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This is a joint consultation by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) (jointly ‘the regulators’). Responses will be shared between authorities.
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Responses are requested by Friday 31 March 2023.
Please address any comments or enquiries by email to: CP15_22@bankofengland.co.uk
Alternatively, please address any comments or enquiries to:
Governance Remuneration and Controls Policy Team, PPD
Prudential Regulation Authority
1.1 This Consultation Paper (CP) sets out the Prudential Regulation Authority’s (PRA) and Financial Conduct Authority’s (FCA) (jointly, ‘the regulators’) proposed changes to the current requirements concerning the ratio between fixed and variable components of total remuneration (the ‘bonus cap’). Although the regulators have considered the following proposals independently of one another, and in accordance with their statutory objectives, the regulators have decided to consult jointly to avoid unnecessary duplication.
1.2 The proposals in this CP would result in the removal of the current bonus cap requirements, through:
- changes to the Remuneration Part and the Disclosure (CRR) Part of the PRA Rulebook (Appendix 1 and Appendix 4), and to Senior Management Arrangements, Systems and Controls (SYSC) 19D: Dual-regulated firms Remuneration Code that is part of the FCA’s Handbook (Appendix 2); and
- updates to the PRA’s Supervisory Statement (SS)2/17 ‘Remuneration’ (Appendix 3).
1.3 The FCA does not intend to update the reference to the bonus cap in paragraph 4.4 of Finalised Guidance (FG)20/5footnote  at this time; this FG would be reviewed at a later stage rather than making edits in relation to the bonus cap in isolation.
1.4 The proposals to remove the current limits on the ratio between fixed and variable components of total remuneration aim to strengthen the effectiveness of the remuneration regime by increasing the proportion of compensation at risk that can be subject to the incentive setting tools within the remuneration framework – including deferral, payments in instruments, and risk adjustment. Over time, the regulators consider that the proposed changes should also help remove unintended consequences that have arisen as a result of the bonus cap, namely growth in the proportion of the fixed component of total remuneration, which reduces firms’ ability to adjust costs to absorb losses in a downturn. The regulators consider that the proposals support their statutory objectives and the reasons for this are outlined throughout this CP.
1.5 This CP is relevant to banks, building societies, and PRA-designated investment firms, including third-country branches which are subject to the Remuneration Part of the PRA Rulebook and to the FCA SYSC 19D: Dual-regulated firms Remuneration Code (jointly referred to as ‘banks’ in this CP). This CP is not relevant to credit unions, insurers, and FCA solo-regulated firms. While this CP does not affect FCA solo-regulated investment firms which are subject to other Remuneration Codes, it will be of interest to solo-regulated investment firms that are members of a group to which the Dual-Regulated firms Remuneration code applies on a consolidated basis.
1.6 The regulators have a statutory duty to consult when changing rules (FSMA s138J and S138I). When not making rules, the regulators have a public law duty to consult widely where it would be fair to do so.
1.7 In carrying out its policy making functions, the regulators are required to comply with several legal obligations, including the FCA’s compatibility statement in relation to the regulator’s objectives and regulatory principles, cost benefit analysis, impact on mutuals and equality and diversity considerations as set out in the relevant sections of this CP. In addition, Appendix 5 lists the statutory obligations applicable to the PRA’s policy development process. The analysis in this CP explains how the PRA has had regard to the most significant matters, including an explanation of the ways in which having regard to these matters has affected the proposals.
1.8 The regulators’ remuneration regime aims to ensure greater alignment between risk taking and individual reward, to discourage excessive short-termism and encourage more effective risk management. This is achieved through the core elements of the variable remuneration framework, including:
- linking payment of awards to risk-adjusted performance;
- payments in instruments;
- deferral; and
- application of risk adjustment, including the use of malus and clawback.
1.9 The bonus cap is part of the regulators’ remuneration rules, which transposed EU legislationfootnote  in line with the UK’s legal obligations as an EU member state at the time. The bonus cap was introduced in the regulators’ rules in two tranches. Firstly in 2014, during the transposition of Capital Requirements Directive (CRD) IV, the regulators applied the cap to all large and systemically important CRD-regulated firms, choosing to disapply the cap for smaller firms on proportionality grounds.footnote  Secondly in December 2020, in line with the implementation of CRD V, the regulators extended their respective remuneration regimes, including the bonus cap, to a wider set of firms, exercising discretion where possible to exempt smaller firms in line with the UK’s earlier approach.footnote  The rules were introduced during the transition period prior to the UK’s withdrawal from the EU (during which time the UK remained subject to EU law).
1.10 The regulators opposed the bonus cap during the EU negotiations.footnote  Since the bonus cap does not limit total remuneration, the regulators consider it can place upward pressure on salaries and allowances that may not be linked to longer-term performance and cannot be reduced or clawed back in the event of later failure and/or previous misconduct coming to light. A larger element of remuneration that is fixed, rather than variable, can also reduce firms’ flexibility to adjust to changes in conditions. Over recent years, the regulators consider that growing evidence has emerged of undesired consequences of the rules on firms’ safety and soundness and UK competitiveness. As set out below in Chapter 2, empirical evidence on the impact on pay structures, waiver applications received since the extension of the rules to a wider set of firms, and other findings gathered as part of a PRA evaluation of the remuneration regime have collectively highlighted the need to review the existing limits on the ratio of the variable component of total remuneration. This CP sets out proposals in relation to the bonus cap, in light of the evidence gathered. The regulators believe that the proposals in this CP support their objectives.
1.11 The proposed changes resulting from this CP would come into force the next calendar day after the publication of the final policy –anticipated for Q2 2023 ‑ and would apply to firms’ performance year starting after that (so for most firms that is likely to be performance years starting 2024). We believe that this approach ensures any changes are made to future remuneration structures, as opposed to where fixed pay for the year had already been set and paid out to staff. However, the regulators are aware that across the affected population of firms, performance year start dates span the calendar year, and therefore encourage firms that believe they may be disproportionately disadvantaged by the timings of any final policy to respond to this CP.
Responses and next steps
1.12 This consultation closes on 31 March 2023. The regulators invite responses on the proposals set out in this consultation. Please address any comments or enquiries to CP15_22@bankofengland.co.uk. Please indicate in your response if you believe any of the proposals in this CP are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.
1.13 Unless otherwise stated, any remaining references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.footnote 
2. The regulators’ proposals
- Deleting Rule 15.9 (3) of the Remuneration Part of the PRA Rulebook, which sets out the limit on the maximum ratio between fixed and variable pay, and connected provisions in Rules 15.10, 15.11, 15.12 and 15.13 on shareholder approval and discount rates, as well as a consequential change to Rule 3.1(B).
- Amending paragraph 1(d) of Article 450 (disclosure of remuneration policy) of the Disclosure (CRR) Part of the PRA Rulebook.
- Amending paragraph (d) of Annex XXXIII Table UK UKREMA of the Disclosure (CRR) - Pillar 3 Templates and Instructions Part of the PRA Rulebook.
- Amending paragraphs (3.16, 5.32 – 5.33, 5.39, 5.40 – 5.43) of PRA SS2/17, and an amendment to Table D: Disclosure requirements by proportionality level.
- Deleting the following Rules in the FCA Handbook: SYSC 19D.1.3R(2), SYSC19D.3.48R(3), SYSC 19D.3.50R, SYSC 19D.3.51R, and SYSC 19D.3.52R.
2.2 Subject to the outcome of this consultation, the regulators also propose a transitional provision for remuneration awarded in relation to a performance year starting before the implementation date of the final policy being consulted on in this CP. In that situation, such remuneration would still be subject to the current requirements on the bonus cap.
2.3 Firms would still be subject to the remaining provisions in the respective regulators’ rules under Rule 15(9) of the Remuneration Part of the PRA Rulebook and SYSC 19D.3.48R of the FCA Handbook. These require that ‘A firm must set an appropriate ratio between the fixed and variable components of total remuneration and ensure that:
- fixed and variable components of total remuneration are appropriately balanced; and
- the level of the fixed component represents a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable remuneration components, including the possibility to pay no variable remuneration component.’
2.4 The rules outlined in paragraph 2.3 require firms to set their own ratios for in-scope individuals,footnote  allowing these ratios to reflect the individuals’ role and potential for excessive risk taking. The requirements also ensure that no individual is dependent exclusively on variable remuneration, or to an extent likely to encourage them to take risks outside the risk appetite of the firm. While high-level, these rules require firm-level accountability and controls around remuneration structures, consistent with the FCA’s approach for to MIFIDPRU investment firms under the remuneration code in SYSC 19G.
2.5 The introduction of the core elements of the remuneration rules since 2013 (under CRD IV) has led to changes in firms’ remuneration structures. In particular, the regulators consider the bonus cap entering into force in 2014 was associated with an increase in fixed pay, and a drop in variable pay as a proportion of total remuneration for individuals in scope of the rules (those classified as Material Risk Takers (MRTs))footnote  - see Figure 1. The increase in the share of fixed pay was in part through the use of Role-Based Allowances (RBAs), which have been introduced by firms to increase pay for those individuals in scope of the rules.footnote 
Figure 1: Average MRT bonus/total remuneration ratios
- Notes: Figures sourced from the Remuneration Policy Statements submitted by 13 Proportionality Level 1 (total assets >£50bn) banks operating in the UK. The ratio in the graph is calculated as the average of MRT variable to total pay ratios. The number of MRTs within this population of firms varies year-on-year, including due to regulatory changes in MRT identification criteria. These occurred twice during this period (the introduction of EU Regulatory Technical Standards in 2014 – when the number of MRTs trebled from 2600 in 2013 to 7800 in 2014; and following the implementation of CRD V in December 2020, when the MRT threshold was amended and as a result brought in lower paid MRTs into scope of the criteria; bringing total number of MRTs among these firms in 2021 to 9000).
2.6 In addition, findings from the evaluation of the remuneration regime by the PRA, supported by a Staff Working Paper (Sakalauskaite and Harris, 2022)footnote , have provided new evidence on the impact of the bonus cap. This work finds that when an MRT’s bonus ratio gets close to 200% (being in the 175%-200% bonus/fixed pay range), next year their fixed pay – mostly driven by rises in RBAs – grows much faster than that of other MRTs, as the bonus cap starts to constrain their bonus growth. This suggests that firms are choosing to increase fixed pay to compensate in-scope individuals as a consequence of the bonus cap constraints. Such effects – not accounting for various other factors affecting MRTs’ pay (for example, shocks that impact remuneration in each bank annually, MRTs’ bonus levels or bonus-to-fixed pay ratios) –– are illustrated in Figure 2, which plots median year-on-year remuneration component growth for MRTs, depending on their bonus to fixed pay ratios.
Figure 2: Y-o-Y% changes in remuneration components after MRTs reach a given bonus/fixed pay bucket
- Source: BoE staff calculations based on MRTs in six major UK Deposit Takers 2014-2019.
2.7 This increase in the proportion of fixed pay is undesirable in the consideration of the regulators’ statutory objectives for three core reasons:
- it increases firms’ fixed costs, thereby reducing their ability to adjust costs to absorb losses in a downturn;
- it limits the relative proportion of remuneration that is performance-based, and subject to regulatory requirements regarding the calibration of performance scorecards; and
- it reduces the relative amount of ‘at risk compensation’ that other parts of the remuneration regime — e.g., risk adjustment, can be applied to, thereby limiting the effectiveness of the remuneration rules on incentive setting.
2.8 While the regulators consider that some of the adverse impacts of the bonus cap, namely the relative growth of fixed pay, has already occurred, the proposals to remove the bonus cap would allow firms to restructure their pay over time. The regulators consider their proposals to remove the limits on the ratio between fixed and variable components of total remuneration would achieve the following:
- give firms greater flexibility over the design of their remuneration structures, which, over time, would allow them to rebalance these more towards the variable component; and
- increase the proportion of remuneration that is performance-based, and subject to the incentive-setting rules of the regulatory framework, particularly including performance scorecards, payment in instruments, deferral, and risk adjustment (including malus and clawback).
2.9 In addition, removing the bonus cap from the PRA Rulebook and the Dual-regulated firms Remuneration Code would also align with other FCA remuneration codes (e.g., for FCA solo investment firms in SYSC 19G and for AIFM/UCITS in SYSC 19A and 19E) that contain a number of rules to curb excessive risk-taking by MRTs without a fixed ratio on bonuses. This includes requirements on an appropriate balance between fixed and variable remuneration; payment of a substantial part of remuneration in eligible instruments; and malus and clawback arrangements. These requirements allow for a flexible remuneration policy that can mitigate excessive risk-taking without the need for a specific ratio.
2.10 The regulators have also considered other alternatives to removing the bonus cap, including: setting a different (higher) limit on the maximum ratio of variable to fixed pay, retaining the bonus cap only for a subset of MRTs – for example Senior Management Functions holders (SMFs) ‑ and/or having alternate mechanisms for setting limits on the maximum ratio. Ultimately, the regulators consider there is an adverse effect of the bonus cap on the balance between fixed and variable remuneration, and there is extra cost for firms in attracting talent (in terms of higher fixed pay) (see next section). Therefore, the regulators consider that a regulatory limit on the ratio between fixed and variable components of total remuneration is undesirable from the perspective of meeting their statutory objectives and removing it will help to enhance our objectives – see below.
PRA objectives analysis
2.11 The PRA considers the proposals would advance the PRA’s safety and soundness objective by removing a constraint which has not served its purpose, and which has unintended consequences. The removal of the bonus cap would be expected to make it easier for firms to adjust their variable remuneration through time to reflect their financial health. By adjusting down variable pay in the event of a downturn, firms would have more resources that could be used to absorb losses, thereby promoting the safety and soundness and long-term viability of the firm. Variable remuneration also falls in scope of the PRA’s rules on maximum distributable amounts, which apply when a firm is not meeting its combined buffer and are aimed to ensure a firm is able to conserve its capital position in time of stress.footnote  Therefore, a restructure towards greater proportions of variable pay can both increase the amount to which restrictions on distributions could be applied to, and also give firms greater flexibility over how they apply the restrictions within the scope of the rules (variable remuneration, discretionary pension benefits, dividends, and shares).
2.12 From an incentive-setting perspective, the wider remuneration regime primarily applies to the variable component of pay, and so removing regulatory constraints on maximum levels of variable pay would allow for a larger proportion of total pay to be subject to the other remuneration policy requirements that were introduced after the financial crisis. These rules – which will remain in place under the regulators’ proposals – aim to better align remuneration with prudent risk taking, by shaping the nature of incentives and ensuring accountability, including by continuing to require:
- at least 40% (and in the case of certain senior MRTs or individuals who receive variable remuneration £500,000 or more, at least 60%) to be deferred for a minimum of four years, and longer for individuals performing an executive PRA Senior Management Function in regulated firms;
- at least 50% of the variable remuneration to consist of shares or other non-cash instruments that reflect the performance of the firm; and
- all variable remuneration to be subject to risk adjustment, including in-year adjustment, malus, and clawback, which in some circumstances must be applied based on the performance of the firm, the business unit, and the individual.
2.13 The combination of deferral and risk adjustment tools aim to disincentivise individuals from taking excessive risk to achieve a high return in the short-run without due consideration for the long-term consequences. In addition, by deferring the payment (or ‘vesting’) of part of an award, there is an opportunity to reassess the nature, scale, and outcomes of the risks taken in order to assess the performance for which variable remuneration has been awarded. Linking a substantial proportion of variable remuneration to the performance of the firm aims to align incentives of MRTs with long-term value creation and interests of shareholders (addressing the ‘principal-agent’ problem).footnote  Firms will also continue to be subject to ‘buy-out’ rules, which help ensure variable remuneration remains subject to risk adjustment as MRTs change employers within the regulated sector.footnote 
2.14 The PRA considers that removing the bonus cap could help increase the amount and proportion of ‘at risk’ compensation that would be in scope of the deferral, payments in instrument and risk adjustment tools mentioned in paragraph 2.12. This means that individuals whose decisions can have a material impact on the firm’s risk profile will have a larger share of their remuneration at risk should financial, or non-financial risks – including those that affect the financial performance of the firm - subsequently come to light.footnote 
2.15 As identified in the PRA’s evaluation of the Senior Managers and Certification Regime (SM&CR) (2020),footnote  there is evidence of firms holding individuals to account through these remuneration tools. However, there may be scope to improve the alignment of and interlinkages between the two regimes, to further support senior management accountability for risk taking and the effectiveness of risk adjustment tools; the PRA will consider these issues further in due course. The proposals in this CP to remove regulatory limits on the share of variable remuneration complement this future work. The PRA considers placing a large share of remuneration at risk contributes to avoiding rewarding failure that can undermine the safety and soundness of firms and the wider financial system.
2.16 The initial rationale set out for the bonus cap was that it would limit risk taking by capping the maximum gains, in the form of bonus, that an individual MRT could get. It is possible that removing the bonus cap could lead to higher total remuneration for some employees, which could, in turn, incentivise excessive risk taking, which could adversely impact safety and soundness of firms. However, the PRA does not consider that the proposals create material risks in this regard. There is no apparent evidence that the bonus cap as implemented has had any positive impacts on limiting risk-taking. In addition, there are other rules in place to mitigate excessive risk-taking behaviours, including other rules on remuneration structures, and the SM&CR which reinforces individual accountability.
2.17 A review of the literature (see below in paragraphs 2.17 and 2.18) on the impact of the bonus cap suggests there is no conclusive evidence that the bonus cap – in its implemented form – has reduced risk taking, and therefore contributed to safety and soundness of firms. Hakenes and Schnabel (2014) present a theoretical model of how a cap could reduce risk-shiftingfootnote  – but this is based on bankers being rewarded in bonus only. Asai (2016) also note that a bonus cap could reduce risk-shifting by bank executives but aggravates underinvestment as they forgo risky and productive projects. Experimentally, Harris, Soane and Tanaka (2020) find that application of a bonus cap and malus could reduce risk-taking, although this reduction can be significantly weakened in the presence of relative performance pay. However, in the set-ups in these papers, fixed pay does not increase as a result of the cap on bonuses. In fact, in some research studies, bankers are rewarded in bonus only, so a cap on bonus also puts a limit on total reward.
2.18 There is further evidence (Sakalauskaite and Harris, 2022) demonstrating that individuals close to the cap are paid higher fixed pay rather than bonus, thereby dampening the cap’s potential to limit total remuneration (see above paragraph 2.6). Colonnello et al. (2018) also fail to find evidence that banks with executives that are more affected by the rule reduced their risk-taking. In fact, Colonello et al (2018) show that the cap – in its implemented form – has had unintended consequences and that in response to the rule’s introduction, banks increased senior executives’ fixed pay so as to keep the total compensation unaffected.
2.19 Removing the 100% (or in the event of shareholder approval, 200%) limit gives firms flexibility to determine what is appropriate for them, given their cost and incentives structures, and the nature, scale, and complexity of their business model and therefore, it should promote the safety and soundness of firms.
2.20 The regulators would continue to monitor firms’ approach to remuneration and where appropriate, may discuss this with the responsible Senior Manager (typically the Chair of the Remuneration Committee) to gain assurance regarding a firm’s approach to incentive setting.
2.21 The PRA has assessed whether the proposals in this CP facilitate effective competition. The PRA considers that giving firms greater flexibility over the design of their remuneration structures – which it considers is partially impeded by the bonus cap – would help facilitate effective competition. The removal of the bonus cap would provide firms with more flexibility to share risk with employees, thereby helping firms to explore new opportunities, especially for smaller firms and/or new entrants who often have fewer financial resources and more limited access to external financing options.
2.22 The Financial Services and Markets Bill 2022 includes measures to amend the PRA’s objectives by introducing a new secondary competitiveness and growth objective. At the point that this Bill receives Royal Assent, this new secondary objective would require the PRA (in discharging its general functions in a way that advances its primary objectives and so far as reasonably possible) to act in a way that facilitates (subject to aligning with relevant international standards) (a) the international competitiveness of the economy of the United Kingdom (including in particular the financial services sector through the contribution of PRA-authorised persons) and (b) its growth in the medium to long term. In light of this and the proposed implementation date for the changes proposed in this CP (Q2 2023), the PRA has also considered whether the proposals set out in this CP would facilitate competitiveness and growth as described in the new objective. For the same reasons as those set out in paragraph 2.23, the PRA considers that the proposals will facilitate competitiveness and growth as described in the new objective and that the proposals would be in the same form if the objective applied at the date of publication of the CP. The FCA is subject to the same requirement, please see paragraph 2.34 below.
PRA Have regards analysis
2.23 In developing these proposals, the PRA has had regard to the regulatory principles (including as they will be amended by the Financial Services and Markets Bill 2022), the aspects of the Government’s economic policy set out in the HMT recommendation letter from 2021 and the supplementary recommendation letter sent April 2022, and given that the proposed rule(s)/rule change in this CP is a ‘CRR rule’ (as defined in section 144A of FSMA), the additional have regards applicable to CRR rules. The following factors, to which the PRA is required to have regard, were significant in the PRA’s analysis of the proposals:
- the principle that a burden or restriction which is imposed on a person should be proportionate to the benefits which are expected to result from the imposition of that burden (FSMA regulatory principle). The PRA considers the introduction of the bonus cap has led to firms’ restructuring towards fixed pay, which has adversely affected firms’ ability to recruit highly skilled staff, particularly from other sectors (e.g., technology) and from jurisdictions that do not enforce a bonus cap. The PRA considers that the burden of the bonus cap outweighs the benefits as:
- it has increased fixed costs (with the increase of salaries and the use of RBAs), which creates a burden to firms and reduces firm flexibility and the share of remuneration at risk, which are unintended consequences of the bonus cap rule.footnote 
- there is evidence that five out of six UK deposit takers have obtained shareholder approval and apply a 2:1 ratio, and therefore the 1:1 ratio is a constraint because it increases the administrative/compliance burden for those firms.
- the CRD V reforms have increased burdens on smaller firms that were brought into scope. During the course of 2021/2022 (since the implementation of CRD V), the PRA granted a number of modifications of remuneration rules where the impact of the bonus cap was a relevant consideration.
- Rules requiring deferral, payment in instruments, and risk adjustment will continue to apply (on a proportionate basis), and their effective application will continue to ensure that in-scope individuals are not incentivised to take excessive risks, and that their personal interests are aligned with the long-term interests of the firm. In addition, firm-wide requirements that ensure (i) appropriate adjustments for current and future risks (both ex-post and ex-ante), and (ii) that variable remuneration does not limit a firm's ability to strengthen its capital base, will continue to ensure remuneration practices align with effective risk management.
- Efficient and economic use of PRA resources (FSMA regulatory principle). Since the implementation of CRD V, the PRA assessed in the last 18 months a number of waivers as part of which the impact of the bonus cap was a relevant consideration. These applications create a resource burden for both the PRA and firms, both at the time of application, and when reviewed at the point of expiry and potential renewal.
- The desirability of sustainable growth in the economy of the United Kingdom in the long term (FSMA regulatory principle). The PRA considers that its proposals remove a regulatory constraint, potentially providing firms with greater flexibility over the design of remuneration structures (where not otherwise constrained at consolidated level). The PRA considers this would incentivise greater activity in new business lines, and support the attractiveness of the UK as a place to do business. The PRA considers this could also support labour mobility – into and across the UK financial services sector (from other sectors and jurisdictions) – as the removal of the bonus cap would give firms more ability to offer reward packages that can attract talent into the UK banking sector.
- Competitiveness and innovation (HMT Recommendation Letters) and Relative Standing of the UK (CRR rules ‘have regards’). The PRA considers its proposals would support the UK remaining an attractive domicile for internationally active financial institutions, and retaining its position as a leading international financial centre. The PRA’s remuneration evaluation found some evidence that the bonus cap has been a factor in limiting labour mobility and thereby affecting UK international competitiveness. The PRA considers its proposals are in line with the international principles and standards on sound compensation practices set out by the Financial Stability Board, which do not set out a specific ratio between fixed and variable pay.
International benchmarking shows that the bonus cap is not routinely imposed outside the EU. For example, Australia, Canada, Hong Kong, Japan, Singapore, Switzerland, and the US largely rely on core elements of remuneration regimes (e.g. use of deferral, malus, and clawback) in a similar way to the regulators, yet do not impose a bonus cap.
2.24 The PRA has had regard to other factors as required. Where analysis has not been provided against a ‘have regard’ for this proposal, it is because the PRA considers that ‘have regard’ to not be a significant factor for this proposal.
FCA Compatibility statement
2.25 When consulting on making new rules, the FCA is required by section 138I(2)(d) of the Financial Services and Markets Act 2000 (FSMA) to include an explanation of why it believes making the proposed rule/s are (a) compatible with its general duty, under s. 1B(1) FSMA, so far as reasonably possible, to act in a way which is compatible with its strategic objective and advances one or more of its operational objectives, and (b) its general duty under s. 1B(5)(a) FSMA to have regard to the regulatory principles in s. 3B FSMA. The FCA is also required to have regard to the principles in the Legislative and Regulatory Reform Act 2006 the Regulators’ Compliance Code and HM Treasury recommendations on economic policy (as set out in their letters from March 2021footnote  and April 2022footnote ).
2.26 This section also sets out the FCA’s view of how the proposals are compatible with the duty on the FCA to discharge its general functions in a way which promotes effective competition in the interests of consumers (s. 1B(4)). This duty applies in so far as promoting competition is compatible with advancing the FCA’s consumer protection and/or integrity objectives.
2.27 There are many parallels with how these proposals advance both regulators’ objectives, but for clarity the rationale has been outlined separately. The FCA has relied on the PRAs’ policy analysis when preparing its compatibility statement whilst also adding the FCA’s own perspective where relevant.
2.28 Based on the analysis set out in this consultation the FCA considers that the proposals will, in the long-term, advance its objectives. The FCA considers the removal of the bonus cap is compatible with its strategic objective of ensuring that relevant markets work well, as the Dual Regulated Remuneration Code is likely to better meet its aims of promoting effective risk management in the long-term interests of the firm and its customers, ensure alignment between risk and individual reward, support positive behaviours, and healthy firms cultures, and discourage behaviours that can lead to misconduct and poor customer outcomes. For the purposes of the FCA’s strategic objective, ‛relevant markets’ are defined by s. 1F FSMA.
2.29 The FCA considers that removing the bonus cap mainly advances its integrity and competition objectives:
2.30 Integrity objective: Removing the bonus cap could make it easier for firms to adjust their variable remuneration to reflect their financial situation (for example, by adjusting down variable pay in the event of adverse financial conditions, firms would have more resources that could be used to absorb losses and therefore promoting the long-term viability of the firm). In addition, removing the limits on bonuses could allow for a greater proportion of total pay to be subject to the tools such as performance criteria, deferral, use of instruments and risk adjustment (including malus/clawback) described above. This in turn could contribute to a better alignment of incentives and financial rewards with the long-term interests of the firms which is likely to foster better market conduct and prudent risk management among MRTs improving the safety and soundness of dual-regulated firms and the wider financial system.
2.31 Competition objective: Removing the bonus cap would reduce long-standing competitive distortions between FCA regulated firms who are subject to the Dual-regulated Firms Remuneration Code and those that are not. This is particularly problematic in the context of investment activities – which can be carried out by both - MiFID investment firms (which are not subject to the bonus cap) and credit institutions and designated investment firms (which are). The proposals aim to create a better level playing field for being able to compete for talent where staff may otherwise be affected by different regulatory incentive structures for carrying out similar roles. In addition, the removal of the bonus cap could enhance UK competitiveness as it could increase the attractiveness of the UK as a base for businesses due to greater flexibility to remunerate and attract key talent to the UK banking sector. Secondly, UK competitiveness is promoted in global financial markets, through UK firms being able to more effectively compete when doing business in jurisdictions such as US or Hong Kong, where there is no bonus cap.
2.32 It is unlikely that there will be any direct implications for consumers. The FCA considers that these proposals could also indirectly advance its consumer protection objective by more greatly aligning risk and individual reward. This would allow key decision makers within firms to be more greatly incentivised in line with performance objectives including factors linked to non-financial performance such as adherence to expected standards of market conduct and consumer outcome metrics. Ultimately, this could lead to a greater focus on supporting positive behaviours and healthy firm cultures. In addition, as explained under the integrity objective above, since the proposals could result in more prudent risk taking by MRTs, this could also ultimately benefit consumers by discouraging behaviours that can lead to misconduct and poor customer outcomes.
2.33 In preparing the proposals set out in this consultation, the FCA has had regard to the regulatory principles set out in s. 3B FSMA:
- The need to use resources in the most efficient and economic way: the proposals are consistent with this principle as they would allow the FCA’s supervisors to focus on ensuring that firm’s remuneration policies support a healthy culture and encourage positive outcomes. Through our proposals, firms would still need to set their own ratios to ensure they actively monitor and manage the risks arising from high ratios of variable to fixed remuneration. They will also need to ensure that there is an appropriate balance between fixed and variable remuneration. The proposals would mean that supervisors do not have to monitor compliance with a fixed ratio, instead supervising the extent to which firms are meeting the new requirements and holding their senior management and chairs of remuneration committees to account.
- The principle that a burden or restriction should be proportionate to the benefits: The proposals support this principle as the FCA is acting to remove an excessive burden – as above, as the introduction of the bonus cap had led to restructuring towards fixed pay, which may have also adversely affected firms’ ability to recruit highly skilled staff, particularly from other sectors and from jurisdictions that do not enforce a bonus cap.
- The desirability of sustainable growth in the economy of the United Kingdom in the medium and long term: The FCA considers that these proposals are consistent with this principle because they are likely to foster prudent risk management, promoting financial safely while helping drive sustainable growth in the UK economy in the medium and long term for example by potentially providing a greater degree of flexibility to firms to design remuneration structures. This in turn could also help with attracting key talent to the UK banking sector (both from other sectors and jurisdictions).
- The responsibilities of senior management: The FCA considers that these proposals should increase senior management accountability because they would be more greatly personally impacted by the outcomes they achieve. The removal of the bonus cap rule could help to increase the amount and proportion of ‘at risk’ compensation, meaning that individuals whose decisions can have a material impact on the firm’s risk profile will have a larger share of their remuneration at risk in case financial, or non -financial risks, including those that affect the financial performance of the firm, were to occur.
- The desirability of recognising differences in the nature of, and objectives of, businesses carried on by different persons including mutual societies and other kinds of business organisation: Mutual societies are subject to SYSC 19D, so are at a disadvantage to firms in other sectors in their ability to design incentive arrangements that attract and retain staff – these proposals address this problem.
- The desirability of publishing information relating to persons subject to requirements imposed under FSMA, or requiring them to publish information: This principle is not relevant to these proposals.
- The principle that the FCA should exercise its functions as transparently as possible: The proposals are consistent with this principle. The FCA explained its rationale and evidence for proposing to remove the bonus cap and the consultation process ensures that the FCA collates and reviews feedback, before deciding on final rules.
- Compatibility with the duty to promote effective competition in the interests of consumers: In preparing the proposals as set out in this consultation, the FCA has had regard to its duty to promote effective competition in the interests of consumers. The FCA considers that the proposals would reduce long standing competitive distortions between FCA regulated firms who are subject to the Dual-regulated Firms Remuneration Code and those who are not.
2.34 The Financial Services and Markets Bill 2022 includes measures to amend the FCAs objectives by introducing a new competitiveness and growth objective. At the point that the Bill received Royal Assent, this new objective would require the FCA (in discharging its general functions and so far as reasonably possible) to act in a way that facilitates (subject to aligning with relevant international standards) (a) the international competitiveness of the economy of the United Kingdom (including in particular the financial services sector and (b) its growth in the medium to long term. In light of this and the proposed implementation date for the changes proposed in this CP (Q2 2023), the FCA has also considered whether the proposals set out in this CP would facilitate competitiveness and growth as described in the new objective. For the same reasons as those set out above the FCA considers that the proposals will facilitate competitiveness and growth as described in the new objective and that proposals would be in the same form if the objective applied at the date of publication of the CP.
Cost benefit analysis (CBA)
2.35 As set out in this CP, there is little evidence of benefits of the bonus cap on risk-taking of MRTs. The proposals in the CP would remove the undue burden and complexity created by the rules, based on the evidence received since their implementation, while retaining other features of the remuneration regime that support the desired outcomes of the broader framework. As outlined in this CP, the regulators believe that the proposals in the CP would help regulators to pursue their statutory objectives.
2.36 Due to data constraints, the regulators consider it difficult to assess the quantitative impact of the proposals in terms of numbers of firms and individuals who could be affected by the removal of the regulatory limits on the fixed/variable ratio (noting that some firms may choose to maintain the limits). The regulators collect data annually from Level 1 proportionality firms,footnote  which are those with total assets in excess of £50bn (over a rolling 3 year period). From this, the regulators know that as based on latest available data:
- Five out of six UK deposit takers and 12 out of 13 subsidiaries/branches in the UK with headquarters outside the EU have sought shareholder approval for raising variable to fixed remuneration limit from 100% to up to 200%;
- 9.8% of MRTs within firms who did not ask for approval, have their variable to fixed ratios within the 75%-100% range; and
- 9.6% of MRTs within firms who did ask for approval, have their variable to fixed ratios within the 175%-200% range.
2.37 The proposals to remove the bonus cap would impact all MRTs, and in particular are likely to affect those captured above, unless they are subject to other internal limits, or, in the case of those institutions headquartered outside of the UK, there are regulatory limits applied at a consolidated basis.
2.38 In addition to looking at those already in scope of the current rules, the proposals to remove the bonus cap could also impact new joiners – including those entering the UK banking sector from other parts of the UK financial services industry, other sectors, and/or from other jurisdictions where they are not affected by such limits. This impact on new joiners in particular is difficult to quantify, as there may be other factors that may influence the extent to which the benefits are realised with respect to those individuals. For example:
- The absolute level of pay and other aspects of the remuneration structures (including deferral, payment in instruments, risk adjustment), and how these compare to others that are available to potential new joiners.
- Other regulatory requirements that differentiate the UK financial services sector, for example the SM&CR. As all MRTs are in scope of the SM&CR, they are therefore subject to fitness and propriety assessments by the firm and individual conduct rules. In addition, the more senior roles are captured within the SM&CR (and as a result have a number of accountability mechanisms attached, including Senior Manager Conduct Rules) and are subject to longer deferral and clawback periods.
- General attractiveness of working in the UK banking sector and/or working/living in the UK.
Costs of the proposals
2.39 The regulators consider that the amendments proposed in this CP could introduce some one-off and ongoing costs of adapting firms’ remuneration structures. However, firms would incur these costs only if they choose to alter their current remuneration structures following the removal of the bonus cap. Firms would choose to pursue these changes only if they believe the benefits outweigh the costs of changing remuneration structures. As more firms adapt their remuneration structures, firms may need to adapt their remuneration structures too to compete for talent.
2.40 The bonus cap was introduced with a view to limit excessive risk-taking. If it had achieved its objective, removing the bonus cap could potentially incentivise more risk-taking. However, following the introduction of the bonus cap, firms introduced RBAs. Individuals whose variable to fixed ratios are close to the cap have been, instead, paid higher fixed pay, via RBAs. As noted above, according to the PRA’s research on the UK data, when an MRT’s bonus ratio gets close to the 200% cap, their fixed pay grows faster, and bonus grows more slowly, than that of other MRTs in the subsequent year, with the total remuneration growth not differing significantly from that of MRTs whose bonus is not close to the cap. This means that under the cap, excessive risk-taking could still be rewarded by higher RBAs/salaries. Therefore, in practice, it can be argued that the bonus cap has had a limited impact on the maximum financial rewards individuals can get. Colonnello et al. (2018) find the same result when examining the impact of EU bonus cap (see paragraph 2.6). It was found for top executives whose variable-to-fixed pay ratio exceeded the bonus cap before its introduction in 2014, fixed pay increased after 2014 to keep the total compensation unaffected, and in addition, they do not find evidence that the bonus cap reduced banks’ risks. Therefore, the regulators do not consider removing the bonus cap, on its own, would lead to a significant change in risk-taking.
2.41 In addition, other firm-wide remuneration rules that ensure risk management (including consideration of current and future risks), as well as affordability around remuneration decisions, will continue to apply. The effective application of rules should support the necessary control environment in relation to incentive setting and support the safety and soundness of UK regulated firms.
Benefits of the proposals
2.42 The proposals to remove regulatory limits on the ratio of fixed to variable remuneration would advance the regulators’ objectives by giving firms greater flexibility over their cost base and design of remuneration structures, and enable them to place greater weight towards variable components of remuneration, which could support incentive setting among MRTs. There are qualitative benefits for firms and the wider economy derived from our proposals such as greater flexibility on remuneration structures (see below). The regulators consider that quantitative benefits cannot be reliably estimated.
2.43 Flexibility to restructure remuneration to align with interests of firm: The proposed removal of the bonus cap rule would allow firms greater flexibility to better align their remuneration structures with their long-term interests and consider the best ways to ensure prudent risk management through remuneration structures and resource management. However, the regulators consider that this would likely only come in the medium term; many firms may not be able to reduce fixed pay quickly as for existing employees this will involve implementing a change to the individual’s employment contract, including, for example, where salaries have been increased rather than making use of RBAs. However, once firms have had the ability to adjust pay structures towards variable pay (if they choose to), the flexibility to reduce bonuses during economic downturns would help promote firms’ safety and soundness.
2.44 Incentive setting could be positively affected in due course: The removal of the bonus cap rule could, over time, lead to a higher proportion of variable to fixed pay. With a higher proportion in variable, other remuneration rules such as deferral and risk adjustment, payment in instruments would apply to a larger amount, and so could be more effective in helping ensure that individuals are not incentivised to take excessive risks. While the remuneration structures of existing personnel are expected to re-adjust only over time, due to the rigidity in changing pay structures, the pay packages for new staff could reflect the removal of the bonus cap much more quickly. Given the relatively high staff turnover in the financial services industry, the regulators consider the adjustment would not take a long time; however, equally, it may not be instant.
2.45 Improved business opportunities: Variable remuneration facilitates risk sharing between firms (shareholders) and employees by partially absorbing negative shocks.footnote  The proposed removal of the bonus cap would allow firms to explore/pursue business opportunities which may not be feasible under a remuneration structure with higher fixed pay, under which they have to pay upfront even if the opportunities turn out not to be profitable.
2.46 Ability to attract new staff: The proposals could also improve labour mobility of senior executives and other MRTs through recruiting from a wider pool of highly skilled staff from other sectors (e.g., technology), other parts of the financial services sector (e.g., hedge funds and private equity), and from other jurisdictions. This could in turn deliver the benefits set out above. The scale of these potential impacts and resulting benefits is uncertain as it depends not only on the number of new firms and personnel entering into the UK market but also the impact of improved ability to retain talent from firms having increased flexibility over remuneration contracts. There are several other factors involved, however, inflexibilities in compensation structures in the banking sector have been cited as one of the obstacles faced by recruitersfootnote  and firms. The proposals, if implemented, should help drive a positive change in this area.
2.47 Enhanced UK Competitiveness: The removal of the bonus cap rule could enhance UK competitiveness to an extent through two routes. Firstly, it could increase the attractiveness of the UK as a base for businesses due to greater flexibility over remuneration structures. Second, through UK firms being able to more effectively compete when doing business in jurisdictions such as US or Hong Kong, where there is no bonus cap, thereby promoting UK competitiveness in global financial markets.
2.48 Reduced compliance costs: The regulators consider that removing the bonus cap would lead to a reduction in ongoing compliance costs for firms to comply with the bonus cap rule (e.g., obtaining shareholders’ approval to apply a higher ratio of up to 200%, determining the discount rate), especially for the smaller firms that were brought into scope by CRD V as the increase in compliance costs – including, in some cases, the application for waivers – disproportionately affected them. These reduced compliance costs only form a proportion of total compliance costs for firms to comply with remuneration rules.
2.49 Reduced costs for regulators: The proposals would lead to a corresponding reduction in costs for the regulators in supervising and monitoring compliance with the bonus cap rule. In addition, it reduces the cost for firms and the regulators in considering waivers of the bonus cap rules on a case-by-case basis. These reduced costs only form a proportion of supervisory and monitoring compliance costs for regulators for all remuneration rules.
2.50 Based on our assessment, we believe benefits are likely to outweigh costs. While noting difficulty in quantifying benefits, we expect the costs of this proposal to be small in light of the other features of the remuneration regime that support the desired outcomes of the broader framework.
Impact on mutuals
2.51 The regulators consider that the impact of the proposals on mutuals is expected to be no different from the impact on other firms.
Equality and diversity
2.52 The regulators are required under the Equality Act 2010 to ‘have due regard’ to the need to eliminate discrimination, harassment, victimisation, and any other conduct prohibited by or under the Act, advance equality of opportunity between persons who share a relevant protected characteristic and those who do not, and to foster good relations between people who share a protected characteristic and those who do not.
2.53 The regulators have considered the equality and diversity issues that may arise from the proposals in this CP. There is evidence suggesting that bonus pay gaps are typically larger than fixed pay gaps, and the banking sector, in the consideration of the regulators, has high gender pay gaps.footnote  Such pay gaps may exist for other protected characteristics as well.
2.54 Removing the bonus cap may indirectly increase this issue if firms do not take mitigating action. The FCA has existing requirements for dual-regulated firms to ensure their remuneration policies and practices are gender neutral. Firms are also reminded that the Equality Act 2010 prohibits discrimination on the basis of an individual’s protected characteristics. Firms should ensure that when they assess individual performance, the assessment process and any variable remuneration awarded does not discriminate on the basis of the protected characteristics of the individual. Supervisors may follow up directly with their firms on how they are managing and monitoring this.
2.55 The regulators will also continue to consider the equality and diversity implications of the proposals during the consultation period and will revisit them when making any final rules which result from this consultation.
Available at Finalised Guidance FG20/5.
Capital Requirements Directive (2013/36/EU) – CRD IV; and Capital Requirements Directive (2019/878/EU) – CRD V.
See the 2016 FCA/PRA joint statement.
See paragraph 3.42: PS26/20 'Capital Requirements Directive V (CRD V)' (bankofengland.co.uk) and paragraphs 2.5 – 2.23: FCA PS 20/16 ‘Updating the Dual-regulated firms Remuneration Code to reflect CRD V: feedback to CP20/14 and final rules.
See the 2016 FCA/PRA joint statement.
For further information please see Transitioning to post-exit rules and standards.
Including the possibility of setting different ratios for different categories of staff.
MRTs are employees, identified on certain quantitative and/or qualitative criteria, whose decisions have the potential to have an impact on a firm’s risk profile.
RBAs are payments in addition to salary, benefits, and bonus and depending on their features, can be classified as variable or fixed. The 13 firms in the sample have classified them as ‘fixed’; these allowances are a cheaper way for firms to increase fixed pay compared to salary increases.
See para 3.1 of SS6/14 'Implementing capital buffers' - January 2021.
See box on ‘The ‘agency problem’’ in: Bank of England Quarterly Bulletin 2015 Q4.
These rules were introduced in response to industry practice whereby firms recruiting staff ‘buy-out’ deferred bonus awards that have been cancelled by their previous employer, thereby effectively enabling individuals to insulate themselves against an ex-post risk adjustment of their past awards at their old employer. (see CP2/16 for more information).
See the 2016 FCA/PRA joint statement available at: PRA and FCA statement on compliance with the EBA guidelines on Sound Remuneration Policies.
According to agency theory, risk shifting is a moral hazard problem between shareholders and creditors. After raising debt, shareholders have incentives to invest in risky projects, as the potential profits accrue to the shareholders, while the downside risk falls to the debt holders. In other words, risk shifts from the former to the latter.
PS 26/20 par 3.53, available at: PS26/20 'Capital Requirements Directive V (CRD V)' (bankofengland.co.uk).
Level 1 firms are dual-regulated banks, building societies, and PRA-designated investment firms with average total balance sheet assets over £50billion.
See ‘FSB compensation workshop 2019: Key takeaways’ available at: FSB compensation workshop 2019: Key takeaways, paragraph 6, ‘Competition for talent’.