The draft Capital Requirements Directive V (CRD V) and Capital Requirements Regulation II (CRR II) legislation has now been approved by the Council of the EU. The press release, including links to the legislative text, can be accessed here. The legislation will now be subject to adoption by the European Parliament and Council.
Following the 2007-08 financial crisis, the European Union introduced regulation to help reduce risk in the banking sector. This included regulations impacting remuneration.
The EU remuneration regulations first implemented the Financial Stability Board’s Principles for Sound Compensation Practices and the related Implementation Standards. This has since expanded to include more robust remuneration requirements, including, for example, the so called ‘bonus cap’, and significant disclosure obligations. The regulations have, however, included a subjective concept of ‘proportionality’, allowing firms to disapply certain structural remuneration requirements where appropriate.
Following a negotiation process which began in November 2016, the regulations impacting the banking sector are changing again, including in relation to remuneration. The changes to the remuneration requirements primarily focus on ensuring that a more consistent approach is taken across the EU to the concept of ‘proportionality’ and the disapplication of certain remuneration requirements for small banking firms and lower paid staff. There are also a number of other amendments, as summarised below.
2. CRD V
Previous Capital Requirements Directives have set out various requirements which impact the structure of remuneration within banking firms. These include a requirement for: certain portions of remuneration to be deferred; remuneration to be paid in certain instruments, such as shares; and for malus and clawback provisions to be implemented. The rules also contain a ‘bonus cap’.
CRD V contains the following material changes:
- Categories of staff considered to have a material impact on a firm’s risk profile have been clarified and there is a mandate for regulatory technical standards to be produced by the European Banking Authority (EBA) to provide further clarity on this.
- An ability for listed firms to award share-linked instruments that track the value of shares has been added. This was only previously available to non-listed firms.
- The minimum deferral period has increased from 3 to 4 years and, for members of the management body and senior management in ‘significant’ firms, to 5 years.
- There is now an ability for payment in instruments, retention and deferral (including deferral / retention of discretionary pension benefits) to be disapplied under the following derogations:
- where the firm is not a ‘large institution’ (as defined under certain metrics) and the firm’s average asset value (on an individual basis) is equal to or less than EUR 5 billion over the 4 years preceding the current financial year, although a member state may lower or increase this threshold (up to EUR 15 billion); and/or
- where the relevant staff member’s variable remuneration does not exceed EUR 50,000 and does not represent more than 1/3rd of their total annual remuneration, although a member state may decide this exemption will not apply. There is also a mandate for the EBA to produce guidelines on these derogations.
- Clarification that the remuneration requirements will not apply on a consolidated basis to certain subsidiary undertakings which are subject to other specific EU remuneration requirements.
- Remuneration policies and practices must be ‘gender neutral’, with a mandate for further guidelines on this to be produced by the EBA.
3. CRR II
The original Capital Requirements Regulation sets out various remuneration disclosure requirements. CRR II contains amendments which clarify a number of the existing requirements without materially altering the substance. There are, however, the following material changes:
When disclosing quantitative information (split by senior management and staff who have a material impact on the firm’s risk profile), the following must now be disclosed:
- a description of the fixed components of remuneration awarded for the financial year;
- separate information on the amounts and forms of each of the upfront and deferred parts of variable remuneration;
- information on any guaranteed variable remuneration awards during the financial year (wider than only sign-on and severance payments) and the number of beneficiaries;
- information on previously awarded severance payments that were paid during the financial year; and
- separate information for each of the upfront and deferred parts of any severance payments awarded during the financial year.
Where a new CRD V derogation (see above) is applied, the following must be disclosed:
- which derogation(s) apply;
- which remuneration principles the derogation(s) have been applied to;
- the number of staff members that benefit from the derogation(s); and
- their total remuneration, split into fixed and variable remuneration.
For large institutions (formerly ‘significant’ institutions), quantitative disclosure on the remuneration of the institutions’ collective management body must be made available to the public, differentiating between executive and non-executive members.
The changes are expected to be adopted by the Parliament and Council in Q2 2019. The legislation will then be published in the Official Journal of the European Union and enter into force on the 20th day following publication.
The remuneration provisions of CRD V are expected to be implemented into local law within 2 years of CRD V entering into force and the remuneration provisions of CRR II are expected to apply directly (without the need for local implementation) 2 years following entry into force.
The CRD V changes clarify, on a consistent EU-wide basis, which firms and individuals can rely on derogations from the remuneration requirements, with the aim of achieving a more ‘level playing-field’. This replaces different interpretations of ‘proportionality’ from national regulators across the EU. Although this improves consistency, these clarifications are likely to have a profound effect on the remuneration structure of many banking firms, particularly those firms that currently rely on the concept of ‘proportionality’ to disapply certain remuneration requirements, or firms which apply a shorter deferral period than is required under the new rules. The other CRD V changes, in particular the increased minimum deferral periods, are also likely to have a significant impact.
Although the exact timing of the implementation is currently unknown, banking firms should now consider how CRD V will impact their remuneration structure. In particular, firms should consider the following:
- Do you currently disapply certain remuneration requirements using ‘proportionality’?
- Will any disapplication be unavailable after CRD V is implemented?
- If disapplication is currently relied upon but will not be available after CRD V is implemented, do you have the remuneration structures in place to comply with the new rules?
- Will you need to make amendments or introduce new incentive arrangements, or would you like to do so to make use of share-linked instruments?
- Will your policies be compliant after CRD V, e.g. deferral, severance or retention policies?
- Do you need any new policies, e.g. a malus and clawback policy?
- How and when will you communicate any remuneration changes to staff?
- Are your remuneration policies and practices ‘gender neutral’? If not, how will these change?
The CRR II changes increase the granularity of, and also widen, the existing disclosure requirements, as well as introducing new disclosure requirements relating to the new CRD V derogations. Firms should now consider if the new information required by CRR II is readily available and, if not, how such information will be obtained going forwards.
Tapestry has significant experience advising financial services firms on their remuneration compliance, particularly in relation to remuneration regulations. We will shortly circulate invitations to a webinar where we will discuss these changes and how they may impact your remuneration structure.
If you would like to discuss how CRD V or CRR II may impact your remuneration structures, please do contact us.