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Senior UK bankers' bonuses could be clawed back up to 10 years after vesting under new rules


UPDATED: UK banks will be able to order repayment of bonuses by senior bankers up to 10 years after the award where serious misconduct comes to light, according to new rules published jointly by the regulators.

The new rules also extend the 'deferral period', over, or at the end of which a proportion of bonuses and other variable forms of remuneration will be delivered. The EU mandated minimum period is three to five years for all staff deemed to be 'material risk-takers' at banks, building societies and the nine designated investment firms regulated by the Prudential Regulation Authority (PRA). As a result of the new rules, bonuses of designated 'risk managers' at all those firms will have a deferral period of at least five years, and those of senior managers at least seven years, the PRA and its fellow regulator, the Financial Conduct Authority (FCA), said.

The main purpose of the deferral is to make it possible for firms to reduce any deferred amounts before they are paid if relevant issues are uncovered at a later date – for example, negative financial performance by the firm or risk management issues. This process is typically known as ‘malus’, but the PRA and FCA's statements, rules and guidance sometimes use the broader term "ex-post risk adjustment" to refer to an adjustment that in practice would always, or usually, be made by malus. Strictly, malus is only one of three methods of ex-post risk adjustment, the others being: reduction of current or future variable remuneration by an amount equal to the necessary adjustment of earlier remuneration; and clawback of vested remuneration.

In a joint statement, the regulators said that the new framework has been designed to "further align risk and individual reward" and discourage excessive risk-taking. However, financial services employment expert Steven Cochrane of Pinsent Masons, the law firm behind Out-Law.com, said that they could affect perceptions of the competitiveness of UK financial firms.

"While these changes obviously chime with public and political concerns about the lasting impact of the 2008 financial crisis, they will raise some concerns about the competitive position of UK financial services firms," he said. "There is also the possibility of unintended inflationary pressures on total pay, as longer deferral inevitably reduces the value that recipients attach to deferred bonuses."

"The PRA's opposition to the EU bonus cap has been widely reported, and some may find that contradictory to these stricter deferral and clawback rules. The cap, deferral, malus and clawback are all aspects of the same EU legislation. In fact, the PRA's stance is logical: put simply, the PRA thinks deferral, malus and clawback preferable to the cap, as the latter is more likely to drive up pay and harm competitiveness, and less likely to effectively align pay with risk management," he said.

The new rules in effect strengthen the UK provisions implementing the EU-wide remuneration rules included in the revised Capital Requirements Directive (CRD IV), in response to recommendations made in June 2013 by the Parliamentary Commission on Banking Standards (PCBS). CRD IV restricted bonuses to 100% of salary or 200% with shareholder approval, and required bonuses to be paid in a mixture of cash and shares. The new remuneration rules will work together with additional rules giving effect to the PCBS' recommendations, including the new Senior Managers Regime which will come into force next year.

Provisions in relation to bonus deferral and clawback will come into force on 1 January 2016, and include the FCA implementing clawback rules for the first time. The PRA incorporated seven-year clawback periods into its remuneration code at the start of this year. The new clawback rules will be strengthened in relation to senior managers, to allow variable remuneration to be clawed back over an additional three years at the end of the seven-year period if the firm or regulatory authorities are investigating potential "material failures".

Deferral rules will be strengthened. The new regime will introduce a seven-year deferral period for senior managers, a five-year deferral period for PRA-designated risk managers with senior, managerial or supervisory roles, and a deferral period of between three and five years for all 'material risk takers' at the firm whose actions could potentially have a material impact.

The new rules also prohibit the payment of bonuses to non-executive directors at the firm, as well as explicitly forbidding any discretionary payments to be made to the management of a firm that is receiving taxpayer support. Both of these requirements will come into force on 1 July 2015, according to the announcement.

The regulators are also seeking further feedback on the treatment of 'buy-outs', in which a firm compensates a new employee for any unpaid remuneration that is cancelled when they leave a previous role. In last year's consultation paper, the regulators said that they were concerned that compensating new employees in this way meant that their previous firms were unable to reduce any payments still owing if previous misconduct came to light: a practice known as 'malus'. However, instead of banning buy-outs entirely, they instead intend to draft new rules requiring buy-outs to be made in a form that permits them to be subject to malus by the previous employer.

"If the PRA and FCA devise a workable system for ex-employers to apply malus to a new employer's buy-out awards, there could well be pressure for similar changes to executive remuneration outside financial services. Concerns over the potential impact of buy-outs is not limited to that sector, although they would be expressed in other sectors in terms of potential "rewards for failure", rather than the regulation of risk and financial stability" said remuneration expert Matthew Findley of Pinsent Masons.

"The task of devising that system seems to be quite a challenge, however; and any successful solution that relies on a common regulator for the old and new employers may be hard to apply to less intensely-regulated sectors. Of course, we are already seeing malus and clawback being required more stringently and adopted more widely in public companies, so the possibility of buy-out malus, if adopted, spreading beyond banks and large investment firms cannot be ruled out," he said.

Editor's note 30/06/2015: This story was updated to reflect the fact that malus is one of three methods of ex-post risk adjustment

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