CRD 3 and restrictions on remuneration in the financial services sector
An amended version of CRD (the “Capital Requirements Directive”) 3 was published on 30 September 2010 by the Council of Europe.
On 10 December 2010 the Committee of European Banking Supervisors (“CEBS”) published new guidelines on the Capital Requirements Directive (“CRD 3”). These new guidelines are covered separately in our “Breaking News – New CEBS Guidelines Published on 10 December” article, click here.
CRD 3 is to amend CRD in the following areas: remuneration policies; trading book; re-securitisations; and, disclosure of securitisation risks.
The CRD set out the requirements for credit institutions and investment firms to comply with Basel II. It was adopted in June 2006.
CRD 3 applies to directly to credit institutions, for example, banks and building societies, and to investment firms within the scope of MiFID.
The Commission believes that the remuneration arrangements in the financial sector played a significant part in causing the credit crunch. It believes that those remuneration arrangements encouraged excessive risk taking in order to realise short-term profits, at the expense of the long-term health of the financial sector.
CRD 3 required the Committee of Banking Supervisors (“CEBS”) to produce guidance on remuneration policies and practices. In October 2010 CEBS published a consultation on the draft text of this guidance known as CP42. CP42 is expected to be finalised in December 2010 but its guidelines are more readily understood than CRD 3 itself.
Firms must comply with CRD 3 “in a way and to the extent that is appropriate to their size, internal organisation and the nature, the scope and the complexity of their activities”. This means that not all firms have to apply the remuneration requirements in the same way and to the same extent.
The factors that should be taken into account when assessing proportionality include: size; internal organisation and nature scope and complexity.
Which members of staff are caught by CRD 3?
CP42 states that the following staff members are caught: senior management; risk takers; staff engaged in control functions and, any employee whose total remuneration takes them into the same remuneration bracket as senior management and risk takers.
CRD 3 requires firms to have a remuneration policy and CP42 sets out some guidance on what should be taken into account when drafting the remuneration policy.
It is expected that CRD 3 will be published in its final form in the Official Journal by the end of 2010. It is anticipated that its provisions concerning remuneration will be in force from 1 January 2011.
On 4 November 2010 the FSA announced that they would undertake a month long consultation on CRD 3. The FSA now expects to publish its policy statement containing its final remuneration code in December 2010.
CRD 3 Remuneration
CRD 3 splits remuneration into fixed remuneration and variable remuneration.
CP42 states that remuneration includes both monetary and non-monetary benefits.
A maximum ratio of variable to fixed remuneration for relevant staff.
What firms should consider when they pay variable remuneration.
When should be taken into account when determining performance related remuneration.
At least 50% of variable remuneration will not be in cash. Instead it will be comprised of an appropriate balance of shares or equivalent ownership interests and tier 1 hybrid securities.
The ratio between fixed and variable remuneration.
Some financial services firms may have to pay bonuses partly by way of convertible bonds. These bonds would be convertible into equity if either the firm’s performance or market conditions required the firm to increase its regulatory capital.
At least 40% of variable remuneration (rising to 60% where the variable remuneration is particularly high) will have to be deferred for not less than 3 to 5 years. This is to allow for post award adjustment of variable remuneration.
Additional CRD 3 requirements
Additional requirements of CRD 3, as currently drafted, include the following:
The systems and controls that should be in place.
External disclosure of remuneration.
It is likely that income tax and social security contributions and CRD 3’s retention requirements will be an area of concern for some employees. This is due to the fact that there may be a requirement to pay tax upfront on the shares or other instruments and this could exceed the amount of upfront cash paid to the employees.