The long wait is finally over: in December 2015 the European Banking Authority (EBA) published its final revised "Guidelines on Sound Remuneration Policies" (Guidelines) and an opinion (Opinion) on the application of proportionality (following the consultation which closed in June 2015).
The Guidelines are intended to achieve a higher level of harmonisation of remuneration requirements across Member States. Below, we consider the impact of the Guidelines, assuming that they are introduced in their current form by the UK regulators.
Who will the Guidelines apply to?
The Guidelines apply to all entities subject to the remuneration provisions contained in the CRD IV Directive 2013/36/EU (CRD IV). Firms regulated under BIPRU (CRD III), AIFMD and/or the UCITS V Remuneration Codes, where the firm is not also IFPRU, will not be caught unless they are in the same consolidated group as a CRD IV firm.
When do the Guidelines come into effect?
1 January 2017, with the rules first applying to remuneration awarded for the performance year 2017.
The FCA has confirmed that affected firms do not need to change their existing pay practices for the 2016 performance year and it is expected the PRA will take the same view.
As the Guidelines will be adopted by Member States on a "comply or explain" basis, the PRA and FCA are expected to consult on any necessary changes to their Rules and Guidance where they want to comply. Where they do not wish to comply, they must explain why. The PRA and FCA have to state their intention within two months from the date of publication of the translation of the Guidelines in all EU languages, which has not yet happened.
What do firms need to know?
(a) Proportionality / "neutralisation"
All CRD IV firms will have to apply each of the remuneration provisions in CRD IV. The most significant impact of this for smaller firms is that the bonus cap - the ratio of fixed to variable pay – will apply from 1 January 2017 to ALL CRD IV firms, including, those Level 3 entities that did not previously need to apply it on grounds of proportionality.
The EBA has restated its view that CRD IV, in its current form, does not actually permit smaller and less complex firms to effectively "neutralise" certain of the CRD IV remuneration provisions on the grounds of proportionality (but acknowledges that, in practice, this happens in nearly all Member States).
The Opinion sets out the EBA's proposal to amend CRD IV to exclude certain small, non-complex firms and to exempt employees who have low amounts of variable remuneration (including within large firms) from the requirements relating to deferral (malus) and payment in instruments for variable remuneration. However, the bonus cap will not be capable of being "neutralised".
The legislative process to amend CRD IV will need to be completed by 1 January 2017 in order for the proportionality principle to be in place when the Guidelines come into effect.
(b) Fixed and variable remuneration
All remuneration will need to be categorised as either fixed or variable.
Strict new criteria will determine whether remuneration is fixed or variable:
- Remuneration will be fixed if it is predetermined, non-discretionary, permanent, non-revocable, cannot be reduced or suspended, is transparent, does not provide an incentive for risk assumption and does not depend on performance.
- Any remuneration which does not satisfy any of the conditions for fixed pay will, by default, be variable.
- In addition, anti-avoidance provisions are to be introduced so that firms will not be able to circumvent the criteria for fixed pay.
Role-based allowances have been widely used in the UK to increase fixed pay. Under the Guidelines, allowances may only be included as part of the fixed pay calculation of the bonus cap if they meet the criteria for fixed pay. Where it is not clear that role-based allowances are fixed pay, they will be considered to be variable.
LTIP awards are counted as variable pay when calculating the bonus cap. The Guidelines contain detailed rules in relation to the year LTIP awards are taken into account to determine the bonus cap and the value of the awards for that purpose.
Retention awards, buy out awards and severance awards will all be regarded as variable remuneration for the purposes of the bonus cap. However, guaranteed variable remuneration, such as a sign on bonus, does not have to be taken into account when determining the cap where the guarantee is provided when the new employee joins.
(c) Deferral periods
Firms are expected to impose deferral periods on variable remuneration to align with a firm's risk profile in the long-term and to ensure that appropriate adjustments can be made for risk outcomes. The minimum deferral period is 3-5 years with deferral of at least 5 years for members of a firm's management function and its senior management.
(d) Retention periods
Any deferred variable remuneration paid in instruments to identified staff who are members of a firm's management body and senior management (where the deferral period is at least five years) must be retained for one year. For identified staff who do not have management roles, the retention period is six months.
(e) Use of share-linked instruments
The EBA proposes amending CRD IV to allow listed companies to use share-linked instruments (eg phantom awards or share appreciation rights) instead of shares, provided these instruments track the value of the shares.
(f) Groups - Remuneration policies
Even if a firm itself is not subject to CRD IV, where it is part of a CRD IV group, the group-wide remuneration policy will apply and the firm itself must have a remuneration policy which is consistent with the group wide one. Where firms are subject to more than one remuneration code, this can often raise problematic issues as to which code has priority. For further details, please refer to our alert – "The remuneration of UK fund managers: regulatory developments to look for over the next few months".
Where an institution has a subsidiary in a third country which is within the scope of prudential consolidation and subject to CRD IV (for example, the UK branch of an overseas bank), shareholder approval for any increase in the ratio of fixed to variable pay up to 1:2 must be obtained from shareholders of the ultimate parent institution.
Other consultations and reviews
The European Commission's consultation on the impact of the bonus cap and the overall efficiency of the CRD IV remuneration rules closed on 14 January 2016.
The PRA last month issued a consultation on buy-outs of variable remuneration which closes on 13 April 2016. For further details please refer to our alert - "PRA consults on buy-outs of variable remuneration".
The European Commission is due to submit a report following its wide-ranging review of the remuneration provisions of CRD IV to the European Parliament and Council by the end of June 2016.
All CRD IV firms need to review their remuneration arrangements during 2016 to ensure they can comply with the Guidelines for the 2017 performance year.
In particular, firms should scrutinise any role-based allowances to determine whether they satisfy the criteria for fixed remuneration, and, if they don't, their terms will need to be modified if they are not to be included as part of variable remuneration.
Those Level 3 firms who do not currently apply the bonus cap will face the biggest challenge. Smaller banks, investment firms and asset managers which are part of a CRD IV consolidation group will find themselves having to apply the bonus cap to senior staff for the first time. As seen with those firms already subject to the bonus cap, the most likely outcome will be an increase in salaries, particularly, with the more prescriptive criteria applying to role-based allowances. Level 3 firms will, no doubt, also be concerned that CRD IV is amended in time for 1 January 2017 to exclude certain small, non-complex firms and to exempt employees who have low amounts of variable remuneration (including within large firms) from the requirements relating to deferral (malus) and payment in instruments for variable remuneration (as proposed by the EBA).
We will keep you informed of progress and developments on the UK's adoption of the Guidelines as well as any wider issues affecting remuneration arrangements coming out of the European Commission's report later this year.