About Innovate Finance

Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK's leading role in the financial services sector by directly supporting the next generation of technology-led innovators.

The UK FinTech sector covers businesses from seed-stage start-ups to global financial institutions that embrace digital solutions, playing a critical role in technological change across the financial services industry. FinTech has grown enormously since the Global Financial Crisis of 2007/8, which led to mistrust in traditional banks and coincided with an explosion in the use of smartphones, widespread adoption of the use of apps, the advent of blockchain technology, and significant investment in FinTech start-ups.

FinTech is synonymous with delivering transparency, innovation and inclusivity to financial services. In addition to creating new businesses and new jobs, it has fundamentally improved the ways in which consumers and businesses, especially small and medium-sized enterprises (SMEs), access financial services.

We represent most of the UK’s digital-first and digital-only challenger banks, all of whom hold a UK banking licence.

1. Response to consultation
   1.1 Innovate Finance welcomes the opportunity to respond to the joint Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) consultation (PRA CP16/24 and FCA CP24/23) on Remuneration reform.1.2 In preparing this submission, we have engaged with a cross-section of our membership, including start-up and scale-up challenger banks. The banks are diverse in their market focus and specialist capabilities.1.3 We are broadly supportive of the proposals outlined in the consultation and welcome a move to simplify the quantitative criteria based on remuneration to define material risk takers (“MRTs”).

   1.4 Given the importance of the challenger bank sector to the UK and the SME sector in particular, we welcome the harmonisation and simplification of PRA and FCA rules. Reducing complexity and increasing firms’ flexibility to structure remuneration packages enhances these critical banks' ability to attract and retain talent as they build their offering and contribute to the UK economy and growth.

   1.5 Challenger banks face international competition for talent from both cash-rich incumbents and tech firms who do not have the same restrictions on variable pay as UK-regulated firms. The proposals outlined in the consultation better reflect the reality that challenger banks face whereby they are often better placed to incentivise and reward employees through variable remuneration rather than fixed pay. This will enable challenger banks to increase the proportion of performance-based remuneration and help them to compete more effectively for talent in their early years.

   1.6 In particular, Innovate Finance welcomes:

   (a) The FCA’s proposal to permit small Capital Requirement Regulation (CRR) firms to be exempt from rules on buy-outs, thereby aligning with PRA rules; and

   (b) Changes to deferral and retention of variable remuneration, in particular, the:

(i) Planned reduction of the deferral period for variable remuneration for Senior Management Functions (“SMFs”) and non-SMF MRTs to five years and four years respectively;
(ii) Ability to pay interest or dividends on deferred instruments awarded to MRTs;
(iii) Proposal that deferred awards should vest on a pro-rata basis for SMFs from the time of award (rather than after three years); and
(iv) Removal of the need for a retention period for deferred instruments.

1.7 Innovate Finance also welcomes the steps proposed to simplify the process of identifying MRTs by introducing a single quantitative threshold. The corresponding reliance on the qualitative criteria will allow firms greater autonomy in tailoring remuneration policy to fit their business model and risk profile.

1.8 However, in our view, the proposals should go further in enabling early-stage/challenger banks to remunerate key individuals in a way that reflects the stage of development of their business model.

1.9 Generally, given the secondary competition objectives of the PRA and FCA and HM Treasury’s recent communications asking the regulators to focus on growth, we believe the regulators should bear in mind how its approach to remuneration compares with other jurisdictions, in particular in the US and Asian markets. From a talent acquisition/retention and UK attractiveness perspective, the difference in international regulatory standards may cause an issue for FinTechs when expanding their presence both in the UK market and overseas.

1.10 More specifically:

(a) Innovate Finance recommends a separate, simpler treatment of share-based compensation, as distinct from cash-based incentive pay. This would simplify the approach to share-based compensation which is a critical part of the remuneration strategy of most challenger banks (particularly early-stage firms).

(b) The PRA and FCA may wish to review the regulatory filing obligations which small CRR firms have to complete. For example, the regulators should set out the rationale for the high earner and benchmarking report filing, as well as the remuneration policy statements and Pillar 3 disclosure requirements, with a view to help reduce the administrative burden at UK-headquartered banks.

(c) Our members recommended that the current annual audit of compensation policies and processes should be replaced with a 3-year cycle to simplify and reduce administrative resources and costs.

(d) Our challenger bank members also suggest that the PRA consider expanding the CRR small firm regime to include retail-focused banks that exceed the current £20 billion They note that:

(i) The CRR small firm regime has been effective in fostering competition. However, under the current framework, larger challenger banks become subject to burdensome prudential rules designed to mitigate risk-taking that is not relevant to their business models (e.g.
international trading, and derivatives activity).

(ii) These rules that apply to banks outside this regime are designed to disincentivise excessive risk-taking. However, the risks in question (such as market risk or counterparty credit risk) do not apply to retail banking activities which include commercial lending.

(iii) HM Treasury’s ring-fencing rules refer to “retail-focused banks” which include banks focusing on commercial lending, but not banks whose activities are exposed to financial market volatility and higher risk than core banking services (e.g. investment banking, international trading and derivatives activity). Recent reforms to the ring-fencing regime mean it no longer applies to large-scale retail banks that do not have significant investment banking operations, even if the core deposit threshold exceeds £35 billion (of retail and SME deposits), provided trading assets remain below 10% of Tier 1 capital. These retail banks are permitted to operate outside the ring-fencing regime primarily because their risk profile remains low.

(iv) Our members recommend that a similar exemption should be created to enable low-risk retail-focused firms that exceed the £20 billion threshold to remain within the CRR small firm regime.

(v) This would allow remuneration rules to reflect the lower risk profile of retail-focused banks, including those engaged in commercial lending, rather than being tied to a firm’s absolute size. Such an exemption would ensure that challenger banks are not automatically "graduated" out of the CRR small firm regime once they reach £20 billion in assets, even though the risk profile of their business model has not changed. This approach would also make the wider regulatory regime more coherent.

(vi) This approach would also support firms with delivering competitive remuneration packages that will enable them to attract talent while remaining in compliance with the principles of the remuneration code and incentivising long-term good performance.

(e) Members also said that they would welcome clarity regarding the rules on MRTs who have been in role for less than three months of the performance year. The PRA's supervisory statement (SS2/17) originally included guidance which disapplied the pay-out rules for MRTs identified as in role for less than three months of the performance year. This was then deleted as part of the PRA’s amendments to reflect changes that were being introduced under the Capital Requirements Directive V (CRD V).

However, those changes related to requirements for payment in instruments, minimum deferral of variable remuneration, and discretionary pension benefits, and their application to individuals with annual variable remuneration equal to or less than €50,000 and which represents no more than one-third of their total remuneration. They did not go to the 3-month minimum gating criteria for the identification of MRTs, which remains in the European Banking Authority's (EBA) Guidelines on Sound Remuneration Policies (see paragraph 102 of Final report on Guidelines on sound remuneration policies under Directive 2013/36/EU). We therefore call on the PRA to clarify its position on this.

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