New EU rules on bankers' pay (including the bonus cap)
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Briefing
New EU rules on bankers’ pay
(including the bonus cap)
May 2013
Summary
On 16 April 2013, the European Parliament
approved the text of CRD 4, which will, among
other things, impose a cap on bankers’ bonuses.
This briefing considers the main provisions.
Freshfields Bruckhaus Deringer llp New EU rules on bankers’ pay 1
May 2013
On 16 April 2013, the European Parliament the existing requirements of CRD 3 but
approved the text of CRD 4, which will, the provisions in question potentially
among other things, impose a cap on apply to bonuses paid in 2014 in respect
bankers’ bonuses. The basic principles, of performance in 2013.
trailed since a compromise between the
European Parliament, Commission and However, implementation of the cap has been
Council was reached in March, remain delayed until 1 January 2015. Following last
unchanged. These are as follows: minute discussions, article 151 of CRD 4
makes it clear that the provisions on the ratio
• there will be a basic ratio of fixed pay between fixed and variable remuneration
to variable pay of 1:1 with some flexibility (article 90 (1) (f)) only apply to ‘remuneration
to increase that ratio to 1:2 with awarded for services provided or
shareholder approval; performance from the year 2014 onwards.’
The Council’s press release adds that ‘the
• up to 25 per cent of the bonus can be first bonuses to be affected will be those paid
paid in long term instruments valued in 2015 in respect of performance in 2014.’
on a discounted basis (to result in an
effective ratio of more than 1:2). If more The Commission will review and report
than 25 per cent of the bonus is paid in on the impact of the rules by 30 June 2016,
this way, any excess over the 25 per cent assessing their implementation and
will not benefit from the discount; and enforcement and the impact on
competitiveness and financial stability.
• the rules will apply to EU banks operating In particular the Commission must consider
in the EU (including in relation to their whether the bonus cap should still continue
employees based outside the EU) and to to apply to staff of EU financial institutions
non EU banks operating in the EU. working outside the EEA. But by this time
The ratio between fixed and variable pay bonuses for 2014 and 2015 will already have
will only apply in respect of work done from been subject to the cap.
2014 onwards. Therefore, bonuses paid in
2014 but which relate to performance in
Institutions within scope
2013 do not need to comply with the ratio.
Bonuses paid for performance in 2014 will CRD 4 applies to banks and credit
need to comply – even if the arrangement institutions.
was entered into before the date of CRD 4.
However, the introduction of a ratio between
fixed and variable pay might have wider
Timing consequences and there might be a knock-on
impact on other parts of the financial
The European Parliament has voted on the services industry. The Alternative Investment
text in plenary session so there will be no Fund Managers Directive may already be too
further changes to the text. far progressed for any cap to bite in July
Most of the provisions relating to when it is due to be implemented but, in a
remuneration will have to be complied recent vote, the Economic and Monetary
with either from 1 January 2014 or from Affairs Committee at the European
1 July 2014, depending on the publication Parliament showed support for the
date of the directive in the Official Journal. introduction of a similar ratio in the revised
For the most part these provisions will UCITS directive. If a ratio is confirmed in
have less significant impact as they reflect UCITS, it would impact asset managers who
run retail funds marketed in Europe.
2 Freshfields Bruckhaus Deringer llp New EU rules on bankers’ pay
May 2013
Geographical scope Critically, the standard quantitative criteria
would identify staff as material risk takers
The rules apply to EU based financial
if any of the following applies:
institutions at parent company and
subsidiary levels, including staff of EU • their total annual remuneration
based institutions working outside the EEA. exceeds €500,000;
For financial institutions headquartered
outside the EU, it is only in scope employees • they fall within the highest earning
working within the EEA who are affected. 0.3 per cent of staff within the bank;
• their remuneration bracket is equal to
or greater than the lowest total
People in scope
remuneration of senior management
CRD4 defines Identified Staff as ‘senior or other risk takers; or
management, risk takers, staff engaged
in control functions and any employee • their variable remuneration exceeds
receiving total remuneration that takes €75,000 and 75 per cent of the fixed
them into the same remuneration bracket component of remuneration. In other
as senior management and risk takers, words, an employee with a fixed salary
whose professional activities have a material of €100,000 and a bonus of €80,000
impact on their risk profile.’ In the UK would be caught.
these categories would be recognised as The EBA suggests that there would be a
‘Code Staff’ within the existing FCA narrow exemption under which individuals
Remuneration Code. who have been identified solely on the basis
However, the European Banking Authority of (iii) and (iv) above (remuneration bracket
(‘EBA’) published a consultation paper on and variable income) can be excluded if they
21 May which suggests a radical shift in can demonstrate that the staff member has
approach in applying this test when in fact no material impact on the bank’s risk
compared to the identification of Code Staff profile. It is not clear how easy this would be
under current rules. For many banks, the to show and the bank will start on the back
EBA proposal could increase materially the foot as the presumption is that these
number of bankers who are caught and to individuals would be caught. It should be
whom the bonus ‘cap’ and other elements noted that this exception would not be
of CRD4 will therefore apply. available for anyone whose total
remuneration exceeds €500,000 or falls
The proposal focuses on a combination of within the top 0.3 per cent of earners. As the
standard qualitative and quantitative criteria EBA puts it: ‘for staff receiving a particularly
and internal criteria to be developed by the high remuneration it can be assumed that
bank. Importantly, only one of these criteria they always have a material impact on the
needs to be met for an individual to be a institution’s risk profile.’
member of Identified Staff.
The EBA’s proposals will therefore create
The standard qualitative criteria proposed significant concerns for banks, if adopted.
by the EBA would relate to the role and
decision-making power of staff members. The consultation period closes on 21 August
this year. The EBA’s regulatory technical
The internal criteria would be based on standards (RTS) in this area will be finalised
internal risk assessment processes and aim at the beginning of 2014.
at reflecting the specific bank’s risk profile.
Freshfields Bruckhaus Deringer llp New EU rules on bankers’ pay 3
May 2013
The ratio between fixed and variable Staff who may benefit from any increased
remuneration ratio and who are also shareholders may
not vote on the proposal.
The ratio between fixed and variable
remuneration is set at 1:1. Finally, the final wording of CRD 4 allows
Member States to set a stricter ratio between
Member States can allow this ratio to be fixed and variable remuneration. The text
increased to 1:2 with the approval of also makes it clear Member States are not
shareholders. The standard for obtaining obliged to introduce a discount rate for long
shareholder approval is very high and term instruments.
effectively requires a super-majority –
a 66 per cent majority from shareholders
representing a quorum of at least 50 per cent Malus and clawback
of the voting shares and if that quorum is
not achieved, then a 75 per cent majority All of the variable remuneration must
is needed. be subject to the possibility of malus
or clawback.
Up to 25 per cent of the total variable
remuneration may be awarded in the form
of discounted long term instruments. Deferral
These are instruments that are deferred
At least 50 per cent of the variable
for not less than 5 years and which may
remuneration must consist of shares or
be valued for the purposes of calculating
equivalent ownership interests or
the ratio on a discount rate basis. Any long
instruments which reflect the credit quality
term instruments in excess of 25 per cent
of the institution as a going concern or which
will not benefit from the discount rate.
can be written down or converted to equity
The EBA will be required to issue guidelines in adverse circumstances (eg contingent
by March 2014 on the applicable discount convertible bonds).
rate to apply to long term instruments
At least 40 per cent of the variable
(taking account of all relevant factors
remuneration must be deferred over a period
eg inflation rate and risk). Valuation
of not less than three to five years. Where
methodologies will have to be robust
the variable remuneration component is of a
enough to withstand regulator scrutiny.
particularly high amount (in the UK this is
If shareholders are asked to approve an currently set at £500,000), at least 60 per cent
increase in the 1:1 ratio they must be must be deferred.
provided with a detailed recommendation
which provides the reasons for and scope
of the approval sought, the number of staff
Proportionality
affected, their functions and the expected The principle of proportionality will apply
impact on the institution’s capital base. so that smaller and less complex institutions
may not be bound by the full rigour of the
The institution must also provide its
fixed/variable remuneration ratios. This is
regulator with appropriate information
a matter for domestic implementation.
to demonstrate that the higher ratio
Until it is clear what approach applicable
does not conflict with the bank’s capital
national regulators intend to adopt, affected
adequacy obligations and the regulator will
institutions will need to plan on the basis
be required to benchmark institutions.
that the provisions will apply without
any relaxation.
4 Freshfields Bruckhaus Deringer llp New EU rules on bankers’ pay
May 2013
Remuneration committee the EU cannot fix levels of pay and is
inapplicable to matters that are linked to pay.
The obligation on financial institutions that
The Commission’s position is that overall pay
are significant in size and scope to establish
is not being fixed, only the ratio between one
a remuneration committee is familiar from
element of pay and another. During a press
CRD 3. In earlier drafts it was proposed that
conference in early March, Commissioner
the remuneration committee should include
Barnier repeated these views pointing out
one or more employee representatives unless
that there have been no suggestions that the
the inclusion of employee representatives
remuneration provisions in CRD 3 were
was prohibited by national law. However,
unlawful and warning banks not to seek to
the final wording has been softened and
launch any challenge by suggesting they may
now provides that: ‘If employee
wish first to consider any reputational issues.
representation on the management body
is provided for by national law, the
remuneration committee shall include one Contacts
or more employee representatives.’
Members from our CRD 4 team of
remuneration, regulatory and structured
Anti-avoidance finance experts would be very happy to come
and talk to you about the new rules and their
Anti-avoidance provisions will restrict
practical implications for your organisation.
the payment of variable remuneration
through vehicles or methods that facilitate For more information please contact
non-compliance with the ratios described
Simon Evans
above. This is likely to impact the efficacy
T +44 20 7832 7358
of structures that are designed to give banks
E simon.evans@freshfields.com
additional remuneration flexibility.
Alice Greenwell
Scope for legal challenge
T +44 20 7716 4729
There has been press speculation that there E alice.greenwell@freshfields.com
is a legal basis for challenging the ratios
described above. The Commission has been
forthright in dismissing such suggestions. Jocelyn Mitchell
One alleged ground for challenge is that the T +44 20 7832 7191
E jocelyn.mitchell@freshfields.com
remuneration provisions are not compatible
with EU law (Article 153(5) of the Treaty on
the Functioning of the European Union)
Nicholas Squire
which excludes pay from the competency of
T +44 20 7832 7419
the EU. The Commission’s view is that CRD 4
E nicholas.squire@freshfields.com
is a provision to address the activity of credit
institutions and investment firms, their
governance, and their supervisory Caroline Stroud
framework and is not based on the social T +44 20 7832 7602
provisions of the Treaty. The Commission E caroline.stroud@freshfields.com
has also stated that the EU laws that it has
been suggested could form the basis of a
challenge support only the proposition that
Freshfields Bruckhaus Deringer llp New EU rules on bankers’ pay 5
May 2013freshfields.com Freshfields Bruckhaus Deringer LLP is a limited liability partnership registered in England and Wales with registered number OC334789. It is authorised and regulated by the Solicitors Regulation Authority. For regulatory information please refer to www.freshfields.com/support/legalnotice. Any reference to a partner means a member, or a consultant or employee with equivalent standing and qualifications, of Freshfields Bruckhaus Deringer LLP or any of its affiliated firms or entities. This material is for general information only and is not intended to provide legal advice. © Freshfields Bruckhaus Deringer LLP, June 2013, 36102
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