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The Financial Services Authority (FSA)  is looking to put an end to a remuneration culture in the City that encourages excessive risk taking, as it prepares to extend a clampdown on banker payouts to a much wider range of jobs in finance.

The City regulator has begun a consultation on its remuneration code [2] and has warned that its scope would have to expand from the 27 companies currently affected to 2,500 as a result of new European rules, known as the capital requirements directive.

They will include hedge funds, asset managers, venture capitalists, stockbrokers and corporate finance operations. Critics have already expressed concern that the move could encourage a brain drain of the best financial “talent” to countries such as the US or Switzerland, at the risk of putting Britain's financial services industry at a huge disadvantage.

The consultation will also look at the group of employees to which the Code should apply, with a proposal to include any role that could have a material impact on a firm’s risk profile. 

The FSA consultation also sets out ways to stop "rewards for failure" and to ensure that pensions do not inadvertently reward poor performance, by demanding that any enhanced contributions are held in shares for five years.

At the same time, it is suggesting that at least 40% of a bonus must be deferred over a period of at least three years rising to at least 60% when the bonus is more than £500,000. Meanwhile, at least 50% of any bonuses must be paid in shares or other non-cash instruments. No guaranteed bonuses of more than one year can be paid and only then "in exceptional circumstances to new hires for the first year of services".

The regulator intends to clamp down on some of the methods used by firms to avoid its existing code. It plans to stop employers paying staff through "alternative vehicles" or offering "non-recourse loans", which effectively enable them to behave as if they had received their bonuses.

Any companies that allow staff to use hedging strategies to buy insurance contracts to protect their bonuses will also be regarded as breaking the FSA rules. The regulator believes this would break one of the basic tenets of its code – "that remuneration policies must be consistent with and promote effective risk management".

Responding to the consultation, the British Bankers' Association said: “UK banks recognise that reform of pay structures plays a significant part in restoring confidence in the industry. The UK has moved further and faster on reform of pay and bonuses than any other country. Today's proposals from the FSA represent the UKs contribution to levelling the playing field for all EU financial institutions, as they will implement the EU-wide rule changes which will come into force next January.”

"The BBA maintains that reform of the bonus system in financial services must be globally coordinated. A global industry needs to conform to global standards, as any country which takes a lighter approach will prove to be a magnet for business. We now need other countries to coordinate their reforms with the UK and EU rules. We will work with the FSA to ensure rule changes do not damage the banks ability to recruit and retain staff in the UK."

Tamara Cizeika, senior associate at international law firm Eversheds said: "When the FSA began to consult on its new remuneration regime in early 2009, one of the industry's biggest concerns was that it was front running and there was a fear that UK competitiveness could be damaged if regulations elsewhere did not implement similar principles in a similar timescale.

"Although there are still issues to work through, the fact that the EU has largely caught up should mean that there is a more level playing field and that relevant UK firms won't have to compete with one hand tied behind their backs. We also shouldn't forget that when the FSA published its final rules, it said that these might have to be adapted to meet international requirements, but that the fundamental objectives and direction of the rules were likely to remain intact. And that has probably turned out to be the case.”

The consultation period closes on 8 October 2010. The FSA intends to issue a policy statement in November 2010 with rules effective from 1 January 2011.

FSA REMUNERATION CODE AT A GLANCE

•    Application – the FSA is consulting on the group of employees to which the Code applies. These will include senior management and anyone whose professional activities could have a material impact on a firm’s risk profile. 
•    Deferral – at least 40% of a bonus must be deferred over a period of at least three years. At least 60% must be deferred when the bonus is more than £500,000.
•    Proportion in shares – at least 50% of any variable remuneration components must be made in shares, share-linked instruments or other equivalent non-cash instruments of the firm. These shares will need to be subject to a minimum retention policy.
•    Guarantees – firms must not offer guaranteed bonuses of more than one year. Guarantees may only be given in exceptional circumstances to new hires for the first year of service.
•    Strengthening of capital base – firms must ensure that their total variable remuneration does not limit the ability to strengthen their capital base. Total variable remuneration must be significantly reduced in circumstances where the firm produces a subdued or negative financial performance.
•    Voiding provisions – a new rule will be introduced which defines instances where breaches of the code may render a contract void and/or require recovery of payments made.
•    Severance payments – should reflect performance over time and failure must not be rewarded.
•    Pensions – CRD3 states that enhanced discretionary pension benefits should be held for five years in the form of shares or share-like instruments.