The issue of City bonuses has become political dynamite, so a lot was hanging on the publication of the FSA’s remuneration code on 17 December 2010. Despite trepidation in the City, the new code retains a certain level of flexibility, but the challenge for the companies affected is clear: to implement the regulations prior to 1 July 2011 while at the same time getting to grips with those aspects of the code that are still open to FSA interpretation. They must balance the need to retain key staff with the need to comply with the new regulations.
The original code of 2009 applied to 26 large banks and building societies, but from 1 January some 2,700 companies were brought into the scope of the code, including a large number of asset managers, plus some corporate finance and venture capital players, financial advisers and brokers.
One of these is asset management company Old Mutual. Unusually for a lawyer, its general counsel Meekal Hashmi is head of both legal and HR. Hashmi argues that there are advantages to having this dual role, since in the new regulatory environment the functions are intrinsically linked.
“I’m not an employment specialist, but as a lawyer I can bring a certain amount of legal rigour to the HR department given the increasing risk that people carry within an organisation,” he says. “In the financial services sector, the people risk is a large one. I see risk everywhere.”
Taking the code and applying it has been tricky, Hashmi says, because desks run differing strategies that have historically given rise to varying remuneration principles.
“We’re multi-boutique and therefore have long-only funds and hedge funds, so we have people paid different amounts of money and paid in different ways too,” says Hashmi. “There are different charging structures under those and you need to be able to articulate a cohesive policy so they don’t leave. And on top of that you now have to layer the remuneration code.”
With full implementation of the code due in July this year, Hashmi has been conducting a long exercise in reviewing Old Mutual’s remuneration policy to make sure it is compliant with the FSA regulation.
Of particular interest to the regulator is the treatment of what are termed ’code staff’, a group of employees to which the more prescriptive sections of the code will apply. Code staff are defined as persons who perform a significant influence function for a company; senior managers or risk-takers whose professional activities could affect a company’s risk profile. Tier 2, 3 and 4 organisations may have to provide a list of these people to the FSA.
“Remuneration of code staff requires extra awareness of the rules,” notes Hashmi.
Under the remuneration code the company as a whole is categorised, but in an asset management business a fund can be an isolated legal entity.
This has given rise to debate over whether fund managers are code staff as they do not put the wider organisation at risk. “I doubt we’ll be putting all our fund managers as code staff,” says Hashmi. “Obviously our key fund managers are on the executive team so they’ll be designated as code staff, but it’s not an automatic thing that if you’re a fund manager you’ll be designated as such. If you’re taking risk for a separate legal entity it may be the case that your activities do not have a material impact on your company’s risk profile. We’ll look at people individually. You can’t generalise.”
He adds: “At the moment people are focusing on which tier they fall into when complying with the code.”
As we went to press it was unclear whether the FSA would characterise Old Mutual as Tier 3 or Tier 4, but whatever the outcome the company has to explore the implications of the code for all its employees.
“The consequences in terms of tax and employment law issues are only just starting to be discussed,” says Hashmi.
To take just one example, in section 8 the code states: “A firm must ensure that a substantial portion, which is at least 50 per cent, of any variable remuneration consists of an appropriate balance of a) shares or equivalent ownership interests […] or share-linked instruments or equivalent non-cash instruments in the case of a non-listed firm, or b) where appropriate, capital instruments. […] The instruments must be subject to an appropriate retention policy designed to align incentives with the longer term interests of the firm.”
Added to this, section 12 of the code introduces a deferral concept, stating: “A firm must not award, pay or provide a variable remuneration component unless a substantial portion of it, which is at least 40 per cent, is deferred over a period which is not less than three to five years.”
Tier 4 companies have to comply with the restrictions around guarantees and termination payments, while Tier 3 companies also have extra restrictions on the balance between salary and bonus.
However, the FSA encourages all companies to consider these deferral methods as part of enhanced risk management.
“Most asset management firms I know have already introduced or will be introducing a deferral element to their remuneration even though they don’t strictly need to,” says Hashmi.
Thanks to his dual role of head of legal and HR Hashmi is already predicting the next set of issues to be addressed.
“From an employment law perspective, you’re going to have to make changes to people’s contracts, so you’ll have to consult with them,” he says.
“You’re opening yourself up to individual claims if you change the contract so you can claw back their bonus. Could this be a potential constructive dismissal claim? This hasn’t been addressed in employment law thinking.”
At the same time, adds Hashmi, the FSA code could create issues in terms of HM Revenue & Customs’ (HMRC) approach to taxing bonuses.
“If you’re given a bonus, the HMRC view has always traditionally been to try and accelerate the time of the vesting and claim tax from you as soon as possible,” he says. “This seems to contradict the FSA approach of holding back payments from individuals. The implications haven’t been tested yet. Although the tax issues strictly may only apply to Tier 1 and 2 companies, any company that goes on to introduce some level of deferral at risk will face the same issues.”
Whatever the outcome, the code signals a new climate in regulatory thinking.
“It’s clear that these changes signal the arrival of a more intrusive regulatory regime that it is here to stay,” elaborates Hashmi. “A decisive shift from the light-touch regime we had become used to in London. Given the regulations coming out of Brussels and the Government’s attitue to the financial services sector, we’d better get used to an increasing amount of regulation.”
“Still,” Hashmi concludes, “it ensures a key role for the lawyer within the business.”