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Tough new curbs raise concerns

Stephen Levinson summarises the response from the Employment Lawyers Association (ELA) to the latest proposals on bankers’ accountability and remuneration.

Employment lawyers have given a lukewarm reception to new proposals to regulate the financial sector. The ideas in two consultation papers, issued jointly by the Prudential Regulation Authority on behalf of the Bank of England and the Financial Conduct Authority (FCA), are considered by ELA to give rise to serious concerns about the way they will operate and their potential for unfortunate consequences.

Background

The first paper, Strengthening accountability in banking: a new regulatory framework for individuals, deals with tightening the regulatory regime around senior individuals in banks, building societies, investment houses and credit unions. The second, Strengthening the alignment of risk and reward: new remuneration rules, proposes tougher rules on those individuals’ pay.

The background to both papers is the public fury that arose out of the financial crisis in 2008-09 and the scandals in the sector such as the manipulation of LIBOR and the sale of payment protection insurance. The Parliamentary Commission on Banking Standards (PCBS) was set up in 2012 as a joint committee of both Houses of Parliament to consider and report on professional standards and culture in the UK banking sector and to propose new legislation.

The results were legislative changes to the Financial Services and Markets Act 2000 which created a ‘senior managers’ regime’ and new conduct rules. The recent proposals are intended to implement the changes required by the Act and the PCBS recommendations.

Both sets of proposals reflect a desire to enable regulators and employers to hold individuals to account and create a greater acceptance of responsibility amongst senior individuals. The remuneration proposals are supposed to realign risk taking and reward and to discourage short-termism and excessive risk taking.

The irony of parliamentarians, who have been under so much criticism for their own pay practices, preaching to financiers on the subject will not escape most observers.

The Westminster folk, however, are safe in the knowledge that bankers are even less popular that they are. The public mood is clearly on the side of the regulators, who, in this sector, as in many others, grow more powerful every year.

Accountability proposals

Broadly speaking, the accountability paper proposes the following changes. It requires greater clarity about who is accountable for what and introduces statements of responsibilities and ‘responsibility maps’ setting this out for the record. The number of people accepted into the senior managers’ regime will be refined and reduced. The proposals also say relevant firms must provide references for a former employee to a prospective new employer in the sector.

The current regime certifying those carrying out certain functions as ‘fit and proper’ is said to be too narrow and allows firms to be too relaxed over this issue. Accordingly, a list of those who might create ‘significant harm’ is to be put in place and employers will have to ensure they certify them according to new rules, with this certification having to take place again whenever an individual changes roles.

Both regulators propose a new set of conduct rules and those imposed by the FCA will apply to the large majority of those working in the relevant fi rms. They will be defined by exception; in other words, everyone who is not in certain specified categories will be caught. The width of application of these rules is deliberately designed to change cultures and to impose a common understanding of acceptable behaviour. This is complemented by adding an explicit duty on all senior managers to be open with regulators and report serious wrongdoing to them.

The regulators recognise that this may raise problems in relation to the wider issue of whistleblowing, which they avoid tackling in this paper but promise to return to later.

Problems

ELA is principally concerned with the practicality of proposals to change laws and regulations. It leaves the policy decisions for others to propose and dispute. It had many such concerns over these proposals.

It felt that the introduction of the new senior managers’ regime would lead to increases in fixed salary levels because of the degree of risk individuals will have to accept. This is emphatically not what regulators want and so may prove counter-productive to their aims. The HR implications of the regime will probably require significant negotiation between senior managers and employers and create conflict between individual and collective responsibilities. The proposals will also require major changes to appraisals and job descriptions as well as remuneration and disciplinary processes. The negotiation of revised employment terms is likely to be a lengthy process and involve senior managers having to take individual advice to understand the full extent of their responsibilities.

Remuneration proposals

The remuneration paper suggests several ways of controlling inappropriate pay. The current deferral periods before awards vest are considered too short. The paper suggests a period of no less than seven years for senior managers, with a first vesting no earlier than three years and no further vesting other than on a pro-rata basis between years three and seven. This is said to be more in keeping with business cycles.

The minimum period for other ’material risk-takers’ is to be five years. Clawback – the practice of requiring repayment in the event of employee misbehaviour, a material downturn in a firm’s performance or a material risk-management failure – should apply for a minimum period of seven years, with discretion to extend this to ten years if an investigation is in place. There is to be a presumption that no payments or vesting of a discretionary nature should be permitted to the staff or management of bailed-out banks.

This is to toughen-up the existing rules applicable to what might be called the ‘Fred Goodwin problem’. There is also a proposal that non-executive directors should never receive variable remuneration.

Finally, the regulators turned their mind to the issue of new employers buying out forfeited awards for newly recruited staff. They were concerned this practice allows those moving on to evade clawback. The ideas were banning buy-out entirely, prohibiting employers from cancelling unvested awards, allowing the regulator to recover awards made by the new employer where misconduct had been found to exist or simply relying on existing clawback remedies.

The paper spent so much space describing what was wrong with each of these proposals that it was clear the authors had little confidence in any of these ‘remedies’ being effective. With this at least ELA agreed.

Problems

ELA was concerned that that the proposed two-level approach for deferral (at least seven years for senior managers and five years for other employees) would create problems. As with the accountability proposals, this might lead to an increase in the fixed-pay component and it would create a two-tier workforce where the interests of senior managers and other employees were not aligned. In particular, what process would be applied to individuals who were promoted to a senior management role in the middle of a deferral period? Also, clarity was required about the time from which the new rules on clawback and deferral were to apply.

Moreover, the distinction between senior managers and other material risk takers could encourage a reluctance to be promoted given the new enforcement regime and the more stringent clawback terms.

ELA considered that the discretionary powers for employers to increase clawback periods would encourage litigation. To mitigate against this risk, employers would have to put in place robust rules for determining the issue. Further, the implications of such an extension could be seen as a pre-judgement of an employee’s guilt. Generally, these problems could be reduced by introducing a mechanism to mitigate a number of these proposals, many of which appear to be unnecessarily inflexible.

It was also felt it would be unfortunate if different regulators were to apply different standards to periods of clawback.

ELA felt that there was no problem with the proposed ban on non-executive directors earning variable remuneration, as long as there was no such restraint on their other executive roles. The buy-out proposals, as indicated above, were considered impractical other than relying on the clawback rules.

Other concerns

ELA also could not help revealing that it has concerns about the impact of these proposals on the attractiveness of the UK as one of the world’s most competitive and successful financial sectors. Despite the well-publicised misbehaviour of a few, the sector remains important for the UK economy. As policy is not its business, it confined itself to suggesting that this is an important factor for both regulators to consider, and added it would be sensible to review the equivalent rules in other jurisdictions.

It was noticeable and very surprising that both consultation papers expressly avoided off erring any firm opinion on this issue. The papers said that a qualitative analysis of these indirect costs had not been undertaken:

“… as it is considered disproportionate to do so and not reasonably practicable.”

On the contrary, it is suggested that not to carry out such an exercise would be an unacceptable risk. After all, the whole point of this exercise is to encourage everyone to take greater responsibility for their actions, and that presumably also applies to regulators.

This article was written for, and first featured in, the Employment Law Journal.


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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.

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