The new code is designed to achieve two objectives: firstly, that boards focus more closely on ensuring that the total amount distributed by a firm is consistent with good risk management and sustainability; and secondly that individual compensation practices provide the right incentives.
Eight principles have also been added to the FSA's handbook to ensure firms understand how the FSA will assess compliance.
The code makes clear that it is not expected that firms will enter into contracts with individuals which provide guaranteed bonuses for more than one year. It is also expected that for senior employees two-thirds of bonuses will be spread over three years.
Firms are expected to provide the FSA with a remuneration policy statement by the end of October. This will have to be signed off by remuneration committees and will enable the FSA to check compliance with the code. Non-compliant firms could face enforcement action or ultimately, be forced to hold additional capital should they pursue risky processes.
Hector Sants, FSA chief executive, said: "The FSA is determined that banks' remuneration policies should be consistent with, and promote, effective risk management. The new rules and code of practice, which will take effect from January, next year, are aimed at achieving this.
"Whilst there is general international agreement on the need for supervisory action on remuneration policies and practices we will be the first major financial regulator to take this step. We think that it is important to have rules in place for 2010."
The rule and code are consistent with the recommendations of the Financial Stability Board and with the measures being considered by others such as Switzerland and the EU. International negotiations on common guidelines should be concluded in the first half of 2010.
Responding to the FSA's new Code of Practice on remuneration policies, Peter Montagnon, the ABI's Director of Investment Affairs, said: "This is an important step forward. The FSA has stuck to its principle of linking remuneration to risk, while making the Code less prescriptive and narrowing the scope of the organisations covered. The new version is much more likely to deliver the desired outcome without excessive compliance burdens.
"We agree with the FSA that the focus should be on the structure of remuneration, not the size of the package, which companies must be able to determine based on their need to compete.
"And as shareholders, we support the proposal that bonus pools should be formed only after taking into account the cost of capital, adjusted for risk.
"There is still work to be done so the details do not conflict with the Combined Code and other similar codes, ensuring the FSA proposals are in line with international arrangements.
"The FSA has promised further proposals for the wider financial sector in October. We continue to believe that great care needs to be taken to avoid reading across from banks to insurers and asset managers, whose businesses are substantially different in nature and pose much less risk to overall financial stability."
