The reform of remuneration practices in the financial sector is currently the subject of regulatory and political debate worldwide. In the UK, there have recently been some important developments, key amongst which are:
- The bank payroll tax announced by the UK government on 9 December 2009;
- A new code on remuneration published by the Financial Services Authority, the UK body responsible for regulating the UK financial services industry;
- Draft legislation, known as the Financial Services Bill 2009; and
- The Walker Review - a government review of remuneration in the financial services.
These developments have created uncertainty about remuneration practice in the UK financial services industry. With the exception of the new FSA Code, the details of the proposals have not yet been finalized, so questions remain as to those who will be covered as well as the specific obligations to which they will be subject. Moreover, there is a tendency in the media to conflate the different developments under the general banner of “bankers pay” – this overlooks the differences between the various developments, particularly the fact that they cover different (albeit overlapping) parts of the financial services industry.
This client alert summarizes where matters currently stand in the UK as of December 2009 – focusing on the substance of the proposals, to whom they apply and areas where uncertainty remains.
THE BANK PAYROLL TAX
This is a proposed tax of 50% payable by employers qualifying as taxable companies on bonuses paid to relevant banking employees in excess of £25,000 and charged on the amount in excess of £25,000. The UK government has characterised it as a “one-off” tax which would only apply to bonuses referable to the period between 9 December 2009 and 5 April 2010.
Whilst it is clear the UK Government is targeting banks and building societies, the scope of the tax is still uncertain because the relevant legislation is still not finalized.
Which companies are covered?
Under the draft legislation, a taxable company is:
- a bank;
- a UK resident investment company or UK resident financial trading company in a banking group;
- a building society;
- a UK resident investment company or UK resident financial trading company in a building society group;
- a UK branch of a foreign bank or the UK branch of a foreign financial trading company in a banking group.
A “UK resident bank” is defined as a UK FSA regulated company whose activities consist wholly or mainly of “relevant regulated activities” under FSMA or whose activities include accepting deposits. The list of “relevant regulated activities” is broad and encompasses accepting deposits, dealing in investments as principal, dealing in investments as agent, arranging deals in investments, safeguarding and administering investments and regulated mortgage contracts.
While there are customary banking activities not listed, such as advising on investment, managing investments and operating a collective investment scheme, there are also activities carried on by investment managers and brokers that will fall within the listed activities. Accordingly, based on the current draft legislation, broker dealers as well as investment managers (such as private equity and venture capital fund managers), could well fall within the definition because of some of the activities they carry out.
In this regard, the British Venture Capital Association and others have been in discussions with the HMRC, the UK tax authority, about the scope of the payroll tax. In the course of these discussions, HMRC has indicated its agreement in principle that private equity and venture capital fund managers ought not be subject to the payroll tax. Consistent with this is the latest announcement of HMRC which was published on its website on 18 December 2009. In that announcement, HMRC has stated that the payroll tax “does not apply to non-banking companies outside of banking groups (for example, insurance companies, asset managers, stockbrokers etc.)”. The announcement also contains proposed amendments to the current draft of the legislation aimed at addressing concerns that the current draft inadvertently applies to non-banks who are not intended to be covered by the payroll tax. Specifically, HMRC has proposed:
- limiting the definitions of “UK resident banks” and “relevant foreign bank”, so that for a non-deposit taker, they only apply to a person which is in a full scope BIPRU 730K firm investment firm and whose activities consist wholly or mainly of relevant regulated activities;
- adding to the list of companies expressly excluded from the scope of the tax so that the revised legislation excludes (amongst others) a company “whose activities consist wholly or mainly in acting as the operator of a collective investment scheme”;
- removing prime brokers who are full scope BIPRU 730K firms from the scope of the tax; and
- excluding non-banking financial services groups that are incorrectly characterised by the rules as “banking groups” simply because the group structure includes a company with banking activity, even though that is a minor activity within the group as a whole (while keeping the banking activity, but not the rest of the group, within the scope of the legislation).
This clarification goes a significant way towards addressing the doubt and concerns of many within the financial services sector, particularly those not commonly regarded as banks, as to the scope of the payroll tax. However, ultimately, the scope of the new tax will depend on the final legislation.
Which workers are covered
The draft legislation covers “relevant banking employees” who are broadly defined as employees who perform “banking activities” employed by a taxable company. In this context “banking activities” has the same meaning as “relevant banking activities” for the purposes of determining whether a company is a taxable company. This suggests that an employee of a qualifying UK resident bank who carries on asset management activity within that entity's asset management division would not be covered (because asset management is a non-banking activity) and so the bank could pay that person a bonus without being subject to the bank payroll tax. However, again this will ultimately be dependent on the final form of the legislation, any further guidance that is issued and the way in which the legislation is interpreted.
What payments are covered
On the surface, the draft legislation adopts a far-reaching definition of “bonus”. It covers a very broad range of variable element of pay including any elements linked to personal or business performance, where the amount of such pay is referable to or determined during the period between 9 December 2009 and 5 April 2010, whether or not the bonus is actually paid during that period.
Furthermore, the draft legislation includes an express general anti-avoidance provision, together with other provisions targeting specific avoidance measures, such as payments to intermediaries, arrangements for future payments and certain loans. Indeed, the only payments clearly excluded from the legislation are regular salary, wages or benefits, payments where there was a pre-existing contractual obligation to make a fixed payment to an employee before the relevant period (such as a guaranteed bonus whose amount was determined before 9 December 2009), shares awarded under an approved share inventive plan and shares options granted under SAYE option schemes. Unapproved awards of shares or share options fall within the scope of the tax.
THE FSA CODE
The code was published in August 2009 and comes into force in January 2010.
The fundamental objective of the code is to “sustain market confidence and promote financial stability through removing the incentives for inappropriate risk-taking by firms, and thereby to protect consumers”.
The code does not contain any specific requirements as to levels of remuneration – rather it is focussed on the processes for determining remuneration levels. This is reflected in its contents, which consist of an overriding general principle: that firms must “establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management”. There are then eight principles of good regulation, known as “evidential provisions” - which, if breached, would have evidential value in showing that the code's overriding general principle has not been met. The evidential provisions focus on issues such as the need for:
- responsible remuneration committees that account for financial risk;
- documenting remuneration policies and the thinking behind them;
- basing bonuses on profit not turnover and include an adjustment for future risk; and
- having performance metrics to assist in determining bonus levels.
The FSA will have responsibility for enforcing the code, and the sanctions for non-compliance include the FSA taking enforcement action against firms and requiring them to hold additional capital.
Of particular importance is the limited scope of the code. It will only apply to specific UK financial institutions, most of which are banks, broker dealers or building societies (rather than asset management businesses), as opposed to entities who merely have establishments, subsidiaries or other operations in the UK. However, a number of non-UK financial institutions have indicated that they will comply with the code voluntarily. Moreover, the code may set the tone for the way in which remuneration is determined in the financial services sector in the UK. As such, despite only binding a limited number of UK entities, the code may prove to be influential in shaping market practice for remuneration within the financial services industry.
THE FINANCIAL SERVICES BILL 2009 AND THE WALKER REVIEW
The Financial Services Bill 2009 (draft legislation currently being debated by UK parliament) and the Walker Review were both published in mid-November 2009.
Final legislation based on the Financial Services Bill 2009 is expected to come into force after the UK general election (which must be held by 3rd June 2010). The current draft includes general powers enabling further legislation to be implemented, which, amongst other things, may require certain financial institutions in the UK (and in particular banks) to publish information about the amount of remuneration they pay to employees. The expectation is that further legislation will be drafted containing detailed provisions about the substance of these obligations and who will be covered by them. This means that at present there are still no details (even in draft form) about which financial institutions will be required to publish details about the remuneration of their employees and the nature of any such obligations.
Despite the current lack of detail, there is a strong expectation that recommendations contained in the Walker Review will form the basis of the specific requirements to be included in future legislation. There is also a risk of more stringent regulation, since the recommendations in the Walker Review have been criticized in some quarters as not going far enough to regulate remuneration. Amongst other things, the Walker Review has recommended that:
- For FTSE 100-listed banks and comparable unlisted entities, such as the largest building societies, there should be public disclosure in bands of the number of “high end” employees, including executive board members, whose total expected remuneration in respect of a reported year is in the range of £1 million to £2.5 million, £2.5 million to £5 million and in £5 million bands thereafter.
- For FSA-authorized banks that are UK incorporated subsidiaries of foreign entities, there should be comparable disclosure of senior staff remuneration.
CONCLUSION
Despite the uncertainty about their respective specific scopes, the new measures have the potential to be far-reaching and may therefore significantly impact on remuneration practices within the UK financial services industry, particularly when viewed cumulatively. Businesses that are directly in the “bulls-eye” can expect to review their remuneration policies to ensure they to adhere to specific obligations that apply to them. In addition, the new regime may cause those in the financial services industry, whether or not they are subject to specific provisions, to review the way in which they determine pay, possibly in radical new ways. This in turn may lead to the need to change the terms and conditions of employment of employees. For example, there may be greater emphasis on fixed elements of remuneration combined with express contractual rights to review salaries annually with a power to both decrease (as well as increase) base pay.
We will keep you up-dated on future developments in this area.