On 1 January 2011, the FSA's revised Remuneration Code of Practice came into force. It is intended to reduce incentives for inappropriate risk-taking by firms and consequently promote financial stability, sustain market confidence and protect consumers. The revised Renumeration Code replaces the previous version which was introduced with effect from 1 January 2010 in response to widespread concern that certain incentive structures within large banks and other financial institutions had encouraged excessive risk-taking and, as a result, contributed to the financial crisis and its economic impact.
The revised Remuneration Code now applies to a wider array of organisations (from approximately 26 firms to over 2,500). These organisations include banks and building societies, broker dealers and certain investment firms, which may include some hedge fund managers, and firms that engage in corporate finance, venture capital and the provision of financial advice. The Code contains 12 principles covering (amongst other things) the following:
- remuneration policy and structures should be consistent with and promote sound and effective risk management and policies should support the business strategy and long term interests of the firm, not encourage excessive risk-taking, and avoid conflicts of interest;
- larger firms must establish a remuneration committee consisting exclusively of non-executive members;
- measurement of performance conditions for variable remuneration must be based principally on profits, should include adjustments for all types of current and future risks and take into account the cost and quantity of capital and the liquidity required;
- both the assessment of performance and payment of performance-based remuneration should be made over a multi-year period;
- guaranteed bonuses should not be used unless in exceptional circumstances;
- fixed and variable remuneration should be balanced and allow for the possibility of paying no variable remuneration at all;
- payments in connection with early termination of contracts with Code staff should not reward failure;
- at least 40% of variable remuneration (60% in some cases) should be deferred over a period of three to five years;
- at least 50% of variable remuneration (including both the deferred and non-deferred elements) should consist of shares, share-linked instruments or equivalent ownership interests and be subject to a retention policy (that is, only 20-30% of bonuses can be paid immediately and in cash); and
- variable remuneration (including that which is deferred) should only be paid out according to the financial performance or situation of the firm as a whole (that is, the firm should reduce unvested remuneration in the case of employee misbehaviour, material error, material downturn in financial performance or material failure of risk management).
There are also provisions on pensions, the relationship between variable remuneration and the ability of firms to strengthen their capital base, the use of personal investment strategies and Remuneration Code avoidance vehicles.
Those firms which were subject to the previous Remuneration Code must comply with the new Code from 1 January 2011. Firms newly within the scope of the Code are required to comply by 1 July 2011.
Compliance with aspects of the Code is proportionate to the type and size of Code firms. If firms fail to comply with certain Code requirements, then those contractual provisions with Code staff that contravene the Code will be void and firms must take reasonable steps to recover payments made pursuant to those provisions.
Firms subject to the Remuneration Code are required to comply with certain disclosure requirements.
View the FSA's policy statement on revising the Remuneration Code and its final rules (114 page pdf).