|On 23 November 2016, the European Commission issued a proposal for review of the CRD IV in which rules concerning remuneration of credit institutions and investment firms have been modified. While only a small part of the general proposed changes, the suggested changes to the application of remuneration provisions are in line with the findings and recommendations that the iff 2015 Study had made when looking at the remuneration provisions of the CRD IV and the CRR (See iff news July 2016).
As part of the iff Study, the issue of proportionality was investigated with the following findings as of end 2015:
- There are unintended consequences for effectiveness of a one-size-fits-all approach to banking and financial regulation
- The degree of regulation should be related to how much an institution contributes to systemic risks (size, internal organisation, scope, and business complexity - Art. 92 (2) CRD IV)
- Small institutions with simple operations do not offer large variable pay and thus face disproportionate costs of full compliance
- Business models of investment firms is different to those of banks and would require further special attention and investigation
- Diversity of systems due to country specific variation (by size, significance, risk, variable pay, business type, identification procedures) suggests a need for better harmonisation and one should use the common basis for all the exemptions to turn them into criteria that provide sufficient legal certainty and effectiveness
- Small non-complex institutions should be treated differently by the law e.g. an exemption from the rules based on levels of variable remuneration or of assets
- Groups and asset management: Compliance by bank groups suggests parent company application may be sufficient (single shareholder meeting for maximum ratio) but treatment of asset management companies requires proper assessment on the basis of greater empirical evidence
A few weeks ago, the following two publications were released concerning proportionality:
- 23.11.2016: European Commission proposed changes to CRD IV/CRR
- 21/11/2016: EBA Opinion on the application of the principle of proportionality to the remuneration provisions (following 21/12/2015 Opinion)
The latest proposed changes from the European Commission from 23.11.2016 concerning remuneration rules relate to proportionlity and aims to harmonise the approach with new prescriptive requirements on how to apply the rules in practice (making member states no longer free to have their own frameworks for determining application). Disapplication is thus allowed for the requirements on deferral (variable remuneration at risk of 40-60% over 3-5 years) and payout in non-cash instruments (50%), when the following 3 thresholds are respected (restricting the extent of disapplication):
- Firm level: Total average assets (over 4 years) less than €5bn, and
- Individual (material risk taker) level: Variable remuneration of less than €50,000 AND less than 25% of total remuneration
Note: The Bonus cap (maximum ratio variable to fixed) and malus/clawback rules are not subject to disapplication. Member States are free to enact stricter thresholds if they choose
Additional changes also include: 1) Listed organsiations can use phantom shares (instead of real shares); 2) Disclosure of how firms have used proportionality;
Not yet resolved: There are no additional provisions for asset managers. However, the EBA and Commission are still undertaking a broader review of prudential regime for investment firms. Systemic and bank-like investment firms will probably continue to be treated the same as banks, but treatment of other investment firms can be seen as still uncertain – EBA is seeking views on remuneration rules focused around consumer outcomes.
Links to the relevant webpages:
DG JUST: Corporate Governance: http://ec.europa.eu/justice/civil/company-law/corporate-governance/index_en.htm
DG FISMA: http://ec.europa.eu/finance/bank/regcapital/crr-crd-review/index_en.htm
Reform of the CRD IV/CRR (23.11.2016)
Text of the amending Directive
Text of the amending Regulation
Text of the annex to the amending Regulation
Extracts from the FAQ: Capital requirements (CRR/CRD IV) and resolution framework (BRRD/SRM) amendments, 23.11.2016 here
What are you doing to ensure that the EU prudential rules are fit for purpose?
At the EU level, the Commission has already carried out various initiatives to assess whether the existing prudential framework and the upcoming reviews of global standards were the most adequate instruments to ensure that EU institutions would continue to provide the necessary funding to the economy. First, in the course of 2015 the Commission launched a public consultation on the impact of the CRR and the CRD IV on the financing of the EU economy (with a particular focus on the financing of micro, small and medium-sized enterprises (SMEs) and of infrastructure) and a Call for Evidence (CfE) covering all legislative proposals made after the crisis in the area of financial services. In addition, the Commission carried out specific analysis on rules relating to remuneration and on the proportionality of the rules contained in the CRD IV package. All the initiatives mentioned above have provided clear evidence of the need to update and complete the current rules in order to: Reduce further the risks in the banking sector and thereby reduce the reliance on State aid and taxpayers' money in case of a crisis, and Enhance the ability of institutions to channel adequate funding to the economy.
What changes are made to the rules regarding remuneration?
The recent review of the remuneration rules carried out by the Commission showed that the existing rules are generally effective in curbing excessive risk-taking behaviour and short-termism. The review however also showed that the rules should be made more proportionate on the following two points: Firstly, some of the rules, namely the requirements to pay out part of the variable remuneration in instruments and to defer the payment over time, are not workable for the smallest and least complex institutions and for staff with low variable remuneration (as opposed to fixed remuneration). Also, the definition of proportionality reflected in Article 92(2) of the CRD has been interpreted in different ways, leading to an uneven implementation of the rules in the Member States. The Commission therefore proposes a targeted amendment to cater for problems that emerged in the application of the rules on deferral and pay-out in instruments. This amendment consists in exempting small and non-complex institutions and staff receiving low variable remuneration from these rules. The amendment is expected to harmonise the implementation of the rules in the Member States, while leaving competent authorities some flexibility to adopt a stricter approach if deemed necessary. Secondly, the review showed that there are impediments for listed institutions to repeatedly use shares for the purpose of paying out variable remuneration as required under the current rules. Share-linked instruments (often referred to as “phantom shares”) were found to be as effective as shares in terms of aligning the interest of staff members with those of shareholders and with the long term interest of the institution, provided that they closely track the value of shares. The Commission therefore proposes another targeted amendment to the remuneration rules, aimed at allowing listed institutions to use share-linked instruments for meeting the CRD requirements.
Recent EBA Opinions on proportionality:
21/11/2016: EBA Opinion on the application of the principle of proportionality to the remuneration provisions in Dir 2013 36 EU: here
21/12/2015: EBA-Op-2015-25 Opinion on the Application of Proportionality: here
Recent ESMA Guidelines on Remuneration:
14.10.2016: ESMA issues Guidelines on Remuneration Practices under UCITS and AIFMD: here
The European Securities and Markets Authority (ESMA) has published two sets of guidelines that apply from 1 January 2017: 1) The UCITS Remuneration Guidelines apply to management companies and also apply to investment companies that have not designated a management company authorised pursuant to the UCITS Directive. The purpose of the UCITS Remuneration Guidelines is to ensure common, uniform and consistent application of the provisions on remuneration under Articles 14a and 14b of the UCITS Directive; 2) The AIFMD Remuneration Guidelines amend the Guidelines on sound remuneration policies under the AIFMD and have the same scope of application. Specifically paragraph 33 is amended that deals with AIFMs being part of a group: “VIII. Guidelines for AIFMs being part of a group: 32. These guidelines apply in any case to any AIFM. In particular, there should be no exception to the application to any of the AIFMs which are subsidiaries of a credit institution of the sector-specific remuneration principles set out in the AIFMD and in the present guidelines. 33. It may be the case that in a group context, non-AIFM sectoral prudential rules applying to group entities may lead certain staff of the AIFM which is part of that group to be 'identified staff' for the purpose of those sectoral remuneration rules.”
Reminder: In March 2016 ESMA published its final report on Guidelines on sound remuneration policies under the UCITS Directive. This final report, (unlike the draft version) did not include guidance on the dis-application of certain requirements on the pay-out process. ESMA stated at the time that it did not include such guidance in its final report due to work and legal analysis that had been undertaken, which called into question "the existing understanding of the proportionality provisions" under the UCITS Directive. Accordingly, ESMA wrote to the European Commission ("Commission") suggesting that further clarity on the proportionality principle and cross-sectoral alignment was required. On 14 October 2016, ESMA published the finalised Guidelines on sound remuneration policies under the UCITS Directive ("Guidelines"), which are unchanged from those published in the final report in March 2016. The letter written by ESMA to the Commission has not yet resulted in a change to the Guidelines that would provide clarity as to the circumstances in which the relevant requirements on the pay-out process can be dis-applied.
ESMA Guidelines on sound remuneration policies under the AIFMD: here
ESMA Guidelines on sound remuneration policies under the UCITS Directive: here
Letter from ESMA to the Commission, March 2016, ESMA/2016/412, Ref: Proportionality principle and remuneration rules in the financial sector: here
Information about the EU legislative process
As a reminder the three primary institutions involved in the legislative process on financial regulation, are the European Commission (who makes legislative proposals), the Council of the European Union and the European Parliament (who both consider proposals and adopt legislation). Each of these have their own committees and working groups. In addition to the 28 Member States varying perspectives, the three European supervisory authorities also play a significant role (EBA, ESMA, EIOPA). At the Commission, the directorate responsible for policy in the area of banking and finance is the Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA – with circa 380 staff and currently headed by Vice-President Dombrovskis).
While the 2015 iff Study on remuneration provisions was conducted on behalf of the Directorate for Justice and Consumers (DG JUST) within the Unit in charge of Corporate Governance, the review of the CRD IV/CRR is being initiated and implemented by DG FISMA which has set up the Expert Group on Banking, Payments and Insurance, as a consultative entity, comprised of experts appointed by the Member States, provides advice to the Commission in the preparation of draft delegated acts. The issue of Proportionality was discussed by the group. The latest proposal is also based on consultations and a Study on the effects of the CRD IV.
Since 2002, financial services legislation in the EU has followed a four-level legislative procedure referred to as the Lamfalussy approach:
- Level 1. Legislation proposed by the Commission is adopted under ordinary legislative procedure (a directive or a regulation)
- Level 2. Individual articles in the Level 1 legislative act specify where the Commission has been delegated to adopt Level 2 measures (delegated acts, implementing acts or technical standards – these standards are prepared by the relevant ESAs and the Commission decides whether or not to endorse them).
- Level 3. Guidance to facilitate convergence of regulatory practice (ESAs advise the Commission in preparing Level 2 measures and may also adopt ‘comply or explain’ guidelines).
- Level 4. Supervision and enforcement.