Pay and bonuses will be more closely linked to the profitability of larger financial institutions, following concerns the current regime contributed to excessive risk taking in the banking sector.

Its new code will make clear firms should not enter into contracts with individuals which provide guaranteed bonuses for more than one year. For senior employees, the expectation is two-thirds of bonuses will be spread over three years.

Firms will have 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.

The FSA said non-compliant firms could face enforcement action or ultimately, be forced to hold additional capital should they pursue risky processes.

Its new code is designed to achieve two objectives. Firstly, boards should focus more closely on ensuring the total amount distributed by a firm is consistent with good risk management and sustainability. Secondly, individual compensation practices must provide the right incentives.

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The FSA has added eight principles to its handbook to ensure firms understand how the FSA will assess compliance.

Hector Sants, chief executive of the FSA, said: “The FSA is determined that banks’ remuneration policies should be consistent with, and promote, effective risk management.

“While 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 takethis 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.

Peter Montagnon, director of investment affairs at the ABI, commented: “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.

He added: “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.