On 4 March, the European Banking Authority (EBA) published a consultation paper ‘Draft Guidelines on Sound Remuneration Policies’. The guidelines are a substantial rewrite of the 2010 guidelines on remuneration policies and practices published by the Committee of European Banking Supervisors (CEBS) (the predecessor to the EBA) following the adoption of the third Capital Requirements Directive (CRD3). The proposed draft guidelines complement the earlier EBA report on benchmarking of remuneration practices and have been developed on the basis of Articles 74 and 75 of CRD4. The draft guidelines are subject to a three-month public consultation period, during which all stakeholders will be able to submit comments.
- 4 March 2015: consultation document is published by EBA.
- 8 May 2015: public hearing in London (from 1.30pm to 4pm at the EBA premises, Canada Square, Canary Wharf).
- 4 June 2015: closing date for responses to the consultation.
- Summer/Autumn 2015: EBA issues final guidelines.
- Autumn/Winter 2015: within two months of publication of the final guidelines, local regulators must state whether and to what extent they intend to comply with the guidelines and to the extent that they indicate that they do not intend to comply, they must explain the reasons for this (under the ‘comply or explain’ principle).
- 1 January 2016: date of application of the new guidelines.
Identification of staff
- Institutions should go through an annual process of assessing which staff are identified staff before applying the remuneration provisions in a proportionate way.
- Institutions should apply the qualitative and quantitative criteria set out in the EBA’s Regulatory Technical Standards on identified staff (RTS) when going through this assessment process. The guidelines set out how institutions should apply the RTS criteria. They also confirm that institutions should include additional internal criteria, where needed to ensure that all identified staff are identified, which should reflect the levels of risk in different activities within the institution and the impact of staff members on the risk profile.
- The guidelines contain detailed information as to what should be included in the assessment process and in the records kept by the institution of how it has conducted the assessment process. They also set out in detail the process for notifying and obtaining prior approval of any exclusion of staff from the list of identified staff.
- The guidelines set out the requirements in relation to the governance of the identification process and the involvement of internal control functions in the identification process.
- The RTS criteria and any additional internal criteria should be applied on a consolidated and solo basis (except that subsidiaries that are not subject to CRD4 are not required to perform the identification process on a solo basis). In this regard, the guidelines may prove helpful in discussions with local regulators as there should be less scope for local regulators to apply local rules that go beyond the detailed requirements of the guidelines when determining which employees of a subsidiary constitute material risk takers.
- The EBA states that, in its assessment, the ‘neutralisation’ approach to certain of CRD4’s remuneration provisions in small and less complex institutions, which was permitted by the 2010 CEBS guidelines, is not in line with the provisions of CRD4. Its view is that there is no scope under CRD4 for any institution to waive (partially or fully) any of CRD4’s remuneration provisions (which is what the neutralisation approach entails). The EBA states that the European Commission has confirmed that it agrees with its approach on this point.
- As a result, the EBA states in the consultation paper that each of CRD4’s remuneration provisions must be applied by all institutions including smaller banks and investment firms. Each institution should apply CRD4’s remuneration provisions in a manner and to the extent that is appropriate, taking into account the institution’s size, internal organisation and the nature, scope and complexity of its activities.
- Where a minimum level threshold is set by CRD4, eg in relation to the deferral of a portion of variable remuneration or pay out in instruments, this minimum threshold applies to all institutions and the extent of compliance by any institution after it has applied the proportionality principle must not fall below the lowest prescribed figure.
- The EBA states that it supports the introduction of specific exemptions into CRD4 for certain institutions that do not rely extensively on variable remuneration and also potentially for identified staff that receive only a low amount of variable remuneration. The EBA intends to liaise with the European Commission to suggest that amendments are made to CRD4 that would allow for a broader application of the proportionality principle. This lengthy and difficult process would most likely only start once the finalised guidelines come into force. The EBA has asked specifically for institutions to comment on the cost of not being able to apply the neutralisation approach going forward, suggesting that there may be more scope for influencing the outcome of the consultation on this issue than other aspects of the draft guidelines.
Categories of remuneration
- The guidelines set out clear criteria for allocating all remuneration components to either fixed or variable remuneration, specifying that there is no third category of remuneration. They confirm that remuneration policies should set out clear, objectively determined and transparent criteria to assign all remuneration components to the fixed or variable categories.
- Remuneration is fixed only where the conditions for its award and its amount are predetermined, non-discretionary, non-revocable, transparent to staff, permanent, cannot be reduced, suspended or cancelled by the institution, do not provide an incentive for risk assumption and do not depend on performance. Unsurprisingly, the guidelines here complement the EBA opinion on the use of ‘role-based allowances’ which was issued in October 2014. The EBA is seeking to draw a hard line on the categorisation of pay – but it does raise questions about traditional fixed remuneration structures including discretionary salary increases and unpaid leave/suspension.
- The guidelines go on to consider particular cases of remuneration components, including role-based allowances, retention bonuses and severance pay, and explain the approach which an institution should take to the categorisation of each component and the extent to which an award of such a component should be made.
- The guidelines state that where it is not possible for a remuneration component to be clearly allocated to fixed remuneration, it should be considered variable remuneration.
- There are specific provisions dealing with circumvention. These provide that institutions should ensure that variable remuneration is not paid through vehicles or methods which aim at or effectively lead to non-compliance with remuneration requirements.
- The approach of the EBA in strictly defining what constitutes fixed and variable remuneration could potentially be open to question on the basis that it is not compatible with Article 153(5) of the Lisbon Treaty which excludes pay from the competences of the EU.
Remuneration policy, award and pay out of variable remuneration
- Consistent with the 2010 guidelines, institutions must have a fully flexible policy on variable remuneration. In order to assist with the practical implementation of this requirement, the draft guidelines indicate how institutions should approach the setting of fixed pay.
- The remuneration policy should set out in advance the appropriate ratio between fixed/variable pay for identified staff. Different ratios may be set for different locations, business units, functions and categories of staff. The guidelines include detailed provisions on how the ratios should be calculated and set.
- The requirements to make awards subject to a retention period and to defer a portion of variable remuneration should ensure that the award of variable remuneration is aligned with an institution’s long-term risks and performance and that ex-post risk adjustments (such as malus and clawback) can be applied as appropriate.
- The instruments used for the award of variable remuneration should contribute to this alignment of variable remuneration with performance and risk. Priority should be given to instruments which are subject to bail-in and shares rather than the use of value-based items like share-linked instruments. The guidelines effectively preclude listed financial institutions from using phantom share arrangements. This is another area where there appears to be greater scope to influence the final guidelines as the EBA has specifically called for evidence on the impact of this guideline.
- Subject to contract or labour law, malus and clawback arrangements should be applied up to 100% of variable remuneration including deferral or retention arrangements and should always be performance or risk related.
- Where it is difficult or not possible to enforce clawback under national laws, institutions should reflect this in their remuneration policies and ensure that malus or implicit risk alignments (such as the use of increased deferral periods) are applied to the extent possible.
Governance process for implementing sound remuneration policies
- The guidelines set out clear principles on governance and on the structure of remuneration policies. They set out clearly the scope of responsibility of each function within the institution in relation to the setting and governance of remuneration.
- Significant institutions are required to establish remuneration committees at individual, parent company and group level. The consolidating institution should ensure that a remuneration committee is established when legally required. The guidelines here seem to indicate that a remuneration committee is required at subsidiary level.
- The guidelines further explain the role of shareholders in the approval of the remuneration policy and decisions relating to the remuneration, in particular in relation to any vote to approve a ratio between variable and fixed pay of higher than 100%.
Remuneration policies and group context
- Consolidating institutions and local regulators should ensure that a group-wide remuneration policy is implemented and complied with for all staff in all institutions and other entities within the scope of consolidation. This could include asset managers, private wealth firms and insurers owned by banks – even if these entities are not themselves subject to CRD4, they (and their staff) will be subject to the relevant provisions and group-wide remuneration policies when applied on a group level.
- This approach would mean that the bonus cap would be applicable to UCITS or AIFMD regulated subsidiaries of CR4 regulated institutions when neither the UCITS or AIFMD directives provides for such a cap. The legality of the EBA seeking to impose a bonus cap on these subsidiaries ‘through the back-door’ could be questioned. Also, it gives rises to a significant disparity between the position of 'stand alone' funds that are only regulated by UCITS or AIFMD and those that are controlled by a CRD4 regulated firm, which could itself found claims.
- The group-wide remuneration policy of institutions and entities within a group located in more than one Member State should specify how its implementation should deal with differences between national implementations of CRD4, in particular regarding variations in the maximum ratio between fixed and variable pay.
Sound capital base
- Institutions and local regulators should ensure that the award, pay out and vesting of variable remuneration, including the application of malus and clawback arrangements, under the remuneration policy is not detrimental to maintaining a sound capital base.
- Institutions should include the impact of variable remuneration - both upfront and deferred amounts - in their capital and liquidity planning and in their overall internal capital adequacy assessment process.
- The total variable remuneration awarded by an institution must not limit the ability of the institution to maintain or restore a sound capital base in the long term and should consider the interests of shareholders and owners, depositors, investors and other stakeholders.
- Variable remuneration should not be awarded or paid out when the effect would be that the capital base of the institution would no longer be sound.
- Local regulators should intervene where the awarding of variable remuneration is detrimental to the maintenance of a sound capital base by requiring the institution to reduce or apply a cap to the overall pool of variable remuneration determined until the capital adequacy situation improves (and if necessary apply malus and clawback arrangements) and require institutions to use net profits to strengthen the capital base.
Record keeping and disclosures
- The guidelines include detailed provisions in relation to record-keeping requirements (particularly in relation to decision making) and the disclosure of remuneration, which are more onerous than those in the CEBS 2010 guidelines.
Entry into force
- The draft guidelines state that they will apply from 1 January 2016. The accompanying press release gives more detail saying that competent authorities across the EU (ie local regulators) will be expected to implement the guidelines by the end of 2015, “so as to ensure that all institutions apply them for the performance year 2016 and onwards”. If confirmed, this would mean that performance year 2015 – and all payments made in relation to it (including those paid in early 2016) – are not and will not be impacted by the new rules.
- The EBA guidelines – when final – will be non-binding but based on the ‘comply or explain’ principle. This principle enables a local regulator to ‘explain’ how it considers it can implement the requirements of CRD4 in a different manner. Local regulators to whom guidelines apply are expected to comply by integrating the guidelines into local rules and to impose and enforce those rules on the institutions they regulate.
- Where a Member State chooses not to follow the guidelines either partially or entirely, it must inform the EBA and state its reasons for non-compliance. The EBA website will publish this information on its website (in an attempt to put pressure on the relevant regulators).
- There is a remote risk that the EU Commission would initiate infringement proceedings against a Member State for not having complied with CRD4 if it considers the ‘explanation’ inadequate. Such proceedings would ultimately end up in the ECJ where the relevant Member State would have the opportunity to justify its position.
- The EBA has no direct claim against institutions based on the guidelines.
New role for the European Central Bank
- The ECB recently announced it would examine banks’ variable pay policies as part of its new role of European supervisor of banks which it took on last November. The ECB directly supervises 130 banks in Europe focusing on the banks’ ability to maintain a sound capital base. Any statement on remuneration from the ECB might potentially be more effective than the EBA guidelines, at least for the banks it supervises directly.