The European Commission intends to replace the existing Capital Requirements Directive (2006/48/EC and 2006/49/EC) (CRD) with a regulation and a directive: the proposed Capital Requirements Regulation (CRR) and the proposed CRD IV Directive. The detailed EU report on the proposal dated 2 March 2013 (and subsequent press release) set out the principles on the issue of a capped ratio on the fixed and variable component of remuneration and shareholder involvement. The proposal and discussion on a possible challenge to the Directive have attracted a good deal of attention from the banking community and media alike.
Impact of the Directive
| What is changing? | In relation to remuneration, the following principles were agreed: basic salary-to-bonus ratio will be 1:1 but could be raised to a maximum of 1:2 with the approval of shareholders. This higher ratio would require at least 66% of votes in favour, with a quorum of 50% of shareholders; 75% of votes in favour, if less than half the shareholders vote. To encourage more of a link between remuneration and long-term risk, a percentage of the whole bonus could be deferred for at least five years (in the form of long-term deferred instruments (LTDIs)), in which case such proportion may, as discussed below, be discounted for the purposes of the proposed ratio. The rules also raise thresholds of high-quality capital that banks need to set aside in case of future losses, dubbed "Tier 1" capital. Under EU rules, banks will be required to hold a minimum of 8% of Tier 1 capital on their balance sheets from 1 January 2014.Banks will be required to declare their profits, turnover, taxes paid and number of employees in every country in the 27 nations in the EU. |
| Which firms will be affected by CRD IV | Like the Capital Requirement Directive itself, CRD IV will apply directly to credit institutions and to investment firms (firms that fall within the scope of the Markets in Financial Instruments Directive (2004/39/EC) (MiFID)). The provisions currently set out in the CRD that specifically apply to prudential standards for investment firms will be included in the CRR. |
| Which staff will be affected? | This will depend on the draft regulatory standards decided by the European Banking Authority (EBA), who have been asked to identify qualitative criteria to identify categories of staff whose professional activities have a material impact on an institution's risk profile. It may also depend on how the directive is to be transposed into UK law by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) (following the disbanding of the FSA), who will consult on any changes to their respective Handbooks. Staff working at subsidiaries of European companies operating outside of the EEA will also be affected by the new provisions.The existing Remuneration Code (SYSC 19A of the FSA Handbook), is applicable to staff who are deemed "Remuneration Code Staff", including: senior management, risk takers and staff engaged in control functions. It also applies to employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the firm's risk profile. |
| Are there likely to be any significant changes? | Major concessions to the UK are now unlikely at the top political level. However, more minor concessions may still be won. For example, it was announced that for the purposes of the above ratio, variable remuneration can include long-term deferred instruments (LTDIs) which can be appropriately discounted, and that the EBA will be preparing guidelines on the applicable discount factor, taking into account factors such as inflation rate, risk and appropriate incentive structures. The EBA will draft regulatory technical standards to determine the appropriate proportion of the variable component which can be deferred in the form of LTDIs (provisionally agreed as being limited to a maximum of 25%), as well as specifying the classes of instruments that can be deemed an LTDI. The deadline for the submission of these technical standards is 31 December 2013. |
Implementation and scope for legal challenge
| Implementation in the UK | CRD IV is likely to be implemented through Treasury Regulation and the FSA Handbook. Both the FCA and PRA are likely to be involved in both the implementation and the subsequent supervision of firms. The PRA will be the prudential regulator for banks, building societies, credit unions and major investment firms while the FCA will be the sole regulator for the majority of investment firms. Once the legislation is finalised, the UK regulatory bodies are likely to issue a consultation document with draft implementing measures and guidance. |
| Is it legal? | The Lisbon Treaty 2007 (Treaty on the Functioning of the European Union) acts as the EU constitution. Under the section covering social policy, Article 153, section 5, states that the European Parliament and the Council's (the member states) ability to modify policy in this area "shall not apply to pay". However, the EU proposal is put forward as provisions to deal with systemic and macro-prudential risk by amending the Capital Requirements Directive (not social policy). Further, the European Commission may argue that the proposal would not regulate total pay, merely the proportion of variable to fixed pay. |
| International scope | The Directive will have an extra-territorial impact and this may result in a violation of international trade agreements and the risk of legal challenge. |
| Potential solutions | Once the detail of the proposed Directive and Regulation is known, it will become clearer what strategies may be adopted to minimise the impact of the measure. Complex anti-avoidance measures are inevitable. However, credit institutions and investment firms will look to their advisers for innovative ways of mitigating the impact of the measures. Ideas being floated include increasing fixed pay, withholding salary during the year and re-structuring remuneration for valued senior individuals by offering ownership/shareholdings to allow the individuals to benefit from profits alongside shareholders. |
| Next steps | The Commission shall review and report on the application of these provisions with the European Banking Authority, taking into account its impact on competitiveness and financial stability. The Commission should examine whether a fixed ratio regime should continue to apply to any staff working effectively and physically in subsidiaries established outside the EEA, where the parent institution is established within the EEA. The time frame for transposition of the directive is provisionally 1 January 2014 but this may slip; there must be at least 6 months between the date of publication of the legislation in the Official Journal and the date of transposition/application unless there is agreement for a shorter period than 6 months for transposition or a later date is adopted ie 1 July 2014. |
| Mark Ife Partner, Remuneration and Incentives T. +44 20 7466 2133 E. mark.ife@hsf.com |
Andrew Taggart Partner, Employment T. +44 20 7466 2434 E. andrew.taggart@hsf.com |
Lode Van Den Hende Partner, EU and International Law T. +32 2 518 1831 E. Lode.VanDenHende@hsf.com |
| Paul Ellerman Partner, Remuneration and Incentives T. +44 20 7466 2728 E.paul.ellerman@hsf.com |
Andrew Lidbetter Partner, Dispute Resolution T. +44 20 7466 2066 E. Andrew.Lidbetter@hsf.com |
Jemima Coleman Professional support lawyer T. +44 20 7466 2116 E. Jemima.Coleman@hsf.com |
This note does not represent legal advice and you are invited to contact us to discuss any of the matters set out above, or any other aspect of the new remuneration regime.
Key contacts
Steve Bell
Managing Partner - Employment, Industrial Relations and Safety (Australia, Asia), Melbourne
Emma Rohsler
Regional Head of Practice (EMEA) - Employment Pensions and Incentives, Paris
Disclaimer
The articles published on this website, current at the dates of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.