The makers of economic policy of the Western industrialized countries have been occupied, during the financial market crisis by no other topic as much as the remuneration regulations for financial institutions. False incentives in the remuneration systems of major banks, in particular, have been made out as one – if not the – main cause of the financial market crisis. The banks are accused of having induced the responsible players to take unreasonable risks by using remuneration systems with a too short-term orientation. Since then, it has been discussed how to avoid the risks associated with such remuneration systems in the future.
In Germany, the Act concerning Regulatory Requirements for Remuneration Systems for Financial Institutions and Insurance Undertakings (Gesetz über die aufsichtsrechtlichen Anforderungen an die Vergütungssysteme von Institute und Versicherungsunternehmer) came into force on 27 July 2010. This is supposed to transpose the principles for sound compensation practices in the financial sector - developed by the Financial Stability Board and approved by the Group of Twenty Finance Ministers and Central Bank Governors (G 20) - into statutory law. The act provides a legal basis for regulations laying down the details for remuneration arrangements. The Regulation Concerning Regulatory Requirements for Remuneration Systems of Banks and Financial Services Institutions (Verordnung über die aufsichtsrechtlichen Anforderungen an Vergütungssysteme von Kredit- und Finanzdienstleistungsinstituten, InstitutsVergV), which is anticipated to come into force in October 2010, is presented in this paper.
The Regulation Concerning Regulatory Requirements for Remuneration Systems of Banks and Financial Services Institutions applies to all German banks and financial services institutions, their foreign subsidiaries and branch offices and German branches of undertakings located abroad.
It makes a distinction between general and special requirements:
The general requirements of the regulation, which apply to all undertakings and all remuneration systems of all business managers and employees, include the following:
- An appropriate remuneration system that avoids incentives for taking unreasonably great risks:
- No significant dependence on variable remuneration
- No entitlements to severance payments that are independent of negative profit contributions
- Separate remuneration systems for control unit employees that may not run counter to the supervisory function
- The principles of German stock corporation law (§87 of the Stock Corporation Act) must be considered with regard to the amount and form of compensation for management (reasonable proportionality between remuneration and the responsibilities/services or situation of the company; reduction of remuneration when the company's situation worsens).
- Variable remuneration may not restrict the ability to increase the equity capital base as needed.
- Annual duty to audit and, if necessary, adapt remuneration systems
Particular requirements apply to the remuneration systems for business managers and so-called risk takers (employees who can constitute great risks) of so-called "major institutions". Whether an institution is "major" depends on the average of total assets over the last three full fiscal years.
- Institutions having total assets of less than €10 billion are not considered "major" within the meaning of the regulation.
- If an institution has total assets averaging €40 billion or more, it is refutably presumed that it is "major".
- If the total assets are somewhere in between, the institution must decide autonomously whether it is "major". In this respect, the size of the institution, its remuneration structure and the type, scope, complexity, inherent risk and international character of its business activities are to be considered, in particular.
Institutions having total assets exceeding €10 billion must assess on the basis of a written risk analysis whether they are "major". If an institution is major, its remuneration systems must meet the following particular prerequisites:
- "Reasonable proportionality" of fixed and variable remuneration
- Particular requirements apply to the form of variable remuneration:
- Guaranteed bonus payments prohibited
- Individual contribution to profit and overall success of the institution and the organizational unit to be included in the remuneration parameters
- At least 40 percent of the variable remuneration to be retained for a period of at least three years; this part of the remuneration not to be paid out faster than pro rata temporis
- Half of the retained remuneration to depend on the sustainable performance of the institution
- The remuneration's risk alignment not to be limited or cancelled by hedging measures or other measures
The organizational requirements are also stricter for major institutions:
- Risk analysis concerning the risk takers documented in writing
- Establishment of a remuneration committee
- Annual remuneration report by the remuneration committee
- Broader disclosure obligations
According to the regulation, the adaptation of existing contracts and remuneration systems must be carried out on the basis of a legal assessment.
The business managers are responsible for setting up reasonable remuneration systems for employees. The administrative or supervisory boards are in turn responsible for setting up remuneration systems for the business managers. The business managers or the administrative or supervisory boards are therefore liable for non-compliance towards the institutions if the institutions incur a loss because their remunerations systems do not comply with requirements.