Mandatory bonus clawback provisions for UK bankers would take pay governance "into new phase", says expert

The proposals, set out in a new consultation by the central bank, would apply to all financial services firms regulated by the Prudential Regulation Authority (PRA) and could be applied retrospectively in some circumstances, according to experts at Pinsent Masons, the law firm behind Out-Law.com. The proposal is a significant extension of the Bank of England's existing powers to prevent the payment of bonuses that have not yet been awarded to individuals.

"This proposal would take pay governance into a new phase," said Matthew Findley, an expert in executive remuneration, share plans and incentives at Pinsent Masons. "It would be another step towards greater regulation of pay, albeit with an understandable risk management focus."

"Requiring employment contracts to be amended would present a number of issues, not least that it risks blurring the line between whether bonus arrangements are contractual or discretionary. Employees affected by the change may also be alarmed by the retrospective imposition of clawback, which is something companies have not legally been able to do to date without employee consent," he said.

The PRA's Remuneration Code already contains 'malus' provisions which prevent the payment of bonuses which have not yet become fully payable to the employee. The consultation proposes the addition of 'clawback' provisions that could be used where variable pay awards have already become payable, or 'vested' in the employee. The proposed rules would come into force on 1 January 2015, and firms would be required to take "reasonable steps" to apply them to awards made before that date but which vest afterwards subject to a six-year time limit.

Vested remuneration could be clawed back where there is reasonable evidence of employee misbehaviour or material error, or where the firm or a relevant business unit suffers material financial downturn or risk management failures, according to the consultation. Firms would be entitled to claw back bonuses not only from those employees directly responsible for poor performance or risk management failures, but also from indirectly accountable senior staff or those that could have been reasonably expected to be aware of the failure or misconduct but did not take adequate steps to indentify, address, report or prevent it.

The proposals are not intended to replace the recommendations made by the Parliamentary Commission on Banking Standards (PCBS) in relation to pay and performance, and the PRA said that it would consult on taking those forward later this year. The PCBS, led by Treasury Select Committee chair Andrew Tyrie, recommended the creation of a new Remuneration Code for senior bankers, under which more remuneration would be deferred for much longer periods and paid in forms which favour long-term performance.

Employment law expert Christopher Mordue of Pinsent Masons said that the PRA's proposals were "more coherent in policy terms" than the European Commission's recent changes in relation to bankers' pay, which includes a 'cap' on limiting variable pay to 100% of salary in any given year, or 200% of salary with the agreement of shareholders. The UK Treasury is currently challenging the legality of the cap at the Court of Justice of the European Union (CJEU).

"The PRA's changes to the Remuneration Code are aimed at ensuring that bonuses are aligned with responsible long-term approaches and can be recovered in the event of malpractice or failures in risk management," Mordue said. "However, the effect of the bonus cap is that firms are having to move more out of the total remuneration package onto the fixed pay side of the equation and out of the scope of the sort of clawback provisions being proposed by the PRA today."

"The net effect is actually to reduce the amount of pay which is subject to clawback, or other performance and risk adjustments. While 'bonus bashing' remains a popular sport, the reality is that increasing the proportion of the remuneration package which is paid though bonuses creates more scope to make pay conditional on long-term performance and responsible practice, and the bonus cap serves to weaken rather than strengthen the regulation of variable pay."

He added that although it would be straightforward for firms to introduce the proposed new rule in relation to new pay awards, it would be far more difficult to introduce them retrospectively for existing but as yet unvested awards.

"If the terms of the bonus scheme don't allow for unilateral variation by the firm, any variation would have to be mutually agreed which will require some incentive to be given to the employee to obtain their consent for such a material change," he said.

"It may be possible in the case of existing employees to make participation in future awards conditional on applying these rules to existing but unvested awards, but for former employees no such bargaining room will exist. Even though the obligation is to take 'reasonable steps' to achieve retrospective effect, there will be room for argument about what 'reasonable steps' actually involve and how far firms have to go to try to reopen the basis on which existing awards have been granted," he said.