PRA introduces changes to Unvested Pay, Material Risk Takers and Public Appointments

On 15 July 2022, the Prudential Regulation Authority (the “PRA”) published the Consultation Paper 8/22 (the “CP8/22”) proposing its expectations in relation to the instruments or claims which relate to unvested deferred sums awarded to Material Risk Takers (the “MRTs”) as a part of their variable pay. Particularly, the PRA considers cases whereby a change is prompted by the need to manage a conflict of interest arising from an MRT seeking a senior public appointment linked to financial policy or financial services regulation. CP8/22 proposes that a new section is added to Chapter 4 of the Supervisory Statement 2/17 ‘Remuneration’ (Appendix 1) (the “SS2/17”) regarding certain new requirements and expectations of the PRA on remuneration payable to MRTs within the scope of SS2/17.

background

The PRA has been established as a part of the Bank of England under the regulations in the financial services sector introduced after the financial crisis in 2007. The PRA aims to establish policies to be complied with by the firms in the financial services sector and supervise the activities of such firms to ensure the safety and soundness of the provision of financial services and products.

According to the PRA Rulebook, an MRT is a person who is an employee of a United Kingdom (the “UK”) bank, a building society, a UK-designated investment firm (collectively referred to as the “Capital Requirements Regulation Firms” (the “CRR Firms”) or a third country CRR Firm, whose professional activities have a material impact on the firm’s risk profile, such as:

• members of the management body and senior management;
• employees with managerial responsibility over the firm’s control functions or material business units;
• employees entitled to a significant total remuneration in the preceding financial year, where the total remuneration was equal to or greater than £440,000, and equal to or greater than the average remuneration awarded to the members of the firm’s management body and senior management, and the employee performs the professional activity within a material business unit and the activity is of a kind that has a significant impact on the risk profile of a material business unit; and
• employees whose professional activities are deemed to have a material impact on the firm’s risk profile.

The PRA Rulebook and the prudential requirements set out herein apply to PRA-authorised persons (which include the CRR Firms) and certain unauthorised persons. On the other hand, the remuneration part of the PRA Rulebook and SS2/17 specifically apply to (i) the CRR Firms with respect to their UK activities and other activities carried out in a prudential context regardless of location, and (ii) third country CRR Firms regarding their activities carried out through a UK establishment. The remuneration part of the PRA Rulebook aims to ensure that the remuneration policies adopted by the CRR Firms promote sound risk management, prevent excessive risk-taking and align senior employee incentives with the long-term interests of the business; and SS2/17 further clarifies and specifies the expectations of the PRA as to the implementation of the remuneration part of the PRA Rulebook.

Further to the above, CP8/22 and the proposed changes thereunder directly relate to the variable pay of MRTs employed by the CRR Firms and therefore does not capture credit unions or PRA-authorised insurers. Such new expectations may also indirectly concern MRTs and former MRTs looking to take up roles in the public sector, and those who may consider employing an MRT or a former MRT for such roles.

proposed changes made by cp8/22

Purpose of the changes

The main aim of PRA’s proposed changes is to address the potential conflicts of interest which may occur in cases where an MRT or a former MRT that is seeking a public sector appointment continues to have a contingent claim on the equity of a firm, and the firm is prepared to consider converting instruments that comprise unvested, deferred pay. It should be noted that CP8/22 does not set out any changes to the existing PRA requirements or expectations in cases where an MRT seeks to move to any other roles, including a competitor firm. The expectations of the PRA set out under CP8/22 are generally consistent with the primary purposes of the remuneration part of the PRA Rulebook and these are ensuring sound risk management and preventing the excessive risk taking of the CRR Firms. The proposed changes mainly aim to enable a more proportionate application of the PRA’s remuneration requirements while improving transparency.

Additional requirements under Chapter 4 of SS2/17

Moving on, the remuneration part of the PRA Rulebook foresees that firms must ensure that at least 50% of any variable remuneration payable to an MRT consists of an appropriate balance of:

• shares (or equivalent ownership interests, share-linked instruments, or equivalent non-cash instruments); and
• other instruments which are eligible as Additional Tier 1 or Tier 2 instruments (as defined under the Capital Requirements Regulation (the “CRR”) or other instruments that can be fully converted to Common Equity Tier 1 instruments (as defined under the CRR).

In light of this, the following requirements have been proposed by the PRA under CP8/22:

• Unvested, deferred claims that comprise the variable pay of MRTs cannot be converted from an equity claim into a claim for other instruments (or vice versa) after an award has been made. This rule applies to all unvested, deferred sums, and does not exclude amounts above the regulatory minima.
• There are certain exceptions to the above restriction. Accordingly, such conversion may be carried out in certain cases where there are potential conflicts of interest arising from a proposed public-sector appointment which cannot otherwise be sufficiently mitigated, provided that such conversion will still be subject to the prior non-objection of the PRA and the relevant retention requirements. Whether a firm will make use of this exception is at the discretion of such firm and it is the responsibility of a potential third-party public-sector employer to consider what mechanism may be available to it under its own policies to address any such conflicts of interest.
• Additionally, in cases where a conversion to cash would breach the minimum non-cash instruments requirement, a firm may request a waiver or modification of the PRA’s remuneration rules to enable such conversion. Such request would be subject to the case-by-case consideration of the PRA in accordance with the statutory test and shall be submitted together with a reasonable explanation.

next steps

The above changes aim to facilitate the appointment of senior and key business people to public roles, improve the expertise of the MRTs and provide firms with room for manoeuvre when determining the form of the awards they pay to MRTs.

The consultation period for the proposals and expectations of the PRA under CP8/22 has been finalised on 20 September 2022. Once the PRA finalises its proposed amendments, these will become effective as of 12 December 2022.

For more information, guidance, or advice on the remuneration regulations in the financial services sector and CP8/22 of the PRA, Cleveland & Co External in-house counsel™, your specialist outsourced legal team, are here to help.

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