Remuneration Code: Clawback and the Bonus Cap

July 28th, 2014

In recent days, two pieces of news related to the most controversial elements of the Remuneration Code have emerged: clawback, and the bonus cap.  The Remuneration Code applies to the variable remuneration (i.e. bonus) of certain employees of banks, building societies, investment firms, and some overseas firms of a similar nature.

Clawback

Following the conclusion of the PRA’s consultation on “clawback”, the final instrument amending SYSC 19A (the Remuneration Code section of the PRA and FCA Handbooks) has been published by the PRA.  It is available here.

Clawback is a contractual mechanism whereby a firm may require repayment of remuneration already paid to an employee.  Under the proposals, variable remuneration (only) must be subject to clawback for a period of at least seven years from the date on which it was awarded.

The rules will only apply to PRA-regulated firms, which is a smaller group that to which the Remuneration Code applies generally.  For example, although the Code applies to all investment firms, only nine of the biggest investment firms are PRA-regulated. 

The key rule will be SYSC 19A.3.51B R (see the instrument):

A firm must make all reasonable efforts to recover an appropriate amount corresponding to some or all vested variable remuneration where either of the following circumstances arise during the period in which clawback applies:

(a)  there is reasonable evidence of employee misbehaviour or material error; or

(b)  the firm or the relevant business unit suffers a material failure of risk management.

A firm must take into account all relevant factors (including, where the circumstances described in (b) arise, the proximity of the employee to the failure of risk-management in question and the employee’s level of responsibility) in deciding whether and to what extent it is reasonable to seek recovery of any or all of their vested variable remuneration. 

Clearly, firms will struggle with phrases such as ‘all reasonable efforts’, ‘reasonable evidence’, ‘all relevant factors’ and ‘to what extent it is reasonable’.  For an in-depth discussion of the issues relating to clawback (including some of those terms), see Richard Leiper’s excellent article in the ELA Briefing (£).   The PRA’s instrument comes into force from 1 January 2015, and applies only to remuneration awarded after that date.

The Bonus Cap

At present, employees subject to the Remuneration Code may only be awarded a bonus that is no more than 100% of salary: see SYSC 19A.3.44 R.  However, a firm may award bonuses of 200% of salary, so long as the shareholders of the firm consent in accordance with the procedure set out in SYSC 19A.3.44B R.  The procedure requires, among other things, that 66% of the shareholders agree to the higher cap, or 75% if less than 50% of the shareholders are represented at the vote (as measured by voting power, rather than the number of shareholders).  The procedure is transposed from article 94(1)(g)(ii) of CRD4.

The European Banking Authority has now issued a Q&A on the precise mechanisms to be adopted at such a shareholder meeting.  It should be stressed, however, that the Q&As do not have the force of law, nor do they have ‘comply or explain’ status.  However, they may be of persuasive value in any future proceedings, and the Commission has a role in the drafting of the Q&As.   Two issues are usefully fleshed out by the Q&As:

First, there are points as to the specific procedure to be adopted at a shareholder meeting:

…without prejudice to national law, it should be noted that to determine what proportion of the share/ownership rights is “represented” as required by CRD, a poll vote should actually take place at the relevant shareholder meeting (even if the outcome of such a vote may appear obvious from a show of hands and/or any proxies received). In line with the applicable company law, firms should make it clear to shareholders/owners how each form of conduct (voting for or against, sending a proxy, abstaining, attending but not voting etc.) will be treated for the purpose of being represented. The meaning of being “represented” is the same for the threshold test (i.e. the 50% test) as for the majority test (i.e. the 66% or 75% test).

Voting results should be duly documented and disclosed.

Second, the issue of what to do with the votes of employees whose remuneration is at stake in the vote is addressed.  CRD4 and SYSC 19A.3.44B R (4) make clear that those employees are not to be permitted to participate in the vote on the bonus cap.  Helpfully, the Q&A states that the voting rights of those employees should not be counted in relation to the denominator, either.  In other words, when calculating whether a 50%, 66% or 75% threshold has been reached, the voting rights of those employees should be ignored entirely. 

Thomas Ogg

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