CEBS issues final form guidelines on CRD III

On Friday 10 December 2010, following the public consultation in relation to its draft guidelines, the Committee of European Banking Supervisors ("CEBS") issued its final form Guidelines on Remuneration Policies and Practices (the "Guidelines") in relation to the remuneration principles contained in the amendments to the Capital Requirements Directive ("CRD III").

The Guidelines, which will come into force with effect from 1 January 2011, do not go as far as some of the participants in the consultation process would have liked. However, they do provide important clarification on a number of areas, in particular the application of the rules on a proportionate basis. The Guidelines are not binding on the FSA, but are likely to influence the FSA significantly in its implementation of the UK rules which are due to be published by the end of this week.

PROPORTIONALITY

• All or nothing approach to neutralisation in relation to numerical criteria- it remains the case that for "non-complex" institutions and for specific Identified Staff who have less material impact on the risk profile, complete neutralisation can apply to the following requirements (if reconcilable with the risk profile, risk appetite and strategy of the institution and subject to justification in respect of each requirement):
  • Minimum deferral period of three to five years;
  • Minimum portion of 40% to 60% of variable remuneration to be deferred; and
  • Minimum portion of 50% variable remuneration to be paid in instruments.

However, CEBS has confirmed (at paragraph 19 of the Guidelines) that, because the criteria set out in CRD III are stated to be minimum requirements, for "complex" institutions, it is not possible to apply proportionality at an institution-wide level to reduce the periods or percentages specified.

Therefore, if there is insufficient justification for complete neutralisation of any of these requirements, then the relevant minimum criteria will apply and it will not be possible to argue for a relaxation of criteria in order to defer a percentage lower than 40%, defer for a shorter period than three years or to pay less than 50% in instruments. If, of course, complete neutralisation can be justified, it will be open to firms to apply their own internal requirements on deferral which may be more lenient than those specified above.

In addition, it would still be possible to potentially justify a proportionate application of these rules at the level of individual Identified Staff, even in a "complex" institution, where the relevant individual or group of individuals had a less material impact on the risk profile.

This 'all-or-nothing' approach on its face fails to recognise that there can be differing levels of complexity of activities as between the different entities in any group structure. However, groups which are unable to satisfy the required justifications in relation to complete neutralisation on a group-wide basis or for categories of employee, may still be able to justify complete neutralisation at the level of an individual group entity where this is warranted by underlying differences between its business activities and those undertaken by other group entities (see paragraph 27 of the Guidelines).

• Proportionate approach confirmed for limited licence and limited activity investment firms- CEBS has confirmed (at paragraphs 14 and 20 of the Guidelines) that investment firms falling into these prudential categories will be subject to a more proportionate regime, as they present a lower prudential risk profile. In particular:
  • the requirement to set an appropriate ratio between the fixed and variable components of total remuneration can be completely neutralised for such investment firms if this is reconcilable with the risk profile, risk appetite and strategy of the institution; and/or
  • proportionality would apply in relation to ex-ante risk adjustment (although this cannot become completely neutralized) and specific features of such investments firms can be taken into account when determining relevant performance criteria, including in respect of the requirement for there to be a multi-year framework.

• LLPs - CEBS has confirmed in its Feedback document that the principle of proportionality could, where appropriate, apply to LLPs on the basis that the partnership structure naturally aligns itself to risk management principles by removing conflicts of interest.
• Disclosure - The Guidelines state that remuneration disclosures can be made on a proportionate basis and that, as a result, small or non-complex institutions may only be expected to provide some qualitative information and very basic quantitative information where appropriate.

VARIABLE REMUNERATION – SPECIFIC RULES

50% deferred and 50% upfront element to be paid in instruments

• As confirmed in the CEBS Public Consultation meeting in November of this year, CEBS considers that it is not able to depart from the requirement in CRD III that 50% of the variable remuneration is paid in instruments and 50% in cash and that these proportions apply both to the deferred and non-deferred components. Therefore, there will be a de facto limit on up-front cash bonuses for Identified Staff of 20% to 30% in institutions which are not able to completely neutralise the relevant requirements. Unless the FSA allows for a sale of the restricted instruments to be sold or liquidated to cover tax liabilities, this fails to address the considerable taxation issues that may arise in this context and will inevitably lead to more complex arrangements being required to reduce the immediate tax burden on employees subject to the rules.

Pro-rata vesting, no sooner than 12 months

• Confirmation is given in the Guidelines that vesting of deferred instruments cannot take place sooner than 12 months after the end of the accrual period. Annual (or longer period) vesting of deferred remuneration is recommended as good practice as shorter periods would not, in CEBS's view, allow a proper assessment of risk and performance of the employee.

Payment of bonus in own managed funds

• CEBS has confirmed that, when part of a bonus is paid or deferred into own managed funds, this variable remuneration can be considered to be "equity or equity like" provided that the overall risk alignment structure of the remuneration corresponds to the CRD III expectations.

APPLICATION TO NON-EEA BASED STAFF

• Non-EEA based staff who perform duties for EEA-based entities - There is no exemption under the Guidelines for non-EEA based staff who perform services or duties for an EEA institution. In such circumstances, the default position would appear to be that the remuneration requirements of the jurisdiction of the relevant EEA institution should be followed. It is hoped that the FSA will provide additional clarity, in particular for non-EEA headquartered institutions with senior managers based outside the EEA whose primary duties are owed to the non-EEA parent but who also have certain responsibilities in relation to one or more EEA group institutions.

IMPLEMENTATION TIMEFRAME

• CEBS acknowledges flexible approach to implementation may be required - the Guidelines state (at paragraph 10 of the Guidelines) that firms should undertake "urgent actions to immediately start the process for the adoption of the Guidelines" and confirm that CRD III does not contain any transitional provisions. However CEBS does acknowledge that some steps in the process may take time (including those requiring shareholder approval or amendments to employment contracts and/or collective agreements). It also confirms that, if deemed appropriate, supervisors can take this into consideration in their supervisory responses related to the implementation of CRD III and the guidelines by 1 January 2011. This approach seems to be compatible with that of the FSA, which has, so far, proposed a six month transitional period for extended scope firms in implementing its revised Remuneration Code.

Institutions now await the final word from the FSA on the implementation of CRD III in a UK context.