Introduction
Compensation guidelines
Comment
To more closely align the regulatory framework for non-banking financial companies (NBFCs) with mainstream governance practices, the Reserve Bank of India (RBI) introduced a new scale-based regulatory framework for NBFCs in October 2021, which included certain governance-related requirements. The new framework required NBFCs to put in place a compensation policy approved by their board of directors "to address issues arising out of excessive risk taking caused by misaligned compensation packages" and prescribed that the RBI would issue guidelines on compensation. On 29 April 2022, the RBI issued compensation guidelines for key managerial personnel (KMP) and senior management of all NBFCs other than "base layer" NBFCs and government-owned NBFCs. These guidelines will come into effect on 1 April 2023.
Under the compensation guidelines, the board of directors of an NBFC is required to constitute a nomination and remuneration committee (NRC) in accordance with section 178 of the Companies Act 2013. The NRC must consist of at least three non-executive directors, at least half of which must be independent directors. Section 178 also prescribes certain duties and responsibilities of the NRC. The key function of the NRC under the compensation guidelines is to oversee the framing, review and implementation of the board-approved compensation policy of the NBFC. The compensation guidelines also prescribe that the NRC should coordinate with the risk management committee of the NBFC to achieve "effective alignment between compensation and risks".
The compensation levels of an NBFC are to be guided by the need for retention of earnings and maintenance of adequate capital. The compensation of KMPs and senior management must be reasonable and must adhere to statutory requirements and industry practices. A compensation package can comprise fixed and variable pay components, ensuring that compensation is proportional to risk outcomes, and the mix of cash, equity and other forms of compensation are consistent with risk alignment. The fixed component of compensation may include:
- cash;
- all perquisites that are reimbursable up to a monetary ceiling;
- contributions towards superannuation and retirement benefits; and
- the monetary equivalent of non-monetary benefits (eg, as accommodation and cars) provided by the NBFC.
Performance measures and remuneration criteria for variable pay should be clearly defined at the beginning of the performance measurement period. The variable component of compensation may be in the form of share-linked instruments, or a balanced mix of cash and share-linked instruments. The proportion of the variable component of compensation must be comparable with the role and prudent risk-taking profile of KMPs or senior management (ie, higher the responsibility, the higher the proportion of variable pay). The variable component should be variable in letter and in spirit, and it can be zero based on performance at an individual, business-unit and company-wide level. The variable portion, whether in cash or otherwise, may also be deferred and provided in tranches on the basis of risk assessments, depending on the decision of an NBFC's board of directors.
In the event of subdued or negative financial performance of the NBFC or the relevant line of business or employee misconduct, the deferred compensation may be subject to:
- "malus" arrangements – arrangements enabling prevention of payment of the deferred remuneration; and
- "clawback" arrangements – contractual agreement between the employee and the NBFC, where the employee agrees to return previously paid remuneration to the NBFC under certain circumstances.
NBFCs must identify indicative situations that would require them to invoke the malus and clawback provisions. NBFCs may also specify a time during which such provisions can be applied.
Compensation of KMPs and senior management engaged in financial control, risk management, compliance and internal audit must be commensurate with their role in the NBFC and be independent of the business areas they oversee. While such KMPs and senior management may have a higher proportion of fixed compensation, there should also be a reasonable proportion of variable pay to ensure that malus and clawback options are not ineffective. The compensation guidelines also prescribe that KMPs and senior management cannot be provided guaranteed bonuses. However, a joining bonus for new hires may be offered, and such bonus will not form part of fixed or variable portion of compensation.
The compensation guidelines are a move towards healthy governance practices. These provide broad guidance to NBFCs, and this is reflective of the move towards principle-based regulation and a more wholesome relationship between NBFCs and the RBI.
For further information on this topic please contact Aditya Bhargava or Sristi Yadav at Phoenix Legal by telephone (+91 22 4340 8500) or email ([email protected] or [email protected]). The Phoenix Legal website can be accessed at www.phoenixlegal.in.