19 June 2020

The European Banking Authority (EBA) has published its final draft Regulatory Technical Standards (RTS) on the criteria to identify those members of staff that have a material impact on the risk profile of a firm regulated under the revised Capital Requirements Directive (CRD). The draft RTS has now been submitted for adoption by the European Commission.  

Key points 

• The RTS are intended to define and harmonise the criteria for the identification of material risk takers under the revised CRD across the EU, and establish a range of qualitative and quantitative criteria that firms must consider during the identification process, alongside the identification criteria set out in the revised CRD and any additional internal criteria established by a CRD firm.
   
• The RTS will supersede the previous Commission Delegated Regulation (EU) No 604/2014 which established the qualitative and quantitative criteria used to identify material risk takers in CRD firms. The qualitative criteria from the previous regulation have been largely retained in the RTS with a few amendments.
   
• The draft RTS underwent a consultation process at the end of last year and a number of changes have been made in response to the feedback received. 
   
• In particular, numerous changes have been made to increase the clarity of the RTS in response to the feedback received. For example, the definition of ‘managerial responsibility’, which was perceived to have initially been drafted too wide, has been revised to take into account the fact that institutions of different sizes have different layers of hierarchical levels. The EBA also clarified how the identification criteria should be applied on a consolidated, sub-consolidated and individual basis, clarifying that the quantitative criteria set out in the draft RTS should be applied to institutions only on an individual level, so that subsidiaries that are subject to specific remuneration requirements can follow those. 
   
• A few changes have also been made in response to the feedback received to ensure that the RTS are proportionate. For example, the quantitative identification criterion that applies to the 0.3% of staff with the highest remuneration has been amended to only apply to institutions that have more than 1,000 staff members in order to reduce the burden for small institutions. 
   
• The next step is for the European Commission to adopt the RTS. It is unclear when the new RTS will start to apply and, in the consultation feedback, the EBA noted that the final date of application depends on the timing of the adoption procedure but recognises that there is a general desire for the new RTS to apply, at the earliest, to the performance year 2021 for the identification of 2021 identified staff onwards. 

Tapestry comment: 
It is positive to see that the EBA has accommodated a number of the points raised during the feedback process, with the final draft RTS applying a more proportionate approach and dealing with a number of points that previously lacked clarity. Although the EBA did not accommodate all of the feedback raised during the consultation process, the generally positive response demonstrates the importance of impacted firms reviewing and responding to these consultation processes to mitigate the risk of practical issues arising in the future. 

As reported here, the EBA has started a similar consultation process on the identification of material risk takers for investment firms that will be regulated under the new Investment Firms Directive, as well as a consultation process on variable remuneration instruments. If you would like to discuss these with us, please do let us know. 

The application date for the draft RTS is currently unknown but it is likely that the identification criteria will apply from the performance year 2021 onwards. CRD firms should review the RTS in detail and model the impact that this may have on the material risk taker population and identify those staff members who were not previously caught by the scope of the more onerous remuneration requirements but who will now be caught. Firms should also consider how the RTS will impact the drafting of the identification criteria set out within the firm's remuneration policy, given the requirement to set out objective criteria to determine whether the professional activities of staff or categories of staff have a significant impact on a material business unit’s risk profile.

If we can support you with your remuneration arrangements, please do let us know.

Matthew Hunter

5 June 2020

Following our recent alert in relation to the implementation of the EU Investment Firms Directive (IFD) and Investment Firms Regulation (IFR), the European Banking Authority (EBA) has now published the first public consultation papers which cover prudential, reporting, disclosures and (of huge interest to us) remuneration requirements.

There are four consultation papers covering these topics:

1. Remuneration requirements: there are two papers on remuneration. One covers the criteria to identify which staff are considered material risk takers. The second covers the classes of instruments that adequately reflect the credit quality of the investment firm as a going concern and possible alternative arrangements that are appropriate to be used for the purposes of variable remuneration of risk takers.
    
2. Prudential requirements: this paper covers the reclassification of certain investment firms to credit institutions, capital requirements for solo level, and the scope and methods of prudential consolidation for group level.
    
3. Reporting requirements and disclosures: which includes drafts on the levels of capital, concentration risk, liquidity, the level of activities as well as disclosure of own funds and the information that investment firms have to provide in order to enable the monitoring of the thresholds that determine whether an investment firm has to apply for authorisation as a credit institution.

The consultation is open until 4 September 2020 and the papers can be found here. There will also be public conference calls on 30 June 2020.

Tapestry Comment:
As previously reported, IFD and IFR will have a profound impact on some firms' remuneration structures. 

This is the first step on the journey to the implementation of IFD and IFR. These consultations provide an opportunity to shape the detail that is due to be announced in the Regulatory Technical Standards in October 2020. 

Although it is likely that firms will not be required to apply the remuneration rules until the performance year beginning after June 2021, and this may be impacted by Brexit, firms need to be prepared. Firms should not miss the opportunity to review and comment on the draft provisions contained in these consultations.         

We expect to have a roundtable to discuss some of the points in the draft consultations.

Carla

4 June 2020

On 2 June 2020, the European Banking Authority (EBA) published a roadmap relating to the EBA’s mandates under the EU Investment Firms Directive (IFD) and Investment Firms Regulation (IFR). The roadmap includes detail on the EBA’s policy, strategy and expected timeline for deliverables under the EBA's remuneration-related mandates.

1. Background
   
   The IFD and IFR were formally published on 5 December 2019 and establish a new prudential framework for EU investment firms previously caught by the Capital Requirements Directive IV (CRD) and the Capital Requirements Regulation. The new framework contains specific remuneration requirements, which we outlined in a previous alert.
   
   The IFD and IFR mandate the EBA, as the appropriate EU supervisory authority, to assist with the implementation of the new framework by producing additional legislation or guidance to help firms and local regulators around the EU to understand and apply the requirements. The roadmap sets out the key policy, strategy and expected timelines.
    
2. Key remuneration points from the roadmap

The key objectives of the EBA’s strategy in the area of remuneration are to ensure there is a comprehensive framework for investment firms within the EU, taking into account their specificities and the application of proportionality, and to ensure, when possible, there is cross-sectoral consistency between the remuneration framework under the IFD and the CRD, taking into account the remuneration requirements under the Alternative Investment Fund Managers Directive and the Undertakings for Collective Investment in Transferable Securities Directive.

On 2 June 2020, the European Banking Authority (EBA) published a roadmap relating to the EBA’s mandates under the EU Investment Firms Directive (IFD) and Investment Firms Regulation (IFR). The roadmap includes detail on the EBA’s policy, strategy and expected timeline for deliverables under the EBA's remuneration-related mandates.

1. Background
   
   The IFD and IFR were formally published on 5 December 2019 and establish a new prudential framework for EU investment firms previously caught by the Capital Requirements Directive IV (CRD) and the Capital Requirements Regulation. The new framework contains specific remuneration requirements, which we outlined in a previous alert.
   
   The IFD and IFR mandate the EBA, as the appropriate EU supervisory authority, to assist with the implementation of the new framework by producing additional legislation or guidance to help firms and local regulators around the EU to understand and apply the requirements. The roadmap sets out the key policy, strategy and expected timelines.
    
2. Key remuneration points from the roadmap

• The key objectives of the EBA’s strategy in the area of remuneration are to ensure there is a comprehensive framework for investment firms within the EU, taking into account their specificities and the application of proportionality, and to ensure, when possible, there is cross-sectoral consistency between the remuneration framework under the IFD and the CRD, taking into account the remuneration requirements under the Alternative Investment Fund Managers Directive and the Undertakings for Collective Investment in Transferable Securities Directive.
• The estimated timelines for the remuneration deliverables are as follows:

Tapestry Comment:
Firms are only required to apply the core remuneration requirements from 26 June 2021 and will likely only be required to apply the rules to remuneration payable in relation to the first performance year beginning on or after this date or a later date. Given this, and the competing priority of reacting to Covid-19, there may be a feeling within some firms that there is a lot of time available to consider the impact that the IFD and IFR may have on the firm’s remuneration structures. 

For some firms, however, the IFD and IFR will have a profound impact on the firm’s remuneration structures (the key changes are outlined in our previous alert, linked above). Investment firms should prioritise focussing on the IFD and IFR changes now to understand how their remuneration structures may be impacted and what steps will need to be taken to deal with that impact, and also how any changes would be communicated to the firm’s workforce. If we can help you with this process, please do let us know. It is, however, worth noting that the impact of the IFD and IFR on UK investment firms will depend on the outcome of the ongoing EU-UK Brexit discussions and the approach that the UK decides to take in relation to the IFD and IFR. In the meantime, it is advisable that firms be prepared to apply the IFD and IFR in full.

With regard to the roadmap and the remuneration mandates outlined above, the publication of indicative timings for the deliverables is useful but it is worth noting that the EBA has not yet published any useful detail on content and each of the individual mandates will be subject to public consultations, the timing of which is currently unclear. We will issue further alerts once the content and timing of the consultation processes becomes clearer, or if we become aware of the proposed timelines being pushed back in any way. 

If you would like to discuss the possible impact of the IFD / IFR on your firm’s remuneration structures, or anything else, please do contact us.

Matthew

13 May 2020

The Financial Stability Board (FSB) has published its key takeaways from their November 2019 workshop on the implementation of compensation reforms. The workshop was attended by internationally active banks, insurance and asset management firms, trade associations and academia, and forms part of the FSB’s work in monitoring the implementation of the FSB’s Principles for Sound Compensation Practices and Implementation Standards (Principles and Standards).
 
Key takeaways
 
1. Effectiveness of compensation policies:

• Firms are embedding the Principles and Standards into their cultures but are generally at an early stage of developing frameworks to assess the effectiveness of compensation policies and practices.
• Effective communication with employees is an important factor in driving behavioural and cultural change.

2. Risk alignment:

• Effective risk alignment is at the heart of regulatory efforts to reform compensation. All participating firms take steps to align compensation with risk but, given banking compensation was regulated earlier, banks are often more advanced on this work than other firms.
• Non-financial performance metrics are increasingly important in compensation arrangements but there are difficulties with choosing appropriate non-financial metrics, including challenges associated with measuring the outcome of ESG metrics.
• Positive compensation adjustments can be a powerful mechanism for promoting and incentivising positive behaviour.

3. Using data in compensation practices:

• Systems for gathering and analysing compensation data within firms has improved, increasing the ability of line managers to make effective decisions and accountability for, and objectivity of, compensation-related decision-making.
• New tools allow for more effective analysis of compensation data, including real-time analysis during compensation rounds, helping to deliver more effective compensation decisions, but these tools can be complicated and costly.
• Some firms are assessing how they can use data to identify correlations that may allow a more forward-looking approach.
• Firms are trying to find ways to present detailed information to senior management and boards in a manner which is concise and useful for decision-making.
• In banks, there appears to be a correlation between directors holding (and not frequently selling) shares and bank profitability. To align directors’ remuneration with a firm’s long-term interests, academic work suggests that restrictions on equity for a longer period than their tenure should be considered.

4. Compensation governance:

• Control functions play a central role in compensation processes.
• Again, given banking compensation was regulated earlier, banks are more advanced than other firms in embedding compensation decisions in governance processes, but most firms reported a greater focus on embedding compensation decisions in governance processes at board level and the increased importance of firms’ compensation policies and practices, in particular for non-executive directors.
• Firms referenced the importance of balancing consistent processes and governance with the ability to apply discretion on compensation decisions within a clear framework.
• Despite greater harmonisation of compensation regimes in recent years, key differences (e.g. deferral, bonus cap, disclosure regimes) continue to present difficulties when designing and implementing consistent compensation policies across international groups.

5. Compensation tools (e.g. in-year adjustment; malus; clawback):

• The use of malus and clawback is limited because of complexity and, in some jurisdictions, legal challenges. Clawback use is extremely limited, including due to perceived legal risks. In-year adjustment is the compensation tool used most frequently.
• Where malus or clawback is applied to an individual, this will likely have a significant negative impact on the individual’s career progression and may make it less likely that they will be hired by another firm. Therefore, to ensure decisions are fair and employees have appropriate opportunities to make representations, the process involves considerable governance, which can take time and be resource-intensive.
• Some firms noted the extent to which severance payments have become a focus since they may not provide effective risk alignment.
• The time typically taken to identify events where operational risks have crystallised (e.g. misconduct) may be a factor that needs to be considered when determining the length of deferral periods.

6. Competition for talent:

• Firms face hiring challenges for three reasons: (i) they increasingly need to hire from other sectors where compensation structures are different; (ii) the extent to which financial services firms are no longer considered employers of choice; and (iii) the extent to which factors other than compensation now influence the decisions of prospective employees, such as ESG and a firm’s purpose and culture.

Tapestry comment
The FSB compensation workshops are a useful way for firms to input into the FSB’s ongoing compensation monitoring and the takeaways can be a useful barometer for compensation-related challenges that firms are experiencing. The discussion on compensation tools and the reluctance of firms to use malus and clawback, for instance, shows that the participating firms focus on making in-year adjustments and do not fully utilise all of the compensation tools at their disposal due to perceived practical or legal difficulties.
 
Firms will be familiar with many of the points noted above and most of the takeaways will not cause concern. Other than the possible general reluctance to use malus and clawback, the key point of interest will be the suggestion from academia that restrictions on equity for directors should apply for a longer period than their tenure to further align director remuneration with the firm’s long-term interests. Although the Principles and Standards contain deferral and retention provisions, they do not currently provide for an explicit post-termination shareholding requirement, although UK listed financial services firms will be familiar with the recent focus on such requirements in the UK corporate governance code and the Investment Association’s Principles of Remuneration.
 
It is yet to be seen how, if at all, the FSB will respond to these takeaways for example, whether they decide to take steps to encourage national legislators to remove legal obstacles to malus and clawback, implement provisions that directors hold stock for a period longer than their tenure, or provide further clarity on appropriate non-financial performance measures to address the difficulties identified. Firms should keep an eye out for developments from the FSB. We will issue an alert if any such developments are announced. 
 
If you have any questions about this alert, or if you would like to discuss your remuneration structures, please do contact us.

Matthew Hunter

14 April 2020

The European Banking Authority (EBA) has published the first phase of its reporting framework 2.10 - a set of amendments to the current EBA supervisory reporting requirements framework. The EBA uses this framework for remuneration benchmarking, based on information collected in previous years, and separately produces a high earners report.

Remuneration

The EBA is updating the format and methodology the EBA uses to gather information for benchmarking and reports in regard to remuneration. For remuneration, the format will now reflect the integration of the remuneration benchmarking templates and the EBA Guidelines on the data collection exercise regarding high earners into the data point management (DPM) and eXtensible Business Reporting Language (XBRL) taxonomies.

This is what they have said about the technical formatting:  The DPM is a structured representation of collected data (such as business concepts and validation rules) containing all the relevant technical specifications necessary for developing an IT reporting solution. The XBRL Taxonomy presents the date described by the DPM in the technical format of an XBRL taxonomy (a standards-based way to communicate and exchange business information between business systems).

Other changes

This comes as part of a wider package including the integration of the EBA Guidelines on fraud reporting, new specific reporting requirements on market risk, technical amendments on the Resolution framework and changes to the Implementing Technical Standards on Supervisory Benchmarking of internal models.

Tapestry comment
The changes in the format in how the data will be collected should not change what data is being collected. These changes are being phased, with the earliest applying from late December this year and the latest from late March 2021, and they are primarily intended for use in data transmission between competent authorities and the EBA, keeping on top of these updates is key as authorities may choose to use the proposed XBRL taxonomy or a similar one for collecting data from credit institutions and investment firms. This may mean that the way in which credit institutions and investment firms report information for remuneration benchmarking and the high earners report may change to include DPM and XBRR taxonomies.

If you have any questions about this update or in relation to your remuneration regulation compliance generally, please do contact us.

Janet Cooper OBE

14 April 2020

The EU Insurance and Occupational Pensions Authority (EIOPA) has published an opinion which seeks to enhance supervisory convergence on the supervision of the remuneration principles in the insurance and reinsurance sector, as set out under the Solvency II Delegated Regulation ((EU) 2015/35). The opinion follows a 2019 consultation and the feedback statement from that consultation has also been published.

Application

• The opinion is addressed to national supervisory authorities, that is, national regulators. EIOPA will begin monitoring the application of the opinion by regulators from early 2022.
• The opinion focusses on a reduced scope of staff, identified as potential higher profile risk-takers, who fall within defined categories (as set out at 3.1 of the opinion, including material risk takers and executive directors), and whose annual variable remuneration exceeds EUR50,000 and represents more than 1/3 of total annual remuneration.
• Regulators may apply the opinion to staff not covered by the opinion but may instead adopt a proportionate and more flexible risk-based approach for those staff members.
• Regulators may also adopt a proportionate and more flexible approach when supervising remuneration in ‘low risk’ firms, including the design of remuneration policy.
• When supervising global systemically important firms, regulators should also take into account the FSB Principles and Standards for Sound Compensation Practices.

Key points

The guidance relates directly to the principles set out in Solvency II Delegated Regulation ((EU) 2015/35):

• Balance of fixed and variable components of remuneration. Where a variable to fixed remuneration ratio exceeds 1:1, regulators should engage with the firm to investigate whether the remuneration policy is balanced with regard to the proportion of variable remuneration. Regulators should pay specific attention to very low fixed remuneration.
• Deferral of a substantial portion of variable remuneration. 40% of variable remuneration is considered to be ‘substantial’ and regulators should engage with firms where deferral is lower than 40%. A larger deferred portion is recommended for particularly high variable remuneration, e.g. if the variable to fixed remuneration ratio is higher than 1:1.
• Assessment of performance. Where variable remuneration is performance related, the total amount of variable remuneration has to be based on a combination of the assessment of individual, business unit and overall firm or group performance, and should be set in a multi-year framework.
• Performance criteria. Both financial (quantitative) and non-financial (qualitative) criteria should be used, with non-financial criteria particularly important for key function holders, and the firm needs to be able to describe the consequences on the pay-out of variable remuneration where criteria are not met. Financial and non-financial criteria need to be appropriately balanced, e.g. 80% financial and 20% non-financial is unlikely to be appropriately balanced. Performance criteria should be linked to decisions of the relevant staff member and ensure the remuneration award process has an appropriate impact on individual behaviour.
• Performance measurement must include downward adjustments for exposure to current and future risks. Regulators should consider downward adjustment to include malus, clawback and in-year adjustments, and should require firms to provide a clear description of any downward adjustments. Downward adjustments should not just be used where staff members do not meet personal objectives but also when business units and/or the firm as a whole fail to do so. If a firm is likely to breach, or has breached, the Solvency Capital Requirements, downward adjustments should be applied.
• Termination payments must reflect performance and not reward failure. Regulators should assess a firm’s approach to termination payments and the termination payment policy, which should contain the maximum payment or the criteria for determining the amount of the payment. The opinion clarifies which termination payments are generally taken into account as variable remuneration and those which are not generally taken into account as variable remuneration.

Tapestry comment
The Solvency II Delegated Regulation ((EU) 2015/35) sets out high-level remuneration principles for firms in the insurance and reinsurance sector. The high-level nature of these principles has led to divergent practices across the EU with different national regulators and firms applying the principles inconsistently. The opinion seeks to create supervisory convergence to ensure that there is a ‘level playing field’ where the remuneration principles are applied consistently throughout the EU.

For many firms, the added clarity will be helpful. EIOPA states in the opinion that they do not seek to add requirements or to create administrative burden. In practice, those firms that already comply with other (more stringent) remuneration rules, such as under CRD IV, the UCITS V Directive or AIFMD, will already be familiar with many of the points set out in the opinion and so should not be materially impacted. That said, all firms should read the opinion in detail to ensure that current practice aligns with the expectations set out in the opinion. Although EIOPA will only looked to monitor how regulators are applying the opinion from 2022, we anticipate that national regulators will expect firms to comply with the opinion as soon as is practicable.

If you have any questions about this update, or in relation to your remuneration regulation compliance generally, please do contact us.

Matthew Hunter