EU: CRD IV - New definition of "Code Staff": key issues and summary of the draft rules

The European Banking Authority ("EBA") has published draft regulatory technical standards on the definition of Identified Staff ("Code Staff" under the UK Remuneration Code) which, when finalised, will create compulsory rules on classifying Identified Staff.

These standards are intended to harmonise the rules as to which staff are treated as Identified Staff and who are therefore subject to the more onerous of the current CRD III remuneration provisions, as well as the cap on variable pay being introduced by CRD IV.

The standards are being introduced in response to a survey on the implementation of the existing CRD III remuneration provisions, which the EBA states showed that the range of staff being identified varied significantly between Member States and between institutions, and "sometimes failed to identify appropriately staff members for which the regulatory requirements regarding the payment of remuneration should be applied".  CRD IV therefore included a provision mandating the EBA to develop regulatory standards with respect to quantitative and qualitative criteria for the purposes of identifying staff whose professional activities should be deemed to have a material impact on the risk profile of the institution.

Key Issues

The key issues arising from the draft regulatory standards are:

• The standards will have direct effect across Europe, and so will not be subject to interpretation by local regulators. 
• The standards create a list of 12 criteria, of which if any one is met, the staff member must be treated as Identified Staff (without any further consideration by the firm as to whether or not the individual in fact has a material impact on the risk profile of the firm).
• The standards sets a further 2 criteria which create a presumption of the staff member being Identified Staff.  These criteria are capable of capturing relatively lower paid staff.
• The compulsory criteria for treating a staff member as Identified Staff include:
  • any staff member receiving total remuneration of €500,000 or more;
  • all senior management; heads of risk control, compliance, audit, legal, tax, HR and IT functions; and heads of any business unit or geographical location;
  • staff who have authority to commit to credit risk exposure of 0.25% or more of Tier 1 capital;
  • traders who have authority to commit to transactions which represent an own funds requirement for market risks of 0.25% or more of Tier 1 capital (or where an internal model based approach is used, represents 5% or more of the institution's internal value-at risk limit); and
  • any manager of other Identified Staff or of staff collectively who would satisfy any of the criteria (such as a head of a desk). 
• Firms must also create additional internal criteria for classifying Identified Staff to fully reflect the risks affecting the firm. 

The standards make no changes to the remuneration rules applicable to staff who are Identified Staff.  This means that firms that fall within Proportionality Level 3 in the UK will continue to be able to rely on the proportionality principle to disapply certain of the remuneration requirements, including the most onerous risk alignment principles applicable to the remuneration of Code Staff.  However, the broader definition of Code Staff will still affect these firms, as it will be mean more staff must be included on the Code Staff list and these staff will then also be caught by the remuneration disclosure provisions.

Timing

The draft standards are due to be finalised by the EBA at the "beginning of 2014".  They must be formally adopted by the European Commission, and then published in the Official Journal (following which they will take effect 20 days later).

The standards are therefore likely to come into force during 2014. Our assumption is that firms will be expected to be in compliance by the start of the next remuneration round, although this is not addressed by the EBA.

The EBA Criteria

The list of criteria is set out in two parts, referred to as the Qualitative Criteria and the Quantitative Criteria.

Qualitative Criteria

The staff member shall be treated as having a material impact on the firm's risk profile if the staff member:

(a) is a member of the management body;

(b) is a member of senior management;

(c) is responsible to the management body for the risk control function, the compliance function or the internal audit function;

(d) heads a business unit. This would apply to any staff member heading "any separate organisational or legal entities, business lines [or] geographical locations";

(e) heads a function responsible for legal affairs, tax, HR, IT, budgeting, economic analysis, or business continuity planning;

Criteria (a) to (c) and (e) are broadly in line with the roles that are currently listed in the FCA Remuneration Code.  However, under the FCA Remuneration Code, the factors were subject to the requirement that those staff members in fact had a material impact on the risk profile of the firm.  This will no longer be the case, such that staff members who fall within any of the Qualitative Criteria will now automatically be Identified Staff.

(f) has, individually or collectively with other staff members, authority to commit to credit risk exposures of a nominal amount per transaction representing 0.25% or more of Common Equity Tier 1 capital (the "credit risk" criterion);

(g) has, individually or collectively with other staff members, authority to commit to transactions on the trading book which in aggregate represent either (i) where the standardised approach is used, an own funds requirement for market risks of 0.25% of Common Equity Tier 1 capital; or (ii) when an internal model based approach is used, 5% or more of the internal value-at-risk limit for trading book exposures at a 95th percentile, one-tailed confidence internal level (the "market risk" criterion).  This criterion does not apply to small institutions that do not have to apply the trading book rules;

(h) has managerial responsibility for a group of staff members whose individual authorities in respect of credit or market risk in aggregate exceed the thresholds set out in (f) or (g) above;

(i) has managerial responsibility for a staff member who is Identified Staff; or

(j) has, individually or collectively, the authority to take, approve or veto decisions on the introduction of new products, material processes or material systems.

The EBA states that (f) is intended to capture staff members taking credit risks, both through the granting of credit and also by entering into positions which contain other credit risks (the EBA gives the example of "bonds"). 

(g) is intended to capture staff members who have a material impact on the market risk of an institution.  The EBA states that as market risk limits are generally set for traders or for desks, this limit "should be reasonably straight forward to apply".

The reference in (f), (g) and (j) to the criteria  being satisfied "collectively" will capture both staff who are responsible for  advising on or initiating the commitments or decisions; and staff who are members of a committee which has authority to make such commitments or decisions.

Quantitative Criteria

The staff member shall be treated as having a material impact on the firm's risk profile if the staff member:

(a) could (under the terms of the firm's remuneration policy) be awarded variable remuneration that exceeds both (i) 75% of fixed remuneration; and (ii) € 75,000;

(b) has been awarded total gross remuneration in one of the two preceding years which is equal to or greater than the lowest total remuneration paid to a staff member that meets one of the Qualitative Criteria or is Identified Staff pursuant to the firms additional internal criteria;

Both (a) and (b) of the Quantitative Criteria create a presumption that that staff member is Identified Staff.  This means that, where the staff member would be Identified Staff solely by reason of falling within (a) or (b), the firm can treat the staff member as not being Identified Staff if both the individual's role does not have a material impact on risk and the individual in fact does not have a material impact on risk (taking into account a number of factors, including total remuneration). 

Criteria (a) measures the remuneration that could potentially be paid to the individual, and so applies irrespective of actual remuneration.  Firms will therefore need to look at each individual's earnings potential in the relevant year.

(c) has been awarded total gross remuneration of €500,000 or more in either of the two preceding years; or

(d) is within the 0.3% of staff who received the highest total gross remuneration in either of the preceding financial years. 

The Quantitative Criteria set out in (c) and (d) are not presumptions, and instead a staff member who satisfies either of (c) or (d) is to be automatically treated as Identified Staff.

According to the 2011 benchmarking data, the EBA states that the average total remuneration of risk takers was €508,000.

In response to an EBA survey, 23 firms across the EU provided data on the number of individuals that would be caught as Identified Staff above certain pay thresholds.  At the limit chosen by the EBA of €500,000, this would result in the number of Identified Staff across those firms increasing from 1,792 to 4,796.  That increase is attributable to an increase in the number of Identified Staff in 11 of the 23 firms, whereas 12 of the firms reported that a threshold of €500,000 would have no effect on the number of Identified Staff. 

In applying the Quantitative Criteria, the full value of remuneration paid or awarded needs to be taken into account, excluding any discount to variable remuneration applied in determining the cap on variable remuneration.  Any amounts awarded but not paid (including amounts subject to deferral) are to be valued as at the date of award.

For part time staff, remuneration is to be valued on a full time equivalent basis.

For more information please contact Paul Ellerman, Mark Ife or Bradley Richardson in Hernert Smith Freehills' Remuneration and Incentives team.