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Clawback declawed?

As reported everywhere with banker-bashing glee, the PRA yesterday published its final rule on clawback. The final formulation reflects feedback received in response to the Clawback Consultation Paper (CP6/14); contrary to most cursory readings, either celebrating or bemoaning the draconian aspects of the rule; the final formulation represents a climb-down from the original proposal. While minimally extending the clawback period from six to seven years, the grounds for application have been significantly narrowed by the removal of the “material downturn in financial performance” trigger, and there is no retrospective effect. The net result is to privilege the arguably gentler remedy of malus[1] over clawback. Formally cited as the Senior Management Arrangements, Systems and Controls (Remuneration Code – Clawback) Instrument 2014, the rule comes into force on 1 January 2015.

  • Timing– clawback will only apply to remuneration awarded on or after 1 January 2015
  • Duration– clawback will apply for a period of at least seven years from the award date
  • Application– a firm must make “all reasonable efforts” to recover some or all of a vested bonus when:
  • a) there is reasonable evidence of employee misbehaviour or material error
  • b) the firm suffers a material failure of risk management, taking account of the employee’s proximity to the failure and the employee’s level of responsibility

Note that the rule will only apply to Level 1 and level 2 PRA-authorised banks and investment firms and only to “Code Staff” (material risk takers (MRTs) and directors) within them. Even in slightly diluted form, clawback poses points of conflict with existing employment law:

  • the PRA expects firms to alter employment contracts to reflect the final rule. Any changes will require the employee’s consent. In the absence of consent, an employer would need to dismiss and re-engage the employee on new terms, with attendant risk of an unfair dismissal suit
  •  deductions from wages (including variable remuneration) are prohibited without prior consent, existing contracts will have to be re-drawn to explicitly include clawback
  •  even when employee consent is given, if the clawback is regarded as a penalty clause, it may be unenforceable. New contracts will have to be well-drafted and clawback amounts will need to be well-calibrated estimates of the loss directly attributable to the employee
  • such conflicts will be doubly applicable in the context of foreign employment law e.g. a Swiss employee working for a UK bank

Clawback aims to mitigate agency malfeasance arising from a typical ownership and control dichotomy. Although the final rule allows for more flexibility in the malus\clawback combination, it is a crude tool at best. While governments, regulators and bank chairmen proclaim the need for radical culture re-engineering, there is a radical disconnect between rhetoric and reality. Until a metric is applied on nebulous, but worthy corporate ideals such as good citizenship, and the metric defines the bonus incentive- short-term profit will remain the cardinal virtue.

 

[1] The PRA\FCA distort the term, using it to refer to the withholding of part or all of a bonus. As the Latin opposite of bonus, it more usually denotes an actual penalty rather than mere removal of a benefit.

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