The EU Insurance and Occupational Pensions Authority (EIOPA), the European Supervisory Authority responsible for the regulation of the EU insurance sector, has published a consultation paper on its draft opinion (Opinion) on the supervision of remuneration in the insurance and reinsurance sector. The consultation ends on 30 September 2019. 

Background
The remuneration rules that apply to insurance and reinsurance firms are found in the Solvency II Delegated Regulation (EU) 2015/35 (Solvency II). Solvency II establishes a range of remuneration requirements that are typically less detailed, and are subject to less detailed guidance, than the remuneration rules impacting other types of financial services firms. The impact of this is that Solvency II firms and supervisory authorities have 'considerable discretion' as to how the remuneration requirements are applied. 

EIOPA has identified that this discretion has led to divergent practices across Europe. The Opinion aims to enhance convergence in the supervision of the remuneration policies of EU insurance and reinsurance firms. The Opinion is targeted at supervisory authorities and gives guidance to them on how to challenge the application of the remuneration requirements by firms. EIOPA has, however, stated that it is not their intention to add requirements or to create administrative burden. 

Scope
The Opinion applies to remuneration for staff in the categories listed below, whose annual variable remuneration exceeds EUR 50,000 and represents more than 1/4 of their total annual remuneration: 

• members of the administrative, management and . 
• supervisory body; 
• other executives who effectively run the firm; 
• key governance holders as defined in EIOPA's Guidelines on the system of governance; and 
• categories of staff whose professional activities have a material impact on the firm's risk profile. 

EIOPA has, however, stated that for staff not covered by the Opinion, supervisory authorities may adopt a proportionate and more flexible approach, including applying the Opinion to staff outside of the scope identified above but in a more flexible manner.

Key points

• Balance between fixed and variable remuneration: the proportions of fixed and variable remuneration must be such that employees do not become overly dependent on variable components and, if a firm exceeds the 1:1 ratio, the supervisory authority should investigate whether the remuneration policy is properly balanced. Supervisory authorities should also pay specific attention to very low fixed remuneration.
• Deferral of variable remuneration: firms should use different deferral periods depending upon the risks entered into, as opposed to only applying the 3 year minimum. Supervisory authorities should use their judgement to consider whether a deferral rate higher than 40% and/or a longer deferral period is needed. When deferral is lower than 40% supervisory authorities should engage with the firm to understand the specific situation. The deferral rate is recommended to be higher than 40% in the case of a particularly high variable remuneration e.g. a ratio higher than 1:1. 
• Financial and non-financial criteria: supervisory authorities should ensure that firms, when assessing an individual's performance ex ante, set out financial (quantitative) and non-financial (qualitative) criteria and describe the consequences on the pay-out of variable remuneration when the criteria are not met by the individual. The criteria used should be linked to decisions made by the individual and should ensure the remuneration award process has an appropriate impact on the individual's behaviour. When assessing performance in a multi-year framework, the following should be taken into account: (a) financial criteria covering a period long enough to capture the risk taken by staff; and (b) non-financial criteria contributing to creation of value for the firm, e.g. compliance, client service, achievement of strategic goals, staff turnover and reputation. The financial and non-financial criteria should be appropriately balanced and supervisory authorities should challenge where appropriate. 
• Downward adjustments: variable remuneration should not only be adjusted downward when staff do not meet their personal objectives, but also when their 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 Requirement its remuneration policy should prescribe that downwards adjustment will be applied. Supervisory authorities should require a clear description of the downwards adjustment(s) from firms, including at least: (a) how short to long-term risks, cost of capital, internal capital requirements and dividends policies have been taken into account; (b) examples of how the downwards adjustment works; (c) rationale for the chosen downwards adjustment and triggers used; and (d) clarification that the downwards adjustments are designed in a way that any unvested portion of variable remuneration may be subject to malus. 
• Termination payments: remuneration policies should specify the possible use of termination payments, including maximum payment or criteria for determining the amount. The Opinion identifies payments that should qualify as termination payments. When defining the maximum level of any termination payment, the fixed/variable remuneration ratio should be taken into account.  Deferral requirements will apply to termination payments, with some exceptions as outlined in the Opinion. There is also guidance to help firms ensure that termination payments reflect performance achieved over time and are not being made to reward failure or being made in other circumstances where such payments should not be made. Supervisory authorities must ensure firms are able to demonstrate the reasons for the payments, the appropriateness of the amount and criteria, and that the payment is linked to performance achieved over time and does not reward failure. 
• Variable remuneration composition: supervisory authorities should ensure firms award 50% of variable remuneration in shares, equivalent ownership or share-linked instruments. The instruments should be subject to an appropriate retention policy.
• Reporting: supervisory authorities should collect qualitative and quantitative data to enable them to perform a supervisory review of the remuneration principles in accordance with the Opinion. 

Tapestry comment

This Opinion follows the UK PRA's recent comments on the application of Solvency II, in which the PRA identified disparities in how the Solvency II remuneration requirements have been implemented. It is notable that a few of the areas of disparity identified by the PRA, such as in relation to downward adjustments and the calculation of performance, are also addressed in the Opinion. This shows that the disparity identified by the PRA for UK firms may also be present throughout the EU generally.

As the Opinion is addressed at supervisory authorities, as opposed to firms directly, it is clear that EIOPA expects supervisory authorities to take action to deal with the divergent supervisory framework, in line with the new guidance, before taking a more direct intervention. If supervisory authorities do not effectively deal with the areas of disparity before EIOPA starts to monitor the application of the Opinion two years after publication, we may see more direct intervention. Any such intervention is unlikely to happen soon and, in the interim, supervisory authorities have time to try and bring firms into line with the expectations outlined in the Opinion.  

As the Opinion is only in a draft format, firms should review their existing policies and practices with the draft guidance in mind and consider: (a) whether to engage in the consultation process; and (b) whether, if the Opinion was to come into effect as drafted, the firm's remuneration policy would be compliant with the expectations outlined in the Opinion and, if not, either identify any required remedial action or be prepared to explain and justify any area of divergence.

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

The Australian Prudential Regulation Authority (APRA) has released a consultation on new rules aimed at clarifying and strengthening remuneration requirements in APRA-regulated entities. The consultation period will close on 23 October 2019 and APRA has indicated that it intends to release the final rules before the end of 2019 or in early 2020, with a view to the rules taking effect on 1 July 2021.

The proposed rules are materially more prescriptive than APRA’s existing remuneration requirements, which are considered to have not delivered satisfactory outcomes. This is demonstrated by the recent high-profile issues suffered by the Australian financial services sector and evidence that existing remuneration arrangements have been a factor driving poor consumer outcomes.

APRA hopes that the new rules will create a remuneration framework that better aligns with the long-term interests of firms and their stakeholders, including customers and shareholders. The proposed reforms also address recommendations from the recent Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. 
 
Key proposals: 

• To limit the focus on financial metrics and to put greater focus on non-financial risks (e.g. culture; governance), financial performance measures (e.g. revenue, profit and volume based measures; certain share-based measures) must not comprise more than 50% collectively or 25% individually of the performance criteria used to allocate variable remuneration.
• The firm must set specific criteria for the application of malus for variable remuneration, including the minimum criteria set out in the draft rules.
• For firms determined by APRA to be ‘significant financial institutions’, certain structural rules will apply, including requirements that: (a) a minimum of 60% of the total variable remuneration of the Chief Executive Officer must be deferred for at least 7 years, with no vesting before year 4 and vesting no faster than pro-rata after that; (b) a minimum of 40% of the total variable remuneration for a senior manager (other than the CEO) and for a highly-paid material risk-taker, must be deferred for at least 6 years, with no vesting before year 4 and vesting no faster than pro-rata after that; and (c) the variable remuneration of a senior manager or a highly-paid material risk taker must be subject to clawback for at least 2 years from the date of payment or vesting and, in circumstances involving a person under investigation, at least 4 years from the date of payment or vesting. Specific criteria must be set for the application of clawback, including the minimum criteria set out in the draft rules.
• Boards must approve and actively oversee remuneration policies for all employees and regularly confirm they are being applied in practice to ensure individual and collective accountability. The Board must also ensure risk outcomes are reflected in remuneration outcomes.
• The remuneration policy needs to be subject to annual compliance reviews and triennial effectiveness reviews of the remuneration framework need to take place.

APRA has indicated that it also intends to consult on a ‘practice guide’ in 2020 to support the implementation of the new rules, as well as possible additional disclosure requirements.  
 
Tapestry comment 

The approach that APRA proposes to take will bring APRA-regulated firms closer to the style of regulation that entities regulated by the European Union are subject to. It is worth noting, however, that APRA did stop short of simply matching the onerous approach taken by the EU. For example, APRA has noted that they have chosen not to include a ‘bonus cap’ or to prescribe specific types or forms of variable remuneration on the basis that they have not seen evidence of these approaches being effective in promoting better outcomes. Although these two requirements are not included in APRA’s proposals, the proposed reforms will materially impact the remuneration structure for APRA-regulated firms, particularly due to the onerous deferral, malus and clawback requirements that will be imposed on certain employees.

In case these rules are finalised, firms should consider how these changes may impact any policies and award documentation, and also how the extended deferral periods, and malus and clawback arrangements, will be implemented and communicated. As an initial step, firms should consider whether to participate in the consultation process ahead of the 23 October 2019 deadline.
 
If you have any questions in relation to this update, or on anything else, please do contact us.

The Bank of England (BoE) has published a speech by Anna Sweeney, Director, Insurance Supervision, on increasing diversity in the financial services sector, in which she expressed the importance of making impactful change on diversity across the sector as a whole, with the Prudential Regulation Authority (PRA) playing a crucial role in facilitating this. Anna emphasised the need for improved diversity, conduct and culture in the workplace, and supported and acknowledged efforts that have been made to aid such change so far.  

Key Points:

• The PRA is interested in how the quality of decision-making is impacted by “groupthink”. In light of the global financial crisis, the PRA understands that uniformity is a poor basis from which to challenge existing practices.
• PRA rules are hugely important for emphasising the need to promote diversity of skills and experience at board level. Since April 2018, the PRA has required insurers to have a policy in place that does this and considers a wide range of qualities and competencies in recruitment.
• Recent reports of sexual harassment and bullying allegations may impact the PRA’s perception of the fitness and propriety of individuals under the senior managers and certification regime (SM&CR).
• Cultural change needs to occur in firms to allow staff to express concerns where there are issues that could impact the financial soundness of the firm. Culture also acts as an indicator to the Financial Conduct Authority (FCA) as to how firms could treat customers.
• The PRA welcomes and supports initiatives by Lloyd’s of London and the training that they have provided to improve diversity, conduct and culture. Along with the FCA, the PRA will closely monitor progress and engage in talks with Lloyd’s to see demonstrable progress.

Tapestry comment

There is a growing awareness of the importance of diversity within the financial services sector and beyond. This speech by the BoE demonstrates their focus on improving diversity in the sector, as well as their support for the ways in which financial services firms are trying to achieve this. Lloyd’s of London are leading by example and we hope that they inspire other financial services companies to follow in their footsteps.

Tapestry has significant experience advising financial services firms on their remuneration compliance. If you would like to discuss your compliance with us, please do contact us.

As we reported here, the regulation of remuneration within EU-regulated banks is subject to significant change, probably the biggest change since the introduction of the bonus cap in 2014. On 7 June 2019, the Capital Requirements Directive V (CRD V) and Capital Requirements Regulation II (CRR II) were published in the Official Journal of the EU and will enter into force on 27 June 2019 (20 days following publication). 

The adopted texts can be accessed here: 

• Capital Requirements Directive V
• Capital Requirements Regulation II

Following entry into force:

• CRD V must be implemented into local law by EU member states by 28 December 2020 (and to apply those measures from 29 December 2020); and
• CRR II will apply directly (without local implementation) from 28 June 2021.

We will be hosting a webinar on 27 June 2019 to discuss the changes and how they may impact your remuneration policies and practices. If you would like to join, please use the registration button below. 

Tapestry comment

The implementation deadline for CRD V will fall into December 2020, earlier than some firms may have hoped. It may be that the application for the rules to  firms will be pushed back to the first performance year beginning on or after 1 January 2021. However, member states may choose to implement CRD V prior to the December 2020 deadline. The Investment Firms Directive and Investment Firms Regulation that will impact the regulation of investment firms (currently caught by CRD IV / CRR) has not yet been published and so there is a risk that the timing of implementation of those rules does not line up with CRD V / CRR II. 

We will update you when further clarity is available. In the interim, firms should be preparing for the implementation and application of the remuneration changes. 

Tapestry has significant experience advising financial services firms on their remuneration compliance, particularly in relation to remuneration regulations. If you would like to discuss your remuneration compliance, please do contact us.

The UK Prudential Regulation Authority (PRA) updated their Remuneration Policy Statement (RPS) template for reporting under Solvency II earlier this year. The RPS has a reporting deadline of 31 July, so firms caught should make sure to use the new template or comply with the level of detail required through alternate reporting.

Background

The Commission Delegated Regulation (EU) 2015/35 contains the remuneration rules applicable to insurance and re-insurance undertakings regulated in the EU.

On 1 January 2016 the remuneration requirements in the Delegated Regulation became directly applicable to Solvency II firms, with national authorities expected to ensure firms are compliant. In the UK, the PRA categorises firms into 5 categories depending on their impact of risk and likelihood to disrupt the interests of policyholders. The PRA's category 1 and 2 firms must be able to demonstrate compliance with the remuneration requirements. To assist firms in demonstrating compliance, the PRA designed a Remuneration Policy Statement (RPS) which has recently been updated. 

Although the template is intended to help firms meet the PRA's expectation of the level of detail required, use of the template is voluntary and firms may document how their remuneration policies comply with the Solvency II remuneration requirements in a different way. 

Updates
On 9 May 2019, the PRA published updated versions of its: 

• Remuneration Policy Statement reporting template for PRA category 1 and 2 firms for the 2018 performance year - this template sets out the details required to demonstrate compliance; and 
• Identified Staff Table (RPS Table 1) - this table sets out information on those individuals whose activities may have a material impact on the risk profile of the Solvency II firm.  

Although there are no material changes against the previous RPS template, it is important to note that the PRA has asked firms in scope to submit their RPS (or equivalent method of compliance) to the Bank of England Electronic Data Submission (BEEDS) portal as an occasional submission by 31 July 2019. 

There are also no material changes to the Identified Staff Table. However, the table now refers to the Senior Managers & Certification Regime expansion which was applicable to insurers from December 2018 and will be relevant for 2019 performance year reporting. Firms must submit their completed Solvency II Identified Staff Table alongside the RPS. 

Tapestry comment

PRA-regulated Solvency II firms in scope have been asked to submit a copy of their RPS to BEEDS by 31 July 2019. Firms should prepare this information as soon as possible to meet the deadline. 

Any category 1 and 2 firms which do not intend to use the updated template should ensure the documentation submitted for recording remuneration policies, practices and procedures is in line with the Solvency II requirements. 

Tapestry has significant experience advising financial services firms on their remuneration compliance. If you would like to discuss your compliance with us, please do contact us.

The UK Senior Managers and Certification Regime (SM&CR) for UK banks, building societies, credit unions, PRA-designated investment firms and branches of foreign banks operating in the UK came into force in March 2016. The regime was extended to insurers in December 2018 and, from 9 December 2019, will be extended to apply to all firms authorised under the UK’s Financial Services and Markets Act 2000. The upcoming extension will focus on Financial Conduct Authority (FCA) 'solo-regulated' firms.

The SM&CR focusses on senior managers and individual responsibility, replacing the previous ‘approved persons regime’. The new regime seeks to reduce harm to consumers and to strengthen the integrity of the market by making individuals more accountable for their conduct and competence, ensuring there is a clear understanding of responsibilities within the firm, and developing a 'culture of accountability' and improving conduct at all levels.

The precise impact of the SM&CR will depend on how the relevant firm will be categorised under the new regime. A firm will either be a ‘core firm’ (this will be most firms), a ‘limited scope firm’ (subject to the fewest requirements) or an ‘enhanced firm’ (subject to the most requirements). Firms should establish which category is relevant and understand the applicable rules. 

The 3 key parts of the SM&CR which will apply to all firms are as follows:

• Senior Managers Regime - focussing on the most senior people in the firm. All senior managers will need to be FCA approved and there must be a clear statement of responsibilities, identifying what the senior manager is responsible and accountable for. All senior managers will be subject to a 'duty of responsibility'.
• Certification Regime - focussing on employees who are not senior managers, but whose jobs mean they can have a big impact on customers, markets or the firm. Firms will need to certify that such employees are fit and proper to perform their role (at least annually).
• Conduct Rules - new, high-level standards that apply to almost every person who works in the financial services industry.

You can find more information, including a guide summarising the FCA’s rules and guidance, here.

Tapestry comment

For those firms that are already caught by the SM&CR, the extension will not have an impact. The extension will, however, impact approximately 47,000 firms, including investment firms, asset managers, mortgage brokers and consumer credit firms. This extension is unlikely to be a surprise development for these firms and we expect that many of the impacted firms will already be working through the implementation process.

The extension of the SM&CR is indicative of the increasing interest and focus on individual accountability and responsibility by the FCA and the UK Prudential Regulation Authority (PRA). Both regulators have identified in their 2019/20 business plans that they will review and evaluate the effectiveness of the SM&CR over the next year.

This focus has already influenced the approach taken by the FCA and the PRA to the regulation of remuneration. For example, there is already an expectation that malus and clawback provisions (and similar remuneration adjustment mechanisms) are applied not only to individuals who are directly responsible for issues impacting the firm, but also to those individuals who have overarching responsibility. We expect that regulatory supervision and expectations in relation to remuneration will continue to focus on ensuring that individuals are held accountable, including through the remuneration that they receive.  

The extension of the SM&CR will see a new standard of conduct which the FCA hopes will strengthen market integrity by forcing individuals to take responsibility. It will be interesting to see how these changes impact risk-taking within firms and how this will be reflected in the remuneration policies and practices within those firms.

Tapestry has significant experience advising financial services firms on their remuneration compliance. If you would like to discuss your remuneration compliance with us, please do contact us.

The Capital Requirements Directive V (CRD V) / Capital Requirements Regulation II (CRR II) and the Investment Firms Directive (IFD) / Investment Firms Regulation (IFR) developments were adopted by the European Parliament at its first reading yesterday (16 April 2019). The developments will significantly impact the prudential regulation of credit institutions and investment firms, including with regard to remuneration. We will shortly issue an alert for each legislative package which considers the impact on remuneration in more detail. 

The adopted texts can be accessed using the following links:

• Capital Requirements Directive V
• Capital Requirements Regulation II
• Investment Firms Directive
• Investment Firms Regulation

Timing 
Following the date of entry into force, CRD V and IFD will be implemented into local law by EU member states within, and the IFR will apply directly (without local implementation) from 18 months following the entry into force of the relevant legislation. The CRR II remuneration disclosure provisions will apply directly (without local implementation) from 24 months following the entry into force. The date of entry into force for each piece of legislation is currently unknown. 

Tapestry has significant experience advising financial services firms on their remuneration compliance, particularly in relation to remuneration regulations. If you would like to discuss your remuneration compliance with us, please do contact us.

The UK Prudential Regulation Authority (PRA) has published its 2019/20 Business Plan, outlining the PRA's strategic goals and the workplan that they intend to implement over the coming year to achieve these goals. In addition to a range of strategic goals, including those relating to financial and operational resilience, competition and Brexit, the PRA will focus on robust prudential standards and supervision. 

This focus on robust prudential standards and supervision will impact the regulation and supervision of remuneration within banks and insurers. The PRA has stated that they will move from developing and implementing new policies to embedding and evaluating them, including embedding and evaluating effective governance regimes and accountability. As part of this change in focus, the PRA has stated that, in 2019/20, they will begin an evaluation of the effectiveness of the Senior Managers & Certification Regime and remuneration policies for banks and insurers. The PRA will also continue to review firms' governance arrangements in areas such as remuneration practices, diversity, and corporate governance at board level. 

Tapestry comment

Firms should read the Business Plan and each strategic goal identified to ensure they understand the PRA's area of focus for the coming year. It will be encouraging for firms to see that the PRA is not concentrating on developing and implementing new policies, especially given that banking firms will already need to take action in relation to the upcoming remuneration changes driven by the Capital Requirements Directive V / Regulation II and the Investment Firms Directive / Regulation. Firms should, however, be aware that the focus on evaluation and embedding of existing governance and accountability regimes may lead to increased scrutiny by the PRA, or at least an increased focus on remuneration disclosures. 

Tapestry has significant experience advising financial services firms on their remuneration compliance, particularly in relation to remuneration regulations. If you would like to discuss your remuneration compliance with us, please do contact us.

On 8 October 2018, the Financial Stability Board (FSB) hosted a workshop in London with 17 large internationally active banks to discuss their experiences of implementing the FSB’s Principles for Sound Compensation Practices and the related Implementation Standards. The FSB has now published a short note which summarises the issues discussed at the workshop and the key takeaways.

The workshop focussed on:

1. Big picture - a review of how compensation structures have changed since the crisis and thoughts on further changes in the coming years.
2. Implementation of the FSB’s Principles and Standards by banks - practical steps taken by international banks to implement compensation reform, including the designation of material risk takers.
3. Effectiveness - steps banks are taking to assess the effectiveness of current compensation policies and practices in terms of better aligning risk and reward.

Tapestry comment

The FSB uses these workshops to gather feedback which will inform their biennial progress report on compensation practices. This process forms part of the FSB’s consideration of the alignment of risk and reward within banks and provides a greater understanding of how international banks have implemented, and look to implement, the FSB’s Principles and Standards (and any related legislation) to align risk and reward. The short note provides some useful insights and we recommend that firms read it.

The FSB have asked for any feedback to be sent to them by Tuesday 7 May 2019 to fsb@fsb.org.
 
Tapestry has significant experience advising financial services firms on their remuneration compliance, particularly in relation to remuneration regulations. If you would like to discuss your remuneration compliance with us, please do contact us.

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