The regulatory response to the GFC continues, with the UK Financial Services Authority (FSA) now seeking comment on the extension of remuneration disclosure requirements to banks, building societies and investment firms subject to capital adequacy controls under the EU’s Third Capital Requirements Directive (CRD3) (the final text of which was agreed in July 2010). 

 

The FSA released their commentary paper on 10 November.  It has implications for a few Australian financial services companies that have more than branch operations in the UK.

 

CRD3 will require firms to set remuneration policies and practices taking into account several principles covering the structure, amount and timing of variable remuneration payments.  CRD3 also introduces requirements for remuneration disclosure.

 

Underlying these recommendations is the view that stakeholders will benefit from greater clarity regarding firms’ remuneration practices, notably whether and how these practices support effective risk management. There is also the view that investors should be given the opportunity to understand how a firm’s remuneration practices affect its ability to pay an adequate risk-adjusted return on capital.

 

Following the announcement of the CRD3 remuneration disclosure rules, the FSA has taken over responsibility for these matters from the UK Treasury (which had published draft regulations on disclosure of remuneration by financial firms in March 2010), given that the Pillar 3 disclosures come under the remit of the FSA.

 

Currently, the UK Companies Act 2006 requires firms to disclose selected details of executive director pay.  Firms must also disclose certain financial information relating to directors’ remuneration as part of their annual accounts, usually including information on levels of pay awarded, including shares, but there are no explicit requirements on the level of detail required for disclosure. 

 

The FSA’s key proposals on remuneration disclosure include:

 

1.     Disclosure of:

 

–    information on the remuneration decision-making process;

 

–    the link between pay and performance;

 

–    the most important design characteristics of the remuneration system;

 

–    performance criteria for assessment of remuneration;

 

–    main parameters and rationale for variable compensation; and

 

–    aggregate quantitative information on total remuneration, variable remuneration, deferred remuneration, and sign-on and severance payments, in respect of senior management and staff with a material impact on the firm’s risk profile.

 

2.     Form and frequency of disclosure:  Firms will need to disclose details of their remuneration as soon as practicable, and at least annually.  CEBS guidance indicates that disclosure may take the form of a stand-alone report or may be included in the firm’s annual report.

 

3.     Institutions and staff to whom the requirements will apply, and proportionality: a proportionate approach in applying the rules is proposed, reflecting CRD3 which provides that ‘credit institutions shall comply with the requirements…in a way that is appropriate to their size, internal organisation and the nature, the scope and the complexity of their activities’.  The FSA intends that this will be broadly in line with its general approach to proportionality with regard to the Remuneration Code.  The FSA also invites feedback on extending the disclosure requirements to non-EEA firms operating as branches in the UK.

 

The most controversial aspect of the proposed new rules is their possible application to non-European Economic Area firms operating as branches in the UK.  This will impact some Australian financial services companies with UK operations.

 

Current disclosure requirements that focus on capital and risk do not apply to (non-EEA and Treaty) overseas firms that operate in the UK through branches.  Capital adequacy is most appropriately addressed at firm level, not least because branches are not subject to individual capital requirements.  The FSA has asked whether the same arguments apply in relation to remuneration, given that “… it is meaningful to talk of remuneration arrangements in relation to a branch, and requiring the disclosure of information in respect of such arrangements would require a meaningful part of the picture to be disclosed.  This in turn could make a real contribution to market discipline.  While extending the requirement to branches will involve some cost, it will also support our regulatory efforts to promote effective risk management.  In addition, it would also provide a level playing field between firms operating in the UK through branches and [domestic] firms.”

 

Newspaper reports suggest that overseas firms have reacted with horror, concerned at the possibility that remuneration details for the Wall Street-based bosses to whom the senior UK executives report may have to be disclosed.  They may be less horrified and more amused at the relatively modest pay of Australian bosses.

 

The FSA’s consultation paper CP10/27 Implementing CRD3 requirements on the disclosure of remuneration was published on 10 November 2010, and is available HERE.  Responses are required by 8 December 2010.  Get in quick.

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