Proposals reflect drive to enhance the competitiveness of the UK regulatory landscape.
On 26 November 2024, the PRA and the FCA published a joint Consultation Paper on changes to the remuneration rules (PRA CP16/24, FCA CP24/24). The changes are relevant to banks, building societies, and PRA-designated investment firms.
While the amendments to the rules on deferrals and retention had been previewed by both the PRA (see this Latham blog post) and the Chancellor in her Mansion House speech (see this Latham blog post), the proposals also seek to reform other elements of the regime and would result in significant changes. The consultation forms part of the agenda under the new government to ease the burden on regulated firms where post-crisis reforms have gone too far. It also follows the removal of the bonus cap last year, the introduction of which the UK has always opposed.
With these changes, the regulators intend to make the regime more effective, simple, and proportionate. While the proposals would retain the core pillars of the regime, they seek to address some of the most complex and burdensome areas of the remuneration rules. However, the PRA is also proposing to raise expectations regarding links between the remuneration regime and the SMCR, having not seen enough evidence of adjustments to remuneration right up the chain of responsibility in response to adverse events, so it is not all good news for firms, especially those whose Senior Managers are responsible for the management of risks set out in PRA Periodic Summary Meeting letters. This ties in with the regulators’ review of the SMCR, on which they are expected to publish a consultation shortly.
Key Proposals
Identifying Material Risk Takers
The current rules for identifying Material Risk Takers (MRTs) are based on EU legislation, and include both qualitative and quantitative criteria. While the regulators consider the qualitative criteria (based on an individual’s role and impact) are working well, they believe the quantitative criteria (which can bring individuals not otherwise captured by the qualitative criteria into scope) are no longer fit for purpose, since they were designed in a pan-European context and not specifically for the UK market. This is probably code for the PRA having disagreed when this approach was taken at an EU level.
The current quantitative criteria include a threshold of income equal to or greater than £660,000, plus an alternative threshold of being within the 0.3% of highest earners within the firm, if the firm has over 1,000 employees. There is also a remuneration threshold of £440,000 to identify high earners within material business units as part of the qualitative test.
The PRA proposes to simplify the rules by creating a single quantitative threshold to identify MRTs. Under this proposal, firms would be expected to consider identifying individuals within their 0.3% of highest earners as MRTs. Both of the monetary thresholds outlined above would be deleted because, as the PRA observes, these thresholds capture individuals who do not materially affect the risk profile of the firm, as the monetary thresholds are relatively low by UK industry standards.
Further, the PRA proposes to place the single quantitative threshold in its Supervisory Statement on Remuneration (SS2/17) rather than the Rulebook, meaning it would operate as an expectation, not a rule. Therefore, firms would have discretion as to whether or not to designate individuals within the top 0.3% as MRTs. An additional consequence is that firms would no longer need to seek approval from the regulators to exclude individuals solely identified by the quantitative criteria from categorisation as MRTs. However, SS2/17 would contain an expectation that Chief Risk Officer approval would be obtained, and that firms would document any exclusions applied.
Given that this approach would place more responsibility on firms, the PRA is proposing to introduce new expectations regarding the governance of MRT identification processes. It hopes to achieve the right balance between firm autonomy and appropriate guardrails. To effect this, the PRA is proposing a new rule requiring employees who have responsibility for the overall management of the risk controls of a firm to annually review the firm’s MRT methodology. It is also proposing new guidance in SS2/17 regarding firms’ design and implementation of the MRT identification process.
Enhancing Proportionality for MRTs
The PRA is conscious that the complex tiering system imposed by the EU requirements has resulted in an increased number of MRTs being subject to the full remuneration requirements. It proposes to reinstate the pre-CRD V threshold (adjusted for inflation) at which firms may disapply certain remuneration rules (such as deferral) to MRTs. Specifically, it proposes that MRTs would need to meet the following conditions to benefit from proportionality:
- Total remuneration does not exceed £660,000
- Variable remuneration does not represent more than 33% of the employee’s total annual remuneration
The PRA also proposes to raise the variable remuneration threshold, at which at least 60% of variable remuneration must be subject to deferral requirements from £500,000 to £660,000. To further reduce complexity, the PRA proposes to delete the concepts of “higher paid material risk taker” and “significant firm”. This would mean that firms would only need to consider whether or not individual MRTs are above or below a single proportionality threshold.
Deferral and Retention Periods
Noting that most jurisdictions have shorter deferral periods than the UK, along with industry feedback that the seven-year deferral period for Senior Manager Function holders constitutes a significant challenge to the competitiveness of the UK, the PRA is proposing a simplified two-tier deferral framework. It cites data suggesting that shorter deferral periods than currently required may allow sufficient time for risk events to crystalise, although it notes that the data also highlights that some risk events do take longer to emerge. However, the PRA also believes that longer deferral periods appear to have led to a higher proportion of remuneration being fixed. Therefore, it believes that on balance the proposed adjustments would lead to preferable outcomes, as they would enable firms to readjust towards awarding a greater proportion of variable remuneration, rather than fixed pay.
Specifically, the PRA is proposing to:
- reduce the seven-year minimum deferral period currently applicable to certain Senior Managers to five years, and reduce the minimum deferral period for other MRTs to four years;
- specify that, for Senior Managers, deferred awards should vest no faster than on a pro rata basis from the time of award. Currently vesting starts no earlier than the third year for some Senior Managers;
- introduce new guidance that firms are not expected to set a retention period for deferred instruments. This is a departure from the EBA Guidelines, which suggest that firms set retention periods of between six and 12 months for deferred instruments, depending on the length of the deferral period; and
- remove the prohibition on payment of interest or dividends on deferred instruments.
Remuneration and Individual Accountability
The PRA is conscious that there could be better links between the remuneration rules and the SMCR, having found little evidence that remuneration adjustments have consistently been made to accountable individuals up the management chain. Consequently, it intends to link these regimes more closely to help ensure that variable remuneration better reflects risk taking outcomes and individual responsibilities.
In particular, the PRA proposes to introduce a new rule, and associated guidance, to require firms to consider variable remuneration adjustments in situations where it is reasonable that MRTs, by virtue of their role or seniority, could be held responsible for risk events that occur in areas where they are the responsible manager. The PRA also proposes to introduce a new rule and associated guidance requiring that material or urgent actions requested by the PRA in a Periodic Summary Meeting should be reflected in a Senior Manager’s Statement of Responsibilities. The PRA expects that this new rule would incentivise senior management to increase their own internal monitoring when they delegate tasks, as well as ensuring that actions identified by PRA supervisors are addressed promptly. Firms that already find the tracking of responsibilities under SMCR challenging may see this proposal as only adding to that burden.
Finally, the PRA proposes to make further amendments to SS2/17, to:
- clarify how firms should document the link between senior management variable remuneration outcomes and responsibilities;
- set out its expectations on: (1) how remuneration committees should engage at board level with other committees to improve risk management; and (2) the information remuneration committees should consider when incidents occur; and
- recommend that performance adjustments should be considered even if an incident does not result in a loss for the firm.
Changes to the FCA Handbook
The FCA proposes to streamline its rules for dual-regulated firms in SYSC 19D by cross-referring to relevant provisions in the Remuneration Part of the PRA Rulebook, rather than keeping rules that are duplicative of PRA requirements. This would mean that most of the remuneration rules would be set out in one place in the PRA Rulebook, and would be a welcome change for those used to grappling with two sets of parallel rules, making the rules more user-friendly and accessible. The FCA plans to retain rules that are specific to the FCA and have no PRA equivalent, along with FCA-specific guidance.
Streamlining SYSC 19D would not result in any policy changes, except in one instance. The PRA rules currently exempt small firms from the rules on buyouts, whereas the FCA rules do not (although they do have some flexibility). Therefore, by removing the FCA rules and replacing these with a cross-reference to the PRA rules, small firms would no longer be subject to the rules on buyouts.
Linked to the above proposals, the FCA plans to retire two pieces of guidance: FG23/4: Dual-regulated firms Remuneration Code (SYSC 19D): Frequently asked questions on remuneration, and FG23/5: General Guidance on Proportionality: The Dual regulated firms Remuneration Code (SYSC 19D). It considers that this guidance largely reflects that in PRA SS2/17. The FCA is also proposing to amend FG23/6: General guidance on the application of ex-post risk adjustment to variable remuneration so that it would no longer apply to dual-regulated firms, although it would retained as it would continue to apply to firms in scope of the MIFIDPRU Remuneration Code.
It does not appear that the FCA intends to align its rules for solo regulated firms with the PRA’s rules where the PRA’s requirements are more flexible.
Next Steps
Responses are requested by 13 March 2025. The regulators are currently aiming to publish a policy statement in H2 2025. They intend that the changes would take effect the day after publication of the final policy materials and would apply to firms’ performance years starting after that date. They do not intend the changes to apply retrospectively to previous performance years.
