The European Banking Authority (EBA) has launched a public consultation on proposed amendments to its Guidelines on Sound Remuneration Policies (Guidelines). The proposed amendments do not represent a substantive re-write, and instead merely reflect the changes that have been made to the remuneration provisions of the Capital Requirements Directive (CRD5).  In particular, there is greater emphasis on ensuring that remuneration policies are gender neutral.

At a European level, the CRD5 changes primarily exempted smaller CRD firms from certain of the more onerous remuneration requirements and it is therefore unsurprising that the changes to the Guidelines are not wide-sweeping, and will result in very little changing for large banks, particularly as a result of the way in which the PRA and FCA are proposing to apply the consolidation group provisions. The Guidelines are, however, likely to take on more relevance for UK Level 3 banks that will be brought within the scope of the remuneration rules as a result of CRD5's narrower proportionality provisions.

The consultation is open until 29 January 2021, and the revised Guidelines will apply from 26 June 2021.

1. The EBA’s proposed changes in a nutshell

The key changes proposed to the Guidelines include:

  • a relaxing of the rules for the Remuneration Committee of smaller banks in relation to independence;

  • clarifying how the remuneration rules should be applied on a group level under the CRD5 provisions;

  • clarifications to the way in which retention bonuses and severance payments should be  treated, to avoid circumvention of the bonus cap;

  • Remuneration Committees to be required to measure gender pay gaps and take action to rectify any gap;

  • minor changes to pay-out process rules to clarify their application; and

  • removal of disclosure guidance, which is now included within technical standards.

2. Governance

The Guidelines confirm that Global- and Other- Systemically Important Institutions must continue to have a Remuneration Committee which is majority independent. The Remuneration Committees of other “significant” institutions (as determined by competent authorities) may now, however, simply have a sufficient number of independent members. In the UK, however, the PRA already requires the Remuneration Committees of significant institutions to be comprised solely of non-executives, and so this change at the European level will have limited effect in the UK. The guidance that institutions should implement other measures to avoid conflicts of interest if sufficient independent members are not available has been removed.

The EBA now also specifically requires Remuneration Committees to consider ESG risk factors in setting remuneration policy.

3. Application of CRD5 on a Group level

Cross-border Groups

A number of the remuneration provisions of CRD5 are drafted on the basis that competent authorities in EU member states may adjust how those provisions are applied in their jurisdiction. The Guidelines clarify that where a group extends across multiple EU member states and it is applying remuneration requirements on a consolidated basis, material risk takers (MRTs) within subsidiaries should be subject to the stricter of:

  • the remuneration requirements in the consolidating institution’s jurisdiction; and

  • the remuneration requirements in the relevant subsidiary’s jurisdiction.

Groups will therefore need to review to confirm whether any subsidiaries are located in jurisdictions which implement CRD5 on a stricter basis than in their home jurisdiction, and will need to amend the pay arrangements of any MRTs employed by those subsidiaries accordingly. An exception to the obligation to apply requirements to subsidiaries in third countries has been introduced where such arrangements would be unlawful under that third country’s national law.

Sector Specific Regulations

The Guidelines are to be revised to clarify how CRD5 is intended to be applied to groups which include entities that are subject to other remuneration regulations (for example AIFMD, UCITS V or, once it comes into force, IFD), subject to local enhancement in this respect. The default position under CRD5 is that the CRD5 remuneration rules will not to apply to individuals who would be MRTs under CRD5 save that they are otherwise subject to sectoral-specific regulations. This would mean, for example, that staff of investment firm subsidiaries would no longer be classified as MRTs and be subject to the bonus cap. It is open, however, to competent authorities to continue to require such individuals to fall within scope of the CRD5 remuneration rules.

In the UK, the PRA and FCA have stated that CRD5 provisions should continue to apply to all staff within the group who are MRTs on a group basis, irrespective of where they are employed (replicating the current position). MRTs within these group entities will therefore not be able to take advantage of being exempted from the bonus cap, and such gold plating means that level playing field issues are likely to persist for asset management subsidiaries of UK banks.

4. Retention Bonuses and Severance Payments

The EBA has expanded its guidance on retention bonuses, with institutions being required to document the justifications for such a bonus and being specifically restricted from granting multiple bonuses to an individual as a result of the same set of circumstances. Competent authorities have been provided with a list of factors to consider in determining whether retention bonuses are appropriate, which focus on the legitimacy of the concerns that lead the institution to believe the individual may leave, and the potential impact of their departure.

The circumstances in which severance payments may be excluded from the bonus cap calculations in early termination scenarios have also been restricted. In particular, where an institution seeks to exclude a severance payment made under a settlement agreement from the bonus cap calculation, the inclusion of a non-compete clause will not be sufficient in itself to enable the whole amount paid for early termination of the contract to be excluded for bonus cap purposes. Instead only the amount paid for the non-compete should be excluded. Where the duration of non-compete covenants is restricted by local legislation, this should be factored into determining what portion of the payment has been made to secure the non-compete.

Where severance payments are excluded from the bonus cap on the basis of having been calculated using a pre-defined formula, the competent authority may require that they are pre-notified if this is a material amount and the justifications for such payment must then be given. The EBA have stated that discretionary pension benefits should not be treated as severance payments, even where an employee retires early.

5. Gender Neutrality

The Guidelines are to be revised to add substance to the requirement in CRD5 for remuneration policies and practices to be based on “equal pay for women and men for equal work or work of equal value”. These provisions are unlikely to lead to any significant changes being made to remuneration policy or practice, but are there to ensure that banks continue to focus attention on gender pay issues, and banks would be advised to ensure that in revising any documentation there are specific references to gender. For listed banks, and other banks whose shareholders approve the remuneration of directors or other senior managers, the EBA requires the Bank to set out how it ensures that its remuneration policy is gender neutral and that equal opportunities for all genders exist.

The Guidelines now state that the annual policy review should include gender pay gap analysis, both across the workforce and at management level, on a country by country basis. Where there are material pay gaps, institutions should document the reasons for this, take action to resolve the gap and should be able to demonstrate that the gap is not as a result of a non-gender neutral remuneration policy and that equal opportunities are available for all genders. The EBA will publish a follow-up report on gender neutrality in remuneration within two years of the revised Guidelines coming into force.

6. Pay-out Process Rules

In addition to the changes required to reflect CRD5 developments (for example, minimum four year deferrals for all MRTs) other minor changes have been made to the guidance on pay-out process rules. For example, although not going as far as the PRA has done for UK banks, the minimum deferral period for members of the management body and other senior managers is now specified as five years.

The EBA have recommended that for senior management who are subject to five year deferral periods, significantly more than the minimum 50% of deferred variable remuneration should be paid in instruments (this is separate to the requirement to defer 40/60% of variable remuneration in the first place).

In a softening of its stance, the EBA have removed the recommendation that clawback should be capable of application where an individual contributes significantly to subdued or negative financial performance (in the absence of fraud or negligence). This brings the Guidelines more in line with the approach set out by the PRA in the Rulebook and Supervisory Statement which already focus more on individual culpability.

7. Disclosure

Disclosure guidance has now been removed from the Guidelines, following the publication by the EBA of draft technical standards on disclosure in June 2020. Those standards are based on the guidance in the previous iteration of the Guidelines, but with revisions to align with CRR2 disclosure requirements and Basel Pillar 3 requirements. The standard will come into force once adopted by the European Commission, and will then apply from 30 June 2021.

8. Brexit considerations

As more fully set out in our previous briefing, the PRA and FCA have proposed that a regime that closely follows the EU CRD5 regime will apply in the UK for performance year 2021 onwards. It is anticipated that the PRA and FCA will publish their responses to feedback on their proposals imminently, although there may be further revisions in the light of the proposed amendments to the Guidelines.

9. Next Steps

The consultation on the revised Guidelines is now open and comments can be submitted to the EBA using the response form available on the consultation page. Responses should make reference to the marked-up version of the Guidelines, available here.

10. Updates

We will continue to update you on the EBA’s consultation and UK implementation of the revised Guidelines and CRD5 more generally. In the meantime, if you have any queries, please contact a member of the Remuneration and Incentives team.