PS1/23 – Remuneration: Unvested pay, Material Risk Takers and public appointments

1. Overview

1.1 This Prudential Regulation Authority (PRA) Policy Statement (PS) provides feedback to responses to Consultation Paper (CP) 8/22 – ‘Remuneration: Unvested pay, Material Risk Takers and public appointments’. It also contains the PRA’s final policy, as follows:

• updated Supervisory Statement (SS) 2/17 – ‘Remuneration’ (hereafter SS2/17) (Appendix 1).

1.2 This PS is relevant to PRA-authorised banks, building societies, PRA-designated investment firms, including third-country branches, that are subject to the Remuneration Part of the PRA Rulebook (firms).

Background

1.3 In CP8/22, the PRA proposed to add a new section to Chapter 4 of SS2/17, setting out the PRA’s expectations that:

• in general, unvested, deferred claims that comprise the variable pay of Material Risk Takers (MRTs) should not be converted from an equity claim into a claim on other instruments (or vice versa) after an award has been made;
• this expectation should apply to all unvested, deferred sums, and not exclude amounts above the regulatory minima; and
• in exceptional circumstances, such as where there are potential conflicts of interest arising from a (proposed) public sector appointment that cannot otherwise be sufficiently mitigated, it may be appropriate for a conversion to occur subject to the PRA’s prior non-objection, and on the basis that the relevant retention requirements remain unchanged.

1.4 It was also proposed that SS2/17 be amended to outline the circumstances in which the PRA considers it more likely a waiver or modification to the relevant remuneration rules would meet the FSMA statutory test, where, in wholly exceptional circumstances, an adjustment is sought in relation to a public sector appointment with a view to converting an award comprising equity or other instruments to a cash sum.

Summary of responses

1.5 The PRA received five responses to the CP. Most respondents welcomed the proposals or viewed them as helpful. One asked for further clarification without expressing a view on the proposals. The points that were raised are set out in Chapter 2.^{footnote [1]}

Changes to draft policy

1.6 The PRA has made modifications to the draft SS text:

• to aid clarity, the addition of a footnote (number 19) noting that there may on occasion be circumstances other than public appointments where a conversion is appropriate;
• in response to feedback received, addition of a footnote (number 20) to clarify that the use of the terms ‘equity’ and ‘other instruments’ are used for convenience to include those instruments that fall under sections 15.15(1)(a) and 15.15(1)(b) of the Remuneration Part of the Rulebook, respectively;
• the addition of a line (paragraph 4A.11) to state that in the event of a conflict of interest arising from a public appointment due to instruments being held during a retention period, the onus should be on a public sector employer to determine whether (or not) its conflicts of interest policy is able to address any conflicts; and
• drafting changes to add clarity.

1.7 In carrying out its policy making functions, the PRA is required to have regard to several matters, as set out in CP8/22 in Appendix 2, 'The PRA's statutory obligations'. In CP8/22, the PRA explained how it had had regard to the most relevant of these matters in relation to the proposed policy. In the next section, the PRA provides relevant updates to some explanations, taking into account consultation responses. The PRA considers that the other previous explanations remain appropriate.

1.8 In developing CP8/22, the PRA had considered the following ‘have regards’ as significant to the proposal: the principle that the PRA should exercise its functions transparently.

1.9 In particular, the modifications enhance transparency by clarifying that the use of the terms ‘equity’ and ‘other instruments’ include all instruments that can fall respectively within sections 15.15(1)(a) or 15.15(1)(b) of the Remuneration Part.

Implementation and next steps

1.10 The new policy will take effect on 10 February 2023.

1.11 References related to the UK’s membership of the EU in the SS, covered by the policy in this PS, have been updated to reflect the UK’s withdrawal from the EU. Unless otherwise stated, any remaining references to EU or EU-derived legislation refer to the version of that legislation which forms part of retained EU law.^{footnote [2]}

2. Feedback to responses

2.1 The PRA must consider representations that are made to it in accordance with its duty to consult on its general policies and practices and must publish, in such manner as it considers fit, responses to the representations.

2.2 The PRA has considered the responses received to the CP. This chapter sets out the PRA’s feedback to those responses, and its final decisions.

2.3 The responses received have been grouped as follows:

• conversion of unvested remuneration and retention periods; and
• scope, process, and privacy.

Conversion of unvested remuneration and retention periods

2.4 The PRA proposed that in general, firms should obtain the PRA’s non-objection in cases where they propose converting unvested, deferred remuneration in the form of equity into other instruments (or vice versa).

2.5 One respondent asked whether the policy had any implications for the use of share-linked instruments used by some firms in place of shares. The PRA has considered this, and clarifies that the policy does not seek to change the definition of the instruments eligible for inclusion in either section 15.15(1)(a) or 15.15(1)(b). As a matter of convenience, CP8/22 referred to the category of shares, equivalent ownership interests, share-linked or equivalent non-cash instruments falling within section 15.15(1)(a) as ‘equity’, whereas instruments eligible for inclusion in section 15.15(1)(b) were termed ‘other instruments’. Hence, the use of the term ‘equity’ does not exclude share-linked instruments from being covered by the policy. The text added to SS2/17 has been amended accordingly.

2.6 One respondent noted that firms would require rigorous systems and processes to be able to meet the expectation of making conversions between instruments outlined in CP8/22, or to achieve the circumstances in which a waiver or modification is more likely to be granted. The PRA agrees there are system and administrative implications for those firms that wish to undertake the conversion of unvested, deferred pay from one form into another. However, as underlined in CP8/22, the PRA is not creating an expectation that firms should undertake conversions for a particular reason. It is for firms to judge whether they wish to do this, and approach the PRA to obtain either its non-objection, or to apply for a waiver or modification.

2.7 It was further suggested that restricting the possibility to convert awards to a cash claim to ‘wholly exceptional circumstances’ was overly restrictive. The PRA continues to judge it likely that, in the context of public appointments, a firm would be able to satisfy the relevant waiver or modification criteria only in wholly exceptional circumstances. However, such decisions are based on statutory criteria and whether a firm can demonstrate that the relevant test is met will depend on the facts of the case.

2.8 It was also suggested that the PRA should allow firms to convert an unvested, deferred award into a cash-settled award linked to other instruments already issued by the firm. In making its proposals, the PRA does not seek to amend the definitions of those instruments eligible for inclusion under section 15.15(1)(b) of the Remuneration Part of the PRA Rulebook. It remains the case that an arrangement that involves more than converting an instrument that is included in section 15.15(1)(a) to one included in section 15.15(1)(b) (or vice versa) would require a waiver or modification to the rules. The PRA does not consider it necessary to make a specific amendment to the Rulebook on this point, due to the possibility of firms requesting a waiver or modification.

2.9 One respondent noted that the retention requirements applicable under the Remuneration Part may also result in conflicts of interest in the context of public appointments. The respondent suggested that similar principles outlined in respect of unvested, deferred pay should apply also to instruments being held during a retention period. The PRA has considered this point. In such circumstances, the PRA considers that the onus should be on a public sector employer to determine whether (or not) the ongoing application of the retention requirement can be managed within its conflicts of interest policy (or similar code). Consequently, the PRA’s policy on retention remains unaltered as a change would be disproportionate given the likely scale of the issue and the other means by which it might be addressed.

Scope, process, and privacy issues

2.10 One respondent noted that there may be reasons for firms to seek to convert unvested, deferred pay other than facilitating a public appointment. The PRA acknowledges that there may be other reasons why a firm may wish to make a conversion. While the policy focuses on facilitating public appointments, firms that believe it is appropriate to convert unvested, deferred pay into another instrument or cash in other circumstances where this would maintain the purpose of the PRA’s policy on variable remuneration should approach their supervisory contact.

2.11 It was additionally noted by one respondent that the ability to make conversions might be constrained by regulatory requirements in other jurisdictions where an individual is identified as an MRT in one or more jurisdictions outside the UK. As CP8/22 noted, the firms’ ability to undertake conversions may be constrained by other applicable laws and regulations. While the PRA notes that some firms might wish for greater alignment in this area, it is outside the scope of this policy work. Stakeholders may nonetheless wish to raise the issue with other authorities.

2.12 The PRA was asked if its prior non-objection to a conversion (eg from equity to other instruments) had to be obtained on an individual-by-individual basis in circumstances where there was high degree of commonality in the rationale for the conversion. The PRA considers such an approach is reasonable and could result in a more proportionate approach. It would, however, be a matter for the relevant supervisor to consider whether it is appropriate for the non-objection process to be framed in such a way that it would be applicable to a class of conversions within pre-notified parameters.

2.13 One respondent enquired about the privacy of MRTs (or former MRTs) in cases where a firm applies for a waiver or modification in connection with a conversion of unvested, deferred pay into a cash sum. The PRA understands this concern. Normal practice in similar cases would be to refer to the name of the firm (as applicant) rather than the MRT in cases where a waiver or modification is granted.

2.14 One respondent asked the PRA to clarify that it was not seeking to impose any new expectations on firms in respect of their communications with any prospective public sector employer. In response, the PRA notes the policy proposals in CP8/22 do not create an expectation that any firm should seek to facilitate public appointments. Whether they choose to do so is a matter for the firm concerned. However, as CP8/22 noted, where a firm seeks the PRA’s prior non-objection to a conversion or makes a request for a waiver or modification, the SS envisages the PRA should be presented with a reasoned case outlining why this, together with other measures, would be appropriate and sufficient to address the conflict of interest identified. If an adjustment to the basis on which variable pay is awarded, along with other measures, is not effective in addressing the conflict, it is unlikely that the PRA would provide its non-objection or grant an application for a waiver or modification.