Development and monitoring of the remuneration structure
1. To ensure that the remuneration structure and strategies of the Authorised Person are appropriate to the nature, scale and complexity of the Authorised Person's business, the Governing Body should take account of the risks to which the firm could be exposed as a result of the conduct or behaviour of its Employees. The Governing Body should play an active role in developing the remuneration strategy and policies of the Authorised Person. A remuneration committee of the Governing Body could play an important role in the development of the firm's remuneration structure and strategy.
2. For this purpose, particularly where remuneration structure and strategies contain performance based remuneration (see also Guidance no 7 and 8 below), consideration should be given to various elements of the remuneration structure such as:
a. the ratio and balance between the fixed and variable components of remuneration and any other benefits;
b. the nature of the duties and functions performed by the relevant Employees and their seniority within the firm;
c. the assessment criteria against which performance based components of remuneration are to be awarded; and
d. the integrity and objectivity of the process of performance assessment against the set criteria.
3. Generally, not only the senior management but also the Persons Undertaking Key Control Functions should be involved in the remuneration policy-setting and monitoring process to ensure the integrity and objectivity of the process.
Who should be covered by remuneration policy
4. An Authorised Person's remuneration policy should, at a minimum, cover those specified in Rule 5.3.31(1)(c). Accordingly, the members of the Governing Body, the senior management, the Persons Undertaking Key Control Functions and any major risk taking Employees should be included in the firm's remuneration policy. With the exception of the 'senior management', all the other three categories attract their own definitions. Although the expression "senior management" carries its natural meaning, Rule 5.3.30(3) describes the senior management's role as the "day-to-day management of the firm's business…" Guidance No. 3 under Rule 5.3.3 gives further clarification as to who may perform senior management functions.
Remuneration of Persons Undertaking Key Control Functions
5. Any performance based component of remuneration of Persons Undertaking Key Control Functions as well as other Employees undertaking activities under the direction and supervision of those Persons should not be linked to the performance of any business units which are subject to their control or oversight. For example, where risk and compliance functions are embedded in a business unit, a clear distinction should be drawn between the remuneration structure applicable to those Persons Undertaking Key Control Functions and the Employees undertaking activities under their direction and supervision on the one hand and the other Employees in the business unit on the other hand This may be achieved by separating the pools from which remuneration is paid to the two groups of Employees, particularly where such remuneration comprises performance based variable remuneration.
Use of variable remuneration
6. Where an Authorised Person includes in its remuneration structure performance based variable components (such as bonuses, equity participation rights such as share based awards or other benefits), especially if they form a significant portion of the overall remuneration structure, or remuneration of any particular Employees or class of Employees, the Governing Body should ensure that there are appropriate checks and balances relating to their award. This is because, while such performance based remuneration is an effective tool in aligning the interests of the Employees with the interests of the firm, if used without necessary checks and balances, it could lead to inappropriate risk taking by Employees.
7. Therefore, the Governing Body should, when using any performance based variable component in the Authorised Person's remuneration structure, ensure that:
a. the overall remuneration structure contains an appropriate mix of fixed and variable components. For example, if the fixed component of remuneration of an Employee is very small relative to the variable (eg. bonus) component, it may become difficult for the firm to reduce or eliminate bonuses even in a poor performing financial year;
b. there are clear and objective criteria for allocating performance based remuneration (see below in Guidance note (7);
c. there are appropriate adjustments for the material 'current' and 'future' risks associated with the performance of the relevant Employee, as the time horizon in which risks could manifest themselves may vary. For example, where practicable, the measurement of performance should be set in a multiyear framework. If this is not practicable, there should be deferral of vesting of the benefits or retention or claw-back arrangements applicable to such components as appropriate;
d. there are appropriate prudential limits, consistent with the Authorised Person's capital management strategy and its ability to maintain a sound capital base taking account of the internal capital targets or regulatory capital requirements;
e. in the case of Employees involved in the distribution of financial products whose remuneration is commission based, there are adequate controls and monitoring to mitigate marketing which is solely commission driven; and
f. the use of guaranteed bonuses is generally avoided as such payments are not consistent with sound risk management and performance based rewards. However, there may be circumstances where such guaranteed bonuses may be paid to attract new Employees (for example to compensate bonuses forfeited from the previous employer).
8. The performance criteria applicable, particularly relating to the variable components of remuneration, as well as the performance assessment against such criteria, contribute to the effectiveness of the use of performance based remuneration. Therefore, the Governing Body should ensure that such criteria:
a. are clearly defined and objectively measurable;
b. include not only financial but also non-financial elements as appropriate (such as compliance with regulation and internal rules, achievement of risk management goals as well as compliance with market conduct standards and fair treatment of customers);
c. take account of not only the individual's performance, but also the performance of the business unit concerned and the overall results of the firm and if applicable the Group; and
d. do not treat growth or volume as an element in isolation from other performance measurements included in the criteria.
9. Where an Authorised Person provides discretionary payouts on termination of employment ("severance payments", also called "golden parachutes"), such payment should generally be subject to appropriate limits or shareholder approval. In any case, such payouts should be aligned with the firm's overall financial condition and performance over an appropriate time horizon and should not be payable in the case of failure or threatened failure of the firm, particularly to an individual whose actions may have contributed to the failure or potential failure of the firm.