EU Publishes Recommendations On Risk-Taking Employees' Renumeration

by Ulrika Lomas, Tax-News.com, Brussels

04 May 2009

The European Commission has adopted a Recommendation on remuneration in the financial services sector. It recommends that Member States should ensure that financial institutions have remuneration policies for risk-taking staff that are consistent with and promote sound and effective risk-management.

The Recommendation sets out guidelines on the structure of pay, on the process of design and implementation of remuneration policies and on the role of supervisory authorities in the review of remuneration policies of financial institutions. The Commission has also adopted a Recommendation on directors' pay.

Internal Market Commissioner Charlie McCreevy said: “Up to now, there have been far too many perverse incentives in place in the financial services industry. It is neither sensible nor sane that pay incentives encourage excessive risk-taking for short-term gain. The G20 agreed that the FSF's tough new principles on compensation schemes should be implemented. The Commission is leading the way. Incentives need to be aligned with long-term, firm-wide profitability. Of course, remuneration levels should continue to be based on performance. But performance criteria should be risk-adjusted and take into account cost of capital and liquidity. Design and oversight of remuneration policies should remain the responsibility of the board and not be delegated to senior management. An increased role of supervisory authorities in the review of remuneration practices is also needed to promote sound remuneration practices in financial institutions.”

The Recommendation invites Member States to adopt measures in four areas:

• Structure of pay: remuneration policies for risk-taking staff should be consistent with and promote sound and effective risk management. For this purpose, financial institutions should strike an appropriate balance between the level of the core pay and the level of the bonus. The payment of the major part of the bonus should be deferred in order to take into account risks linked to the underlying performance through the business cycle. Performance measurement criteria should privilege longer-term performance of financial institutions and adjust the underlying performance for risk, cost of capital and liquidity. Financial institutions should also be able to claim back already paid bonuses, where data has been proven to be manifestly misstated (claw-back).
• Governance: remuneration policy should be transparent internally, should be clear and properly documented and contain measures to avoid conflicts of interest. The board should have responsibility for oversight of the operation of the remuneration policy for the financial institution as a whole with an adequate involvement of internal control functions and human resources departments or experts. Board members and other staff involved in the design and operation of remuneration policies should be independent.
• Disclosure: remuneration policy should be adequately disclosed to stakeholders. The disclosure should be made in a clear and easily understandable way and contain core elements of the remuneration policy, its design and operation.
• Supervision: supervisors should ensure, using the supervisory tools at their disposal, that financial institutions apply the principles on sound remuneration policies to the largest possible extent and have remuneration policies consistent with effective risk management. In order to address the question of proportionality, supervisors should take account of the nature and scale of the financial institution and the complexity of its activities in order to assess its compliance with the principles on sound remuneration policies.

The Recommendation takes due account of efforts already made by several Member States and aims to foster these developments by identifying best practices to ensure greater convergence in the EU. The Recommendation covers all sectors of the financial services industry so as to avoid loopholes and prevent distortions of competition between different sectors and financial institutions. The principles apply to all categories of staff whose professional activities have a material impact on the risk profile of the financial institution.

The Recommendation will be followed up by legislative proposals to bring remuneration schemes within the scope of prudential oversight. In June, the Commission will present proposals to revise the Capital Requirements Directive to ensure that regulatory capital adequately covers the risks inherent in banks' trading book, securitisation positions and remuneration policies, continued the Commission’s statement.

After one year, the Commission will examine both Recommendations in the light of the experience acquired and of the outcome of the monitoring and will submit an evaluation report on Member States' application of both Recommendations.

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