3.21G).

Principle 8 Profit based measurement and risk adjustment

In order or remuneration policies to support e ective risk management, irms need3.49to ensure that their techniques or assessing variable remuneration take su icientaccount o current and uture risks. This is an area o ocus or us in the comingreview process. Last year we paid close attention to how irms adjust or risks a terthe pay-out o bonuses (so-called ex-post risk adjustment). This year we intend to

ocus on the techniques used by irms to take account o risks when calculating theirbonus pools prior to pay-out (ex-ante risk adjustment). This is clearly relevant orall irms, especially those that pay substantial bonuses.

We are there ore proposing new rules (SYSC 19.3.22R) on risk adjustment to state3.50that irms must take into account current and uture risks when determining variableremuneration. This is in line with CRD3. Further details are set out in Chapter 4.

Firms that operate Long Term Incentive Plans (LTIPs) should ensure that uture risks3.51are taken into account in the per ormance measures (SYSC 19.3.24G(1)).


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Principle 9 Enhanced discretionary pension benefits

SYSC 19.3.29R(1) states that a irms pension policy must be in line with the3.52business strategy, objectives, values and long-term interests o the irm.

CRD3 introduces new requirements on enhanced discretionary pensions. Such3.53

pensions are enhanced pension bene its granted on a discretionary basis by a irm toan employee as part o that employees variable remuneration package, but excludingaccrued bene its granted to an employee under the terms o their company pensionscheme. The new rule is not intended to apply to an employees standard pensionplan entitlements or the irms inancial contribution schedule to meet its contractualpension obligations. The intended ocus is to capture any non-standard one o payments on an individual basis that are deemed to be o a variable nature.

CRD3 also states that such discretionary pension bene its should be held or ive3.54years in the orm o shares or share-like instruments (SYSC 19.3.29R (2) and (3)).We expect SYSC 19.3.29R (2) and (3) may only apply in limited circumstances andto the most senior management i it is to be applied proportionately to meet theaims o the Directive. We are taking urther advice on the application o thesepension provisions.

Principle 10 Personal Investment Strategies

CRD3 introduces a new rule (SYSC 19.3.30R) requiring irms to ask employees to3.55undertake not to use personal hedging strategies, or to take out insurance contracts,that undermine risk alignment.

A irms e orts to operate an appropriate remuneration structure that takes account3.56o risk will, i su iciently e ective, occasionally result in a downward adjustment tothe amount o remuneration paid to sta . This will be the case, or example, i per ormance adjustment measures such as malus 30 are implemented.

The purpose o such measures is to maintain the alignment between risk and3.57reward; in other words, to ensure that employees do not avoid the downside risksrelating to activities that they have undertaken. The e ectiveness o such measuresthere ore will be signi icantly weakened i the employee is able to trans er thedownside risks to another party through hedging certain types o insurance.

We would argue that the employee has, in e ect, hedged away the risk o a3.58downward adjustment in remuneration i :

the employee enters into an arrangement with a third party; anda)

the arrangement requires the third party to make payments directly or indirectlyb)to the employee that are linked to or commensurate with the amounts by whichthe employees remuneration has been reduced.

The e ectiveness o risk alignment would also be undermined i the employee were3.59to buy an insurance contract that promises to compensate the employee in the event

o a downward adjustment in remuneration. As a general rule, however, this would

30 See Glossary


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not prohibit insurance designed to cover personal payments such as healthcare andmortgage instalments.

We there ore propose that irms should ask employees not to use personal hedging3.60strategies, or to take out insurance contracts, that undermine risk alignment. Firmsshould maintain e ective arrangements to ensure that employees comply.

Principle 11 Avoidance of the Code

We are proposing a new rule (SYSC 19.3.32R) stating that irms should not award3.61remuneration through alternative vehicles and methods in an attempt to avoid therules within our Code. This is consistent with our views on groups structures asexpressed in paragraph 3.24 above, but is also intrinsically linked to the generalrule, and hence is relevant to all irms.

One area we intend to scrutinise closely is the practice by certain irms o providing3.62

non-recourse loans to sta . It is intended that highly paid sta will receive a largeproportion o remuneration in stock or equivalent instruments, subject to rules onde erral and retention. In our view, a irm that allows sta to pledge stock orinstruments that are still subject to de erral or retention periods as collateral or anon-recourse loan (whether rom the irm or another source) is unlikely to be incompliance with the proposed Principles 10 and 11.

Q4: Do you agree with our proposals or changes to theRemuneration Principles 1-11?

Principle 12 Remuneration structures

Introduction

Principle 12 is concerned with the structure o remuneration awards and covers a3.63range o issues such as de erral, per ormance adjustment and guarantees. It alsoproposes our approach to the de minimis concession . Our starting point is that weintend to retain the rule, as expressed in our Code or 2009, that a irm must ensurethat the structure o an individuals remuneration is consistent with and promotese ective risk management.

In last years implementation process, we ound that the rules and guidance on3.64remuneration structures presented the most challenges and so, ollowing issuance o a supervisory ramework to irms in December 2009, we are now proposingadditional guidance on these key aspects.

Performance measurement

Principle 6 o the current Code states that non- inancial per ormance metrics should3.65orm a signi icant part o the per ormance assessment process.

Principle 5 o the current Code states that per ormance assessment on a moving3.66

average o results can be a good way o measuring long term per ormance.


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We are not proposing any changes to the substance o either o these principles. We3.67are retaining them in the Handbook text as guidance (SYSC 19.3.35G).

Fixed/variable balance

Having a ully lexible policy on variable remuneration meets the FSB principle o 3.68symmetry between pay and per ormance. We there ore propose including a new rule(SYSC 19.3.42R), to ensure irms have an appropriate balance between the ixed andvariable elements o total remuneration, to rein orce the existing guidance. Theproposed new rule is not dissimilar to the existing guidance in the Code.

CRD3 requires CEBS to set out speci ic criteria to determine the appropriate ratios3.69between the ixed and the variable component o total remuneration. We shallreview our Handbook text on this point once these guidelines have been published.

There are also questions around disclosure o ixed/variable pay within the EU. We3.70await the CEBS guidelines or urther clari ication on this.

Deferral

Our aim is to de ine an approach to de erral structures that is aligned with the3.71FSB Standards and CRD3.

We propose:3.72

A rule (SYSC 19.3.46R (1)) stating that at least 40% o the variable remunerationa)component must be de erred with vesting over a period o at least three years orall Code Sta and be correctly aligned with the nature o the business, its riskand the activities o the individual in question. Remuneration payable underde erral arrangements must vest no aster than on a pro-rata basis, with the irstvesting no sooner than one year a ter the award.

A rule (SYSC 19.3.46R (3)) stating that at least 60% o all variable remunerationb)must be de erred when variable remuneration is a particularly high amount. Wepropose to interpret this as 60% de erral when total remuneration is in excess o 500,000 (as per last years supervisory ramework).

While any total remuneration component o 500,000 or more paid to Codec)Sta must be subject to 60% de erral, irms should also consider whetherlesser amounts should be considered to be particularly high taking account,

or example, whether there are signi icant di erences in the levels o variableremuneration paid to the Code Sta within a irm.

Guidance (SYSC 19.3.47R (2)) stating that we would expect a irm to have ad)irm-wide policy on de erment, subject to de minimis, which includes a rising

proportion o de erment according to the amount o variable remuneration.

Rule (1) is in line with FSB Standards that state that a substantial portion o variable3.73compensation, such as 40% to 60%, should be payable under de erral arrangementsover a period o years.


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Rule (3) is consistent with the FSB requirement o 60% de erral or the most senior3.74management and highly paid sta .

We recognise that our proposed approach may not be aligned with some other3.75international jurisdictions; and that some globally active UK irms eel that this leadsto recruitment and retention issues. However, we are aware o our obligations toimplement CRD3 and the need to adopt an approach that will be applied consistentlyby all irms in scope to ensure we can apply the voiding powers granted to us by theFinancial Services Act 2010.

We propose that LTIP awards may be included in the calculation o the de erred3.76proportion to meet the Codes requirements, but only i we are satis ied that upsideincentives are adequately balanced by downside arrangements such as malus. TheLTIP award should be valued at the time it is granted, using an appropriatevaluation technique. For this approach to work, the LTIP award must be linked to aspeci ic per ormance year, and the counting o that LTIP award towards de erral can

only be in relation to that one year.

Firms that operate LTIPs should also consider3.77 The Walker Reviews recommendationthat hal o the award should vest a ter not less than three years and the remaindera ter ive years (SYSC 19.3.24(2)).

De minimis

Last year our supervisory ramework speci ied that employees earning under 500,0003.78and whose bonus was less than 25% o total remuneration would be subject to our deminimis concession and would not be required to meet our de erral requirements.

As part o our approach to proportionality, we are now proposing (SYSC 19.3.6)3.79that or Code Sta whose bonus is less than 33% o total remuneration and whosetotal remuneration is less than or equal to 500,000, we would not generallyconsider it necessary to apply the rules relating to: de erral; per ormance adjustment;proportion o remuneration paid in shares; and guaranteed bonuses.

We do not anticipate that this proposed change will have a large impact on the Code3.80Sta o the current irms in scope. However we are proposing the change as part o our intention to apply a proportionate approach to the irms that will come intoscope or the irst time rom 1 January 2011. We will review this proposal ollowingpublication o the CEBS guidelines later in the year. Our approach to proportionalityis discussed urther in Chapter 4.

Proportion in shares

In order to urther align the Code with CRD3 and the FSB Implementation Standards,3.81we propose to add a new rule (SYSC 19.3.45R) requiring at least 50% o any variableremuneration component to be made in shares, share-linked instruments, or otherequivalent non-cash instruments o the irm, and, where appropriate, other long dated

inancial instruments that adequately re lect credit quality (as a group re erred to here

as share-equivalent instruments), subject to the legal structure o the irm.


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We are aware that there are di erent interpretations o the CRD3 requirement.3.82Firms should consider the most suitable arrangement in the context o their overallremuneration policy. The interpretation put orward in a press release on behal o the European Parliament rapporteur was that the 50% requirement applies equallyto both the de erred and the non-de erred portions o variable remuneration.

We have taken the view that the re erence in CRD3 to the 50% requirement applies3.83to variable remuneration as a whole. Firms can decide whether shares orm part o the non-de erred payment, part o the de erred element, or a mixture o both. Ourview is a provisional one and we will need to consider whether it is appropriate tomaintain this view when we inalise the rules, in the light o the ongoing CEBSdiscussions. We and irms will also need to have regard to the inal CEBS guidanceon this.

These shares and share-equivalent instruments will need to be subject to de erral3.84or a retention policy. For the portion o shares or share-equivalent instruments

issued as up ront payment, irms will be required to implement appropriatepolicies stipulating minimum trans er retention periods. This is distinct romde erral, as retention periods may apply to awards paid up ront or de erredawards that have vested.

For example, our view would suggest that i the level o de erral is greater than or3.85equal to 50% o variable remuneration, the irm can choose to issue the ull de erredproportion as shares and this would meet the proposed share-based requirement.However, i the de erred shares amount to less than 50% o variable remuneration(e.g. 40% de erred), the remaining required portion (e.g. 10% up ront) should be

allocated in shares or share-equivalent instruments and subject to a retention period.The objective o linking remuneration to an instrument, such as shares, that intrinsically3.86re lects irm per ormance, is an important concept. However, or irms that are unableto issue shares, or example mutuals (building societies), we recognise that thisrequirement is not easily applied and we are sensitive to the di iculties in implementingsuitable alternatives to shares and share-linked instruments. We will also want to besatis ied that the instruments which irms intend to use to meet this requirement (whichwill typically orm a component o Tier 1 capital) meet our capital requirements.

We will continue to encourage the use o shares as a method or de erral (subject to3.87

our new per ormance adjustment requirements set out below) or irms where thisis practicable. However, in recognition o the challenges, although irms shouldcommence the application process by 1 January 2011, we are proposing that irmsmay be able to justi y not complying with these requirements by 1 January 2011,provided they take reasonable steps to comply as soon as reasonably possible andin event by 1 July 2011(see Chapter 4 on transitional arrangements). We will alsobe taking account o the CEBS guidelines on this matter.

Performance adjustment

Firms should retain the ability to make adjustments to an individuals unvested3.88de erred amounts o variable remuneration, a ter the amount has beencommunicated to the employee, to re lect actual outcomes as they materialise over


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time. We re er to this as per ormance adjustment, encompassing the key elements o ex-post risk adjustment. 31

Per ormance adjustment o awards can be a valuable tool in encouraging a culture3.89o longer-term ocused, accountable behaviour within a irm. We consider itimportant that su icient thought is put into the design and implementation o per ormance adjustment schemes to establish a credible, e ective link between the

uture risk o activities undertaken and individual reward.

We distinguish between adjustments made to de erred variable remuneration that has3.90not yet vested (known as malus) and that which has already vested but which theindividual agrees to repay (known as clawback). Our ocus in this section is on malusarrangements 32, where, as a result o poor per ormance, a reduction is made to ade erred award prior to vesting (i.e. be ore ownership has trans erred to the employee).

Proposed changes

Principle 8 in our current Code states that a signi icant proportion o the variable3.91component o remuneration should be linked to the uture per ormance o the irm,the employees division or business unit, or business undertaken by the employee

We propose to amend our current Code to include a rule (SYSC 19.3.27R) which3.92stipulates that all de erred remuneration is subject to an appropriate orm o per ormance adjustment. This is in line with CRD3.

As a consequence, irms should have a per ormance adjustment scheme which is3.93documented and communicated to all Code Sta . Details o the scheme should beavailable or our review on request.

As noted, our proposed new rules will require all de erred compensation to be3.94subject to an appropriate orm o per ormance adjustment and irms policies andprocesses to be e ective in identi ying conditions under which malus should beconsidered. Our new Evidential Provision on per ormance adjustment requires that

irms consider applying malus in the ollowing situations, where:

there is evidence o employee misbehaviour or material error;a)

the irm and/or the business unit subsequently su ers a material downturn in itsb)inancial per ormance;

the irm and/or the business unit in which the employee works su ers ac)material ailure o risk management.

How irms choose to incorporate and implement these measures is a decision or3.95irms, typically guided by their RemCos. Nonetheless, we believe that the three areas

set out above provide the basis on which policies should be designed. This shouldhelp put into practice measures that allow malus to operate at the irm, businessunit, and individual per ormance level and is in alignment with the FSB principles.

31 See Glossary32 We recognise there are limits to the ways in which clawback can be operated as an e ective per ormance

adjustment technique.


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On share and share-linked de erred awards, although the share price will provide a3.96orm o per ormance adjustment at the irm level, in many cases the link between

individual per ormance and share price per ormance can be relatively weak (exceptin certain cases such as the CEO). It is there ore highly desirable or irms to havethe ability to reduce the number o shares awarded based on business unit and/or

individual per ormance (SYSC 19.3.49E). We view this as an important step towardsestablishing a more e ective link to individual behaviour. This is also in line withcurrent discussion on per ormance adjustment at CEBS level.

Guarantees

The current Code states that guaranteed minimum bonuses, 3.97 which run for a period of more than one year .. are likely to be inconsistent with Remuneration Principle 8.Furthermore, the FSB principles only allow one-year guaranteed bonuses or new hiresin exceptional circumstances.

We are aware o irms concerns to ensure that a level playing ield is maintained.3.98We propose to introduce:

A rule (SYSC 19.3.38R) stating that irms must not o er guaranteed bonuses o

more than one year. Guarantees may only be given in exceptional circumstancesto new hires or the irst year o service only.

An evidential provision (SYSC 19.3.39E) that a signing on/buy out bonus

should not exceed the terms o ered by a previous employer under the de erredremuneration or incentive plan arrangements which it is seeking to buy out. Thevesting schedule or the award rom the new employer should match or exceedthe vesting schedule o the previous arrangements. The award rom the newemployer should be subject to per ormance adjustment requirements.

Guidance (SYSC 19.3.41G) on retention bonuses (see paragraph 3.101).

Guidance (SYSC 19.3.47(3)) that all guaranteed bonuses should be subject to

the same de erral criteria as other types o variable remuneration.

Guidance (SYSC 19.3.40G) to note that it is good practice to extend the above

rule and Evidential Provision to all employees.

Arrangements or existing employees

Guaranteed bonuses awarded in the irst year o employment cannot be extended3.99beyond this period, even i the employee has moved into a new role with less certaintyaround the uture potential per ormance o that unit. For some irms, each year, wemay request the names o individuals who have been o ered guaranteed bonuses, tocheck that the same people are not being o ered guaranteed bonuses repeatedly (evenin cases o an internal promotion).

We would expect retention bonuses to be permitted only in exceptional circumstances i 3.100the irm is undergoing a major restructuring and a case can be made or the retention

o key sta on prudential grounds.


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Firms should not award guarantees or the purpose o retention except in3.101exceptional circumstances, or example where key sta must be retained during amerger process or when a irm is winding down. Supervisory assessment o aninstitutions risk pro ile will determine whether a retention award might be grantedon a case-by-case basis in these situations.

Severance pay

Proposed changes

The current Code does not speci ically re er to severance pay, which is an important3.102component o a irms overall strategic Human Resources and remuneration policy. Weare proposing a new rule (SYSC 19.3.43R) and guidance (SYSC 19.3.44R) to ensurethat payments related to the early termination o a contract re lect per ormance overtime and do not reward ailure. The proposed text will be aligned with CRD3.

We recognise that there will o ten be a sound rationale or granting severance pay,3.103 which is essentially intended to provide a inancial sa ety net or sta in case o early termination o the employment contract or reasons other than cause. Webelieve that severance arrangements that generate large payouts to senior sta thatdo not relate to e ective per ormance, or are given in situations where inappropriaterisk taking has occurred, are incompatible with our Code.

Firms should set up a ramework in which severance pay is determined and3.104approved in line with their general governance structures or employment. Firmsshould be able to explain to us the criteria they use to determine severance pay. Itis good practice to de er any outstanding bonus payments or LTIPs and or theseto mirror the original de erral schemes.

Q5: Do you agree with the above proposals regardingremuneration structures (Principle 12)?

Effect of breaches on the Remuneration principlesSection 6 o the Financial Services Act 2010 has given us express powers to:3.105

prohibit a irm rom remunerating its sta in a speci ied way;

render void any provision o an agreement that contravenes such a

prohibition; and

provide or the recovery o payments made, or property trans erred, in

pursuance o a void provision.

We recognise that these powers are only likely to be e ective where the e ect o the3.106prohibition can be clearly ascertained in advance. This would be the case, orexample, with a contract that o ers a multi-year guaranteed bonus, which would bein clear breach o Principle 12 (SYSC 19.3.51R) o the amended Code. Similarly, we

recognise that these powers will only be e ective in respect o sta or whom setrules have been de ined.


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We currently propose to exercise this power only in relation to Code Sta and only3.107in relation to:

de erral arrangements, as set out in SYSC 19.3.46R, and

guaranteed bonuses, as set out in SYSC 19.3.38R.

Where it has been established that our voiding powers apply in respect o a3.108particular contract, the irm will be obliged to recover payments made or propertytrans erred to the individual. Firms would be restricted rom making urther variableremuneration awards to the individual in respect o the same per ormance yearunless they have legal advice that the award complies with the Code. A paymentmade in breach o this rule would be void and must be recovered (SYSC 19 Annex 15R and SYSC 19 Annex 1 7R). With respect to secondees, this obligation will applyto the entity or person making the payments to the secondee.


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4 Implementation

IntroductionThe irst section o this chapter sets out the extent to which we can use the4.1provisions in CRD3 to apply a di erentiated approach to irms according to theirnature, scale, scope, internal organisation and complexity. The second section setsout how we plan to implement the Code in respect o the 2010 bonus round orthose irms currently in scope (including our plans or a programme o meetingsduring Q4 2010) and irms who will come into scope on 1 January 2011. The thirdsection gives urther in ormation on how irms should take account o risk whenassessing and calculating their bonus pools. The inal section discusses thetransitional arrangements we intend to apply.

Approach to proportionalityCRD3 gives regulatory authorities the lexibility to apply a proportionate approach4.2to applying the remuneration provisions. As set out in Appendix 1 [ irms] shallcomply with the ollowing principles in a way and to the extent that is appropriateto their size, internal organisation and the nature, the scope and the complexity o their activities. 33

Our approach to proportionality alls under the ollowing broad pillars:4.3

application to irms;

application to sta ; and

supervisory approach.

This consultation gives guidance on our approach to proportionality. Further work4.4needs to be done to establish precisely how to apply a proportionate approach to all

irms. A key unresolved question is how to agree clear distinctions between di erentproportionate approaches. We invite irms to provide urther in ormation andopinions on this through our consultation questions.

33 See http://register.consilium.europa.eu/pd /en/10/st11/st11527.en10.pd


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Furthermore the Committee o European Banking Supervisors (CEBS) working group4.5on remuneration is considering several issues concerning proportionality. Its report isexpected to be published in October 2010. We are participating ully in theirdiscussions and will take their recommendations into account in any subsequentproposals. We may be in a position to provide more detail on proportionality in our

Policy Statement (PS) later this year. However we may need to consult urther onproportionality guidelines once the CEBS process is complete.

Applying the Code to firms

Paragraphs 3.6 and 3.7 set out how the scope o the Code will be changed when4.6CRD3 is implemented rom 1 January 2011 and indicates the broad range o irmsto be covered.

In our view it is clear that proportionality cannot be interpreted as a complete4.7exemption rom the Code or any irm within the scope o CRD3. All irms will

be required to consider the application o the ull Code to their irm in the ormo a sel -assessment. We will challenge the outcome o these assessmentswhere appropriate.

While some o the Codes rules will apply to all irms in scope, we recognise thatapplying the ull Code may be inappropriate and/or overly burdensome or others.These irms may be able to apply speci ic rules in a manner that takes account o their nature, scale, scope and complexity. They may also be able to apply rules on acomply or explain basis, since we will expect irms to justi y why it would bedisproportionate to apply the principles ully. 34

Annex 5 shows three tables which set out our proposals on:4.8

minimum requirements expected o all irms (Proportionality Table 1);

rules which could be applied proportionally in line with a irms nature,

scale, scope and complexity (Proportionality Table 2); and

rules which could be applied on a comply or explain basis

(Proportionality Table 3).

We intend to conduct urther analysis and engage with trade bodies and irms4.9to identi y the parameters that will determine our expectations or each rule.We will then provide examples and guidance to help irms conduct their ownsel -assessments against the Code. Examples o possible parameters include:

irms impact ratings as communicated as part o our ARROW risk

assessment process;

di erent types o legal status;

di erent types o business undertaken; and

34 A Comply or Explain basis means a irm could be released rom the requirement to apply certain rules i they cansatis actorily justi y their reasons or doing so.


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other inancial metrics e.g. levels o capital (as currently used in the current

Code or larger irms), assets, unds under management, liabilities.

We also intend to de ine criteria to identi y irms that will be required to apply the4.10rules within the Code. These irms will still be able to use the de minimis concession

or individual Code sta (see below).

Applying the Code to staff

The Code applies to a de ined group o employees, Code Sta ,4.11 35 as set out inparagraphs 3.8 to 3.14.

In paragraph 3.79 we set out the proposed conditions where certain rules

relating to remuneration structures need not apply. We will consider theposition o individual proprietors and general partners. Limited partners,whose position is more akin to employees, will not be excluded.

Q6: Do you agree with our proposals, as set out in Annex 5,or applying proportionality at the rules level?

Q7: Which metrics and thresholds do you believe areappropriate to determine how di erent irms canapply the speci ic rules o proportionality?(Pleasere er to Annex 5)

Supervisory approach

From 1 January 2011, we propose to incorporate the review o irms remuneration4.12policies into our existing supervisory processes. We intend to use the ARROWimpact ramework 36 to implement the Code in a risk-based way.

We propose that all irms in scope will be required to submit a minimum level o data4.13via an electronic return on the GABRIEL system 37 at their year end. This regulatoryreturn will include a requirement to certi y that the irms remuneration policies arecompliant with the Code. Where appropriate, we may ask irms to provide thenecessary explanation under the comply or explain procedure. We will consult onthese changes later this year.

Using ARROW impact scores to achieve a tiered approach, we envisage the4.14 ollowing supervisory approach.

High impact groups, which contain at least one CRD3 irm, should submit aa)Remuneration Policy Statement (RPS) annually ahead o their year end/bonusseason. These will be discussed at an annual meeting with the RemunerationCommittee (RemCo) Chair and/or senior management. Some high impact irmswill also be expected to supply details o their remuneration awards or

35 It should be noted that the general rule applies to all employees o a irm.36 www. sa.gov.uk/Pages/About/What/Approach/Assessment/index.shtml37 See List o acronyms used in this Consultation Paper.


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supervisory review in the weeks be ore their planned pay out date. Some highimpact irms may also be required to conduct an annual capital exercise relatedto their intended pay-outs.

Medium high and medium low impact CRD3 groups/ irms will be requiredb)to prepare an RPS annually that supervisors will request as part o the standardsupervisory processes, or example be ore an ARROW review.

Low impact irms will only be required to prepare an RPS i they are part o ac)thematic review. Otherwise, their GABRIEL regulatory returns will providetheir minimum reporting requirements or these irms.

This approach is summarised in the table below:4.15

Table 4.1 Proposed supervisory approach

Required compliance checks

Group/Firm

ImpactCategory

SupervisionType

RegulatoryReturns

(GABRIEL)

Meeting with RemCoChair or appropriate

governing body

RemunerationPolicy Statement and

associated spreadsheets

HClose &

Continuous(C&C)

YesAnnual meeting as part

o minimum C&C meetingsrequirements.

RPS submitted annuallyas part o minimum C&C

data requirements.

MH & MLFull ARROWor ARROW

LightYes

Meeting may orm parto ARROW/SREP risk

assessment and/or i irm

is selected or a thematicreview o remunerationpractices.

RPS may be requested aspart o ARROW/SREP riskassessment and/or i irm

is selected or a thematicreview o remunerationpractices.

L Small Firms Yes

Meeting may be requiredi irm is selected ora thematic review o

remuneration practices.

RPS to be requestedi irm is selected ora thematic review o

remuneration practices.

The level o detail within an RPS can be proportionate to a irms size and internal4.16organisation, and the nature, scope and complexity o its activities. An RPS will needto be reviewed and, i necessary, updated annually. We will assist irms in preparing

an RPS by providing a template.

Implementation in 2010For the purposes o the 2010 bonus round, we intend to apply a dual approach to4.17our assessment o the current scope and extended scope o irms as an interimmeasure or this year only. Our intended approach is set out below.


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Firms currently in scope

For the 2009 remuneration round, we limited our scope to a group o large banks,4.18building societies and broker-dealers. For the orthcoming remuneration round, weintend to divide our review o the remuneration arrangements or these irms intotwo parts.

The irst part will

cp10_19 revising the remuneration code

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