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08 Mar 2023

PRA proposes smaller banks will no longer have to operate clawback on key staff bonuses

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The Prudential Regulation Authority (PRA) has proposed that smaller banks will not have to include malus and clawback provisions in the bonus pay-out arrangements for key staff members. Malus and clawback provisions are where banks have the right to reduce key staff member bonuses before payment and claw back bonuses after payment in the event of personal or collective misconduct, material financial underperformance or risk failings.

Background

In 2021, all banks operating in the UK become obliged to adopt a number of pay practices for their key staff following the implementation of EU-wide banking remuneration reforms known as CRDV. While many parts of the remuneration regime still only applied to larger banks (e.g. deferring bonuses and part paying bonuses in shares), some of the CRDV package of measures was applicable to all banks. Included in the universal provisions were the bonus cap and also what have become known as "malus and clawback" provisions.

While larger banks had a long history of having to include these provisions in their remuneration arrangements, many small banks (including branches) had not previously applied malus and clawback (or the bonus cap) and it meant that their share plans, bonus plans and employment contracts had to be amended to provide for this with a substantial employee information programme. Their introduction has often been an emotive issue within these banks.

Following a September 2022 Government announcement, the PRA and Financial Conduct Authority (FCA) last year proposed that the bonus cap would be disapplied by all banks for remuneration applicable to performance periods beginning after the proposals took effect – so 2024 remuneration for most banks. A consultation period will close on this at the end of March. Click here for our alert on this.

PRA proposal

Following on from the bonus cap announcement, the PRA is now proposing that smaller banks will no longer need to apply malus and clawback provisions, as well as the buy-out rules. The buy-out rules limit the terms on which firms could buyout bonuses from former employers, both as to quantum and payout schedules and also include terms on which those bonuses were subject to malus and clawback. If malus and clawback rules are being removed, then it therefore clearly makes sense for these buy-out rules to be removed too.

The PRA recognises that maintaining malus and clawback regimes and buy-out rules are disproportionately expensive for smaller firms, who often lack the size of HR departments that larger banks maintain and that these higher costs could even threaten their cost base. Allowing them to operate without these strictures could also make them more attractive employers, thereby promoting competition within the new sector and assisting new entrants, potentially drawing overseas firms looking to do business in the UK. The PRA reports that it has in any event been giving a number of waivers to smaller banks allowing them not to apply these rules in any event.

It proposes that these rules should cease to be requirements from the first performance period after the rules take effect, which, with final rules likely to be published in Q4 2023, is likely to be 2024. This means that bonus payouts in 2025 might be the first to benefit from these changes, but there will be pressure for the rule changes to take effect sooner. The PRA also recognises that firms could be affected by having a performance year that starts later than the calendar year.  While firms with years that start later in the calendar year have often had a greater time to implement the steadily tougher regimes in the last 15 years, the flipside of this is that they are later to exit from these regimes where there are any relaxations of rules. The PRA encourages banks that are negatively affected to feed into the consultation.

Other points are:

  • The PRA is currently conducting a general review and consultation exercise on what "small" means in the banking context as part of the "Strong and Simple framework". However, the proposed small bank exception for remuneration purpose will go further. The main change from the current categorisation of small firm is that the threshold below which the bank's average total assets must fall is being raised to £20bn from £13bn. More details are contained in the consultation paper.
  • The PRA makes clear that it is not proposing that remuneration awarded by smaller banks for performance years from 2021 onwards should retrospectively have malus and clawback provisions removed. Banks will therefore have to operate two different regimes for some time, which will appear odd and there may be consultation pressure to change this and relieve past awards from having to continue to contain these terms. 
  • The PRA is not proposing any other easements and so smaller banks will therefore still need to continue to operate the remaining remuneration rules as they apply to them.
  • Finally, smaller banks are of course free to continue to operate malus and clawback as well as buy-out provisions, but importantly on the bank's own terms.

Comment

As with the disapplication of the bonus cap, smaller banks are likely to welcome these proposals and may well favour larger banks having to apply them as that will return them the competitive advantage that they used to have before 2021. However, they will probably be disappointed that these rules cannot be disapplied earlier with many having to apply these rules to remuneration being paid out for 2022 and 2023. We are likely to see pressure to accelerate the introduction of the changes and/or acceleration of them taking effect on the basis that banks' continued implementation of rules which are in the process of being dismantled does not seem particularly worthwhile.

It is also worthwhile noting that small asset managers implementing the Investment Firms Prudential Regime (IFPR) do not have to implement these malus and clawback rules, and so there is now a general trend to reduce the compliance burden for smaller firms, though it is not clear how much further the regulatory bodies are prepared to go.

Link to proposal: CP5/23 – Remuneration: Enhancing proportionality for small firms | Bank of England

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Paul Reeves

Paul Reeves
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