Response to consultation on Guidelines on sound remuneration policies
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We suggest that the detailed requirements in paragraph 14 are removed, or at a minimum limited to identified staff only. The remuneration policies at the institution level will need to address the link between performance against risk objectives and remuneration. However, an individual’s detailed objectives should remain part of his/her performance assessments and not included in the institution’s disclosed remuneration policy itself.
It is not clear from the draft guidelines to what extent individuals employed in other parts of a mixed activity group that perform services on behalf of institutions within a consolidated sub-group subject to CRD4 are to be considered “identified staff” of the in-scope institution. Given that the remuneration requirements are intended to address risk taking of credit institutions and investment firms, it does not seem appropriate that individuals who are employed in horizontal support roles within a non-consolidated group (for example, internal audit or human resources) should be subjected to remuneration provisions where they do not have a material impact on the risk profile of the institutions within consolidated sub-groups that are subject to CRD4. The guidelines seem to acknowledge this issue when they discuss staff of subsidiaries only being subject to the extent that they perform the activities on a consolidated basis for the CRD4 regulated sub-group. The guidelines should make clear that the same considerations apply for all group staff and not just subsidiaries of the CRD4 institutions.
The investment firms within LSEG operate as neutral, open access trading platforms, for equities and bonds respectively. They do not take positions, or risk principal or otherwise engage in risk taking activities that are intended to be the primary focus of CRD4. The tiering system that was put in place by the UK Financial Conduct Authority (and similar arrangements in other member states) to deal with such types of investment firms subject to CRD4 addresses the risks posed by MTFs (which are designed to be risk neutral) by putting them at the lowest level of application of the remuneration rules, with neutralisations of certain principles being possible. We believe that for institutions which are designed to be non-complex and do not seek to take market or credit risks, CRD4 should be amended to explicitly reflect that many neutralisations would be appropriate in practice.
Additionally, CCPs such as LCH.Clearnet SA are designated as credit institutions under French law for a number of domestic reasons, including but not limited to, access to the central bank liquidity necessary to operate a CCP and not because of any conventional banking or investment activity that it undertakes. Furthermore, operational and governance risks specific to CCPs and their operating structures are addressed in EMIR and its delegated acts (which comprise specific remuneration rules for CCPs) and the CRD4 should be amended so as to allow for proportionate neutralisations where CCPs have to manage their risks pursuant to other relevant EU legislation.
Regarding the measures to be documented in the self-assessment exercise, we would expect that the means by which people are identified as risk-taking staff pursuant to Regulation 604/2014 would be part of the standing remuneration policies. In addition, some of the minimum information to be included in the self-assessment is unclear:
• It is not clear how the self-assessment is supposed to be coherent with the “business strategy and models” of the consolidated institution. These terms are very vague and it is not clear how an institution would document this.
• It is not clear what “the requirements regarding the documentation of the identification outcome” means. If this is meant to say that evidence of the identification process should be retained, the guidance should say this in a clear manner.
For the guidance on identification of staff where they are responsible for functions on a consolidated or sub-consolidated basis (para 101), there is no discussion of how this works for group staff which are not subsidiaries of the regulated institution but rather staff employed by unregulated entities within the group who provide services across all group entities. It should be equally clear that staff of unregulated group entities should also be excluded from the remuneration requirements where they are not primarily responsible for the functions of the CRD4 regulated institution, or only have peripheral connection to such functions.
Importantly, the guidelines related to LTIP appear to suggest that it should be valued at the time of vesting and not the time of award. This is inappropriate for a number of reasons:
• A significant increase in share price between the time of award and the time of vesting or the achievement of full performance conditions would imply that annual bonuses may have to be reduced or cancelled in order to achieve a compliant fixed to variable pay ratio. It would be impossible for an institution to project share price three years in the future in order to attempt to value the award accurately;
• It creates an inappropriate incentive whereby an increase in share price or the achievement of full performance conditions (to the benefit of shareholders) would result in a reduced bonus payout to the relevant staff. Also, it is not always possible to align the timing of the annual bonus payout and the vesting on a long-term award in order to meet the required ‘bonus’ cap. The incentive this provides goes against what the EBA should be trying to achieve, i.e. incentivising staff to act in the best interest of shareholders; and
• It is not clear how existing LTIP awards would be characterised and valued.
We believe the removal of current allowances could lead to an increase in base pay in order to compensate for its removal. It is difficult to see how this could have a positive impact on financial stability.
The proposed one-year retention period on buy-outs penalises staff who are recruited from non-regulated organisations or from a different sector as the rules mean they will have to wait an additional year to receive their deferred compensation, even though it is not connected with any regulated activity.
• We agree that there should be transparency regarding the compensation process. The Remuneration Committee with input from Risk has the ability to apply judgement to the level of an award and its refund) (paragraph 190).
• Having established that institutions should use the same risk measurement models for compensation calculations as internal risk measurement (paragraph 196), which seems plausible, the document goes on to indicate that therefore ‘more sophisticated ICAAP models should lead to a more sophisticated variable remuneration policy’ (paragraph 197). In light of the call for firms to use the same risk model as the one used in their internal risk measurement, it is not clear why the Guidelines then go on to specify a preferred model.
• We believe paragraph 228 should be deleted; in our view it is unnecessary and would deliver the wrong outcome. If a requirement is needed at all, it should be for institutions to use measures for determining bonuses that are consistent with the financial reporting methods, rather than potentially requiring them to be different.
We believe the CRD4 measures and the proposed Guidelines on Remuneration are intended to protect against a culture of excessive risk taking by the risk takers of institutions that intentionally take balance sheet risk as part of their core operations. This is not the case for investment firms whose only investment activity is operating an MTF. We believe the regulatory requirements should be refined in order to reflect more accurately the substance of any activities carried on within different categories of entities. We would encourage the EBA to consider potential recommendations in this area taking into account the interpretation and approach of national competent authorities. In our view it is not the policy intention to apply the remuneration rules to entities that do not seek to take balance sheet risk as part of their core operations. As the CRD4 itself states, “it would not be proportionate to require certain types of investment firms to comply with all of [the remuneration] principles” and it should be made clear that for certain types of investment firms and market infrastructure providers many provisions are inappropriate and not necessary to address the Parliament’s and Council’s concern of excessive risk taking by institutions.
Banning the payment of dividends on deferred awards in shares decouples the alignment of the interest of identified staff with that of shareholders. This could reduce the incentive of senior management of an institution to award dividends in the first place (which could prejudice the interests of shareholders who are not identified staff).
Similarly, banning the payment of interest on deferred awards in cash erodes the value of the award over a number of years and reduces both incentivisation and retention of key staff at the expense of the firm’s success and shareholders’ benefit.
Q 2: Are the guidelines in chapter 5 appropriate and sufficiently clear?
We believe the guidelines could be clearer with respect to the remuneration policy (see para 14). The context and legal requirements of CRD4 suggest that the remuneration policy should be in place for the institution as a whole. However, the proposed guidelines on what the policy should contain appear very granular, and seem to be specific to the individual staff member concerned. We do not support this approach. Staff in different business areas with different responsibilities may have different performance objectives, measurements of performance and structures for variable remuneration. It would be inappropriate (and risks violating data privacy and confidentiality laws) to disclose publically an individual’s performance objectives as part of an institution’s general remuneration policies.We suggest that the detailed requirements in paragraph 14 are removed, or at a minimum limited to identified staff only. The remuneration policies at the institution level will need to address the link between performance against risk objectives and remuneration. However, an individual’s detailed objectives should remain part of his/her performance assessments and not included in the institution’s disclosed remuneration policy itself.
Q 3: Are the guidelines regarding the shareholders’ involvement in setting higher ratios for variable remuneration sufficiently clear?
In relation to shareholder involvement concerning any outsourced or intra-group service providers, the current text is not clear. The section explaining which shareholders are entitled to vote – i.e. the ones in the institution where the identified staff operates (paragraph 36 (a)) could be read as applying to (i) the entity providing the service or (ii) the relevant CRD4 entity. Given that the risk being addressed is that an institution is remunerating individuals to a level which undermines effective risk controls, the appropriate shareholders for such voting would be those of the regulated CRD4 institution and not those of the outsourced entity. This supports the position that only the remuneration in respect of the services to the regulated institution should be caught by the CRD4 requirements.Q 4: Are the guidelines regarding remuneration policies and group context appropriate and sufficiently clear?
There are a number of instances where the guidelines say that the CRD4 requirements apply to the “group” but what the guidelines actually mean is “consolidated group” or “consolidated sub-group”; an example of this is the end of the first sentence of paragraph 63 which refers to activities having an impact on the “group’s” risk profile. This contradicts other statements that ‘identified staff’ requirements should only apply to the extent that those individuals are influencing the risk decisions of the CRD4 regulated sub-groups. This needs to be clarified to limit references to only “consolidated group” or “consolidated sub-group”.It is not clear from the draft guidelines to what extent individuals employed in other parts of a mixed activity group that perform services on behalf of institutions within a consolidated sub-group subject to CRD4 are to be considered “identified staff” of the in-scope institution. Given that the remuneration requirements are intended to address risk taking of credit institutions and investment firms, it does not seem appropriate that individuals who are employed in horizontal support roles within a non-consolidated group (for example, internal audit or human resources) should be subjected to remuneration provisions where they do not have a material impact on the risk profile of the institutions within consolidated sub-groups that are subject to CRD4. The guidelines seem to acknowledge this issue when they discuss staff of subsidiaries only being subject to the extent that they perform the activities on a consolidated basis for the CRD4 regulated sub-group. The guidelines should make clear that the same considerations apply for all group staff and not just subsidiaries of the CRD4 institutions.
Q 5: All respondents are welcome to provide their comments on the chapter on proportionality, with particular reference to the change of the approach on ‘neutralisations’ that was required following the interpretation of the wording of the CRD. In particular institutions that used ‘neutralisations’ under the previous guidelines for the whole institution or identified staff receiving only a low amount of variable remuneration are asked to provide an estimate of the implementation costs in absolute and relative terms and to point to impediments resulting from their nature, including their legal form, if they were required to apply, for the variable remuneration of identified staff: a) deferral arrangements, b) the pay out in instruments and, c) malus (with respect to the deferred variable remuneration). In addition those institutions are welcome to explain the anticipated changes to the remuneration policy which will need to be made to comply with all requirements. Wherever possible the estimated impact and costs should be quantified, supported by a short explanation of the methodology applied for their estimation and provided separately for the three listed aspects.
We believe the CRD4 measures and the proposed Guidelines on Remuneration are intended to protect against a culture of excessive risk taking by the risk takers of institutions that intentionally take balance sheet risk as part of their core operations. This is not the case for investment firms whose only investment activity is operating an MTF. We believe the regulatory requirements should be refined in order to reflect more accurately the substance of any activities carried on within different categories of entities. We would encourage the EBA to consider potential recommendations in this area taking into account the interpretation and approach of national competent authorities. In our view it is not the policy intention to apply the remuneration rules to entities that do not seek to take balance sheet risk as part of their core operations. As the CRD4 itself says, “it would not be proportionate to require certain types of investment firms to comply with all of [the remuneration] principles” and it should be made clear that for certain types of investment firms and market infrastructure providers many provisions are inappropriate and not necessary to address the Parliament’s and Council’s concern of excessive risk taking by institutions.The investment firms within LSEG operate as neutral, open access trading platforms, for equities and bonds respectively. They do not take positions, or risk principal or otherwise engage in risk taking activities that are intended to be the primary focus of CRD4. The tiering system that was put in place by the UK Financial Conduct Authority (and similar arrangements in other member states) to deal with such types of investment firms subject to CRD4 addresses the risks posed by MTFs (which are designed to be risk neutral) by putting them at the lowest level of application of the remuneration rules, with neutralisations of certain principles being possible. We believe that for institutions which are designed to be non-complex and do not seek to take market or credit risks, CRD4 should be amended to explicitly reflect that many neutralisations would be appropriate in practice.
Additionally, CCPs such as LCH.Clearnet SA are designated as credit institutions under French law for a number of domestic reasons, including but not limited to, access to the central bank liquidity necessary to operate a CCP and not because of any conventional banking or investment activity that it undertakes. Furthermore, operational and governance risks specific to CCPs and their operating structures are addressed in EMIR and its delegated acts (which comprise specific remuneration rules for CCPs) and the CRD4 should be amended so as to allow for proportionate neutralisations where CCPs have to manage their risks pursuant to other relevant EU legislation.
Q 6: Are the guidelines on the identification of staff appropriate and sufficiently clear?
The Guidelines suggest that the self-assessment exercise for ‘identified staff’ should take place annually, but then later says that the self-assessment should be updated ‘periodically’. We understand that this periodic updating should be annually or wherever a person begins or ends a term of work in a function with a material risk impact on the consolidated sub-group.Regarding the measures to be documented in the self-assessment exercise, we would expect that the means by which people are identified as risk-taking staff pursuant to Regulation 604/2014 would be part of the standing remuneration policies. In addition, some of the minimum information to be included in the self-assessment is unclear:
• It is not clear how the self-assessment is supposed to be coherent with the “business strategy and models” of the consolidated institution. These terms are very vague and it is not clear how an institution would document this.
• It is not clear what “the requirements regarding the documentation of the identification outcome” means. If this is meant to say that evidence of the identification process should be retained, the guidance should say this in a clear manner.
For the guidance on identification of staff where they are responsible for functions on a consolidated or sub-consolidated basis (para 101), there is no discussion of how this works for group staff which are not subsidiaries of the regulated institution but rather staff employed by unregulated entities within the group who provide services across all group entities. It should be equally clear that staff of unregulated group entities should also be excluded from the remuneration requirements where they are not primarily responsible for the functions of the CRD4 regulated institution, or only have peripheral connection to such functions.
Q 7: Are the guidelines regarding the capital base appropriate and sufficiently clear?
We agree with the EBA’s assessment that it is important that the remuneration policy is considered in the firm’s capital and liquidity planning. In this way the policy would contribute to safeguarding a sound capital base and prevent it from leading to shortcomings in the institution’s liquidity or capital position that it is required to maintain under Basel III/CRR. However, it is important to stress that use of variable remuneration which can decrease in times of low performance is a useful method for mitigating capital risk.Q 8: Are the requirements regarding categories of remuneration appropriate and sufficiently clear?
We agree that most of the criteria for determining whether remuneration is fixed (outlined in paragraph 117 of the Guidelines) are reasonably clear. However, further clarification may be needed in relation to Paragraph 117 (c) – which requires that the conditions for award of the remuneration are transparent to staff. It is not clear whether the conditions have to be transparent to all staff of the entity, a sub-set of staff, or just to the staff member concerned.Importantly, the guidelines related to LTIP appear to suggest that it should be valued at the time of vesting and not the time of award. This is inappropriate for a number of reasons:
• A significant increase in share price between the time of award and the time of vesting or the achievement of full performance conditions would imply that annual bonuses may have to be reduced or cancelled in order to achieve a compliant fixed to variable pay ratio. It would be impossible for an institution to project share price three years in the future in order to attempt to value the award accurately;
• It creates an inappropriate incentive whereby an increase in share price or the achievement of full performance conditions (to the benefit of shareholders) would result in a reduced bonus payout to the relevant staff. Also, it is not always possible to align the timing of the annual bonus payout and the vesting on a long-term award in order to meet the required ‘bonus’ cap. The incentive this provides goes against what the EBA should be trying to achieve, i.e. incentivising staff to act in the best interest of shareholders; and
• It is not clear how existing LTIP awards would be characterised and valued.
Q 9: Are the requirements regarding allowances appropriate and sufficiently clear?
We understand the EBA’s position that allowances should not be used as a vehicle to facilitate circumvention of the rules. However, if a firm is required to provide an explanation (as proposed in Paragraph 123), this is likely to increase the regulatory burden even though it is not clear how this, alone, would make circumvention less likely.We believe the removal of current allowances could lead to an increase in base pay in order to compensate for its removal. It is difficult to see how this could have a positive impact on financial stability.
Q 10: Are the requirements on the retention bonus appropriate a sufficiently clear?
It is important that the draft guidelines clarify that staff who do not pose material risks for the CRD4 institution should not be considered in scope of the rules on retention bonuses. This is relevant in a group context where the staff member is not primarily responsible for the institutions subject to CRD4. The guidelines should make it clear that the rationale for retention bonuses can be in respect of the services supplied to and needs of unregulated parts of a group which are not CRD4 institutions.Q 11: Are the provisions regarding severance payments appropriate and sufficiently clear?
In Paragraph 143 (a) it is not clear what constitutes an obvious failure.The proposed one-year retention period on buy-outs penalises staff who are recruited from non-regulated organisations or from a different sector as the rules mean they will have to wait an additional year to receive their deferred compensation, even though it is not connected with any regulated activity.
Q 12: Are the provisions on personal hedging and circumvention appropriate and sufficiently clear?
The rules in respect of personal hedging are relevant for the malus and clawback provisions are applicable to identified staff (Article 94(1)(n) of CRD4), but the draft guidelines appear broader and could apply to all types of staff or those individuals acting on behalf of the CRD4 institution. The guidelines should be clarified to ensure that they are aligned to the Level 1 CRD4 text and apply only to identified staff.Q 13: Are the requirements on remuneration policies in section 15 appropriate and sufficiently clear?
In respect of the factors for determining fixed remuneration, it is very unclear what is meant by “the constraints” and how these are relevant. In terms of determining suitable fixed remuneration, institutions should be in a position where they can best determine remuneration based on their business need, in line with applicable national employment legislation and applicable collective bargaining agreements. The guidelines are unhelpful in suggesting social/cultural considerations which are outside of an institution’s capacity to determine.Q 14: Are the requirements on the risk alignment process appropriate and sufficiently clear?
Outlined below are some of the areas that stand to benefit from further clarity, or that are not appropriate in their current form in our view:• We agree that there should be transparency regarding the compensation process. The Remuneration Committee with input from Risk has the ability to apply judgement to the level of an award and its refund) (paragraph 190).
• Having established that institutions should use the same risk measurement models for compensation calculations as internal risk measurement (paragraph 196), which seems plausible, the document goes on to indicate that therefore ‘more sophisticated ICAAP models should lead to a more sophisticated variable remuneration policy’ (paragraph 197). In light of the call for firms to use the same risk model as the one used in their internal risk measurement, it is not clear why the Guidelines then go on to specify a preferred model.
• We believe paragraph 228 should be deleted; in our view it is unnecessary and would deliver the wrong outcome. If a requirement is needed at all, it should be for institutions to use measures for determining bonuses that are consistent with the financial reporting methods, rather than potentially requiring them to be different.
Q 15: Are the provisions on deferral appropriate and sufficiently clear?
In paragraph 237 it is not clear what constitutes a “high amount”. Further clarity is required to enable businesses to determine situations in which a 60% deferral would apply.We believe the CRD4 measures and the proposed Guidelines on Remuneration are intended to protect against a culture of excessive risk taking by the risk takers of institutions that intentionally take balance sheet risk as part of their core operations. This is not the case for investment firms whose only investment activity is operating an MTF. We believe the regulatory requirements should be refined in order to reflect more accurately the substance of any activities carried on within different categories of entities. We would encourage the EBA to consider potential recommendations in this area taking into account the interpretation and approach of national competent authorities. In our view it is not the policy intention to apply the remuneration rules to entities that do not seek to take balance sheet risk as part of their core operations. As the CRD4 itself states, “it would not be proportionate to require certain types of investment firms to comply with all of [the remuneration] principles” and it should be made clear that for certain types of investment firms and market infrastructure providers many provisions are inappropriate and not necessary to address the Parliament’s and Council’s concern of excessive risk taking by institutions.
Q 16: Are the provisions on the award of variable remuneration in instruments appropriate and sufficiently clear? Listed institutions are asked to provide an estimate of the impact and costs that would be created due to the requirement that under Article 94(1)(l)(i) CRD only shares (and no share linked instruments) should be used in parallel, where possible, to instruments as set out in the RTS on instruments. Wherever possible the estimated impact and costs should be quantified and supported by a short explanation of the methodology applied for their estimation.
Paragraph 247 states that variable remuneration in instruments should “consist of a balance of different types of instruments”. It is not entirely clear what this means. Additionally, if the requirement for a balance of different types of instruments is intended to lead to a mixture of different types of instruments, this may not be easy to reconcile with the second part of the same paragraph which suggests firms should prioritise the use of instruments subject to bail-in, the effect of which is to reduce the level of choice.Banning the payment of dividends on deferred awards in shares decouples the alignment of the interest of identified staff with that of shareholders. This could reduce the incentive of senior management of an institution to award dividends in the first place (which could prejudice the interests of shareholders who are not identified staff).
Similarly, banning the payment of interest on deferred awards in cash erodes the value of the award over a number of years and reduces both incentivisation and retention of key staff at the expense of the firm’s success and shareholders’ benefit.