On 26 November 2024, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) (together the Regulators) published a joint Consultation Paper (PRA CP 16/24, FCA CP 24/23) on reforming the remuneration regime applicable to banks, building societies, and PRA-designated investment firms.  

See also Restrictions on bonuses relaxed for UK senior bankers.

Background and rationale

The current remuneration framework in the UK for banking sector firms was introduced in the wake of the 2008 global financial crisis through EU legislation. The regime pre-financial crisis was thought to have overly incentivized bankers to take excessive risk and was thought to be one of the contributing factors to the crisis.

For dual-regulated firms, the current remuneration regime is set out in the Remuneration Part of the PRA Rulebook and the FCA Remuneration Code in SYSC 19D.

It was expected that further relaxation of the remuneration rules would be forthcoming, and the Consultation follows on from the Regulators’ removal of the bankers’ bonus cap and amendments that enhanced proportionality for small firms last year.

The Consultation also follows hot on the heels of Chancellor of the Exchequer Rachel Reeves’ recent Mansion House speech in which she described regulation as having “gone too far”, before headlining plans to reform the Senior Managers and Certification Regime (SMCR) and remuneration.

In the Consultation, the Regulators propose various changes to make the remuneration regime for banks “more effective, simple and proportionate”, whilst still ensuring accountability for risk taking and appropriate outcomes for consumers and markets. Crucially, the proposals also support the Regulators’ secondary objectives, which are to support the international competitiveness of the UK economy and its growth in the medium to long term.

Proposals under the consultation

Population to be impacted by the remuneration rules

MRT identification

The remuneration rules apply primarily to individuals identified as “Material Risk Takers” (MRTs), being employees whose professional activities have a material impact on a firm’s risk profile. Currently, firms are required to identify MRTs using qualitative and quantitative criteria. The Regulators are not proposing to change the qualitative criteria (relating to roles), but changes are proposed to the quantitative criteria (relating to remuneration as they have been deemed not fit for purpose – having been introduced to apply across a range of EU financial markets, rather than just in the UK.

Under the current regulatory framework, the quantitative criteria are met if an employee earns equal to or greater than £660,000 ($835,000), or is within the 0.3% of highest earners within a firm. The Regulators are proposing to have a single quantitative MRT identification threshold whereby firms are expected to consider identifying as MRTs individuals within their 0.3% of highest earners. Note that this will become an expectation instead of a rule-based criterion, meaning that firms will have discretion to consider whether staff within their 0.3% of highest earners, not already captured by qualitative criteria, should be categorized as MRTs.  

In line with the move away from rule-based quantitative criteria, the Regulators propose to remove the requirement for firms to seek regulatory approval for excluding any individuals (solely identified by quantitative criteria) from MRT categorization. This gives firms greater autonomy and flexibility. However, this emphasises the importance of having adequate and effective controls in the MRT identification process to ensure that individuals with the potential to materially impact the risk profile of a firm continue to be captured as MRTs. To enable this, the Regulators are proposing to introduce a rule to require employees who have responsibility for the overall management of the risk controls of a firm to annually review the MRT methodology.

MRT proportionality thresholds

The PRA proposes to amend the remuneration threshold at which firms may disapply certain remuneration rules (such as deferral or payment in instruments), to MRTs, by reverting to the previous (ie pre-CRD V) individual proportionality threshold of £500,000 ($633,000), adjusted for inflation to £660,000 ($835,000) total remuneration. CRD V had reduced the threshold from £500,000 ($633,000) total remuneration to £44,000 ($56,000) variable remuneration, thereby significantly increasing the number of MRTs subject to full remuneration requirements.

This means individual MRTs at firms will need to meet the following quantitative conditions to benefit from proportionality and disapply the rules mentioned above:

• total remuneration does not exceed £660,000 ($835,000); and
• variable remuneration does not represent more than 33% of the employee’s total annual remuneration.

In addition, the PRA also proposes to simplify the rules applicable to MRTs by removing the categories of “Higher Paid” MRTs and “Significant firm” that were introduced in CRD V implementation. This will simplify the current regime which has a complex matrix due to the interaction of various pay thresholds and firm categories, resulting in two MRT proportionality categories for all types of dual-regulated firms.

Changes to Remuneration Rules

Deferral and variable remuneration

Currently, the payment of variation remuneration (such as bonuses) provided to certain Senior Management Functions (SMFs) are deferred for at least seven years. The rationale behind deferring the payment of such bonuses is that it would help to incentivize senior bankers to focus on the long-term performance of the firm, as the result from the risk-taking often only becomes clear over time.

However, the PRA identified that other jurisdictions have shorter deferral periods than the UK and industry feedback indicated that the seven-year deferral period for SMFs constituted a significant challenge to competitiveness – making it more difficult to attract talent from abroad or from other sectors, for example technology. Research had also found that longer deferral periods may have resulted in firms compensating SMFs with higher total remuneration and a larger proportion of that remuneration being fixed – increasing firm’s fixed costs and reducing the relative amount of remuneration subject to remuneration rules, for example performance adjustment.

As a result, the Regulators propose to reduce the seven-year minimum deferral period that applies to certain SMFs to five years, and in the case of a non-SMF MRT, the minimum deferral period would be four years. The PRA considers that on balance shortening deferral periods is acceptable from the perspective of safety and soundness.

The PRA is also proposing to allow deferred remuneration awards to SMFs to vest on a pro rata basis from the time of award, rather than only starting to vest after three years. This means that the relevant SMFs will begin to receive their bonuses a lot faster, which will facilitate the attraction of talent to the UK and also reduce the costs of compliance for firms operating across other international jurisdictions, thereby enhancing the UK’s competitiveness.

Finally, the PRA is also proposing to remove the ban on the payment of dividends and interest, which means that firms will no longer discount the value of instruments upon awarding them to MRTs, thus lowering compliance costs. The PRA will also remove the regulatory minimum length of retention periods for deferred instruments, which will lower costs of compliance by giving firms discretion to choose what the appropriate minimum length should be.

Managerial accountability through remuneration

The PRA is proposing changes to link the SMCR with the remuneration regime more closely. Although the two regimes were set up with different aims, they complement each other, and most individuals identified as MRTs under the remuneration regime will either be an SMF or a certified function under the SMCR.

As a result, the PRA proposes to introduce a rule and expectations for firms to consider adjusting remuneration in situations where it is reasonable that MRTs, by virtue of their role or seniority, could be held responsible for risk events or for failings or weaknesses in relation to risk events.  The PRA’s analysis had shown that in 80% of risk events that led to the application of malus to some bank employees, no SMF’s remuneration was affected.

It is expected that this new rule will result in more senior MRTs (with relevant oversight responsibility for the individuals they line manage or oversee) having their remuneration impacted as a result of adverse risk events, even in circumstances where the senior MRT is not directly culpable for malfeasance and where the risk event does not result in loss.

The PRA also proposes to introduce a requirement to ensure that a senior manager’s variable remuneration should reflect their failure or success when delivering PRA supervisory priorities (for example those set out in PSM letters), aiming to incentivize senior management to increase their own internal monitoring when they delegate tasks as well as to ensure that actions identified by supervisors are addressed promptly.

Lastly, the PRA proposes to clarify expectations for remuneration committees when making variable remuneration adjustments. The proposed amendments include updated expectations on:

• how firms should document the link between senior management variable remuneration outcomes and responsibilities to enhance pay transparency and aid remuneration decisions;
• how remuneration committees should engage at board level with other committees to improve risk management, and the information remuneration committees should consider when incidents occur(for example, accountability reviews, root cause analyses, and findings from audit and internal or external regulatory reviews);
• that performance adjustments should be considered even if an incident does not result in a loss for the firm.

Simplifying the duplicative PRA and FCA rules

Currently, the Regulators each have a set of remuneration rules which dual-regulated firms must comply with, and they substantially mirror each other. The FCA proposes to change the structure of its remuneration rules so that they largely cross-refer to the PRA’s remuneration rules, although there will remain a handful of cases where the FCA will retain rules and guidance that are specific to the FCA with no PRA-equivalent.

This proposed simplification would remove the need for the FCA to maintain its own set of parallel remuneration rules, and it would also ensure that the FCA’s remuneration rules for dual-regulated firms automatically update each time the PRA updates or changes its rules. 

There is one substantive policy change that the FCA is specifically proposing, which is to exempt dual regulated small firms from the buy-out requirements. The FCA did not make the corresponding policy change at the time the PRA updated its rules on this, so this change is now being made as part of the alignment of the Regulators’ rules.  

Comments

The proposals will no doubt be welcomed by banks, who stand to benefit from a reduced regulatory burden and a greater ability to attract top talent.

The move will have the effect of:

• reducing the number of senior bankers impacted by remuneration restrictions; and
• making such restrictions (to the extent they do apply) less onerous.

Firms will need to identify the correct pool of MRTs once the new rules come into effect and, for those who continue to be MRTs, work out whether the requirements to defer, etc can be disapplied. Similarly, firms will need to think about the appropriate remuneration structures for those who drop out of the MRT regime. 

This signifies both the PRA’s continued efforts to achieve its secondary competitiveness and growth objective and a post-Brexit step away from the EU-originating rules and (for example, thresholds introduced by CRD V). The reduction of pay deferral length however simply brings the UK in line with EU counterparts, the UK previously being an “international outlier”, as was flagged by Ms Reeves in her Mansion House speech.

In giving firms greater autonomy and flexibility, firms will need to consider updating their remuneration structures, policies, processes and governance framework, for example to ensure that they (and accountable senior managers and Remuneration Committees) have robust evidence and audit trails in respect of the identification of MRTs and performance adjustment considerations for MRTs, even in circumstances where the MRT is not directly culpable and the risk event does not result in a loss for the firm.  

The Regulators’ wish to improve “managerial accountability through remuneration” seems designed to drive a cultural shift within some firms (given the 80% figure mentioned above). It is also something that firms should bear in mind during investigations, disciplinary processes, etc. For example, if an individual is found to be guilty of a significant oversight or regulatory failure, firms ought to consider what impact that should that have on the variable remuneration paid to that individual’s line manager.

Next Steps

The Regulators invite feedback on the proposals set out in the consultation by March 13, 2025.  The proposed changes in this consultation paper would come into force on the next calendar day after publication of the final policy (anticipated for 2025 H2) and would apply to firms’ performance years starting after that date. The proposals are not intended to be applied retrospectively as the Regulators understand that retrospective application would be overly burdensome for firms.