1. Human Capital
Reward Advisory
EBA consults on updated remuneration
guidelines
On 4 March 2015, the European Banking Authority (EBA) published a Consultation Paper
EBA/CP/2015/03 providing updated guidelines on sound remuneration policies. It is intended that
the new guidelines, once finalized, will apply from 1 January 2016, when the current guidelines
published in 2010 by the EBA’s predecessor, the Committee of European Banking Supervisors
(CEBS), will be repealed.
The proposed guidelines are significant and contain a number of key changes in response to
regulatory developments and the industry’s response to these since 2010. Some of the proposals
will have a significant impact on firms beyond those regulated under the Capital Requirements
Directive (CRD), and therefore all regulated institutions should be encouraged to respond to the
consultation process.
Headline Potential impact
Stricter approach to
proportionality
Increase in number of firms and individuals subject to the more onerous
remuneration requirements of CRD
Different sectorial
remuneration requirements in
a group context
Uneven playing field for captive versus non-captive asset managers
Material Risk Taker (MRT)
Identification Process
Enhanced governance, documentation and disclosure requirements
The use of instruments to
deliver variable remuneration
Firms that currently use share linked instruments rather than shares will need to
have a clear rationale for taking this approach. Firms should be prepared to
articulate why other non-share based instruments such as bail-in bonds are not
being used
Categories of remuneration
and role-based allowances
• Detailed guidance on allocation of remuneration costs, which may increase the
compliance burden.
• Permanent increase in fixed costs and application to a wider population with
respect to role-based allowances
Broad and all-encompassing
circumvention guidance
Traditional arrangements aligned to investor and customer interests (e.g., co-
investment and carried interest structures) may inadvertently be affected
Increased prescription,
governance and supervision
There are a number of other proposed guidelines which will increase the
compliance burden on firms, including the need for enhanced systems and
processes
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Background
The CEBS guidelines were published in 2010. The updates contained in the draft EBA guidelines
are particularly broad in scope as they are intended to cover the following key changes since
2010:
• Updates to CRD
• Bonus caps
• Stricter rules on the application of malus and clawback
• More granular disclosure requirements
• Regulatory Technical Standards (RTS)
• MRT identification
• Instruments that can be used for variable remuneration
• Other developments in the way remuneration policies and practices have evolved, including
experiences from regulatory supervision
• Approach to proportionality
• Definitions of fixed and variable remuneration
• The use of allowances
• The impact of sectorial remuneration principles following the publication of the
Alternative Investment Fund Managers Directive (AIFMD) and Undertakings for Collective
Investment in Transferable Securities V (UCITS V)
Scope
The draft guidelines apply to competent authorities (national regulators) and credit institutions,
including branches of credit institutions whose head offices are outside the EU and who are subject
to CRD (credit institutions and investment firms). They apply on an individual, sub-consolidated
and consolidated basis, including subsidiaries that are not themselves subject to CRD.
It is important for firms that are not subject to CRD to be aware of these proposed guidelines
and the dialogues now taking place, as they are likely to have a bearing on future remuneration
requirements under AIFMD and UCITS V.
Key points
Proportionality
• The current CEBS guidelines allow for some of the more onerous remuneration provisions of
CRD (deferral, payment in instruments, malus and clawback provisions) to be disapplied on the
grounds of proportionality. The EBA does not believe that this disapplication is permitted under
the terms of CRD, and has received the European Commission (EC)’s interpretation indicating
that the remuneration requirements need to be applied to all institutions without exception or
exemption.
• The draft guidelines also appear to suggest that the bonus cap provisions cannot be disapplied
on the grounds of proportionality if someone has been identified as an MRT.
Such an interpretation would have a significant impact on both the number of firms and
individuals subject to the more onerous remuneration requirements outlined above.
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• The EBA is asking for responses from the industry to support the advice they are intending to
provide to the EC, suggesting legislative amendments for a broader application of the
proportionality principle.
A number of firms impacted by AIFMD have used proportionality arguments to disapply the
more onerous aspects of the remuneration requirements, as currently supported by the
European Securities and Markets Authority (ESMA) guidelines on remuneration. These firms
should monitor the consultation closely and be aware of how proportionality will work for CRD
firms as it is likely to indicate how other regulations will develop.
Sectorial remuneration principles
• The draft guidelines recognize the impact of current sectorial remuneration guidelines for
AIFMD firms and the fact that ESMA is mandated to issue remuneration guidelines under
UCITS V.
• Currently, there is uncertainty on how the remuneration provisions of the various Directives
operate within a group context where one firm (and its staff) could be subject to multiple
regulatory requirements depending upon the nature of its business and the Directives it needs
to comply with.
• The draft guidelines suggest that the strictest set of requirements will apply, taking account of
the rules that the group is subject to and then adding on any specific sectorial requirements.
• There is concern from firms that are not currently subject to CRD, that some of the stricter
remuneration requirements of CRD could spread to their firms to address consistency and
uneven playing field arguments.
Clarification from ESMA would be welcome, to the extent it adds more certainty. Firms should
ensure they respond to the consultation process to ensure their views and the impact on the
industry are fully recognized.
Concerns around an uneven playing field will resurface where; for example, those individuals
working for a captive asset manager are subject to the bonus cap rules, while those who work
for stand-alone non-CRD firms are not.
MRT identification process
• The draft guidelines make it clear that, in a group context, the identification of MRTs needs to
take place at a consolidated and sub-consolidated level and within subsidiaries that may
themselves not be subject to CRD.
• Firms will be required to use additional criteria, beyond those in the RTS, in their self-
assessments to ensure a complete identification of all MRTs.
• The draft guidelines also emphasize the need for a documented and transparent self-
assessment process that is periodically updated. The self-assessment also needs to be updated
throughout the year with at least the results of the qualitative criteria of the RTS.
• The importance of the MRT identification process is highlighted by the degree of governance
and disclosure suggested by the guidelines and the active involvement of the remuneration
committee, where one is established.
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Firms will need to ensure that they have the requisite process, policies and governance in place
to identify their MRTs on an ongoing basis and to seek any regulatory approvals to exclude staff
who meet the quantitative thresholds.
• The guidelines attempt to provide further clarity on the identification process in a group
context, but would seem to imply that an individual who is in the management body of a
significant subsidiary could be excluded (provided all other criteria are also met), if he or she is
not in the management body of the parent institution.
• The draft guidelines also suggest that those subsidiaries that are subject to CRD need to carry
out their own solo-level identification process, unless they are small and less complex. This
may have a number of practical implications depending on the nature of the organization
and how it is structured and managed.
Instruments that can be used for variable remuneration
• The draft guidelines prioritize the use of instruments, such as bail-in bonds and shares over
share-linked instruments. They indicate that other instruments (e.g., instruments subject to
bail-in) should be used where available.
• As part of their consultation process, the EBA has requested information from listed firms on
the impact of using shares and, where possible, other instruments set out in the RTS. Given
the current limited use of other such instruments, the rationale for this will need to be
clearly articulated.
• It would appear that the draft guidelines would prohibit the payment of dividends and interest
on deferred elements of variable remuneration, even if they are paid after the end of the
deferral period. This is contrary to the current CEBS guidelines and there would appear to be
no basis for this restriction. These payments are common practice, and therefore clarity
should be sought through the consultation process on the rationale for this exclusion.
Categories of remuneration and role-based allowances
Given the importance of the bonus cap ratio, the EBA has sought to clarify what should be
included as part of remuneration and how various remuneration elements should be categorized
between fixed and variable remuneration.
Firms will need to review the guidance given and ensure that their processes capture all aspects
of remuneration to include in their calculations and reporting. For instance, the treatment of
expatriate compensation and benefits previously varied across the industry.
The proposed guidance on Long Term Incentive Plans and when they should be included in
variable remuneration seem at odds with other parts of the requirements and will require
clarification through the consultation process.
The circumstances in which guaranteed bonus payments can be made remains restricted. But it
is interesting to note that the draft guidelines indicate that, in certain circumstances, these
awards do not need to be included in bonus cap calculations and also that they can be paid
entirely in cash.
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The draft guidance on allowances is consistent with the EBA opinion issued in October 2014.
Firms should therefore review this guidance in relation to their own allowances and consider any
necessary changes, and their timings, given that this is likely to be an area of focus. In
particular, those who have used allowances only for those individuals who are identified as
MRTs and are subject to the bonus cap, or those who have used instruments to deliver the
allowances, may need to reconsider their approach.
Circumvention
The draft guidelines contain more granular information on what constitutes circumvention. Under
these proposals, firms will need to review these criteria against their own arrangements and pay
special attention to any co-investment and carried interest type arrangements to ensure that they
are in line with regulatory expectations.
It would appear that carried interest structures, whereby staff receive a return solely based on
their investment in the vehicle can still be excluded from the definition of remuneration. If the
return to staff is not solely a return on their investment it should be included as variable
remuneration. For staff receiving such remuneration arrangements that are subject to the
bonus cap, plans will need to be reviewed and potentially changed. This may be in conflict with
investor interests and requirements.
Disclosure
The draft guidelines call for enhanced disclosure in line with the requirements of the Capital
Requirements Regulation. Key new items that need to be disclosed are:
• Explanations of any differences between the remuneration policy that is applicable at a group
level and what is applied at other levels in the organization.
• Details of how the MRT identification process has been applied, including the additional criteria
used in the self-assessment process.
• How variable remuneration reacts to performance changes in the institution.
• The most important design characteristics of the remuneration system; these have now been
prescribed under eight separate headings in the draft guidelines.
• Granular disclosure on the ratios between fixed and variable remuneration.
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Other points of interest
There are a number of other points in the draft guidelines that give an indication of the EBA’s
thinking and the trend toward greater governance and regulatory supervision. Firms may wish
to review these to ensure that current policies, processes and governance arrangements are in
line with the currently published regulatory thinking.
• There is more focus on all risk types when aligning the remuneration policy with the firm’s risk
strategy and appetite.
• There is an increased focus on business unit involvement in the development of the
remuneration policy.
• The need for a separate remuneration committee for all significant institutions within a group.
However, if the subsidiary is subject to specific sectorial legislation, then it is the sectorial
legislation which will determine the need for a separate remuneration committee.
• The proposed requirement for the remuneration committee to review a number of possible
scenarios to test how the remuneration policies and practices react to external and internal
events and back-test the criteria used for determining the award and the ex-ante risk
adjustment based on the actual risk outcomes is now more specific. In addition, there now
appears to be a requirement to provide significant detail on how variable remuneration reacts
to performance changes. This transparency appears to be aimed at providing staff with clear
direction on the circumstances under which remuneration could be significantly reduced (to
zero) due to performance or conduct issues. Close cooperation between different internal
functions (e.g., HR, finance, risk and strategic planning) will be required to design the
parameters for the reward stress testing against different performance criteria and conduct
failures.
• The EBA has stated that they may choose to consult further on the remuneration requirements
applicable to staff whose conduct could affect, directly or indirectly, consumers. Some national
regulators have already increased the scrutiny on such remuneration arrangements and we
anticipate that this will be an ongoing trend.
• The definition of staff has been expanded to include any other person acting on behalf of the
institution and its subsidiaries. Firms will need to ensure their internal processes capture
certain contractors and clarification will be required through the consultation process on the
extent to which others (e.g., advisors) acting on behalf of the firm need to be captured.
• The draft guidelines mention staff behavior in the context of the remuneration policy, which is
in line with current focus of a number of regulators on the behavioral impact of remuneration
design. The compliance function would also be tasked with assessing the impact of the
remuneration policy on risk culture.
• The need for an annual independent review of remuneration policies is emphasized further
together with guidance on how (including documentation requirements) and who should
conduct these reviews in different types of organization.
• Further emphasis is placed on the need for documentation underpinning reward governance,
policy and process, including the decision-making process.
• A framework for role descriptions is identified as a key component of the remuneration policy.
While a fundamental part of any remuneration framework, this had not been specifically
referenced by the current CEBS guidelines.
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• Firms may now need to demonstrate that the remuneration arrangements for control functions
are distinct from other roles by evidencing a higher fixed to variable ratio compared to other
roles in the business.
• Given the bonus cap limits, firms will now need to document their policy on the ratio between
fixed and variable remuneration in a far more granular fashion.
Regulatory sanctions have been added to the criteria that need to be reviewed in the ex-post risk
adjustment malus and clawback process.
Next steps
The EBA is consulting on these guidelines for three months and the consultation period will end on
4 June 2015.
It is intended that the new guidelines, once finalized, will be applicable from 1 January 2016.
EY will be responding to this consultation paper and we would be happy to discuss any issues
you may have, from your institution’s perspective, when formulating our response.
