Has the regulator implemented rules in relation to remuneration paid by banks to its staff?
There is currently no legislation in Hong Kong regulating banking remuneration but the Hong Kong Monetary Authority (HKMA), the supervisory authority for the banking sector in Hong Kong, has issued a guideline that banks are expected to follow. In March 2010, the HKMA issued, as part of its Supervisory Policy Manual, a Guideline on a Sound Remuneration System (2010 Guideline). In August 2014, the HKMA issued for consultation a draft replacement guideline similar to the 2010 Guideline but with more prescriptive disclosure requirements (Guideline). Other than the more prescriptive disclosure requirements, there is minimal difference in the content of the two guidelines. The Guideline, once formally issued by the HKMA, will supersede the 2010 Guideline.
Although the Guideline is still in draft form it cannot be ignored by banks as it reflects the intended approach of the HKMA. Banks authorised under the Banking Ordinance (Cap. 155) (AIs, and individually, an AI) should therefore be looking to review and align their remuneration practices with the Guideline, if they have not done so already. New entrants to the banking industry will likely be expected to prepare their remuneration structures on the basis of the Guideline.
The Guideline focuses on governance and control arrangements for, and operation of, remuneration systems on particular on the incentives for risk-taking. The Guideline does not have any statutory effect and is only a guidance note. Nevertheless, as the 2010 Guideline (and subsequently the Guideline) forms part of HKMA’s supervisory framework, all AIs are expected to comply with it.
The Guideline provides that AI boards should be prepared to justify and explain to the HKMA any departure from the principles set out in the Guideline on the basis that the relevant requirement is not applicable to their institution / relevant division or that the AI has adopted effective alternative control measures. Failure to comply with the Guideline may result in the HKMA taking such supervisory measures as it considers appropriate, including setting a quantitative limit on the total variable remuneration payable by the AI.
What categories of staff are caught by the regulator’s rules?
The Guideline is applicable to all AIs, whether incorporated locally or outside Hong Kong.
For locally-incorporated AIs, the Guideline applies to all employees. This includes employees working at overseas branches and subsidiaries of locally-incorporated AIs that are subject to HKMA’s consolidated supervision. Although the Guideline applies to all employees noted above, it is particularly focused on the remuneration arrangements for employees whose activities, during the course of their employment, whether individually or collectively, could have a material impact on the AI’s risk profile and financial soundness. The categories of staff that the Guideline advises to have specific regard to include senior management (i.e. those who are responsible for oversight of the AI’s firm-wide strategy or activities or those of the AI’s material business lines, including, but not limited to, executive directors, chief executive, and other senior executives), risk takers (i.e. employees whose activities, individually or collectively, involve the assumption of material risk or the taking on of material exposures), staff engaged in control functions, and employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers.
The Guideline recognizes that it may not be appropriate to apply the same measures to junior employees who receive relatively insignificant amounts of variable remuneration, or those who are in a position that is unlikely to materially impact an AI’s risk profile.
For overseas-incorporated AIs, the Guideline applies to officers and employees engaged in the conduct of an AI’s business and operations in Hong Kong. Where an AI in Hong Kong is a subsidiary of a banking group or a branch of an overseas-incorporated bank, it may adopt the group remuneration policy only if it is broadly consistent with the Guideline and can demonstrate to the satisfaction of HKMA; and to the extent that it is not so consistent, there are alternative control measures that are equally effective in promoting effective risk management.
Apart from the scope of application, the provisions applicable to locally-incorporated AIs are equally applicable to overseas-incorporated AIs.
What are the key regulatory rules?
The key principles under the Guideline 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 AI, and incorporate measures to avoid conflicts of interest;
- the implementation of the remuneration policy should be subject to central and independent internal review at least annually by the board of an AI, who will be ultimately responsible for overseeing the formulation and implementation of the remuneration policy; and
- risk control personnel, who are independent of an AI’s business units, should have appropriate authority and be actively involved in the process of design and implementation of an AI’s remuneration policy.
The Guideline endorses the proportionality principle, meaning that the application of certain remuneration principles may vary based on an AI’s size, the internal organization and the nature, the scope and the complexity of its activities.
Are bonuses subject to the regulator’s rules?
The Guideline distinguishes between fixed and variable incentive-based remuneration. There are no specific provisions that deal with bonuses. Depending on the structure of the AI’s remuneration system, bonuses are likely to be regarded as a type of variable remuneration.
There are no specific limits to the relationship between fixed and variable remuneration under the Guideline. The Guideline recommends that a proportionate balance be struck between fixed and variable remuneration. To achieve this, AIs should consider employees’ seniority, roles, responsibilities and activities and the importance of promoting employee behavior that supports the AI’s risk management framework and long-term financial soundness. In general, the ratio of variable remuneration to total remuneration is expected to increase in parallel with an employee’s seniority and responsibility, such that a substantial proportion of the remuneration to senior management and risk takers in an AI should be paid in the form of variable remuneration.
The form of payment of variable incentive-based remuneration to an employee should be commensurate with long-term value creation and time horizons of risk, and reflect their seniority, role, responsibilities and activities within the AI. Accordingly, equity-related instruments may be effective in restraining the risk-taking incentives of senior management and key personnel, whose activities could have a material impact on the overall performance.
The Guideline does note that guaranteed minimum bonuses, which are awarded irrespective of an employee’s performance, are not consistent with sound risk management and should be subject to board approval.
What is the position concerning role based allowances?
As mentioned above, the Guideline distinguishes between fixed and variable incentive-based remuneration. There are no specific provisions that deal with role based allowances.
Do the regulator’s rules on remuneration have extraterritorial effect?
Yes, the Guideline will have extraterritorial effect to the extent that it is applicable to overseas branches and subsidiaries of locally-incorporated AIs that are subject to HKMA’s consolidated supervision. For overseas-incorporated AIs, as noted above, the Guideline only applies to officers and employees engaged in the conduct of the AI’s business and operations in Hong Kong.
Do you anticipate further reform in this area?
We anticipate that the Guideline will become effective within the first half of 2015. Except for the formal issue of this Guideline, we are unaware of any further reform on the remuneration practices of AIs.
Must an institution’s remuneration policy be disclosed to the regulator?
An AI’s remuneration policy and information on the AI’s monitoring and review of the operation of the remuneration policy should be provided to the HKMA upon request.
Further, an AI should make certain disclosures on remuneration at least annually and, as far as possible, on one site or in one document for ease of reference (for example, in a remuneration report or in a section of its annual report). The qualitative and quantitative information that should be included in the disclosure is set out in the annexes to the Guideline. Additional disclosure should also be made if it is deemed appropriate in the circumstances.