The new conduct and remuneration regime for bankers: “Making individual accountability a reality”

July 30th, 2014

Introduction

On Wednesday 30 July 2014, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) released consultation papers relating to individual accountability and remuneration in the banking industry.  The changes apply, broadly speaking, to banks, building societies, credit unions and the nine investment firms designated by the PRA.

The proposed changes are detailed and wide-ranging.  This post concentrates on what is ‘new’: was revealed by the consultation paper, rather than setting out the framework that was set out in the Banking Reform Act and the Parliamentary Commission on Banking Standards.

The headlines are as follows:

Remuneration

  • The regulators have proposed new deferral and vesting periods for variable remuneration.  The minimum deferral period for Code Staff is increased from three to five years, and for senior managers (see below) the minimum deferral period is increased to seven years.  In both cases vesting must be no faster than pro rata.  The first vesting event must be delayed by a year for Code Staff, and by three years for senior managers.
  • Clawback, where a firm requires repayment back to the firm of remuneration already paid to employees, is proposed to be applied to the remuneration of both FCA and PRA-regulated firms currently within the Remuneration Code’s scope.  Clawback must be possible for a period of at least seven years from the date of the award of the remuneration.  For senior managers, firms must ensure that there is an option in employee contracts for the deferral period to be extended by three years (i.e. to ten years) where a firm has commenced an internal investigation (or a regulator has commenced an investigation) that could potentially lead to the application of clawback.
  • Buy-outs.  The PRA and FCA are consulting on four potential approaches to controlling the impact of firms buying out the variable remuneration lost by employees when they move positions, on account of ‘bad leaver’ clauses.  The options include: (1) banning buy-outs; (2) banning bad leaver clauses, for the purpose of ensuring that malus rules would continue to apply; (3) in effect, the regulator applying malus to buy-out awards; (4) relying only on clawback to control buy-outs.
  • Metrics.  The regulators are consulting on imposing a uniform rule for the calculation of profit, and for performance metrics, in relation to the calculation of bonus pools overall and for individual bonuses.

Conduct Rules

  • The FCA has stated that it intends to apply the Conduct Rules to all bank staff, except those in generic roles (such as receptionists or catering staff) “whose role would be fundamentally the same as it would be if they worked in a non-financial services firm”.  In other words, a far, far wider population of bank employees may now be disciplined by the FCA for misconduct.  The PRA has adopted a far narrower approach in accordance with its (prudential) objectives.  The rules under APER will continue to apply to non-banks.
  • The content of the proposed Conduct Rules is much the same as under the current approved persons regime (APER).  However, there is one new proposed rule for SMFs that is of note: “You must take reasonable steps to ensure that any delegation of your responsibilities is to an appropriate person and that you oversea the discharge of the delegated responsibility effectively”.
  • Notification of disciplinary matters.  Firms are proposed to be required to report breaches or suspected breaches of the Conduct Rules by a SMF within seven days of the firm becoming aware of the matter.  In relation to other staff, firms will be required to produce a quarterly report only to the FCA.
  • The PRA has elected not to provide detailed guidance as to the effect of the new Conduct rules.  The FCA, however, has produced guidance.  This accords with the regulators’ differing approaches to producing policy material.

Senior Managers Regime

  • PRA-specified senior management functions (SMFs), who are the most senior individuals in a bank, are relatively small in number.  Only 11 specific positions are specified in the consultation paper.  The FCA-specified SMFs are far more numerous, including all non-PRA-specified board members, and certain functions currently specified under APER (e.g. the compliance and money laundering functions).
  • Banks will be required to produce a ‘responsibilities map’ which sets out how management and governance arrangements are allocated throughout the firm.  The responsibilities map should designed so that there are no gaps in accountabilities, and the firm’s board will be required to confirm annually that the map has no such gaps.
  • The PRA and FCA have taken slightly different approaches to the allocation of responsibilities amongst senior managers.  The PRA allocates specific responsibilities to each type of SMF – e.g. the chief finance function is responsible for finance.  In addition, the PRA has set out 18 ‘prescribed responsibilities’ that must be allocated to SMFs in the firm (whether PRA- or FCA-specified SMFs).
  • By contrast, the FCA will require the first 8 of the PRA’s prescribed responsibilities to be allocated to SMFs, but otherwise has a more flexible regime of ‘key functions’ that the FCA expects ought in most circumstances to be allocated to an individual SMF.  However, the consultation paper is relatively curt as regards the expected approach to handover certificates, and the content of statements of responsibilities.

Certification regime

  • The core of the certification regime is that banks rather than the regulators should assess the fitness and propriety of employees within the scope of the regime (which includes employees who could cause the bank ‘significant harm’, but are not SMFs).  However, the FCA does not propose to set out detailed rules for firms to apply.  Rather, it will amend the FIT section of the FCA Handbook “so that its application and relevance for firms’ assessments is readily apparent”.  By contrast, the PRA proposes to make general rules in due course.
  • Although the regulators differ slightly on their approach to general guidance, both regulators will require firms to (1) undertake a criminal records check before appointing a person to a certification function or a SMF and (2) take up references covering the last five years of the individual’s employment history for the same purpose.  Firms providing references will be required to disclose whether an individual breached a Conduct Rule, the basis for the firm’s conclusions, and any disciplinary action taken as a result.  This is a further expansion in the importance of references for individuals applying for jobs in the financial service industry.
  • The FCA’s proposed scope for individuals subject to the certification regime includes ‘material risk takers’ (i.e. individuals subject to the remuneration code); anyone who would have been a ‘significant influence function’ under APER but is not a SMF; customer-facing roles that have qualification requirements, as set out the Training and Competence Sourcebook section of the FCA Handbook; and anyone who supervises or manages another certified person.  However, only ‘material risk takers’ will be certified persons within the PRA certification regime, with certain exceptions.
  • If a firm refuses to renew the certificate of an individual, it will be required to “take reasonable care to ensure the individual ceases to perform the certification function in question”.  Clearly, the reasonableness of the removal of the certification will be key for the purposes of any unfair dismissal claims arising.

Impact on non-banks

  • Prior to the release of the consultation paper, the FCA had indicated that it was considering the changes that it would make to the approved persons regime for non-banks in the light of the changes for banks set out in the Banking Reform Act.  It would appear, at first sight, that those changes for non-banks are relatively limited.  Footnote 2 of the CP on accountability states: “Other regulated firms are not affected by the changes“.  As a result, the regulatory systems for individuals in respect of banks and non-banks will be quite different for the foreseeable future.

The deadline for responses to the two consultations is 31 October 2014.

Thomas Ogg

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