Alignment with risk and long-term performance

The alignment between the payment of remuneration and risk-taking and long-term performance follows the path of ensuring that payment is adjusted for all types of risk and designed to capture any ramifications in the future to ensure sustainable performance. Achieving this is possible using ex-ante and ex-post measures. Ex-ante measures, which have immediate effect on risk-taking behaviour, require institutions to adjust remuneration to all types of risk afterwards when assessing the performance of their staff (which should be based on defined objectives and financial and non-financial criteria related to the business strategy and risk appetite of the firm).136 This adjustment is done by using risk measurement methods based on quantitative and qualitative measures which require judgement and are less transparent and less accurate than the quantitative measures. This adjustment is also encouraged for periodic re-assessment to ensure a multi-year performance framework which is also encouraged for the payment of a deferred part of the remuneration.137

Since the ex-ante risk-adjustment using risk measures has its own shortcomings as not all risks can be fully taken into account, the ex-post measures of malus and clawback also apply.

135 _{ibid 650.}

136 _{CEBS Guidelines on Remuneration (n 100) paras 86 & 95.} 137

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Deferral of at least 40 to 60 per cent of remuneration depending on the seniority and responsibility of the staff for at least three to five years or more depending on the future risk and business cycles is introduced to help in operating the ex-post measures.

In addition to that, the payment of variable remuneration should be divided and at least 50 per cent should be paid in shares, share-linked instruments, and equivalent non-cash instruments for non-listed firms or other instruments which reflect the credit quality of the institution as a going concern. These instruments apply to the payment of deferred and upfront parts of the variable remuneration.138 However, these instruments must be retained after vesting for both the upfront and deferred instruments139 to ensure their effectiveness as a mean of aligning reward with performance and exposing executives and traders to the downside of their decisions.

Therefore, institutions need to use a back-testing or performance adjustment to ensure that the

ex-ante risk adjustment was correct and accurate. When the actual risk outcome is different from the initial calculation, institutions are expected to reduce the value of the deferred part of the remuneration.

Institutions are encouraged to set specific criteria for applying malus and clawback. These criteria apply to when the staff member participated in or was responsible for conduct which resulted in significant losses to the institution and/or failed to meet appropriate standards of fitness and propriety. The CEBS already recommended some criteria under the CRD III which should include the following: evidence of misbehaviour or serious error by staff; significant downturn in the business unit and/or the institution; significant failure of risk management in the institution and/or the business unit; or significant changes in the institution’s economic or capital base.140

However, a new feature of the CRD IV is that 100 per cent of variable remuneration is subject to malus and clawback. It is worth mentioning that malus cannot be applied to the vesting part of instruments even if they are subject to the retention period, and staff cannot sell them as the vested part in the view of the CEBS belong to the staff and in this situation the institution can apply clawback.141 However, clawback is 138 _{ibid para 122.} 139 _{ibid para 128.} 140 _{ibid para 137.} 141 ibid para 132.

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very limited in application and is relevant only in cases realting to fraud or misleading information.

5.5.2.5 Disclosure

The disclosure requirement in the CRD IV is included in the regulation so it is directly applicable to member states and there is no need for implementation.142 In order to ensure greater transparency, a remuneration report is required on at least an annual basis. The required report must include detailed information of any remuneration policies relating to staff whose activities have a material impact on their risk profile. This information includes matters concerning the decision-making process; information on the link between pay and performance; the most important design characteristics of the remuneration system; information on the performance criteria on which entitlement to shares is based; the ratios between fixed and variable remuneration set in accordance with the directive; aggregate quantitative information broken down in two ways: by business area as well as senior management and members of staff whose actions have a material impact on the risk profile of the institutions. The latter type of aggregate information must include: the amount of fixed and variable remuneration and the number of beneficiaries; the amount and forms of variable remuneration; the amount of outstanding deferred remuneration indicating what has been vested and what has not; and any signing-on and severance payments made during the year along with the number of beneficiaries specifying the amount and the highest award of severance payment.

Unlike CRD III, CRR has included a new requirement to disclose the number of individuals receiving EUR one million or more per financial year, for remuneration between EUR one million and five million broken down into pay bands of EUR 500 000 and for remuneration of EUR five million and above broken down into pay bands of EUR one million.143

In accordance with the proportionality principle, institutions may comply with the disclosure requirement which is appropriate to their size, internal organization and the nature, scope and complexity of their activities. For example, small or non-complex institutions are only expected to provide “some qualitative information and very basic quantitative information

142 _CRR. 143

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where appropriate”. Certain types of information may also be exempt from disclosure on the basis of materiality, their proprietary nature or confidentiality.144

Presently, however, there are no specific requirements as to how such information is to be disclosed, although the CEBS Guidelines make it clear that the information must be “easily accessible”.145

There is a similarity between the requirements of the FSB and the CRR with regard to disclosure requirements. However, both sets of requirements have failed to incorporate the most demanding disclosure requirements, as there is no requirement for the disclosure to be individualized.146