The Policy Statements issued by the PRA and FCA on October 24, 2023 provided for the cap on banker bonuses to be lifted with effect from October 31, 2023. This change applies to banks, building societies and PRA-designated investment firms. The government indicated in 2022 that it would take this approach, which it says will facilitate trade and economic growth to help the UK’s financial services industry prosper.

We wanted to take a look at the reasons why the cap was introduced, what the new rules say and what the practical implications are for affected financial services firms now that the cap has been removed.

Introduction of the bonus cap

The bankers’ bonus cap was introduced in 2014 by the European Union (at a time when the UK was a member of the European Union) following the financial crisis and its effects on the global economy.

The cap limited a payout of bonus to 100% of fixed pay, or 200% where shareholder approval was obtained, and it applied to staff within a firm that were “material risk takers”. The rationale behind the cap was to prevent excessive risk taking by these staff.

At the time, the FCA and PRA stated that the cap was a factor in limiting labor mobility, which they noted did not apply in the world’s leading financial centres outside the European Union.

This move by the government to scrap the rules is indicative of a push to make the UK a more competitive place for business following its exit from the European Union.

What do the new rules say?

Essentially, there is no longer a cap on the variable remuneration that firms can award to “material risk takers”. Both the PRA Rulebook for Capital Requirement Regulation (CRR) firms and the FCA’s Senior Management Arrangements, Systems and Controls (SYSC) sourcebook have been amended accordingly.

The PRA’s Policy Statement has also clarified that, whilst there remains an expectation that firms will make every effort to comply with the European Banking Authority’s 2015 Guidelines on sound remuneration policies, the sections of the Guidelines stipulating a bonus cap no longer apply to firms as a result of the PRA and FCA’s decision to remove the cap.

However, firms must note the following requirements in the FCA’s SYSC sourcebook.

• Firms are still required to set an appropriate ratio between fixed and variable remuneration to ensure they are appropriately balanced.
• When determining the appropriate balance for the ratio, all relevant factors must be considered – including the firm’s business activities and associated prudential and conduct risks, as well as the role of the particular individual in the firm.
• Firms can set different ratios for different categories of staff. The FCA has stated that it considers that it will usually be appropriate to set a lower ratio of variable to fixed remuneration for “control functions than for the business units they control”.
• A firm should be satisfied that it has considered all relevant factors and should be able to explain its decision to the FCA if requested.

The new rules regarding remuneration policies came into effect on October 31, 2023, without any transactional period for firms to adjust their policies. This means that firms have the flexibility to review their remuneration practices at their discretion, but they should avoid falling behind if other firms have already begun reviewing their policies. It’s important for firms to stay up-to-date with their remuneration policies.

Will the main aims succeed?

The removal of the cap might be welcomed by material risk takers as it means that there is no longer a limit on their variable remuneration package. The government’s hope is that this will encourage the relocation of financial services talent to the UK and encourage more business to take place in the UK, making it a competitive financial hub.

The other key aim is to allow firms to have more flexibility over their fixed costs, which should help make them more resilient, especially in turbulent economic times when there is a downturn in transactions and global trade. This change should also help better align risk and reward for firms’ material risk takers.

Whether these aims will come to fruition is currently unknown, but the general sentiment from the government appears to be that the removal of the cap is good for financial services.

Although the potential benefits to firms in the removal of the cap are clear, firms must be careful in ensuring that they can justify their decisions in awarding variable remuneration. The rationale must be documented to assist them in the event that employees and/or the FCA question a particular award.

Firms must ensure that fixed pay remains a sufficiently high proportion of total remuneration. Variable remuneration will also continue to be subject to requirements such as malus, clawback and deferral.

Issues for firms to consider

Firms should take into account the following factors.

• The need to document their compliance with the updated rules; in particular, showing that they have considered what the appropriate balance should be between fixed and variable remuneration.
• Exercising caution in reducing salaries as this could risk claims of constructive unfair dismissal, for example. In the current economic climate, it seems unlikely that bankers and traders will readily agree to reduce their fixed pay in return for higher variable pay.
• Being wary of potential staff attrition if they take a harsher approach than their competitors in implementing the rules, for example by deciding to lower fixed pay significantly.
• Bearing in mind that paying new hires less than existing staff could result in potential discrimination claims, including equal pay claims. This needs to be carefully considered especially in light of the FCA and PRA’s recent consultation papers on Diversity and Inclusion and emphasis on positive firm culture.
• Where shareholder approval was obtained to increase the cap up to 200%, firms must consider whether any approval is required to remove the current cap, for example in a company’s articles of association (this will likely vary from firm to firm). Shareholder meetings commonly take place annually so there could be a delay in receiving approval, where required.

Whilst the new rules might be welcomed by material risk takers and firms alike for the greater flexibility in determining remuneration packages, firms must satisfy themselves of the necessary decision-making process when making remuneration awards. The onus is on them to demonstrate that the ratio between fixed and variable pay is appropriately balanced.