New remuneration requirements under the UK investment firm prudential regime apply to Financial Conduct Authority–authorised investment firms’ performance periods beginning on or after 1 January 2022. This LawFlash provides an overview of certain key requirements, including those relating to setting a ratio between fixed and variable remuneration and performance adjustment, as well as which types of firms and staff are affected.
These remuneration requirements are set out in the new MIFIDPRU Remuneration Code in the new SYSC 19G in the Financial Conduct Authority (FCA) Handbook and have replaced the BIPRU and IFPRU Remuneration Codes for certain investment firms.
What firms are subject to the new requirements?
The rules under the MIFIDPRU Remuneration Code apply to:
How are MIFIDPRU investment firms classified?
The new remuneration requirements are divided into basic, standard, and extended requirements, and their application will depend on the MIFIDPRU investment firm’s classification as either a small and non-interconnected (SNI) firm or a non-SNI firm, and its on-and-off balance sheet.
A firm will be a non-SNI firm if it meets certain thresholds, such as having assets under management of at least £1.2 billion, holding any client money, safeguarding any client assets, holding permission to deal on own account, having an on- and off-balance sheet total of at least £100 million or having total annual gross revenue from investment services (as an average based on annual figures from the preceding two years) of at least £30 million.
An SNI firm is subject to only the basic requirements under the MIFIDPRU Remuneration Code (such as in relation to establishing remuneration policies), whereas a non-SNI firm is subject to both the basic requirements and standard requirements (such as in relation to setting a ratio between fixed and variable remuneration and performance adjustment).
Further, a non-SNI firm is additionally subject to the extended requirements under the MIFIDPRU Remuneration Code (such as in relation to deferral and payment in instruments) if, broadly, the value of its on- and off-balance sheet assets over the preceding four-year period is a rolling average exceeding (1) £300 million, or (2) £100 million if it has a trading book business exceeding £150 million or derivatives business exceeding £100 million.
Which staff are subject to new requirements?
The basic requirements under the MIFIDPRU Remuneration Code apply to all staff. The term “staff” should be interpreted broadly to include, for example, employees of the firm itself, employees of other group entities, employees of joint service companies, and secondees.
Most of the standard requirements, on the other hand, apply only to material risk takers (MRTs) and non-SNI firms’ need to assess at least once a year which of its staff members are MRTs. However, the FCA considers it good practice for a firm to still consider whether applying any of the rules applicable to MRTs to other staff members would contribute to sound risk management or a healthy firm culture.
Who is a material risk taker?
An MRT is a staff member whose professional activities have a material impact on the risk profile of the firm or of the assets the firm manages. A staff member’s professional activities would be deemed to have a material impact on the risk profile of a non-SNI firm or of the assets managed by it if, broadly, the staff member:
Key indicators that a staff member’s professional activities have a material impact on the risk profile of the firm or assets the firm manages include if the staff member (1) has no sufficiently senior and experienced MRT supervising them on a day-to-day basis or to whom they report; (2) is responsible for key strategic decisions; and (3) is responsible for significant revenue, material assets under management, or approving transactions.
What is the requirement for setting ratios?
To ensure that the fixed and variable components of total remuneration are appropriately balanced and that the fixed component represents a sufficiently high proportion of the total remuneration to enable the operation of a fully flexible policy on variable remuneration, a non-SNI firm must set an appropriate ratio between the variable and fixed components of total remuneration in their remuneration policies. Ratios must be set for all staff, and not only MRTs, and there must be appropriate governance and documentation of processes and decisions relating to the ratios.
While this same requirement was under the BIPRU Remuneration Code, most BIPRU firms were able to disapply this requirement on the basis of proportionality (given that the FCA said in its proportionality guidance under the BIPRU Remuneration Code that it would normally be appropriate for a BIPRU firm to disapply this requirement under the BIPRU remuneration principles proportionality rule).
What factors should be considered when setting ratios?
When determining what is an appropriate ratio, a non-SNI firm should consider all relevant factors, including:
When setting a ratio, a firm should consider all potential scenarios, including that a firm exceeds its financial objectives, and must be able to explain its decision to the FCA upon request. The maximum ratio should reflect the highest amount of variable remuneration that can be awarded to the category of staff in the most positive scenario. The ratio must also take into account the maximum level, or the criteria for setting the amount, of any severance pay under the firm’s remuneration policy.
What are the performance adjustment requirements?
A non-SNI firm must ensure that any variable remuneration (including any deferred portion) is paid or vests only if sustainable according to its financial situation as a whole and justified on the performance of the firm, business unit, and individual.
Further, the firm must:
Again, while there were performance adjustment provisions under the BIPRU Remuneration Code, most BIPRU firms were able to disapply these provisions on the basis of proportionality.
What malus and deferral requirements apply?
However, a non-SNI firm that is not subject to the extended requirements under the MIFIDPRU Remuneration Code is not subject to the requirements to defer portions of variable remuneration. If the firm has not deferred any remuneration, it would not be able to apply malus and so it should foresee the use of in-year adjustments and clawback arrangements only. Alternatively, the firm may still voluntarily choose to use deferral, which would enable the use of malus arrangements in addition to in-year adjustments and clawback (and could be a way of reducing the practical difficulties with making adjustments through clawback).
What clawback periods should be set?
A non-SNI MIFIDPRU investment firm must ensure that the clawback period it sets spans at least the combined length of any deferral and retention periods and allows sufficient time for any potential risks to crystallise. This may mean that different periods are set for different categories of MRTs. In setting appropriate clawback periods, the firm should take into account all relevant factors, including the nature of the MRT’s activities, the MRT’s impact on the risk profile of the firm or assets it manages, and the length of the business cycle relevant for the MRT’s role. For a non-SNI firm that will not be subject to the extended requirements, the FCA considers that three years will generally be an appropriate starting point for the firm’s consideration of the appropriate clawback period.
To determine which rules apply and to which staff members, firms should be determining (1) their classification as an SNI firm, a non-SNI firm, or a large non-SNI firm; and (2) which staff are MRTs. For non-SNI firms, a range of employment and incentive-related documents will likely need to be reviewed and (where necessary) updated. These could include, for instance, the firm’s remuneration policies and governance documents, variable compensation plans, template employment contracts (particularly clauses addressing variable remuneration), or any internal employee-facing information pages or “back-office” documents that address variable remuneration arrangements.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyer:
London
Louise Skinner
Steven Lightstone
Thomas A.J. Twitchett