Executive remuneration in credit institutions Executive remuneration in credit institutions

The EU’s Capital Requirements Directive IV (CRD IV) established a complex regulatory regime and covers remuneration policies and practices for all members of staff. This includes staff members whose professional activities have a material impact on the credit institutions’ risk profile and who are called Identified Staff or Material Risk Takers. The rules around remuneration aim to drive positive behaviour that aligns individual reward with sound and effective risk management and the long-term growth of the firm, discouraging risk-taking that exceeds tolerated risk levels.

CRD IV states certain minimum identification criteria to determine Identified Staff. These staff members include:

• Executive and non-executive directors
• Senior management
• Risk takers
• Staff engaged in control functions (such as risk management, compliance and internal audit)
• Any employee whose total remuneration is in the same bracket as senior management and risk takers, and whose professional activities has a material impact on the credit institution’s risk profile.

CRD IV features several regulatory requirements that apply to the total remuneration package of Identified Staff. Most specifically these apply to variable remuneration, since this is the component that could promote risk-taking positions and potentially have a higher negative impact on the institution’s risk profile.

The rules state that a specific portion of the variable remuneration of Identified Staff – including annual bonuses, long-term incentive plans and certain severance payments and discretionary pension benefits – will be subject to minimum deferral periods of at least four years, depending on the category of Identified Staff and the size and complexity of the credit institution.

The payment in shares or other equivalent pecuniary instruments (mandatory in certain cases for a substantive portion of variable remuneration) will be subject to a holding period, and firms will have to apply ex-post adjustments – a mechanism that would allow them to reduce any deferred variable remuneration still to be paid or recover any variable remuneration already paid in certain negative circumstances. These could be a significant downturn in the institution’s financial performance, a risk management failure, or individual misconduct (malus and clawback clauses).

Some of these requirements, such as deferral and payment in shares or instruments, also known as pay-out rules, might be disapplied based on proportionality principle. This principle means that the remuneration requirements must be proportionate and appropriate to the size, internal organization, and the nature, scope and complexity of the activities of the credit institution, so that small and non-complex credit institutions are not subject to overly complicated and stringent requirements.

CRD V introduced certain thresholds that provide a better understanding of when the proportionality principle applies. These quantitative thresholds were largely left to EU Member States under the previous Directive, which opened the door to geographical disparity of treatment for firms and complications for businesses with a multinational footprint. CRD V has now clarified that the option to disapply pay-out rules is available only to:

• Non-large credit institutions with low volumes of assets (less than or equal to €5 billion over the preceding four years on average and on an individual basis), or
• On an individual basis, to Identified Staff members receiving non-significant variable remuneration (generally, annual variable remuneration not exceeding €50,000 and not representing more than one third of the staff member’s total annual remuneration).

These mandatory requirements have a very broad scope of application, ranging from EU based credit institutions to EU branches and subsidiaries of foreign entities as well as non-EU branches and subsidiaries of an EU banking group. Any limitations and particular details are included in each EU Member State’s domestic legislation.

This legal framework is refined every three or four years and the trend is for the requirements to become more stringent, making it increasingly difficult for credit institutions to comply with the rules in practice. Credit institutions need to keep constantly up-to-date in order for them to be able to amend their remuneration policies and practices and to keep the relevant documents aligned with the legislation in force at any time.