GUEST COMMENT: Bonuses will never be the same again
The FSA is proposing to reform City bonus culture by introducing a code of good bonus practice affecting all employees of the 45 or so largest banks and investment firms in the UK.
Its consultation paper on "Reforming Remuneration Practices in Financial Services" was published on the same day as the Turner Report, and so escaped widespread attention.
The proposed changes will require the renegotiation of all employment contracts of the major City institutions. The impact could be significant and controversial because of the need for these City employers to balance FSA requirements with their employees' legal employment rights.
The Code's general principle is that a firm's bonus policies must be consistent with effective risk management. This will be a FSA rule and its compliance will require:
· Every employee's salary to be enough to enable a firm to operate a fully flexible bonus policy (ie. If bonuses are not paid, salaries must be sufficient to live on.)
· Bonus pool calculations are to take into account the cost of capital employed and the amount of liquidity required, with an adjustment for current and future risk;
· Risk and compliance departments are to have significant input into the bonuses of other business areas with every employee's adherence to effective risk management and compliance with the regulatory system a significant part of their individual bonus assessment;
· Every employee must defer at least 66% of any significant bonus, with a vesting period appropriate to the nature of the business and its risks.
· Payment of any deferred bonus must be linked to the future performance of the firm, as well as that employee's division or business unit.
The FSA wants this Code in force by 6 November to catch the next bonus round. It also wants it to apply to every City employee - whatever the terms of their employment contract.
Where terms of current employment contracts prevent a City employer from complying, the FSA will require employers to amend them as soon as possible, and by no later than the end of this year. In all other cases, the final deadline by which employment contracts must be amended or terminated to ensure compliance is 6 November 2010.
The FSA suggests that most current bonus obligations will not extend beyond a year. However, our experience of senior executives' contracts indicates such confidence could be misplaced.
Some executives who have moved recently may be on guarantees which extend beyond November 2010. Further, the deferral of at least 66% of any significant bonus will be a substantial change for many institutions. Executives will want to negotiate the terms of any deferral carefully and to understand precisely the circumstances in which they could lose their deferred bonus.
Ultimately, these regulations could cause leading employees to leave the larger City institutions and set up their own, less heavily-regulated businesses.
Harvey Knight is a regulatory consultant at Withers LLP. Before returning to private practice in 2007, Harvey was the FSA's lead authorisation and approvals lawyer.
