Financial services pay models for firms with European operations have changed profoundly since the financial crisis as a result of European Union and domestic regulation, but the story is far from over. It’s likely that all financial services firms in the UK and across the EU will face increased challenges as further regulations impacting remuneration arrangements are introduced over the next few years. Working through this sea of regulation can be complex – so we’ve provided a guide on what European regulation is out there and the issues that firms should be thinking about and looking to address now.
In this briefing we’ve summarised the regulatory response so far at the global, EU and national levels and we take a closer look at current and future European regulatory challenges for banks and securities firms, asset managers and insurers.
Tom Gosling: Good morning. My name is Tom Gosling, and I am here today with Jon Terry, one of my fellow partners, to talk about the impact of regulation on remuneration in financial services. So Jon, we seem to be hearing endlessly about regulation of various sorts in financial services. Where is it all coming from?
Jon Terry: Well it originally started, of course, Tom, following the financial crisis, and the Financial Stability Board came out with some principles on remuneration, and ever since then, various regulators, driven and really led by the European Union, have been coming up with different regulations for remuneration.
Tom Gosling: Right, OK, so this is covering all sectors, not just banking, but obviously banking is where there has been most focus, and what are we seeing coming down the track there?
Jon Terry: Well right at the moment, the European Union, the so-called “trialogue” are debating and deciding on various aspects of CRD4, which is the next directive, which is due to come into place from 1 January 2013, so less than six months away. And there are four really, really crucial remuneration aspects with this, and probably the one taking all the headlines is the so-called bonus capping.
Tom Gosling: Is this really going to happen, this bonus cap?
Jon Terry: It’s looking increasingly likely. I almost said it’s looking certain, but nothing is certain when you’re dealing with politicians in Europe, of course, but it’s looking increasingly likely that it will happen. Certainly more likely than not that it will happen, yes.
Tom Gosling: And how will that work then?
Jon Terry: Well I wish I could tell you all the answers to that. I can tell you some clues around this. What’s likely to happen is there will be a maximum amount of variable pay that can be paid, so whether that’s just bonus or whether it’s long term awards and deferrals, yet to see. But the maximum amount of variable pay, as compared with fixed pay, and that could be one to one, or one to two, something like that.
Tom Gosling: And from 1 January, potentially.
Jon Terry: Potentially from 1 January. I mean it gets quite technical. But if the trialogue can actually get their act together over the next couple of months, it will take effect from 1 January, and if it does, it will be all payments made from 1 January. In other words, this current bonus year.
Tom Gosling: Right, so it’s a real scenario planning that firms need to do then?
Jon Terry: Absolutely critical, and so of course many organisations are looking at the potential impact of these regulations on their employees and working out, frankly, how they can manage these regulations in the worst case, as well as the better case, scenarios.
Tom Gosling: OK, so you mentioned there are a few things in CRD4. What are the other...
Jon Terry: Well the others, very strongly connected, actually, with the bonus capping, because it’s likely the bonus capping will take effect for the so called identified or code staff, for those who are senior management risk takers. And one of the other aspects being debated the moment is a redefinition of risk takers, to have a monetary limit on the amount that people earn. So if you earn over a certain amount, which could be as low as €500,000 or a €1 million, then you are automatically counted as being a risk taker, and then subject to all the prescriptive rules, including bonus capping. So that’s one really important issue. The other one I’d quickly like to mention is the enhanced disclosure. There’s a lot of debate around disclosure, particularly in the UK, but much wider than the UK, and CRD3, the existing European directive on banks and credit institutions has the so called pillar 3 disclosures come out, and it’s likely there will be greater disclosure around banded pay being disclosed as well.
Tom Gosling: So some really immediate issues for banks, but it’s not just about banking, is it? So what else are we seeing coming through this year?
Jon Terry: No, it’s not just about banking. There is another three European regulations coming down the pipe. One is the alternative directive which will take effect from the middle of July next year, and that will affect all alternative businesses, private equity funds, hedge funds, infrastructure funds and so on. Which are likely, again, still got a lot of uncertainty around the absolute detail, but it’s very much in line with the same sort of regulations affecting banking, and this could mean that hedge funds, for example, who currently are not subject to prescriptive rules on remuneration structure, could well be subject to those rules. So that’s a really crucial one for the alternative sector to look out for. And then of course we have the much delayed Solvency 2, which are the regulations which will affect insurance companies, which currently are not subject to any remuneration regulations across Europe. And so those regulations have been delayed until 1 January 2014. Again, we’re waiting for precise details of the remuneration aspect, but we have the principles. But just a warning on that. If it does continue to take effect from 1 January 2014, that is likely to impact on all pay for 2013 performance year, hence, anything paid after January 2014. So it’s not just banking.
Tom Gosling: So the issue is that even though we don’t know the rules, there’s a fixed date from which they might apply, so again, this scenario planning is really, really important.
Jon Terry: It’s absolutely critical, and for those businesses that actually have a number of different types of businesses – they may have an asset management arm, or a wealth business, a private bank, an insurance business and so on – then they have multiple regulations to be managing, some of which are slightly contradictory, and they will need to be managed together and on a global context, where a number of the... in fact virtually every country interprets regulations slightly differently. That’s a real issue to get their heads round.
Tom Gosling: OK, so a lot to do.
Jon Terry: A lot to do, Tom.
Tom Gosling: Thank you Jon.
Jon Terry: Thank you.