Bankers’ bonus cap lifted: implications for employers

Following the decision to remove the limit, Mark Walker and Ash Saluja explain what this means for businesses

The decision by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) to remove the bankers’ bonus cap means that firms will now be able to pay bonuses exceeding 100 per cent of fixed pay (or 200 per cent with shareholder approval). 

The changes affect banks, building societies and PRA-designated investment firms that are subject to the Remuneration Part of the PRA Rulebook and the Dual-regulated firms Remuneration Code in the FCA Handbook.  

The bonus cap was introduced in 2014 as part of a suite of EU rules aimed at deterring excessive risk-taking by more closely aligning reward with risk. The cap has been unpopular with the investment banking sector, and in particular with US and Asian investment banks operating in London, who found themselves unable to align London pay practices with those in other global centres such as New York or Tokyo. 

While the theory behind the bonus cap was generally considered to be sound, many considered it to be an ineffective blunt instrument – not least because the industry reacted by adopting ‘role-based allowances’ to mitigate the impact of the rules.

The reason for removing the bonus cap remains unchanged. The PRA and the FCA are concerned that, rather than limiting bonus payments to manage excessive risk-taking, in practice fixed pay was increasing. This was seen by the PRA and the FCA as something to avoid, because:

  • fixed pay is not linked to longer-term performance and is not subject to malus and clawback;

  • the increase in fixed pay meant that firms found it difficult to adjust remuneration costs downwards in leaner years.

Another reason for removing the bonus cap is to increase labour mobility and the UK’s competitiveness.

The main points:

  • Firms are no longer required to apply the limit on the maximum ratio between fixed and variable remuneration (the bonus cap) for material risk takers (MRTs). 

  • The key change is that the bonus cap was removed with effect from 31 October 2023. Firms can choose for themselves how and when they change their remuneration structures to deal with the removal of the cap.

  • Although the bonus cap will be removed, firms will still be required to set appropriate ratios between the fixed and variable components of total remuneration. 

  • Existing requirements will continue to apply in relation to deferral, payment in shares or other non-cash instruments, and risk adjustment (ie, malus and clawback).

  • Firms must continue to ensure that fixed and variable components of total remuneration are appropriately balanced. The level of fixed pay must represent a sufficiently high proportion of the total remuneration to allow the operation of a fully flexible policy on variable pay, including the possibility of no variable pay.

  • The PRA and the FCA say they may look more broadly at the rules around remuneration with a view to streamlining those rules and making them more effective and proportionate. It is possible that the PRA and the FCA may also look at the interaction between those rules and the Senior Managers and Certification Regime (SM&CR).

Considerations for employers

Firms that are thinking about removing the bonus cap should determine the ‘appropriate’ ratios. Firms will need to think about the circumstances in which they can depart from their existing remuneration structures. Firms must:

  • Consider whether there should be different ratios for different roles – firms may set different ratios for different categories of staff. 

  • Look at benchmarking, ie, keep an eye on market practice over time.

  • Think about how to incentivise MRTs to agree to change their remuneration structures to adapt to higher ratios, which by necessity will mean lower fixed pay and the possibility of higher variable pay. It is likely that the maximum total remuneration on offer will need to be higher before MRTs will agree to changes. It is expected that there will be discussion over the KPIs/metrics applying to variable pay to justify bigger ratios.

  • Think about how to vary employment contracts. If the ratios are to be changed, fixed pay will almost certainly need to be reduced. Reducing salary will require consent. Removing role-based allowances may be easier if there is an express contractual right to do so, but, where there is not, firms will need to obtain consent. Firms may choose to phase in changes, eg, by offering bigger ratios to new hires or at the time of a promotion but this could lead to disharmony if it creates a two (or multi)-tier workforce.

  • Remuneration policies will need to be amended and this may need shareholder approval.

  • Consider equality and diversity risks. There is evidence that gender pay gaps in bonuses/variable pay are typically larger than in fixed pay, and that the banking sector may have high gender pay gaps. Firms will need to ensure that any changes to ratios are not discriminatory. 

Mark Walker is an employment Of Counsel and Ash Saluja a financial services partner at CMS