Individuals identified as Material Risk Takers (MRTs) under the remuneration regime will also be Senior Managers or Certified Persons under the SMCR. However, the remuneration regime was introduced prior to the SMCR and the regulators are concerned that, although links exist between the two regimes, they are not fully integrated and could be more effective in holding individuals to account.
Proposed requirement 1: Adjusting remuneration up the management chain
The PRA’s existing supervisory statement on remuneration, SS2/17, explains that the application of remuneration adjustment by firms should not be confined to employees held to be directly culpable of misfeasance. Firms are expected to consider making adjustments to the variable remuneration of employees who:
- were aware or could reasonably have been expected to be aware of a failure or misconduct and failed to take adequate steps to address it;
- by their role or seniority could be deemed indirectly responsible for the failure or misconduct; or
- by their role or seniority within control functions could be considered to be responsible for weaknesses and failings in control functions relevant to the failure or misconduct.
However, the FCA and PRA are concerned that firms are not consistently applying remuneration adjustments to accountable individuals in the management chain who may have indirect responsibility for failure or misconduct. In fact, the PRA has assessed that in 80% of risk events occurring at banks which led to the application of malus to some employees, no Senior Managers were subject to remuneration adjustments in relation to the same risk events.
As a result, the PRA plans to introduce a new requirement, in the Remuneration Part of the PRA Rulebook (which will be cross-referenced in the FCA Handbook) and SS2/17, requiring firms to consider making adjustments to the variable remuneration of MRTs where “it is reasonable for a material risk taker to be held responsible” for risk events, failings or weaknesses in relation to risk events, by virtue of their role or seniority. In making this assessment, firms will need to consider whether it is reasonable for an MRT to be held responsible for: (i) the intrinsic risk or risk event; or (ii) weaknesses or failings relevant to the intrinsic risk or risk event.
This new expectation should be read in conjunction with the PRA’s existing expectations, set out above, and the non-exhaustive list of circumstances where firms should consider making a reduction to variable remuneration, in paragraph 4.19 of SS2/17.
The PRA’s view is that this new requirement should ensure that firms identify the full range of individuals who are involved in and/or directly and indirectly accountable for risk events. In turn, the PRA hopes that it will also result in a greater drive on the part of senior MRTs to ensure that more effective systems and controls are implemented and maintained in their areas of responsibly given the clearer link between risk events and their remuneration.
Proposed requirement 2: Statements of Responsibilities
To crystalise the link between a Senior Manager’s responsibilities and their variable remuneration, the PRA proposes to introduce a second new rule, requiring firms to “ensure that any measurement of performance used to calculate variable remuneration for senior management takes into account the member of senior management’s performance in their areas of responsibility”.
As part of this requirement, the PRA is proposing that material or urgent actions it requests in a Periodic Summary Meeting letter should be reflected in relevant Senior Managers’ Statements of Responsibilities and that a Senior Manager’s remuneration should reflect their success, or failure, in delivering the PRA’s supervisory priorities.
The PRA expects this new rule to incentivise senior management to increase their own monitoring when they delegate tasks (consistent with their existing obligations under Senior Manager Conduct Rule 3) as well as to ensure actions identified by the firm’s supervisors are addressed promptly.
Proposed Requirement 3: Remuneration Committees
To support its other two proposals, the PRA is proposing to clarify SS2/17 to set out its expectations about the information that Remuneration and Risk Committees should consider when risk events occur, to determine what impact such events should have on relevant individuals’ variable remuneration. This information includes (but is not limited to the output of:
- accountability reviews, which are designed to identify who was directly and indirectly responsible for the incident that occurred, as well as by virtue of their seniority and any oversight role that they held;
- root cause analyses to identify the underlying root cause of what happened; and
- findings from internal (e.g. audit or risk) and/or external reviews (e.g. investigations conducted by external lawyers, or other third parties).
What firms will need to do
The PRA’s proposals emphasise its focus on holding senior individuals to account when things go wrong in their areas of responsibility, even if they are not directly involved in or accountable for what has happened.
Many firms already commission internal or externally led individual accountability assessments and root cause analyses when material risk events arise and they have well-established processes for considering indirect accountability of their most senior employees, consistent with what the PRA is proposing.
However, the PRA’s impetus for proposing its new requirements show that it considers there is more work to be done in this area and that the PRA will be scrutinising closely the output of firms’ risk adjustment decision-making processes. If implemented, firms will at least need to consider whether adjustments should be made to the variable remuneration of their most senior executives when material risk events crystallise. To support this approach, firms will need to revisit and potentially amend their existing risk adjustment procedures to ensure that they satisfy the PRA’s requirements. Firms should also double-check the contractual arrangements that govern plans and schemes for MRTs’ variable remuneration, to ensure that they allow firms to take the necessary steps in relation to adjust variable remuneration where required.
The fact that the PRA specifically referred to including material or urgent actions from PSM Letters in relevant Senior Managers’ Statements of Responsibilities is a testament to how important the PRA still considers these documents to be. As we near the ninth anniversary of the SMCR coming into force for banks, many firms are revisiting their suite of Statements of Responsibilities to ensure that they accurately reflect their current businesses and governance arrangements, and do not leave any gaps in accountabilities. Firms will also need to revisit this exercise each time they receive PSM Letters in the future. The completeness of Statements of Responsibilities is a topic that the PRA is particularly focused on - last year it became the first regulator to take enforcement action against a firm for failings in relation to its implementation of the SMCR and, specifically, for omissions in a Senior Manager’s Statement of Responsibility.
The joint consultation closes on 13 March 2025.
