The UK government has signalled its intention to enact legislation which will allow market regulator The Financial Services Authority (FSA) to 'tear up' bankers’ contracts of employment if it feels that the structure of the compensation on offer encourages unnecessary risk-taking.
There has, of course, been a great deal of noise as to whether such a move, which represents a direct intervention into private contractual arrangements, in any way contravenes English Law.
Whilst it is true that freedom of contract has, for centuries, been one of the main features of English Law, we have now, however, moved on from that position. It is obviously illegal for parties to enter into a contract which contains illegal terms, and, in the area of employment, there are many situations where parties will be restricted from agreeing terms prohibited by law. For example, it is illegal to enter into a contract of employment which will be discriminatory on grounds of sex, racial groups, disability, religious beliefs, sexual orientation and age.
In March 2008, the FSA published a code of Guidance on banker remuneration practices, which banned multi-year guaranteed bonuses, and provided that the payment of a large percentage of bonuses for senior executives should be made in deferred equity. The code says firms must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management, and the idea is to incentivise bankers by aligning their interests with the long-term performance of their firms.
Whether this measure will have any teeth, of course, will obviously depend on the way the legislation is drafted. Will the legislation broadly follow the guidelines of the above-mentioned Code. Will it be more prescriptive ? Will it merely contain general principles relating to remuneration ? It is clear, however, that the FSA as a regulatory body is perfectly able to lay down rules as to what should and should not appear in contracts of employment of those members regulated by it. Many other regulatory bodies already do so.
What would be a lot more contentious, of course, is if the regulator attempted to amend a contract that was already in existence before the new legislation was introduced. This will clearly be a lot more difficult to achieve, as many banks (and bankers) are likely to fight their corners, and they will likely use administrative law ( via judicial review ) in order to challenge the FSA's actions. And the outcome of a judicial review is by no means certain - either way.
Sharokh Koussari, Partner, Howard Kennedy.