Buy-Outs of Variable Remuneration: PRA Consultation

The PRA has issued a consultation on its proposed new rule to address the issue of buy-outs of variable remuneration. The new rule will apply to all material risk takers at PRA-authorised banks, building societies and designated investment firms (excluding firms falling within the level 3 proportionality framework). 

The FCA is not consulting separately. However, it will follow feedback to the consultation closely and will consider at a later stage whether it is appropriate to apply rules on buy-outs more widely across FCA solo-regulated firms. 

The issue

The new rule is designed to address the situation where an employee changes jobs and the new employer compensates them for any deferred bonuses that have been cancelled by their previous employer. The PRA is concerned that this practice undermines the effectiveness of its rules, which are designed to discourage excessive risk-taking. These rules require employers to defer the payment of bonuses (in order to allow time to reassess the nature, scale and outcomes of risks taken) and to apply clawback where there has been misconduct or a failure in risk management. By moving employers and having their cancelled bonuses bought out, individuals are in effect able to protect themselves against ex-post risk adjustment (i.e. malus) of their past awards, as risks crystallise or the consequences of poor management emerge at their former employer.

The proposed rule

The proposed rule allows for the possibility of malus and clawback to be applied to bought-out awards, based on a determination by the old employer that there has been misconduct or a failure of risk management. The new employer will not be able to provide a buy-out unless it has first entered into a contract with the employee enabling it to apply malus and claw back. The old employer notifies the new employer of its determination and of the amounts that should be applied to the employee’s deferred variable remuneration by way of malus, and/or clawed back where the variable remuneration has already vested. The new employer must then act on this.

Old employer’s obligations

The old employer will be under an explicit duty to act fairly and reasonably in making a determination and an individual will have a private right of action in damages if it fails to do so. The old employer should be able to demonstrate that it has acted consistently in relation to current and former employees and concurrent cases of malus and clawback. 

The proposed rule also requires the old employer to provide the former employee with details and reasons for any proposed malus or clawback and allow the employee to make representations as to why such a determination should not be made. The old employer will be obliged to take account of any representations when making a determination. 

The old employer will also be expected to report cases of malus or clawback against bought out awards to the PRA at least annually.

New employer’s obligations

The new employer would be expected to act on receipt of notification from the old employer, except to the extent that the awards concerned had already been subject to malus or clawback. The proposed rule does not prohibit the new employer from including a provision in the contract providing for malus and clawback to bought-out awards, but the PRA does not anticipate that such a provision would be commonly included.

Where clawback is sought, the new employer would act as the claimant in a contractual claim against their employee, supported by the old employer’s notification, for those sums already vested. There will also be provision in the rule for the new employer to apply for a waiver where they have reason to believe that an old employer’s decision to apply malus or clawback has been manifestly unfair or unreasonable. The grounds for seeking a waiver might include the apparent severity of treatment toward a former employee based on the information provided, or a pattern of determinations suggesting the old employer was not acting fairly and reasonably towards their former employee(s). 

The consultation, Buy-Outs of Variable Remuneration, closes on 13 April 2016.