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The bonus cap is here to stay… for now

Posted: 13/12/2021

Bonus season is in sight - particularly for those in the financial services industry. Deals are up, and there is a post-pandemic war for talent. As a result, record breaking bonuses are predicted this year.

Since the financial crisis in 2008, regulated firms have had to review the way they compensate their staff. The remuneration landscape for these firms has changed quite dramatically over the last 12 plus years.

The Remuneration Code

In response to the financial crisis, the Financial Services Authority, now the Financial Conduct Authority (FCA), implemented the original Remuneration Code in 2010. Initially this applied to 26 of the largest banks, building societies and broker dealers. The purpose of the code was to encourage effective risk-taking and reduce short-termism through regulating remuneration.

As we approach 2022, more than 7,000 regulated firms are captured under one or more of the Remuneration Codes. The codes are supplemented by guidance notes, supervisory statements, and opinions - not only from the Prudential Regulation Authority (PRA) and FCA, but also from the European Banking Authority (EBA).

Bonus caps

In February 2016, the PRA and FCA jointly announced a requirement on regulated firms to comply with the EBA guidelines. This meant all UK regulated firms were now subject to the Capital Requirements Directive IV and required to comply with the guidelines (with some exceptions). This included the controversial so-called ‘bonus cap’. The bonus cap means that the variable pay of ‘material risk-taskers’ should generally not exceed 100% of fixed pay.

However, firms can increase the cap to 200% of fixed pay if at least 66% of the firm’s shareholders agree - or at least 75% of shareholders if less than 50% of the total shares or ownership rights are represented – with the purpose of the cap being to incentivise positive behaviour and appropriate conduct culture.

Whether in practice the bonus cap achieves its aim has led to a lot of dialogue and heated discussion, with many having polar views. The bonus cap has been one of the most sensitive policies amongst the reforms flowing from the crisis and was strongly resisted by many at the time, including the Bank of England and PRA’s, Andrew Bailey and the then Chancellor George Osborne. Both feared London would lose its competitive edge, should the cap be introduced. However, despite abandoning a possible EU legal challenge in 2014, Mr Osborne remained clearly hesitant about the effectiveness of the cap, envisioning that the cap would serve only to see bankers’ fixed pay rise in order to compensate for the lower bonus potential, which would soon prove to be the case.

The introduction of clawback and malus clauses to avoid rewarding ‘bad behaviour’

In addition to the bonus cap, firms must be careful not to have pay structures in place which can be seen to reward ‘bad behaviour’ (a euphemism for misconduct), regardless of whether employees have met their financial targets.

Measures such as deferring part of a bonus over three years, along with clawback and malus clauses in contracts, all serve to promote a healthy approach to risk taking and foster a positive working culture.

It is clear regulating remuneration remains vitally important to the FCA, particularly the measures to stop a bonus being paid out in full or part if an employee has been involved in misconduct. This is reflected in the FCA’s recent update to its 2015 guidance to the MIFIDPRU Remuneration Code on ‘ex-post risk adjustment’. For more information on this, see Ruby Dinsmore’s article here.

Competitive advantage post-Brexit

Post-Brexit, questions have been raised about the attractiveness and competitiveness of London in the financial services sphere, and the Government is considering possible reforms to this end. As part of these discussions, the issue of capping bonuses is back on the agenda.

Many in the financial sector are taking the opportunity to appeal to the Chancellor to review and remove the bonus cap. However, in line with his predecessor, Rishi Sunak has resisted these calls. On this point, the Governor of the Bank of England commented back in September 2021 that, whilst he is no fan of the cap, in his view regulators have little appetite for a wholesale revision of the UK’s financial rulebook after Brexit. That said, the Government has not ruled out reconsidering the remuneration requirements in the future, although politically, it is thought not to be the right time. And so, for now, the Government is concentrating its efforts on other reforms.

We will be posting regular commentary on key issues in the financial markets from an employment angle, but more information on our firm’s wider expertise in this area can be seen here.

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Penningtons Manches Cooper LLP is a limited liability partnership registered in England and Wales with registered number OC311575 and is authorised and regulated by the Solicitors Regulation Authority under number 419867.

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