13 January 2016

Proportionate application of remuneration requirements: new European Banking Authority opinion

This article was written by Tamsin Rickard, Professional Support Lawyer

The interpretation of staff remuneration rules for banks and certain investment firms across Europe looks set to be clarified, following a new opinion from the European Banking Authority (the "EBA") which was published on 21 December 2015. 

The opinion relates to the so-called “proportionality principle” under CRD IV, the EU legislation which, amongst other things, sets out requirements in relation to staff remuneration for banks and certain investment firms. CRD IV strengthened and revised its predecessor (CRD III) in response to the financial crisis. 

CRD IV and the proportionality principle

To recap briefly, CRD IV includes rules on remuneration, such as limits on the ratio of variable to fixed pay (the so-called "bonus cap") and requirements to defer the payment of variable remuneration, to pay a proportion of it in shares or other instruments, rather than cash, and to defer some pension benefits (referred to in this article as the “pay-out process requirements").  

Importantly, however, the CRD IV remuneration rules are subject to a proportionality principle. This allows the local regulator in each EU member state to adapt the remuneration rules according to the size, activities and complexity of the regulated business in question. In other words, it allows financial services firms and their regulators to take a flexible approach to these complex rules to reflect both the burden of compliance on smaller firms, and the varying degree of risk in different types of firm.

The precise approach to proportionality has long differed between EU member states, with divergent interpretations of how the principle should apply. In some member states, such as the UK, regulators interpret the principle as allowing for complete disapplication of some of the more onerous rules such as the pay-out process requirements and, in some instances, the bonus cap. However, the EBA, which is tasked with producing guidelines on the CRD IV remuneration rules, including on proportionality, disagreed with this approach, arguing that on a strict legal interpretation the rules allow only for a softening and not complete disapplication of the remuneration rules in any circumstances. The result has been confusion and to some extent an uneven playing field across Europe for affected firms.

The EBA has now produced an opinion that CRD IV should be amended:

• to explicitly exempt some small, non-complex institutions from the pay-out process requirements;
• to exempt staff who receive low amounts of variable remuneration, including staff in large institutions, from the pay-out process requirements; and
• to allow listed institutions to use share-linked instruments as well as shares themselves to structure variable remuneration payments.

This represents an apparent softening of the EBA’s approach: by acknowledging that for some smaller and less complex firms, it is appropriate to disapply some rules altogether. Although this is welcome news, the proposed exemption will only apply to institutions which are “small in terms of their total balance sheet, off-balance sheet business and non-complex taking into account their internal organisation and the nature, scope and complexity of their activities"; a definition which needs further expansion and clarification for firms to understand whether they are likely to benefit from the exemption or not.  It would not apply to subsidiaries of significant institutions. Some firms which currently disapply these rules under the proportionality principle may find that they do not fall within the scope of the new exemption – and may therefore be obliged to apply the pay-out process requirements, at least to some extent, which could be costly and time-consuming.The EBA has also made clear its view that the bonus cap (ratio of variable to fixed pay) should not be subject to the proportionality principle at all, meaning that all firms in scope of CRD IV will need to apply it.

In addition, the EBA has produced new guidelines on sound remuneration policies under CRD IV. However, these will not replace the current guidelines (the 2010 CEBS guidelines) until 1 January 2017, allowing time for the proposed exemptions to be considered and properly crafted. Local regulators will need to confirm whether they intend to comply with the new guidelines within two months of publication of the translated guidelines, so more information on national approaches will be available during spring 2016.  

What does this mean for employers who are subject to CRD IV? 

Over the course of 2016 it will become clear whether the opinion will be adopted and how any exemptions will apply. Member state regulators are likely to also revise any local guidance on the application of the rules accordingly. Those firms which currently disapply any of the remuneration principles under the proportionality principle should continue to "watch this space" as the new rules become clarified, and give thought to the impact of the opinion on their remuneration structures if implemented.  

Even firms falling outside the scope of CRD IV should be aware of this debate, as proportionality is a key principle under all the remuneration codes across the financial services sector, and the outcome of these reforms could well signpost the future approach to proportionality for the wider sector.

We will keep you posted.

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