[Editor’s Note: The following update is authored by Davis Polk & Wardwell LLP]
Introduction
The move toward stricter regulation of remuneration in the financial services industry in the European Union has resulted in a confusing web of overlapping European Directives and local EU Member State law and regulation, each of which seeks to place limits on remuneration. This client memorandum aims to assist in navigating the new European labyrinth by providing a snapshot of the three main European Directives that regulate remuneration:
- Capital Requirements Directive IV (CRD IV)
- Alternative Investment Fund Managers Directive (AIFMD); and
- Fifth Undertakings for Collective investment in Transferable Securities Directive (UCITS V).
In addition, this memorandum discusses the European Securities Market Authority’s (ESMA) recent Markets in Financial Instruments Directive (MiFID) Guidelines on remuneration policies and practices. The memorandum then considers the additional requirements on remuneration that the UK is planning to impose in relation to the financial services industry.
Pan-European law and regulation on remuneration
Banks and other financial instituions (CRD IV)
CRD IV, which was published in the Official Journal of the European Union on June 27, 2013, includes restrictions on bonus payments by credit institutions and investment firms.
Who
Entities: all credit institutions (including banks) and investment firms in the EU and the non-EU subsidiaries of such entities; in addition, EU subsidiaries of financial institutions headquartered outside the EU.
Individuals: employees whose professional activities have a material impact on the risk profile of the relevant financial institution, including senior management, risk takers, employees engaged in control functions and employees whose total pay puts them into the same bracket as senior risk management and risk takers.
What
Variable pay: “variable pay” is capped at 100% of total fixed pay or, with shareholder approval, 200% of total fixed pay. Variable pay includes payments or benefits that depend on performance and, in exceptional circumstances, other contractual elements that do not “form part of a routine employment package” (examples of routine elements of compensation noted in the Directive include healthcare, child care facilities or proportionate regular pension contributions). EU Member States have the discretion to adopt stricter standards (e.g., lower bonus caps).
Skin in the game: at least 50% of any variable pay must consist of shares or equivalent ownership interests (or share-linked or equivalent non-cash instruments, for non-listed institutions).
Deferred payment: at least 40% of any variable pay must be deferred over a period of at least three to five years.
Clawback arrangements: up to 100% of variable pay will be subject to clawback or malus arrangements. Financial institutions will be required to set specific criteria for such arrangements.
When
EU Member States have until December 31, 2013 to implement CRD IV into local law that should be applicable from December 31, 2013. The ratio of variable to fixed pay will apply to “services provided or performance from the year 2014 onwards, whether due on the basis of contact concluded before or after 31 December 2013.”
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