Proportionality key to overlapping remuneration rules

Remuneration continues to draw attention from the regulators. While wholesale brokers were specifically called out on weak reward structures in this year’s Dear CEO letter, many investment firms are still struggling with meeting the IFPR remuneration requirements and PRA-regulated firms have been hit with a swathe of publications on the topic. Taking the time to analyse how you are affected and setting out a proportional approach for your firm is key to getting it right.

It’s been over a year since the implementation of the MIFIDPRU Remuneration Code (SYSC19G) under the IFPR. We’ve seen several firms making progress in implementing the new remuneration requirements, whilst others are still trying to get to grips with them. Common challenges include striking an appropriate balance between fixed and variable components, complying with the correct remuneration requirements, and ensuring that the correct disclosures are published. In particular ‘exempt-CAD’ firms have had to start from scratch having never had to comply with this type of requirement.

In its ‘Dear CEO’ letter addressed to wholesale broker firms, published on 11 January 2023, the FCA set out that the issues around weak incentive and reward structures that were highlighted in its 2019 ‘Dear CEO’ letter, remain a concern. In particular, the FCA considers that low salaries and high bonuses based on the value and volume of trades are likely to result in a risk to client outcomes.

There have also been a number of regulatory developments in the banking, credit institutions, building societies and PRA designated investment firms’ remuneration space with the PRA issuing a number of publications that propose changes to the remuneration Part of their Rulebook. The main PRA proposal that received attention from the industry is the removal of the ‘bonus cap’. Although this provides firms with the discretion to set their own fixed-to-variable pay ratios, firms will still need to ensure that the ratio is appropriately balanced, and that fixed pay remains a sufficiently high proportion of total remuneration.

In the same way that MIFIDPRU investment firms are required to comply with the requirements under SYSC 19G to set their own fixed to variable pay ratios, PRA regulated firms will have to carry out their own assessment of what they deem to be an ‘appropriate ratio’ with minimal regulatory guidance, although the removal of the bonus cap seems beneficial to them, as it allows firms to tailor variable pay offerings to reflect their individual financial situation.

There are a number of common themes we have seen firms tackle when it comes to complying with remuneration requirements.

Appropriate balance between the fixed and variable components

MIFIDPRU investment firms need to ensure that the fixed and variable components of the total remuneration are appropriately balanced. Non-Small and non-Interconnected (Non-SNI) firms are required to set their own ratios in line with:

  1. the firm’s business activities and associated prudential and conduct risks; and
  2. the individual’s role in the firm and, in the case of Material Risk Takers (‘MRTs’), the impact that those individuals have on the risk profile of the firm or assets it manages.

Non-SNI firms are also required to be able to explain to the FCA why the chosen ratio is appropriate. The FCA has not provided a great deal of guidance on what it considers as an ‘appropriate’ ratio so it’s even more important for non-SNI firms to make sure that their analysis behind the chosen ratio is documented effectively and that they can show they have taken into account the criteria set out above as part of their analysis.

Application of malus and clawback arrangements

All non-SNI firms are required to implement malus and clawback arrangements to the pay of MRTs under SYSC 19G. This means that some firms have had to apply these requirements for the first time and as a result, employment contracts or partnership deeds relating to MRTs have needed to be updated with relevant employees informed accordingly. Introducing these risk adjustment arrangements has also meant that firms have needed to establish formal procedures and put in place the right resources to be able to investigate cases where malus and clawback arrangements need to be enforced How to apply these rules in practice may vary from firm to firm but should be proportionate to your size, business and risk profile.

Application of more than one remuneration code

Collective Portfolio Management Investment firms (CPMIs) are subject to both the SYSC 19B (AIFMD Remuneration Code) or SYSC19E (UCITS Remuneration Code); and SYSC 19G as that they carry out both non-MIFID and MIFID business. Where an MRT working within a CPMI firm has responsibilities for both the MIFID and non-MIFID business of the firm, the firm will need to apply the stricter of the requirements irrespective of whether the MRT works primarily for the non-MIFID business of the firm.

Where CPMI firms need to comply with two different remuneration codes, they need to carry out a number of assessments of the responsibilities of each of their MRTs on a case-by-case basis to determine which of the remuneration codes should be applied to their remuneration arrangements. We have observed that several CPMI firms struggle with carrying out these assessments when taking into account the complexity of the requirements and the divergence between the requirements of the different Codes. It’s worth dedicating time and effort to analyse and map the personnel subject to the respective requirements to get this right.

Disclosures and remuneration report (MIF008)

All MIFIDPRU investment firms need to disclose information relating to their remuneration arrangements. However, the content that needs to be disclosed depends on whether firms are SNIs, non-SNI or large non-SNIs. Due to their size, several firms that are SNI firms are finding that although the FCA only requires them to disclose the total amount of fixed remuneration split into the fixed and variable amounts, there would still be a possibility that disclosing these amounts would result in the indirect disclosure of an individual’s remuneration.

MIFIDPRU investment firms that form part of a group and have staff members that carry out activities for multiple entities find it difficult to determine the amounts of remuneration that should be disclosed split into fixed and variable amounts. Complexity is added if the MIFIDPRU entity is not the entity that awards remuneration. This is a similar issue that firms are experiencing when completing their MIF008 report. The remuneration disclosures are designed to capture remuneration awarded in connection with the regulated activities of a regulated firm. In this regard, firms will need to take into consideration the time that a staff member that performs tasks for a number of different entities spends on performing tasks relating to that particular entity to which the disclosures relate. However, it is not so straightforward when it comes to calculating variable remuneration as it is not a given that this will be awarded on a pro rata basis according to the time spent carrying out tasks for the entity. For example, it may be that the entity did very well for the year compared to the other entities that the staff member carries out tasks for so 80% of the staff member’s bonus derives from that entity’s performance. This should be considered on a case-by-case basis.

How can we help?

We support firms of all business models and sizes on the implementation of the various UK remuneration codes. Specifically, we can:

  1. Carry out an independent review as required under the MIFIDPRU Remuneration Code and assess the design and the operational effectiveness of your firm’s remuneration framework and whether it meets with the regulatory expectations.
  2. Review your firm’s governance arrangements, policies and procedures relating to remuneration to determine whether the design is adequate and appropriate.
  3. Conduct sample checks on the documentation in relation to remuneration of the staff members to determine whether your firm has properly implemented the MIFIDPRU Remuneration Code on operational level.
  4. Present details of our findings on the implementation of the MIFIDPRU Remuneration Code and make recommendations on areas which need improvement in line with the FCA rules and industry best practice.
  5. Provide a disclosure template that sets out all of MIFIDPRU’s disclosure requirements in accordance to whether the firm is an SNI, non-SNI or large non-SNI firm.

We are represented on AIMA’s Remuneration working group so all our clients benefit from the valuable insight into the latest developments in the industry and what is being established as best market practice by their peers.