The PRA’s rules on buy-out awards – what do they mean in practice?

25 October 2016

By Katy Bennett

On 28 September the Prudential Regulation Authority (PRA) finalised new rules on buy-outs for – the recruitment payments made to an individual to ‘buy-out’ awards that they would lose on leaving their old employer. These new rules leave a wealth of practical questions unanswered.

The rules come into effect next year, leaving a lot of work to be done in a relatively short time in an area that’s commercially critical to many companies. Firms implementing these rules – which apply to all material risk-takers in banks, building societies and PRA-designated investment firms – will have to think carefully about how to get adequate systems and processes in place so they can continue their recruitment processes as normal next year.

There’s an awful lot to think through and many different things that may need to change. Here are some of my thoughts on the main areas likely to create challenges. You can read here my observations about the regulatory backdrop to the recruitment process more generally.

Hiring

When a new employee is hired, the rules require that, for any buy-out, contractual arrangements are in place to allow the new firm to apply malus and clawback to the buy-out award(s), based on a determination by the previous employer. This applies when the employee was a material risk taker at a level 1 or level 2 bank at the time the award being bought out was made. There are obvious contractual challenges involved in this, but smaller firms are likely to find it particularly difficult; they may not operate malus and clawback for their employees and so will have to develop their approach from scratch.

Record-keeping

The new rules call for much more detailed record-keeping that covers former as well as current employees. For example, if a malus or clawback trigger event occurs, at the moment level 1 and 2 firms have to think about how this should impact the pay of their employees. These new rules mean that they’ll also need to think about how it should impact former employees.

The processes required by the regulation means you’ll know who these people are, but it won’t be easy to work out if they should be impacted, particularly if the event happened a number of years ago. The rationale for any decision will need to be thought through carefully, as previous employees will have the right to challenge the decision. Your records will need to be detailed enough to provide solid evidence in the event of a dispute.

When an employee leaves, you’ll be required (at the employee’s request) to provide a statement of any awards that could be subject to the buy-out rules. You will need to be ready to give this type of information.

But this doesn’t stop at record-keeping. In financial services it’s inevitable that people move regularly between competing firms. The buy-out rules mean that firms will have to inform a new employer – most likely a close competitor – when a bought out award needs to be reduced. That could create commercial risks that will need to be managed within the new rules.

Application of malus and clawback

When you, as an employer, receive a notification to remove a buy-out there are more things to think about. The individual is likely to be certified or a Senior Manager, so how should a notification impact their status? Given that malus or clawback may relate to a conduct issue, it could be very relevant. But it’s not easy to connect the dots. For example, regulatory references go back six years, but clawback is seven years (or ten in some cases). What do you do if you’re made aware of a conduct issue seven years ago? There are also tricky tax implications around clawback that will need to be sorted out: How should the amount of clawback received by a new employer be treated for corporation tax purposes? And what about the individual’s personal tax position?

This is definitely an example of regulation raising more questions than it answers. We’ll be watching closely to see how the system evolves in practice. You can read more about the implications of the new rules in our client briefing.

 

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