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Summary of Guidelines on Remuneration Policies and Practices

Core Content

The Committee of European Banking Supervisors (CEBS) issued guidelines on remuneration policies and practices in December 2010, in response to the systemic risks posed by inappropriate remuneration structures in the financial sector. These guidelines are aligned with the Capital Requirements Directive (CRD III) and the Financial Stability Board (FSB) Principles for Sound Compensation Practices, aiming to ensure that remuneration policies and practices support sound and effective risk management.

Main Goals and Principles

1. Legislative Basis and International Context

• Recital (1): The guidelines are a response to excessive and imprudent risk-taking that led to financial institution failures and systemic issues. Inappropriate remuneration structures are identified as a contributing factor.
• Recital (2): The CRD III requires credit institutions and investment firms to manage risks effectively. CEBS is tasked with developing guidelines that align with the principles in Annex V of the CRD.
• Recital (13): The principles from the Commission Recommendation of 2009 are consistent with the CRD and support its objectives.
• Recital (14): The guidelines do not override fundamental rights, including those related to labor and shareholder involvement.
• Recital (19): CEBS is responsible for developing guidelines to promote supervisory convergence and transparency in remuneration practices across the banking sector.

Structure and Goal of the Guidelines

• The guidelines are structured around three main blocks: governance, risk alignment, and transparency.
• Proportionality is a key principle applicable across all three blocks.
• The guidelines aim to ensure risk alignment in remuneration practices and to provide clear and consistent standards for both institutions and supervisors.
• Disclosures are required for both internal and external stakeholders, with the goal of enhancing transparency and enabling effective oversight.

Scope of the Guidelines

1.1.1. Which Remuneration?

• Remuneration includes all forms of payments or benefits made directly or indirectly by institutions in exchange for professional services.
• It is divided into fixed remuneration (not based on performance) and variable remuneration (dependent on performance or other criteria).
• Non-monetary benefits such as health insurance, fringe benefits, and special allowances may also be included.

1.1.2. Which Institutions?

• The guidelines apply to credit institutions and investment firms as defined in the CRD III.
• Institutions not subject to MiFID (e.g., those not authorized to provide investment services) are not covered by these guidelines.
• Proportionality is considered for investment firms that do not engage in high-risk activities.

1.1.3. Which Staff to be Identified?

• Identified Staff are those whose professional activities have a material impact on the institution's risk profile.
• Key categories include:
  • Senior management (e.g., directors, CEO, chairman of management body).
  • Staff responsible for day-to-day management (e.g., members of management committees, individuals reporting directly to corporate bodies, heads of significant business lines).
  • Independent control functions (e.g., compliance, risk management, internal audit, CFO).
  • Other risk takers (e.g., individual traders, credit officers, trading desks).

Governance of Remuneration

• Institutions must ensure robust governance arrangements that support sound remuneration practices.
• Management body is responsible for designing, approving, and overseeing remuneration policies.
• Remuneration Committee should be established to ensure proper oversight and reporting.
• Control functions must be independent and have appropriate authority to monitor and assess remuneration practices.
• Shareholders' involvement is also emphasized, particularly in decision-making related to remuneration.

Risk Alignment Requirements

3.1. Basic Principle of Risk Alignment

• Remuneration policies should promote sound and effective risk management.
• Pension policies must align with the institution's risk profile and long-term interests.
• Discretionary pension benefits should not undermine the risk alignment objectives.

3.2. General Prohibitions

• Guaranteed variable remuneration is only allowed in limited contexts (e.g., new staff in the first year).
• Severance pay should reflect performance over time and not reward failure.
• Personal hedging and remuneration-related insurance are prohibited as they may undermine risk alignment.

4.1. Fixed vs. Variable Remuneration

• Variable remuneration should be flexible but not encourage excessive risk-taking.
• The ratio between fixed and variable remuneration should be considered to ensure alignment with the institution's risk profile.

4.2. Risk Alignment of Variable Remuneration

• A risk alignment process must be in place to ensure that variable remuneration reflects risk exposure.
• Common requirements include:
  • Time horizon for risk and performance measurement.
  • Levels of risk and performance.
  • Use of quantitative and qualitative measures.
  • Judgmental measures where necessary.
• Risk measurement and performance measurement are essential to ensure alignment.
  • Performance measures should be qualitative and quantitative.
  • They should be relative/absolute and internal/external.

4.3. Award Process

• Pools of variable remuneration should be set and allocated based on risk and performance.
• Quantitative ex-ante risk adjustment and qualitative measures are used to ensure alignment.
• The risk adjustment should be part of the award process.

4.4. Payout Process

• Non-deferred and deferred remuneration are both allowed, with specific rules on:
  • Time horizon and vesting.
  • Proportion to be deferred.
  • Time span between end of accrual and vesting of deferred amounts.
• Cash vs. instruments:
  • Instruments (e.g., shares, options) should be used to ensure retention and risk alignment.
  • A minimum portion of remuneration should be in the form of instruments, distributed over time.
• Ex-post risk adjustments:
  • Explicit adjustments can be made based on actual performance and risk outcomes.
  • Implicit adjustments are also allowed.
  • Upward revisions may be made if necessary.

Disclosure Requirements

• Pillar 3 external disclosure requires institutions to disclose general remuneration policies and practices.
• Internal disclosure ensures transparency within the organization.
• The guidelines encourage consistent and comparable disclosures to facilitate effective oversight and supervision.

Implementation and Timeline

• The guidelines should be implemented in line with the CRD III requirements, which are effective from 1 January 2011.
• Institution-wide application is required for some principles, while others apply only to Identified Staff.
• CEBS/EBA will monitor and review the implementation to ensure convergent application across the EU.
• Supervisors should apply risk-based supervision, focusing on institutions with higher risks.

Key Considerations

• Proportionality is a core principle for all blocks of the guidelines.
• Voluntary institution-wide application of specific requirements is encouraged to ensure consistency.
• Supervisors must ensure that remuneration policies do not allow circumvention of the guidelines.
• Retention bonuses are allowed only if they meet risk alignment criteria.
• The guidelines aim to ensure fair and effective supervision, with a focus on transparency, governance, and risk management.