FCA and PRA consult on removal of bonus cap

The regulators of the financial services industry, the FCA and the PRA, have opened a joint consultation on removing the bonus cap, the existing limits on the ratio between fixed and variable components of total remuneration. The proposed changes will come into force the next calendar day after the publication of the final policy, which is expected to be Q2 of 2023, and will apply to firms’ performance year starting after that, so for most firms that is likely to be performance years starting 2024. The news will be of interest to banks, building societies and PRA-designated investment firms in particular.

The consultation paper gives the background and the rationale for the proposed changes. On 23 September in his ‘not-so-mini-mini’ Budget the former Chancellor Kwasi Kwarteng announced the Government’s intention to remove the bonus cap. Since then the current Chancellor, Jeremy Hunt, has confirmed he will stick by its removal. Given that policy commitment, the regulators say the aim of their proposed changes is to ‘encourage alignment between risk taking, risk management, long term performance and individual reward’. They say that since the bonus cap does not limit total remuneration, 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. 

Bonus season is in sight and employers are turning to bonuses to avoid inflationary pay deals. As the FT reported back in May, the level of discretionary awards has hit a 9-year high amid labour shortages and rising living costs. Bonus payments stand at their highest since 2013 as a share of UK earnings,

It is no surprise that the emphasis on paying bonuses has been matched by a sharp rise in disputes over the fairness of the payments. This can be difficult for employers and, as we have seen a number of times already this past year, getting it wrong can lead to protracted disputes and expensive litigation. Recognising that, to help clients Pinsent Masons has been working on a new product that may be of interest to HR. Chris Evans has been involved in its development and he joined me by phone from the London office to discuss it: 

Chris Evans: “So what we've developed is a product which takes an employer's bonus scheme and asks a number of pertinent questions about how they implement that bonus scheme to identify whether there are any kind of red flag risks that they ought to be addressing now. So what we often see with bonus schemes is that they either very historic or haven't been looked out for a while and most years there isn't a problem because it's a very good thing the staff are given bonuses but in circumstances where there either are bonuses not being paid out, or bonuses are less than employees expect, that's very often where we see the challenge and what we're looking to do is to pre-empt those challenges by ensuring that employer’s bonus schemes, and the processes they follow through to implement them, are fit for purpose and they're going to send the best possible chance of defending any such claim if one arises.”

Joe Glavina: “I talked recently to the share plans team about this and the problems they sometimes see around discretionary bonuses when people didn’t get the pay-outs they were expecting. It can be very costly for the employer if they’ve got it wrong.”

Chris Evans: “Absolutely, so the costs of getting the bonus scheme wrong, or the implementation wrong, can be extremely high for an employer. One example is a case I did relatively recently was there was a dispute with an employee who was exiting as to the amount of the bonus and the bonus schemes rules were drafted in such a way that there was a level of ambiguity. The ambiguity meant that this individual was able to come to a figure which exceeded a million pounds whereas on our interpretation of the bonus scheme it was far less, around the £100,000 mark. So you could end up in a situation because of the value of the claim, particularly that claim, where you could end up in the High Court and the legal fees alone associated with that would run into the tens, if not hundreds of thousands of pounds. So what we are looking to do here is try and ensure that the bonus scheme is fit for purpose so that when you are presented with a challenge like that you can clearly turn around and say no, the bonus rules are clear, there's an element of discretion here, yes, but we're not acting irrationally when exercising that discretion.”

Joe Glavina: “I can imagine some managers struggling with that. So they might see a decision not to pay a bonus, or to pay a lesser amount, as perfectly rational, but the employee, and perhaps ultimately a court, might see it differently. What’s your message to HR on handling that?” 

Chris Evans: “Yes, I think what is a helpful takeaway for employers is that if you are paying some bonus, and there's an element of true discretion if I can put it that way, so you're not fettered by the contract as to what you can and can't take into account, and you apply the appropriate categories as part of your discretion, as part of your decision making, then a court should be reticent to interfere and there is good case law authority which goes to that. The difficulty, however, which I say is that you very often have ancillary claims associated with a bonus dispute. So there may be a discrimination claim or there may be a whistleblowing complaint, for example, and what we typically see is that an individual will claim that the manager who made the decision about the bonus has subjected them to some form of discriminatory treatment, for example, and that give rise to a significant concern because if they are the ones making that decision, and if there is a finding of discrimination, a court would be quite alive to the fact that actually any discretion which has been exercised could be irrational in circumstances where the decision maker is found to be discriminatory. Now, this is always why I recommend there to be at least a review process as part of a bonus decision making exercise. So even if the manager identifies what bonus they think it's appropriate they should document why, first of all, so we've got an audit trail, but that needs to be independently audited by another manager. So at least then if we get into a dispute we can say, well, yes you may have a complaint against your manager for discrimination, or for whistleblowing detriment or whatever it may be, but the exercise of discretion around the bonus has been independently verified and the second manager has not been tainted, even on your own account, by this alleged discrimination. So again, it just gives us more ammunition to go into litigation, if indeed it arises, so that we can properly defend these claims.”

The joint consultation by the FCA and PRA will be running until 31 March. If you would like to give your views on the proposals you can – there is an email address within the consultation paper. We’ve put a link to that in the transcript of this programme. 

LINKS
- Links to FCA & PRA’s joint consultation papers:
CP15/22—Remuneration: Ratio between fixed and variable components of total remuneration (‘bonus cap’)
CP22/28: Remuneration: Ratio between fixed and variable components of total remuneration