A PRA consultation paper published earlier this month sets out the regulator's proposals for revising the terms on which variable awards that are forfeited when an employee leaves employment are "bought-out" by a new employer. The proposals follow the joint PRA and FCA consultation paper published in July 2014 ("Strengthening the alignment of risk and reward: new remuneration rules") and the policy statement published in June 2015.
What is current practice?
It is not unusual for new employers to "buy-out" a new recruit's existing awards which the employee will forfeit on the termination of their employment and the taking up of new employment. The new employer will typically ensure the new award has vesting provisions which mirror those of the bought-out award.
Who will be affected by the PRA's proposals?
The proposals only extend to Material Risk Takers moving from one Proportionality Level 1 or 2 PRA-regulated firm to another. However, as with many remuneration regulations and practices that have started life in the top tiers of the financial services sector, there's a good chance that other entities within financial services and other sectors altogether may adopt similar practices and/or be subject to the current proposals in due course.
What are the proposals?
The PRA recognises that the culture of buying-out awards undermines the effectiveness of malus and clawback on the original awards. Accordingly, they have proposed that any bought-out awards should remain subject to malus and clawback, with the former employer determining when and whether malus and clawback should be applied. The bought-out awards would therefore continue to be linked with risk and conduct issues identified by the previous employer (i.e. during the employee's previous employment).
The new employer's contract with the employee would need to provide for the possibility of malus and clawback to be applied in respect of bought-out awards based on a determination by the former employer. The grounds for applying malus and clawback would have to include, as a minimum, misconduct or failures of risk management. The former employer will be under a duty to act fairly and reasonably in making any determination and will be required to provide the employee with details and reasons for applying any proposed malus or clawback. The employee will be able to explain why malus or clawback shouldn't apply and the former employer will need to take this explanation into account when determining whether malus or clawback should apply. In addition, the new employer will be entitled to apply for a waiver where they believe the former employer's decision to apply malus or clawback has been manifestly unfair or unreasonable.
Assuming no waiver is sought, the new employer would need to operate malus or clawback to the extent determined by the former employer.
What are the likely problems with the proposals?
With clawback periods being extended, we can see the attraction in the proposals as a means of maintaining the effect and impact of malus and clawback provisions on employees. However, we have identified a few practical difficulties with them. First, it remains to be seen whether new employers will use the waiver process to the benefit of their new employees. In particular, it is not clear how a new employer would be able to judge whether a decision by the old employer that malus or clawback should apply is unfair or unreasonable, given that the new employer is likely to have limited information on the former employer's reasoning. It is also not clear what, if any, information the former employer will be required to disclose either to the employee or the new employer in explaining its decision, and whether confidential or sensitive information may need to be shared, which may not be desirable or possible. Finally, given that clawback could apply for ten years, it is not clear what would happen if a bought-out award was to be bought out again. Presumably the newest employer would always need to reflect a determination made by the original employer with respect to malus and clawback. However, in reality, this is likely to be problematic.
What happens next?
The consultation closes on Wednesday 13 April 2016. Please get in touch with your usual Stephenson Harwood contact if you'd like to discuss the consultation and/or if you'd like for us to feed back your comments on the consultation to the regulators.