Investment firms in the UK (“UK“) who are authorized to perform investment services or activities under the Markets in Financial Instruments Directive (“MiFID”) (EU/2014/65) (including alternative investment fund managers (“AIFM”) with a “complementary” MiFID authorization) will be subject to the new prudential regime for investment firms (“IFPR”), which will come into effect on January 1, 2022. This note provides an overview of the new compensation requirements proposed under the IFRS.
While a main focus of the FCA’s IFPR proposals has been the impact the IFPR will have on the capital requirements of UK investment firms, new rules are also proposed on remuneration and guidance associated which are summarized in more detail below.
The FCA views compensation as the primary driver of behavior for all businesses and individuals, noting that the objectives of its approach are:
- promote effective risk management in the long-term interests of the company and its customers;
- ensuring alignment between individual risk and reward;
- supporting positive behaviors and healthy company cultures; and
- to discourage behaviors that can lead to misconduct and poor client outcomes.
The proposed remuneration rules will be specified in a new single remuneration code, called the MIFIDPRU Remuneration Code (the “Remuneration code”). The compensation code will be contained in SYSC 19G of the FCA Handbook.
- Which companies are affected by the Remuneration Code?
Classification into SNI firms, non-SNI firms and large non-SNI firms
The IFPR regime distinguishes between “small investment firms and non-interconnected investment firms” (“NIS» businesses) and non-SNI businesses. SNI firms are defined in MIFIDPRU 1 and generally include certain investment firms that fall within certain size criteria, do not hold client money or assets and are not permitted to trade for their own account. All other companies will be classified as “non-SNI”.
A company will be considered a “large non-SNI” if: (i) the value of its on- and off-balance sheet assets over the preceding four-year period is a moving average of more than £300 million; or (ii) the value of its on-balance sheet and off-balance sheet assets over the preceding four-year period is a moving average of more than £100 million (but less than £300 million), and it has a trading portfolio of over £150 million and/or a derivatives business of over £100 million.
Application to CPMI firms
Investment firms in collective portfolio management (“CPMI offices”) are UK firms which are licensed as AIF or UCITS management companies in their own right and which also provide certain investment services which generally require authorization under MiFID. Currently, these companies comply with the AIFM Remuneration Code or the UCITS Remuneration Code (as the case may be) and are not subject to a separate code applicable to their “MiFID activity”.
However, under the new IFPR regime, all CPMIs would have to apply the MIFIDPRU remuneration code to their MiFID “additional” activity. This means that CPMIs will now have to apply either of the two different remuneration codes, as their non-MiFID activities will continue to be subject to the AIFM or UCITS remuneration codes, and therefore include a greater number of personnel within the scope of the remuneration rules.
- What are the main requirements of the remuneration code?
The FCA proposes to create three different levels of compensation requirements depending on the classification and size of companies: basic, standard and enhanced requirements.
Basic compensation requirements
The basic remuneration requirements will be principles-based and will apply to all investment firms in respect of all staff. SNI companies will only have to comply with the basic requirements.
Each company is expected to have appropriate compensation documentation and governance commensurate with the structure and activities of the company. Accordingly, all firms will be required to have a remuneration policy that complies with the minimum requirements and covers all the essential elements of the proposed remuneration code, which includes the central policy objective of aligning staff remuneration with risk, as well as ensuring that the compensation policy is gender neutral.
Standard compensation requirements
Non-SNI companies will need to comply with the requirements of the standard in addition to the basic requirements. These companies will have to identify the significant risk takers (“MRT”) among its staff on an annual basis and set an appropriate ratio between variable and fixed remuneration. Variable remuneration must include risk adjustment mechanisms (malus and clawback). The term “staff” will be interpreted broadly and will also include partners or members (in the case of partnership structures) and employees of other group entities, so it will be important to consider all types of roles that may have a significant impact on the company or its assets. Companies should therefore take steps to determine which members of their staff are identifiable as MRTs and review their existing compensation conditions.
The FCA is, however, proposing to exempt certain MRTs who earn below certain thresholds from certain compensation requirements that are broadly aligned with the current approach under existing codes. The proposals exempt MRTs who have variable pay of £167,000 or less and who have variable pay that is a third or less of their total pay.
Extended compensation requirements
Only large non-SNI companies (estimated at 101 UK companies in total) will be subject to extended compensation requirements, including requirements relating to the deferral and payment of variable compensation in instruments and the treatment of discretionary pension benefits. These companies should also establish a remuneration committee.
- Timing and what’s next?
The FCA’s compensation proposals under the IFPR would come into effect from January 1, 2022. Companies will have to apply the new rules from the start of their next performance year beginning on or after that date.
Companies that currently fall within the scope of the IFPRU or BIPRU compensation codes must continue to apply the requirements of these codes until January 1, 2022, or the start of their next performance year after that date, according to the latest date. The FCA is also expected to consult on public disclosure of compensation information in its next IFPR consultation, due out later this year.