The Prudential Regulation Authority (PRA) has published guidance addressing areas of uncertainty in respect of the remuneration changes under CRD IV. The guidance takes the form of a letter on the PRA’s remuneration code webpage to the chairs of the remuneration committees of PRA-authorised firms. The main controversial element of CRD IV was in respect of the cap on bonuses; under CRD IV there is a capped ratio of 1:1 on the fixed and variable component of remuneration, although this can rise to 2:1 with shareholder approval. In addition, last Wednesday saw the release of a consultation paper with draft guidelines from the European Banking Authority (EBA), providing firms subject to CRD IV with further guidelines to consider and comply with.
Guaranteed variable remuneration
Helpfully, the PRA letter confirms that any variable remuneration awarded before an employee’s first performance period should not be counted as fixed or variable remuneration in calculating the ratio. This will allow firms subject to CRD IV to compensate new recruits for forfeited awards, although the letter notes that guaranteed variable remuneration should be used in exceptional cases only. This position was also confirmed in the draft guidelines.
Determining the fixed component of total remuneration for the ratio
Sticking with the theme of the ratio, the letter clarifies how the fixed element of remuneration should be calculated for the year. Where employees have received promotions, their fixed element should be calculated based on the proportion of the year spent at each salary level (i.e. the amount they actually receive for the year). Some firms have been using the employee’s end of year salary and this letter confirms that is not the correct approach. The one exception to the rule is in respect of a new joiner. In these circumstances, firms can calculate the fixed remuneration as if the new joiner had been remunerated for the whole period at that rate. Another welcome relaxation to the rules for new recruits, who may otherwise find themselves in a disadvantageous position under CRD IV.
Another important consideration for PRA-regulated firms currently, is the requirement to make awards granted on or after 1 January 2015 subject to clawback. The letter confirms that the PRA expects “firms to introduce clawback terms so as to maximise their enforceability to the extent permitted by law”. However, it accepts that there may be difficulties introducing clawback provisions to 2015 bonus awards that relate to performance in 2014. The letter refers to difficulties related to section 15 of the Employment Rights Act (right not to have to make payments to employer) and acknowledges that it will take into account these difficulties when “considering whether a firm has made reasonable efforts to recover a 2015 bonus award relating to the 2014 performance year”. Firms are still expected to make all reasonable efforts to introduce a clawback provision, but this acknowledges some practical difficulties with the concept that have still not been overcome.
The PRA letter was written in December and states that once the proposed new guidelines are finalised the PRA will publish a supervisory statement to clarify further key areas of uncertainty that have arisen on the remuneration changes under CRD IV. Well on Wednesday the EBA published a consultation paper on its draft guidelines, so perhaps we can expect a further PRA letter imminently.
The EBA draft guidelines are extensive and cover the governance process for implementing remuneration policies across the EU, such as guidance on setting up a remuneration committee. The draft guidelines also remove the proportionality principle for smaller firms (CRD IV allowed Member States flexibility to apply the rules in a proportionate way). This may result in specific exemptions to the rules. The draft guidelines also provide extensive detail on the criteria for the allocation of remuneration to its fixed and variable components and how to calculate the fixed and variable remuneration ratio.
The Financial Conduct Authority has published a statement confirming that although the EBA guidelines are not final, it strongly encourages firms to consider them and the impact on their business. Once the guidelines do come into force (expected to be later this year), the “comply or explain” principle will apply. Therefore for firms subject to these guidelines, a whole new layer of rules to consider and follow has come into play.