While the UK is still deliberating on its Remuneration Code guidance in relation to rules which came into force on 1^st Jan 2011, the US regulatory framework established under the Dodd-Frank Wall Street Reform Act, has recently issued draft rules on the same area. Essentially the US is catching up on its International obligations in respect of pay structuring and risk management.

Although behind Europe’s accelerated and politicised implementation, it would appear that the United States may be doing a better job at identifying institutions which have a significant financial impact on the market, therefore avoiding unnecessary regulatory burden for managers and brokers that would be otherwise subject to the rules.

From an initial review mangers/advisers, who are already subject to European/UK requirements, but have less than $1 Billion in consolidated assets are likely to be unaffected. Those above this figure will probably just be required to adopt some of the provisions of the remuneration policy as adopted under Europe’s Capital Adequacy requirements. See IMS’s article for comment on UK’s implementation of remuneration requirements for reference.

To’e’mato/Toma’y’to

Apart from the limited scope, the major difference between the two regimes is that in Europe a public disclosure of remuneration is required, whereas in the US, firms are not currently required to report actual compensation figures as part of their disclosures.  The contents of the proposed report is intended to allow US regulators to make a determination of whether the firm’s payment structure or its features are likely to provide covered persons with excessive compensation, fees or benefits. The draft US rules require firms to report to their respective regulator in a format which is yet to be determined.

In simple terms, the US proposes to prohibit excessive compensation, or any feature of an arrangement which would encourage inappropriate risk taking and is putting the responsibility on the firm’s executives to justify how their arrangements remain compliant on an annual basis.

The detailed requirements relating to policies are probably more flexible than those laid down in the UK’s FSA implementation, but are broadly similar to the European requirements once they have been applied. Where a firm has already established its UK policy there is scope to make some simple adaptation. Where clarity has been absent in the UK, it has, in the main been provided within the US proposals.

Usefully the draft rules provide an explanation of what would be considered excessive. It also includes a comparative element and defines covered persons with sufficient clarity to make the process of dealing with the rules more straightforward.

Please see below for the definitions provided relating to covered persons;

1. A principal shareholder is defined as a person who directly/indirectly owns, controls or has the power to vote 10 per cent or more of any class of voting securities of a covered institution.
2. All employees are covered by the prohibition on excessive compensation but as the ban relates to excessive compensation paid, the scope is determined by how the firm pays its employees and what it determines as excessive under the defined criteria.
3. Executive Officer is defined as president, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line.

More onerous provisions such as the 50% deferral of incentive based compensation for no less than 3 years, paid on a pro-rata basis and loss adjusted, are applied to executives of firms which have $50 billion or more in consolidated assets. In such firms, the board or executive committee is charged with identifying those persons who individually have the ability to expose the covered financial institutions to possible losses that are substantial in relation to the firm’s size, capital or overall risk tolerance. It is worth considering this definition in the light of the FSA’s definition of covered persons who have a material impact on the risk profile of the institution.

It has been pointed out by some commentators that a prohibition is yet to be inserted on personal hedging and there may be some confusion over the definition of assets for the purposes of determining application. Currently, the de minimus (i.e. $1 billion) purely relates to the consolidated balance sheet assets of the investment adviser (equivalent of discretionary manager in UK), as distinguished from their assets under management and as such even managers of large pools of “off balance sheet” assets may not be covered. Therefore, it is not likely to result in dual application to European management companies unless their US parent is a significant financial institution with over $1 billion in assets on their consolidated US balance sheet.

The good news seems to be that the majority of these rules will not be enforced on the small to medium size asset managers that are already dealing with enough regulatory upheaval and that the more onerous rules will be only enforced on firms of significant impact which was the original intention of the regulatory architects when they considered the causes of our most recent banking crisis.

The US requirements are currently under consultation until 31st May. If you don’t want to participate in the debate yourself, you can follow other people’s comments on the SEC website as they are lodged (http://www.sec.gov/comments/s7-12-11/s71211.shtm) but it is probably more appropriate to wait and see whether there are any changes following the consultation.

We will look on with interest at these developments however if you would like to talk to us regarding this regulatory update please contact Derek McGibney or your usual IMS consultant.