New EU and national rules on remuneration in listed companies and financial institutions

At present, there are many calls from different quarters urging the adoption of sustainable and moderate remuneration policies by listed companies and financial institutions. In this regard, there have recently been two new developments. On April 29, 2009, the European Commission published two Commission Recommendations: one on the remuneration of directors of listed companies and the other on remuneration in the financial services sector. In addition, on May 6, 2009, the Dutch Central Bank and the Authority for the Financial Markets published joint principles for balanced remuneration policies in the Dutch financial sector.

Partly as a result of the financial crisis, the issue of corporate remuneration is currently the subject of a great deal of attention. In light of this, there have already been various initiatives aimed at changes in the regulation of, and practices in, this area. The more noteworthy of these initiatives are:

• the new Dutch Corporate Governance Code (December 2008);
• the "gentlemen's agreement" between the financial sector and the Dutch Minister of Finance (March 2009);
• the "Principles for Sound Compensation Practices" issued by the Financial Stability Forum (April 2009);
• the report of the Maas Committee (April 2009); and
• the "Interim Report on Market Best Practices" issued by the Institute of International Finance (April 2009).

Recommendations of the European Commission

Under the two Recommendations, consisting of a series of principles and best practices, the European EC (the "Commission") wants the management of risks within companies to be improved and the awarding of incentives to be linked to the achievement of sustainable performance criteria. The Recommendations do not have binding force, but set out the Commission's vision and suggest lines of policy to be followed by EU Member States. However, the Commission expects to come up with legislation at a later stage. Member States are requested to implement both Recommendations by December 31, 2009 and to inform the Commission of the measures taken.

Recommendation on the remuneration of directors

The first Recommendation aims to supplement and sharpen existing Commission Recommendations (2004/913/EC and 2005/162/EC) on the remuneration of managing directors and supervisory directors (for the sake of convenience, both will be referred to below as "directors"). The Recommendation applies to:

• listed companies having their registered office in a Member State, although exceptions can, under certain circumstances, be made for UCITS; and
• companies that are incorporated outside the EU but are listed on a regulated market in a Member State.

In the Commission's opinion, a sound remuneration policy should reward performance and encourage directors to ensure that the business remains healthy in both the middle term and the long term. To this end, the Commission suggests guidelines on (i) the structure of the policy on directors' remuneration, and (ii) the relevant decision-making process, including the exercise of supervision by the shareholders. With regard to the structure of the policy on directors' remuneration, the Commission sets out the following principles:

• internal benchmarking on the basis of predetermined and measurable performance criteria;
• ceilings on termination payments, non-payment in the event of termination due to inadequate performance; and
• share options not to be exercisable for a certain minimum period of time; where shares are granted, part of these to be retained until the end of service; claw-back of variable remuneration to be possible under certain conditions.

The principles relating to the decision-making process include:

• improved communication of information to shareholders, together with more responsibilities on the latter's part with regard to the exercise of their voting rights in relation to the remuneration policy; and
• requirements regarding the members of the remuneration committee: at least one member to have expertise in the field of remuneration policy and all committee members to attend shareholder meetings at which the remuneration policy is discussed.

Recommendation on remuneration in the financial services sector

In addition, the Commission has issued recommendations on remuneration policies in the financial services sector. The relevant Commission Recommendation applies to financial undertakings (such as credit institutions, investment institutions, insurers/reinsurers, pension funds and UCITS):

• whether listed or unlisted;
• whether or not under regulatory supervision; and
• having their registered office or head office within EU territory.

The Commission also states that Member States should ensure that financial undertakings which have their registered office and head office outside the EU but operate within a Member State's territory should be subject to similar principles.

In the Commission's opinion, Member States should ensure that financial undertakings have a remuneration policy for all categories of staff whose professional activities have a material impact on the undertaking's risk profile. To this end, measures should be taken regarding:

• the structure of the remuneration (remuneration to be linked to performance, significant variable remuneration to be deferred and claw-back of variable remuneration to be possible under certain conditions);
• disclosure of the remuneration policy to stakeholders (policy to be internally transparent, clear and properly documented, and adequately disclosed in a clear and easily understandable way);
• governance (independence of staff members responsible for the design and implementation of the policy, management/supervisory board responsible for supervision of policy implementation as a whole);
• regulatory supervision (relevant authorities to use the supervisory tools at their disposal).

Joint principles published by Dutch supervisory authorities

On May 6, 2009 the Dutch Central Bank (De Nederlandsche Bank, the "DCB") and the Authority for the Financial Markets (Autoriteit Financiele Markten, the "AFM") published a set of joint principles for balanced remuneration policies in the Dutch financial sector and, more specifically, for controlling the risks inherent in the use of variable remuneration. Although the principles make no reference to the two Commission Recommendations discussed above, in fact the DCB and AFM are in the forefront in this regard. The two supervisory authorities consider their principles to be an elaboration at national level of the Financial Stability Forum's principles referred to above, and the Maas Committee recommendations to be an elaboration of the DCB/AFM principles.

The joint principles apply to the remuneration policies of financial institutions, whether listed or unlisted and including pension funds, that are supervised by the DCB or AFM (pursuant to the Financial Supervision Act the Pension Act or the Mandatory Occupational Pension Scheme Act) insofar as such policies relate to the remuneration of directors and employees whose remuneration consists (or can consist) of a significant variable component. Such employees typically include senior executives and those in certain commercial positions.

It has been announced that the Ministry of Finance will ensure that the principles for a balanced remuneration policy are anchored in the Financial Supervision Act. In that event, both the AFM and the DCB will be able to enforce them.

The DCB and AFM expect financial institutions to use the principles as guidelines in critically reviewing and, where necessary, amending their remuneration policy. If the supervisory authorities believe that the remuneration policy of a particular financial institution can lead to substantial prudential or conduct-related risks, they will initiate an investigation into these risks and intensify their supervision of the institution as a whole.

The principles have been formulated abstractly so that they can be applied and adapted by financial institutions of all types and sizes to develop a prudent and client-oriented remuneration policy that is suitable for the relevant institution. Although the principles do not contain any quantitative criteria, some of them include one or more examples of good practices and/or undesirable practices. The DCB and AFM have announced their intention to make the principles more concrete after they have learned more about the actual remuneration practices in the Dutch financial sector. An investigation will be conducted by the DCB for this purpose.

The principles are divided into three levels. The first consists of the principles that should underlie a financial institution's remuneration policy. These are:

• the design, implementation and evaluation of the remuneration policy should support the integrity and solidity of the relevant institution;
• although a financial institution can have valid reasons for using variable remuneration, the incentives provided by such remuneration should not harm the interests of clients and other stakeholders.

The second level concerns the governance of the remuneration policy. These principles are directed in particular at large and mid-sized institutions and include the following:

• in the design, implementation and evaluation of the remuneration policy, sufficient attention should be given to the adverse effects of using variable remuneration structures and to controlling the risks associated with a large variable remuneration component;
• the supervisory board is responsible for the design, implementation and evaluation of the policy on the remuneration of the management board and also for overseeing the remuneration policy for the entire institution;
• the control of risks resulting from the remuneration policy should be a joint effort of the human resources, risk management compliance and internal audit departments or staff; and
• the remuneration policy should be made transparent for the relevant stakeholders.

The third level concerns the design of the variable remuneration structures. The principles at this level include the following:

• the institution should establish an appropriate maximum for the ratio of variable remuneration to fixed salary;
• the variable remuneration should be linked to measurable performance criteria that reflect the interests of all the stakeholders as much as possible;
• the mix of variable remuneration in the form of cash, shares, options, etc. should be consistent with the financial institution's risk profile;
• where variable remuneration for commercial performance is established on the basis of financial results, these results should be adjusted for the risks taken; and
• attention should be given to long-term performance.