Has the regulator implemented rules in relation to remuneration paid by banks to its staff?
Yes, the European Commission (Commission) has implemented rules.
In order to ensure that a firm’s remuneration policy does not incentivize staff to take imprudent risks and to ensure it has in place sound and effective risk management, in 2010, the Capital Requirements Directive III (CRD III) introduced a number of technical rules on remuneration paid by EU based credit institutions (banks) and investment firms (that fall within the scope of the Markets in Financial Instruments Directive) (together firms) to certain categories of staff (see question 2).
The Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR) both came into force on 1 January 2014 and essentially carried over the existing provisions of the CRD III relating to remuneration with some enhancements in relation to the bonus cap. The relevant provisions can be found in articles 74, 92 to 95 and 161 (in addition to recitals 62 to 69 and 83) in the CRD IV; and in article 450 on disclosure in the CRR. The CRD IV / CRR regime is supplemented by guidelines and technical standards issued by the European Banking Authority (EBA). These include guidelines on sound remuneration policies and various technical standards including those concerning the identification of material risk takers. The key impact under CRD IV is the increased scope of the application of the rules in relation to “identified staff” to broader categories of employees in practice.
What categories of staff are caught by the regulator’s rules?
As with CRD III, the requirements in CRD IV and CRR apply to certain categories of a firm’s staff.
The more prescriptive requirements apply only to those staff whose professional activities have a material impact on the firm’s risk profile, such as senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers. This list of staff is the same as the list of categories of staff who were covered by CRD III.
However, CRD IV mandated the EBA to develop regulatory technical standards (RTS) “with respect to qualitative and appropriate quantitative criteria to identify categories of staff whose professional activities have a material impact on the institution’s risk profile.” The RTS have been published in the Official Journal of the EU and the EBA has also published FAQs on the RTS.
As a general principle, staff shall be identified as having a material impact on the firm’s risk profile if they meet one or more of the following criteria set out in the RTS, which include:
- a set of 15 standard qualitative criteria relating to the role and decision-making power of staff members; and
- standard quantitative criteria relating to the level of total remuneration of the staff member concerned, in absolute or relative terms.
In practice, this may result in the rules being applied to more employees in practice.
What are the key regulatory rules?
Key requirements under CRD IV that apply to a firm as a whole include:
- remuneration policies and practices should be consistent with and promote sound and effective risk management;
- remuneration policies should be in line with the business strategy, objectives, values and long term interests of the firm, and incorporates measures to avoid conflicts of interest; and
- the implementation of the remuneration policy should be subject to central and independent internal review by the firm’s management body at least annually.
CRD IV / CRR also introduced additional transparency and disclosure requirements for firms relating to staff earning more than EUR 1 million per year. To further tackle excessive risk taking CRD IV strengthened requirements concerning the relationship between the variable (or bonus) component of remuneration and the fixed component (or salary) (see question 4).
The remuneration rules under CRD III were subject to the principle of proportionality. This principle remains an important part of the remuneration framework under CRD IV, which means that the application of certain remuneration requirements may vary based on the firm’s size, internal organization and the nature, the scope and the complexity of its activities.
Are bonuses subject to the regulator’s rules?
Yes, CRD IV contains rules regarding variable remuneration (bonuses).
The CRD IV requires firms to ensure that their remuneration policy makes a clear distinction between criteria for setting fixed remuneration and variable remuneration.
CRD IV introduced “hard” limits to the relationship between the variable component of remuneration and the fixed component. The basic fixed to variable ratio is 1:1 (i.e. bonuses are required to be equal to fixed salary paid to an individual). This ratio can be increased to 2:1 with shareholder approval (with a quorum of 50% of shareholders, 66% of votes in favor would be required; and, if that quorum is not reached, 75% of votes in favor). For the purposes of calculating the maximum ratio, the use of deferred and bail-in-able instruments is encouraged by CRD IV through the application of a notional discount factor to up to 25% of total variable remuneration provided that it is paid in instruments which are deferred for more than five years. Staff who are directly concerned by the maximum levels of variable remuneration are not allowed to exercise any voting rights they may have as shareholders.
CRD IV gives Member States certain discretions including that they may lower the upper limit set for bonuses (i.e. less than 200% as a maximum) and place restrictions or prohibit certain types of deferred instrument.
CRD IV also provides that:
- all variable remuneration must be subject to malus1 or claw-back2 arrangements;
- guaranteed variable remuneration should not form part of an institution’s prospective remuneration plans. The payment of a guaranteed bonus should be exceptional, only occur where the firm has a sound and strong capital base and it should be limited to the first year of employment; and
- remuneration packages concerning compensation or buy-outs of previous employment contracts (golden hellos) must be aligned with the firm’s long-term interests, including retention, deferral, performance and claw-back arrangements.
What is the position concerning role based allowances
In October 2014, the EBA published a report on the application of CRD IV regarding the use of allowances. In the report the EBA stated that it is of the view that role-based allowances which are discretionary, not predetermined, not transparent to staff or not permanent should not be considered as fixed but should be classified as variable remuneration, in line with the letter and purpose of CRD IV. The report can be found here.
Do the regulator’s rules on remuneration have extraterritorial effect?
CRD IV provides that Member State regulators should ensure compliance with the requirements on remuneration for firms on a consolidated basis, that is at the level of the group, parent undertakings and subsidiaries, including the branches and subsidiaries established in third countries. Non-EEA based banks must apply the remuneration requirements to their EEA subsidiaries and EEA branch operations.
Do you anticipate further reform in this area?
CRD IV provides that the Commission, in close cooperation with the EBA, will submit a report to the European Parliament and to the Council of the EU, together with a legislative proposal if appropriate, on the remuneration provisions contained within it and CRR. This report is to be submitted by June 30, 2016.
On January 29, 2015, the European Central Bank issued a press release in which it stated that over the coming months it will thoroughly review the variable remuneration of the EU banks that it supervises.
The FAQs on the RTS concerning material risk takers mentioned that the EBA would be reviewing the existing Committee of European Banking Supervisors (the predecessor of the EBA) guidelines on remuneration policies and practices. An EBA consultation paper on draft guidelines on sound remuneration policies was published on March 4, 2015. The draft guidelines clarify the process for identifying those categories of staff whose professional activities have a material impact on the firms’ risk profile, and do so on the basis of the criteria that were defined in the EBA RTS on identified staff (see question 2). The draft guidelines also give guidance on how the ratio between the variable and the fixed components of remuneration should be calculated, taking into account specific remuneration elements such as allowances, sign-on bonus, retention bonus and severance pay. On the application of proportionality to the remuneration principles set out in articles 92 to 94 CRD IV, the draft guidelines follow a legal reading of the CRD IV, that the requirements on deferral and payment in instruments have to be applied to all institutions. The EBA is of the view that specific exemptions could be introduced for certain firms that do not rely extensively on variable remuneration and, if confirmed by further analysis, also for identified staff that receive only a low amount of variable remuneration. To this regard, the EBA intends to send advice to the European Commission suggesting legislative amendments that would allow for a broader application of the proportionality principle and is, therefore, asking stakeholders for input on this aspect. The deadline for comments on the consultation is June 4, 2015.
Must an institution’s remuneration policy be disclosed to the regulator?
Under CRD IV / CRR a firm is not required to disclose its remuneration policy to the EBA or European Commission. However, article 450 CRR sets out certain detailed disclosures that a firm must make regarding its remuneration policy and practices. These are typically made alongside a firm’s Pillar III disclosures.
From the EU perspective it is worth noting that CRD IV carries on certain requirements contained in CRD III that required Member States to collect data on remuneration practices and remit it to the EBA.
CRD IV imposes obligations on Member States’ regulators to collect information on remuneration practices from firms at the consolidated level and significant subsidiaries to benchmark remuneration trends and practices. Member States’ regulators also collect information on the number of people within an institution that are remunerated with €1 million or more per financial year (the high earners report). Member States currently collect annually the benchmarking and high earners data from institutions by 30 June and submit the aggregate data to the EBA by 31 August. The EBA publicly discloses the data on an aggregate Member State basis.