Bankers’ Bonus Cap Lifted: What It Means for UK Financial Services Employers

In a joint statement on 24 October 2023, the UK Prudential Regulation Authority (PRA) and UK Financial Conduct Authority (FCA) announced the removal of the cap on bonuses that can be paid to material risk takers at banks, building societies, and PRA-designated investment firms.

The regulators’ joint statement follows their joint consultation published in December 2022 (PRA CP15/22 and FCA CP22/28). The FCA and PRA confirmed that the changes would take effect from 31 October 2023 and will apply to a firm’s performance year ongoing at that date and to future performance years.

WHY WAS THE CAP INTRODUCED?

The existing cap was originally introduced at an EU-level in 2014. Under the cap, banks, building societies, and PRA-designated investment firms were required to limit an individual’s variable remuneration (i.e., bonuses) to a maximum of 100% of their fixed pay, or 200% with the approval of shareholders. While colloquially referred to as a “cap,” technically, it did not limit the total remuneration that could be paid—it simply fixed the relevant ratio between fixed and variable pay.

The cap was introduced with the aim of curbing significant bonuses that could otherwise lead to employees chasing short-term goals and taking excessive risks in pursuit of short-term personal financial gains.

WHY HAS THE CAP BEEN REMOVED?

According to the regulators’ joint statement, removal of the cap will

• allow banks, building societies, and PRA-designated investment firms to restructure pay more quickly;
• give those firms additional flexibility over their cost base to deal with downturns;
• give those firms more flexibility to share risk with employees;
• allow for a greater proportion of total pay to be subject to the “incentive setting tools within the remuneration framework sooner,” which “could contribute to a better alignment of incentives and financial rewards with principles of effective risk management, good conduct and the long-term interests of the firm” (in the FCA’s view, this is “likely to foster better market conduct and prudent risk management, thereby discouraging behaviours that can lead to misconduct and poor customer outcomes, and improving the safety and soundness of dual-regulated firms and the wider financial system”);
• improve the competitiveness of the United Kingdom internationally through attracting talent and competing against jurisdictions where there is no bonus cap; and
• remove “undesired consequences of the cap’, such as ‘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.”

There has been a mixed reaction to this announcement. Banking industry professionals have welcomed the move, stating that it will allow the financial services industry in the United Kingdom to be more globally competitive. However, the decision has also drawn criticism from trade unions and campaigners who have declared it an inappropriate change when many households are struggling in a cost-of-living crisis.

WHAT DOES THIS MEAN FOR AFFECTED EMPLOYERS?

The change is facilitative rather than mandative. Banks, building societies, and PRA-designated investment firms are not required to make any immediate changes to their pay practices, but they will have the freedom to restructure pay, unhindered by the bonus cap.

In reality, employees subject to the bonus cap will have contractual arrangements in place reflective of the cap and that embed higher fixed pay and allowances. That is unlikely to change overnight. However, as time passes, banks, building societies, and PRA-designated investment firms may turn to the lifting of the cap to put forward new, and more attractive, incentive arrangements to lure and retain staff and gain a competitive advantage over rivals.

It should also be noted that, as part of the consultation, the regulators expressly considered the impact of the removal of the cap on the gender pay gap. As referenced in the statement, “[t]here is evidence suggesting that gender pay gaps in bonuses are typically larger than in fixed pay, and that the banking sector may have high gender pay gaps.” With this in mind, the joint statement warned firms that the regulators “expect firms to take care to avoid adverse impacts on pay gaps when using this increased flexibility to set more appropriate pay ratios.”

NOT EVERYTHING IS CHANGING THOUGH (YET)

While the cap on bonuses has been removed, banks, building societies, and PRA-designated investment firms must still continue to set an appropriate ratio between the fixed and variable components of total remuneration (for which the regulators will provide principles-based guidance based on corresponding guidance in the FCA’s MIFIDPRU Remuneration Code) and ensure that the fixed and variable components remain appropriately balanced. They must also ensure that the level of the fixed component represents a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable remuneration components, including the possibility to pay no variable remuneration component.

The regulators stressed that its other rules regulating variable pay (e.g., regarding mandatory deferrals, the composition of variable pay, and risk adjustment mechanisms) will also remain in place (for now).

However, the subject of remuneration is likely to be revisited in the near future. In the context of considering comments from respondents to the consultations regarding deferral, the joint statement specifically refers to an October 2022 statement from Sam Woods, PRA CEO and deputy governor for Prudential Regulation:

[The PRA] intend[s] to look more broadly at the whole structure of rules around remuneration. We will consider how these rules, which are a patchwork of EU and UK regulations, can be streamlined and made more effective and proportionate. In doing so, we will be clear that rules around remuneration are an important tool to ensure decision-makers and risk-takers have the right incentives.

It is likely that further developments will follow.

Trainee solicitor Palomi Kotecha contributed to this LawFlash.