Remuneration policy has been implemented at the European level explaining that one main factor of the financial crisis was the inappropriate remuneration structure of certain institutions of the financial sector. More precisely, it was generally recognized that "excessive remuneration in the financial sector fuelled a risk appetite that was disproportionate to the loss-absorption capacity of institutions and of the financial sector as a whole".(1)
In this framework, the Commission de Surveillance du Secteur Financier (hereafter the « CSSF ») issued on 11 March 2011 the Circular 11/505 relating to the implementation of remuneration policies within the financial sector and specifying the application of the proportionality principle (hereafter the "Circular 11/505") (2).
The purpose of this Circular 11/505 is to detail the rules laid down in CSSF circulars 10/496 (3) and 10/497(4) (hereafter the "Circulars CRD III") transposing Directive 2010/76/EU of the European Parliament and of the Counsel dated 24 November 2010 as regards capital requirements for trading books and re-securitizations, and the prudential supervision of remuneration policies (hereafter the "CRD III").
The Circular 11/505 mainly explains the application of the proportionality principle by credit institutions and investment firms when the latter implement their remuneration policies in accordance to CEBS Guidelines (5) on Remuneration Policies and Practices (hereafter the "CEBS Guidelines") published on 10 December 2010 (which are attached to the Circulars CRD III).
The Circular 11/505 also specifies the situations in which financial institutions, typically presenting a lower prudential risk profile, could avoid or neutralized certain remuneration policies according to the proportionality principle.
1- The scope of the remuneration policies
The CEBS Guidelines and the Circular 11/505 aim to specify to which institutions and to which category of staff the remuneration policies shall apply.
The institutions concerned by the remuneration policies:
Pursuant to Circular 11/505, Circulars CRD III apply, under a solo basis, to credit institutions and investment firms incorporated under Luxembourg Law (except some investment firms which are not included in the scope of the CSSF Circular 10/497 (6) and to their foreign branches. Circulars CRD III also apply to branches of non-European credit institutions and investments firms.
Furthermore, mother companies which are supervised by the Luxembourg CSSF under the consolidated control or under the complementary control are also concerned by the remuneration policies.
The Circular 11/505 also states that the mother company of a group has to consider the specificities of the local Laws applicable to its subsidiaries (i.e. the Luxembourg Law if it is a Luxembourg subsidiary) in implementing the remuneration policies at the level of the group.
The staff members concerned by the remuneration policies:
Among the concerned institutions, only few staff members are concerned by the remuneration policies, i.e. those "whose professional activities have a material impact on therisk profile" of the institution. It is the responsibility of each institution to identify the staff members to be concerned. The CEBS Guidelines provides guidance and criteria to the institutions for such identification (7) and considers that the following staff members are concerned (unless it is demonstrated that they have no material impact on the institution's risk profile) (hereafter referred to as the "Identified Staff"):
- Members of the Board (Directors, Chief executive officer, chairman of the management, etc.);
- Staff responsible for independent control functions (senior staff responsible for heading the compliance, risk management, human resources, internal audit, etc.);
- Other risk takers such as staff members whose professional activities can exert influence on the institution's risk profile;
- employees/ persons, whose total remuneration takes them into the same remuneration bracket as senior managers and risk takers who have a material impact on the risk profile of the institution.
In general, the remuneration policies aim to restrict and supervise all aspects of the remuneration including salaries, discretionary pension benefits and similar benefits and particularly focus on the payment of variable remuneration.
2- The proportionality principle
According to the CEBS Guidelines (point 19), the proportionality principle aims to "consistently match the remuneration policies and practices with the individual risk profile, risk appetite and the strategy of the institution".
The effect of the proportionality principle is that financial institutions have not to give substance to the remuneration requirements in the same way and to the same extent.
In that way, institutions will need to apply more sophisticated policies in fulfilling the CRD III's requirements while other institutions can meet these requirements in a simpler manner.
The proportionality principle may lead however to the neutralization of some requirements as it is reconcilable with the risk profit, the risk appetite and the strategy of institution.
The CEBS Guidelines also specify that the institutions have to carry out their self-assessment in order to adapt their remuneration policies with their risk profile.
In this respect, the Circular 11/505 provides additional guidelines to help institutions to proceed to their self-assessment and to identify when the proportionality principle applies and when they could be allowed to neutralize certain requirements.
The proportionality principle distinguishes between two dimensions of proportionality and could be applied at two levels: at the level of the different type of institutions and at the level of the Identified Staff.
1-The proportionality principle at the level of the institutions
The Circular 11/505 reminds criteria defined by the CRD III for the application of the proportionality principle which are the size of the institutions (i.e. the value of the assets; liability or risk exposure), their internal organization (i.e. the legal structure) and the nature, scope and complexity of their activities (i.e. the type of authorized activities, the type of client). Those criteria have to be combined.
The Circular 11/505 provides more specific criteria which may be taken into account:
- For credit institutions:
According to the Circular 11/505, credit institutions are allowed to apply the proportionality principle if those two criteria are concurrently fulfilled, on a solo and consolidated basis:
- The total assets does not exceed EUR 5 billion; and
- The global capital requirement to cover risks is less than EUR 125 (based 100%) or respectively EUR 1,562,5 million
- For investment firms:
Investments firms are allowed to apply the proportionality principle if the net result of their activities is lower than 20% of the global net result before taxation.
When credit institution or investment firms fulfilled the above criteria, there are allowed to neutralize the following requirements (8):
- the minimum portion of 50 % of variable remuneration should be paid in instruments (shares or other instruments);
- the minimum portion of 40 % of variable remuneration should be deferred for at last three or five years;
- the retention policy: the portion of the variable remuneration (including any deferred part thereof) may be adjust and may be paid only if the payment is compatible with the financial situation of the institution; The establishment of a remuneration committee which shall be in charge of the establishment of decisions relating to the remuneration policies.
If credit institutions or investment firms exceed the above criteria (and as a result cannot apply the proportionality principle at the institution level) they could invoke the proportionality principle at the Identified Staff level.
2. The proportionality principle at the level of the Identified Staff:
The CSSF considers that any member of the Identified Staff whose annual variable remuneration which is lower or equal to EUR 100,000 can reasonably be considered as a risk taker who has a limited material impact on the risk profile of the institution and as a result could apply the proportionality principle.
The institution has to justify and to be able to demonstrate whether a person has a limited material impact on the risk profile of the institution.
If the proportionality principle applies the following requirements could be neutralized (9):
- the minimum portion of 50 % of variable remuneration should be paid in instruments (shares or other instruments);
- the minimum portion of 40 % of variable remuneration should be deferred for at last three or five years;
- the retention policy: the portion of the variable remuneration (including any deferred part thereof) may be adjusted and may be paid only if the payment is compatible with the financial situation of the institution.
The application of the proportionality principle does not mean that the institutions may not establish a remuneration policy. The neutralization does not apply automatically and has to be justified by the institutions.
1- Point 1 of the CEBS Guideline
2- http://www.cssf.lu
3- The CSSF circulars 10/496 relates to the credit institutions
4- The CSSF circulars 10/497 relates to the investment firms
5- http://www.eba.europa.eu
6- See point 2 of the CSSF Circular 11/505
7- Point 1.1.3. of the CEBS Guideline
8- Requirements enunciated at the points 4-1 (n), (o) and (p) and 4-2 (2) of the CSSF Circulars 10/496 and 10/497
9- Requirements enunciated at the points 4-1 (n), (o) and (p) of the CSSF Circulars 10/496 and 10/497
