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EU bonus rules may be eased for some lenders and investment firms, says Commission

EU rules on remuneration for credit institutions and investment firms have been effective in curbing risk-taking, but the application of some of the rules may be too costly and burdensome for smaller and less complex institutions and for some staff, the European Commission has said. 29 Jul 2016

Based on work done by the European Banking Authority (EBA), plus two public consultations and an external study, the Commission said the rules may be too onerous in some cases when compared to their prudential benefits.

"This is particularly the case when the rules on deferral and pay-out in instruments are applied in small and non-complex institutions or to staff with low levels of variable remuneration [and] when listed institutions are required to use shares to remunerate their staff," the Commission said.

The remuneration rules make up part of the EU's Capital Requirements Directive (CRD IV) which aims to protect the EU's taxpayers, financial systems and economies from any future financial crisis. Similar regulations have been adopted in other jurisdictions under a globally co-ordinated response to the 2008 financial crisis, set up by the G20 and steered by the Financial Stability Board (FSB).

A 2015 review by the EBA of existing EU guidelines on these remuneration rules concluded that certain requirements had to be applied by all firms subject to CRD IV. Properly interpreted, the directive did not permit any complete waiver of these requirements, even though this was the established regulatory practice for certain types of firm, the EBA said.

The EBA also concluded, however, that a complete waiver of some requirements could be appropriate and it recommended that the European Commission should consider proposing amendments to CRD IV to permit such waivers during a legislative review scheduled to take place in 2016. The recent report from the Commission is a response to those EBA recommendations.   

Financial regulation expert Graeme Standen of Pinsent Masons, the law firm behind, said: "The Commission has now decided that CRD IV amendments may be justified to allow waivers of both the deferred payment of part of the variable remuneration, or bonuses, of senior management and other material risk takers, and the payment of part of those bonuses in shares, bonds or other financial instruments of the employer or its parent. These waivers would be permitted for smaller and less complex institutions, and for identified staff who receive a low level of variable remuneration regardless of the size or complexity of their institution."

Impact assessments will now look into whether the relevant rules should be amended as proposed, the Commission said.

Věra Jourová, EU justice commissioner, said: "Our evaluation shows that there may be room to make remuneration rules more proportionate and less burdensome from an administrative perspective, in particular for smaller and less complex credit institutions and investment firms. But we will make sure that any adjustments to the rules do not affect financial stability, which remains the overarching objective."

If the amendments to CRD IV are made, the Commission will consider whether similar amendments should be made to deferral and payment in instruments requirements set out in other directives that apply to different types of financial services firm, such as those managing undertakings for collective investments in transferable securities or alternative investment funds, it said.

The Commission will also consider further amending CRD IV to permit listed institutions to meet the requirement for the part payment of bonuses in instruments by using "linked instruments" rather than only employer shares or bonds, as currently required. Linked instruments are contractual entitlements that closely track the value of the relevant shares or bonds and expose the employee beneficiary of the contract to similar risks and opportunities to the holding of those shares or bonds.

Incentives and remuneration expert Suzannah Crookes of Pinsent Masons said that some listed banks and investment firms would appreciate being able to use linked instruments rather than only shares or bonds for the payment of incentives to identified staff.

"Some types of firm subject to CRD IV make proportionately greater use of variable remuneration than is common in other sectors, and also have a high proportion of highly paid staff working below board level, many of whom will be identified staff," Crookes said.

"Rewarding executives and employees with shares of course has complexities, costs and constraints for any business, as well as many benefits, and these issues tend to become more onerous as the percentage of share capital committed to employee incentives goes up. That always meant that difficulties were likely to arise from the CRD IV requirement for listed firms to pay bonuses in shares or bonds rather than linked instruments. An ability to use linked instruments instead would therefore be welcomed, although creating appropriate linked-instrument incentives will certainly require expert specialist advice," she said.

The Commission's report said it is too early to assess the impact of the CRD IV bonus cap rules. These have been in force since the start of 2015 and restrict senior staff bonuses to 100% of their fixed remuneration in any given year, or 200% with the agreement of shareholders. 

"[The] review found that for the time being there is insufficient evidence to draw final conclusions on the impact of the rule on competitiveness, financial stability and staff working for non-EEA subsidiaries. It seems that conclusive findings can only be reached once more implementation experience is gained," the Commission said.

This is disappointing, said Standen, who said it  "seems an odd thing to say, since CRD IV expressly requires the Commission to review these potential impacts of the bonus cap this year".

Standen said: "One particularly jarring note sounds from the effective dismissal of concerns about potential negative outcomes of the bonus cap for financial stability, by a statement that 'at this early stage' these concerns 'can be considered to be unsubstantiated'. This seems little different from saying that these concerns cannot be assessed until we experience another financial crisis, which would rather miss the point when assessing rules supposedly designed to fend off any repeat of the 2008 crisis. At the same time, other sections of the report express similar logic to that of arguments that the bonus cap must be counter-productive to its claimed purpose of promoting financial stability and better risk management."

"Fortunately, the UK regulators have already made it clear that they will continue to permit the waiver of the bonus cap by smaller UK-supervised institutions, both credit and investment firms, in defiance of the revised EBA guidelines that will apply from 1 January 2017," Standen said.

"We expect the global FSB to analyse further this year whether the bonus cap approach is counter-productive in terms of promoting financial stability, as has been suggested by parties including the UK's Prudential Regulation Authority (PRA) and the International Monetary Fund (IMF)," he said.

"This analysis will probably appear in a report to the G20 in September, and it could throw much more weight behind arguments that the bonus cap approach should not be used. Of course, the G20 and FSB cannot impose policies upon the EU, but as the financial system is now so globally interdependent, one would expect other nations to press strongly for the reform of any regulation that they believed could undermine the EU's financial stability. In this context, it is worth recalling that the bonus cap is an EU speciality, and the only part of the CRD IV remuneration rules that does not also appear in the globally agreed G20 / FSB prudential requirements for remuneration in systemically important financial institutions," Standen said.

How much this will matter to the UK will depend on the final Brexit deal with the EU, said Crookes.

"Since the bonus cap is EU-specific, but the other remuneration rules broadly reflect the global G20 / FSB approach, the key aspect of CRD IV in this context is the bonus cap itself. It seems likely that the City may have to accept continuing compliance with CRD IV in full, if it retains access to the EU single market, but that might perhaps be an acceptable cost," she said.

"If the UK does not seek or achieve single market access post-Brexit, then the CRD IV rules will only apply to UK firms to the extent that those firms operate within the EU or EEA and remain subject to EU regulation. While many believe that, in general, the City very much wants continued access to the single market, it is also clear that this may be difficult to achieve politically, both domestically and with the EU," Crookes said.