Executive briefing – April 2021

FCA consultation on Investment Firm Prudential Regime: Remuneration requirements

On 19 April 2021, the FCA issued a consultation document regarding its proposals to implement the new UK Investment Firm Prudential Regime (IFPR), including the remuneration requirements. This is the second of three detailed consultation documents that the FCA plans to publish regarding IFPR.

This consultation is open for comments until the end of May and the final rules will be updated following completion of the consultation process (expected later this year). Once finalised, firms will need to apply the new rules from the start of their next performance year beginning on or after 1 January 2022. It is worth noting that the FCA has reserved its position to amend the rules based on feedback and subsequent developments regarding “EU market access”.

The proposed remuneration requirements are similar in substance to those envisaged under the EU-version and, therefore, should not present any major surprises to firms which have been monitoring development of the new regime. That said, there are a few areas where the UK regime is slightly different to the EU approach (e.g. proportionality thresholds, deferral periods). We recommend that all relevant firms consider the details of the proposed rules and the practicalities of implementation.  

Background

Before the UK left the European Union, it was part of a process to design and establish a new prudential framework for European investment firms. The new EU regime is due to come into force from June 2021. That regime was designed to recognise that the risks faced by investment firms are often different to credit institutions.

The UK supported the overall goals of the EU prudential regime for investment firms and now proposes to introduce a UK regime which will achieve similar intended outcomes as the EU regime, whilst taking into consideration the specifics of the UK market. Please see our previous briefings here and here for further background to the development of the UK and EU regimes.

Overview

The new prudential regime for FCA investment firms will be brought into a single rulebook known as MIFIDPRU. This will replace the existing IFPRU and BIPRU rulebooks, including the associated guidance, which will be deleted.

Although the new rulebook will apply to all FCA investment firms, the remuneration requirements provide for a proportionality framework that distinguishes between 3 different classes of investment firm. This reflects stakeholder feedback resulting from the earlier FCA discussion paper and is consistent with the general regulatory philosophy of the UK government. The following diagram (taken from the consultation document) provides an overview of the three levels of remuneration requirements that may apply to investment firms:

The categorisation of investment firms under IFPR is complicated and uses a number of factors to determine the status of a firm. However, the principal metric referenced by the FCA is the on-and-off balance sheet total of the firm. As a general rule of thumb, smaller and non-interconnected (SNI) firms will typically have a balance sheet total under £100m. The middle category will be made up of non-SNI firms with a balance sheet total somewhere between £100 – 300m (although firms can be elevated to the top category based on the nature of their underlying business). The top category will be made up of larger non-SNI firms typically with a balance sheet total in excess of £300m.

Basic remuneration requirements

The ‘basic remuneration requirements’ set a minimum standard which will apply to all FCA investment firms. Larger ‘non-SNI’ firms will also need to apply the ‘standard’ and possibly the ‘extended’ remuneration requirements, as described below. This approach reflects the FCA’s view that it would be disproportionate to require “smaller, less complex firms to comply with all aspects of the IFPR given they are less likely to cause significant harm to customers and markets”.

The ‘basic’ requirements include the following:

• Remuneration policy: Firms should have a remuneration policy in place for all staff (the FCA has set out guidance on its expectations regarding a compliant policy). The remuneration policy must also contain measures to avoid conflicts of interest, e.g. remuneration of control function roles to be overseen by the remuneration committee or management body.
• Balanced remuneration: Firms will be required to ensure that the fixed and variable components of an individual’s total remuneration are “appropriately balanced”. The FCA is not prescriptive regarding what an appropriate balance would be, other than to note that there must be sufficient flexibility to pay no variable remuneration and paying purely variable remuneration to staff would not be appropriate.

• Individual performance: Assessment of individual performance must be assessed by reference to both financial and non-financial criteria.

• Restrictions on variable remuneration: The award, vesting or payment of variable remuneration will be restricted in certain circumstances, e.g. if it would endanger the sound capital base of the firm, or if the firm has benefitted from extraordinary public financial support.

The basic requirements will apply to all staff in FCA investment firms, i.e. not just MRTs.

The nature of remuneration arrangements at investment firms will vary considerably, depending upon the type of firm. The FCA has therefore also provided guidance on what is considered remuneration. For example, carried interest arrangements will normally be considered remuneration, whereas co-investment arrangements would normally be considered a return on equity and not remuneration.

Standard remuneration requirements

The ‘standard remuneration requirements’ will apply to all non-SNI firms (in addition to the ‘basic’ requirements) and will only apply to MRTs (see below regarding identification of MRTs). 

The ‘standard’ requirements include the following:

• Fixed to variable ratio: Firms will be required to set a ratio between variable and fixed remuneration as part of the remuneration policy. The FCA does not intend to set a ‘one size fits all’ maximum ratio (such as the ‘bankers bonus cap’ that applies to CRD firms). Ratios may vary between different categories of firm and from year to year.
• Performance assessment: Performance-related variable remuneration of a MRT should be based on a combination of the assessment of the performance of the individual, the relevant business unit and the firm overall. Assessment of performance must also be based on a multi-year period.
• Risk adjustment: Mechanisms must be in place to potentially apply ex-ante and ex-post risk adjustment, including minimum clawback periods and triggers for the application of malus/clawback. It is worth noting that the existing guidance regarding application of ex-post risk adjustment for dual-regulated firms (under SYSC 19D) is expected to be extended to cover FCA investment firms.
• Non‑performance related variable remuneration: Restrictions will apply to the use of guaranteed variable remuneration and retention awards (which should be used rarely). Buy-out awards are permitted but should be subject to the same pay-out terms required by the individual’s previous employer (as is also the case under the CRD regime).
• Annual review: The design, implementation and effect of the remuneration policy should be subject to internal review by control functions (internal audit) at least annually.

Extended remuneration requirements

The ‘extended remuneration requirements’ will only apply to the larger non-SNI firms and will be in addition to the basic and standard requirements. Based on current data, the FCA expects about 100 firms to be in scope of the extended remuneration requirements. As with the standard requirements, the extended requirements will only apply to MRTs.

The ‘extended’ remuneration requirements include:

• Pay-out in shares or other instruments: At least 50% of the deferred portion of the variable remuneration should be paid out in shares or similar instruments. The FCA considers it good practice for the deferred portion of variable remuneration to contain a higher proportion of shares/instruments than the non-deferred (upfront) portion. This is different from CRD which applies the requirement to pay at least 50% in instruments to each element so this wording appears to allow a greater proportion of the non-deferred element of bonus to be paid in cash as, in most cases, all of any LTIP will be delivered in instruments. 
• Deferral of variable remuneration: At least 40% of the variable remuneration awarded to an MRT must be deferred for at least 3 years. This is shorter than the EU regime (which advocates deferral for 3 to 5 years), but the FCA encourages longer deferral periods for members of the management body and senior executives. Where the variable remuneration is a particularly high amount, and in any case where it is £500,000 or more, at least 60% should be deferred. The deferred variable remuneration should not vest faster than on a pro rata basis.
• Retention policy: Shares and any other instruments issued for variable remuneration should be subject to an “appropriate retention policy”. The FCA have not set a prescribed minimum period for retention but indicate that it would be appropriate for it to vary by reference to the potential impact of the MRT on the risk profile of the firm.
• Remuneration Committee requirement: Larger non-SNI firms must also establish a remuneration committee. At least 50% of members of each of the committee must be non-executive members of the management body.

Identification of MRTs

The FCA has provided draft guidance for the identification of material risk takers (MRTs) as part of the consultation document. Those criteria are similar to the substance of the qualitative criteria issued by the EBA in their draft regulatory technical standards (RTS), published earlier this year. However, unlike the EBA RTS, the FCA has decided not to include quantitative criteria as it does “not view this as a reliable indicator of the level of risk involved in a role in an FCA investment firm”. This will potentially narrow the number of individuals that fall within the scope of the standard and/or extended requirements (compared to the EU-approach). Firms are recommended to closely review the MRT identification criteria to establish which staff will potentially be affected by the standard and extended requirements. 

Individual proportionality

The FCA proposes to exempt those MRTs who earn below a certain amount from the extended remuneration requirements (if they are working at a firm that would otherwise be caught by those requirements). In order to qualify for the exemption, the MRT would need to have:

• variable remuneration of no more than £167,000; and
• variable remuneration which makes up no more than one-third of their total annual remuneration.

Although a similar exemption applies under the EU regime, the thresholds under the UK IFPR are somewhat higher than the EU equivalents (€50,000 and 25%).

Reporting

The FCA aims to “significantly reduce” the amount of information that investment firms need to report about their remuneration arrangements. It plans to introduce a new MIFIDPRU Remuneration Report which will be tailored depending on whether a firm is subject to basic, standard or extended remuneration requirements. The FCA also plans to provide updated template documentation (based on existing IFPRU and BIPRU templates), e.g. Remuneration Policy Statements. Further details regarding the public disclosure requirements will be set out in the third consultation which is expected to be published in Q3 2021.

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or call us on 020 7034 1111 or email us at Info@fit-rem.com. 

This paper is intended to be a summary of key issues but is not comprehensive and does not constitute advice. No legal responsibility is accepted as a result of reliance on the contents of this paper.

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