Part 2 of SYSC 1 Annex 1 provides for the application of SYSC 4.1.1 R (General Requirements).

1. (1)

   If a firm'sremuneration policy is not aligned with effective risk management it is likely that employees will have incentives to act in ways that might undermine effective risk management.

2. (2)

   The aim of the Remuneration Code is to ensure that firms have risk-focused remuneration policies, which are consistent with and promote effective risk management and do not expose them to excessive risk. It expands upon the general organisational requirements in SYSC 4.

3. (3)

   The Remuneration Code covers all aspects of remuneration that could have a bearing on effective risk management including wages, bonus, long-term incentive plans, options, hiring bonuses, severance packages and pension arrangements. In applying the Remuneration Code, a firm should have regard to applicable good practice on remuneration and corporate governance, such as guidelines on executive contracts and severance produced by the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF). In considering the risks arising from its remuneration policies, a firm will also need to take into account its statutory duties in relation to equal pay and non-discrimination.

4. (4)

   As with other aspects of a firm's systems and controls, what a firm must do in order to comply with the Remuneration Code will vary according to the nature, scale and complexity of the firm and its activities. For example, while the Remuneration Code refers to a firm'sremuneration committee and risk management function, it may be appropriate for the governing body of a small firm to act as the remuneration committee, and for the firm not to have a separate risk management function.

5. (5)

   The principles in the Remuneration Code will be used by the FSA to assess the quality of a firm'sremuneration policies and whether they encourage excessive risk-taking by a firm'semployees.

6. (6)

   The FSA may also ask remuneration committees to provide the FSA with evidence of how well the firm'sremuneration policies meet the Remuneration Code's principles, together with plans for improvement where there is a shortfall. The FSA will also expect relevant firms to use the principles in assessing their exposure to risks arising from their remuneration policies as part of the internal capital adequacy assessment process (ICAAP).

7. (7)

   The Remuneration Code is concerned with the risks created by the way remuneration arrangements are structured, not with the absolute amount of remuneration, which is a matter for firms' remuneration committees.

1. (1)

   Remuneration is usually the largest cost incurred by firms after funding costs. The risks arising from the way employees are recruited and managed, including the risks posed by remuneration policies, constitute some of the most important risks faced by firms. Remuneration committees should pay specific attention to these risks.

2. (2)

   While industry comparators may be relevant in setting remuneration they should not override the need for independent decisions that are consistent with the firm's financial situation and prospects.

3. (3)

   Remuneration committees should have a majority of non-executive directors, one or more of whom should have practical skills and experience of risk management, for example through being a member of a firm's risk committee or audit committee. Remuneration committees should receive regular reports directly from the firm's risk management function on the implications of the remuneration policy for risk and risk management.

4. (4)

   The FSA may ask a remuneration committee to prepare a statement on the firm'sremuneration policy, including the implications of the policy for the firm. The FSA will expect the statement to include an assessment of the impact of the firm's policies on its risk profile and employee behaviour. In drawing up this assessment, the remuneration committee should exercise its own judgment and should not rely solely on the judgment or opinions of others. The FSA may seek a meeting with members of the remuneration committee to discuss the statement.

5. (5)

   It is good practice for a firm'sgoverning body or the remuneration committee to issue a separate public document to inform its shareholders and other stakeholders about its remuneration policy and its implications for the firm's risk profile and for employee behaviour.

1. (1)

   Conflicts of interest can easily arise when employees are involved in the determination of remuneration for their own business area. Where these could arise they need to be managed by having in place independent roles for control functions (including, notably, risk management and compliance) and human resources. It is good practice to seek input from a firm's human resources function when setting remuneration for other business areas.

2. (2)

   Remuneration Principle 4 stresses the importance of risk-adjustment in measuring performance, and the importance within that process of applying judgment and common sense. It is good practice for a remuneration committee to ask the risk management function to validate and assess risk adjustment data, and to attend a meeting of the remuneration committee for this purpose.

3. (3)

   Documenting procedures for setting remuneration includes documenting all performance appraisal processes and decisions.

1. (1)

   Remuneration Principle 3 is designed to manage the conflicts of interest which might arise if other business areas had undue influence over the remuneration of employees within control functions.

2. (2)

   The need to avoid undue influence is particularly important where employees from the control functions are embedded in other business areas. Remuneration Principle 3 does not prevent the views of other business areas being sought as an appropriate part of the assessment process.

3. (3)

   The FSA would generally expect the ratio of the potential variable component of remuneration to the fixed component of remuneration to be significantly lower for employees in risk management and compliance functions than for employees in other business areas whose potential bonus is a significant proportion of their remuneration. Firms should nevertheless ensure that the total remuneration package offered to those employees is sufficient to attract and retain staff with the skills, knowledge and expertise to discharge those functions. The requirement that the method of determining the remuneration of relevant persons involved in the compliance function must not compromise their objectivity or be likely to do so (see SYSC 6.1.4 R (4)) also applies.

1. (1)

   Measuring performance based wholly or mainly on revenues or turnover can provide an incentive for employees to pay insufficient regard to the quality of business undertaken or services provided, or their appropriateness for the client.

2. (2)

   Profits are a better measure, but they should be adjusted for risk, including future risks not adequately captured by accounting profits.

3. (3)

   One of the important responsibilities of the remuneration committee is to determine the proportion of risk-adjusted profits that should be accrued, and paid out, in the form of variable remuneration.

4. (4)

   Management accounts should provide profit data at such levels within the firm's structure as enables a firm to see as accurate a picture of an employee's contribution to a firm's performance as is reasonably practicable. If revenue or turnover is used as a component in performance assessment, processes should be in place to ensure that the quality of business undertaken or services provided and their appropriateness for clients are taken into account.

5. (5)

   A number of techniques are available to adjust profits and capital for risk, and a firm should choose those most appropriate to its circumstances. Common techniques include those based upon a calculation of economic profit or economic capital. Whichever technique is chosen, the full range of potential risks should be covered. The FSA expects a firm to be able to provide it with information relating to the workings of the calculations. The results of risk-adjustment are not foolproof, and accordingly a firm should apply judgment and common sense in the final decision about the performance-related component of remuneration.

1. (1)

   Profits from a firm's activities can be volatile and subject to cycles. The financial performance of firms and individual employees can be exaggerated as a result and so the performance-related component of remuneration should not be assessed solely on the results of the current financial year. Effective adjustment for current and future risks in line with Remuneration Principle 4 may also be relevant to compliance with Remuneration Principle 5.

2. (2)

   Performance assessment on a moving average of results can be a good way of meeting Remuneration Principle 5. However, other techniques such as good quality risk adjustment and deferment of a sufficiently large proportion of remuneration may also be useful (see Remuneration Principles 4 and 8).

3. (3)

   In considering whether the performance-related component of an employee'sremuneration is a significant part of his total remuneration, relevant factors include:

   1. (a)

      the proportion of total remuneration which is performance-related; and

   2. (b)

      the absolute amount of remuneration which is performance-related.

   So, for example, it may be consistent with effective risk management to pay a proportionately higher performance-related bonus to a relatively low-paid employee without basing the bonus on longer-term performance.

1. (1)

   Poor performance in non-financial metrics such as poor risk management or other behaviours contrary to firm values can pose significant risks for a firm and should, as appropriate, override metrics of financial performance.

2. (2)

   The performance assessment process and the importance of non-financial assessment factors in the process should be clearly explained to relevant employees and implemented. A 'balanced scorecard' can be a good way to do this.

Many common measures of performance for long-term incentive plans, such as earnings per share (EPS), are not adjusted for longer-term risk factors. Total shareholder return (TSR), another common measure, includes in its measurement dividend distributions, which can also be based on unadjusted earnings data. If incentive plans mature within a two to four year period and are based on EPS or TSR, strategies can be devised to boost EPS or TSR during the life of the plan, to the detriment of the true longer-term health of a firm. For example, increasing leverage is a technique which can be used to boost EPS and TSR. Firms should take account of these factors when developing risk-adjustment methods.

1. (1)

   It is good practice for the fixed component of an employee'sremuneration to be a sufficient proportion of their total remuneration to allow a firm to operate a fully flexible bonus policy. This means that a firm (or a part of it) would have the ability not to pay a bonus in a year in which the firm (or part of it) makes a loss. Such a practice need not prevent a firm from paying a bonus despite making a loss if the bonus is justified on other grounds, for example incentivising employees involved in new business ventures which could be loss-making in their early stages.

2. (2)

   It is good practice for a significant proportion of any bonus to be deferred with a minimum vesting period. Both the proportion of the bonus to be deferred and the vesting period should be appropriate to the nature of the business and its risks. The vesting period of the deferred element should be at least three years. In relation to the proportion to be deferred, if the bonus is significant when compared with the fixed component of an employee's remuneration, a reasonable starting point would be to defer at least two-thirds of the bonus.

3. (3)

   It is good practice for a significant proportion of the variable component of remuneration to be linked to the future performance of:

   1. (a)

      the firm and, where practicable, the employee's division or business unit; or

   2. (b)

      the business undertaken by the employee.

4. (4)

   Deferred compensation paid in shares can meet Remuneration Principle 8 provided that the scheme satisfies appropriate criteria, including risk-adjustment of the performance measure used to determine the initial allocation of shares.

5. (5)

   Deferred remuneration paid in cash should also be subject to performance criteria.

6. (6)

   Bonus pools and individual bonuses should be based on employee, division, business unit, or firm performance during the period under review. Both linkage to the future performance of the firm and linkage to the future performance of a division or business unit can deliver important benefits. The former promotes teamwork, while the latter assures that the risks which the employee had a role in assuming continue to have a bearing on his remuneration. It is good practice for remuneration awards to be based on an appropriate combination of all of these factors.

7. (7)

   'Guaranteed minimum bonuses' which run for a period of more than one year and similar payments in addition to an employee's salary that are not based on performance during the performance period under review are likely to be inconsistent with Remuneration Principle 8.