EBA Guidelines on Sound Remuneration Policies under IFD

The GSR IFDs are part of the overall package of revised regulatory requirements for the remuneration systems of investment firms. The starting point for this are the requirements of the EU legislator in the EU Regulation 2019/2033 (IFR) and in the Directive (EU) 2019/3420 (IFD). The German legislator had to transpose the requirements of the IFD on remuneration systems into domestic law by 26 June 2021 (Art. 67 (1) IFD). On 15 April 2021, the German Bundestag passed the German Investment firms Act (Wertpapierinstitutsgesetz, WpIG), which contains regulations on the remuneration systems of investment firms in Section 46 WpIG and an ordinance authorisation for the Investment firms Remuneration Ordinance (Wertpapierinstituts-Vergütungsverordnung, WVV). BaFin published the draft of the WVV on 4 May 2021 (WVV-E). The final version of the WVV is expected at the end of the first half of 2022.

In Art. 26 (4) and 34 (3) IFD, the European legislator has mandated the EBA to issue the GSR IFD in order to ensure, among other things, a coherent and, as far as possible, consistent application of the supervisory requirements in the national legal regulations. To this end, the EBA published a first draft of the GSR IFD on 17 December 2020 and subsequently conducted a consultation procedure. The final version of the GSR IFD takes into account some of the comments and proposed amendments submitted during the consultation process.

1. The teleological starting point of the IFD: Prudential proportionality principle... and its reception in the GSR IFD

With the revised requirements, the legislator uncouples the remuneration systems of investment firms from the previously generally applicable regulatory regime for the remuneration systems of institutions. The modification of the regulatory framework is based on the maxim of the regulatory principle of proportionality, which allows for less stringent requirements for the content of the remuneration systems for many investment firms in view of the lack of deposit-taking business.

The regulatory principle of proportionality affects the legal requirements for remuneration systems in investment firms on two levels:
From a formal point of view, the legislator has determined a three-part regulatory system for the revised supervisory remuneration regime (see already our Client Alert on the WVV-E). The IFD and the other revised supervisory remuneration regulations cover medium-sized investment firms, i.e. investment firms that do not fulfil at least one of the criteria relevant for the qualification as a small securities institution in Art. 12 (1) IFR, i.e. they engage in proprietary trading, have a total balance sheet and off-balance sheet amount of EUR 100 million or more or have assets under management (AUM) of EUR 1.2 billion or more.

From a material point of view, Art. 30 (3) IFD stipulates that Member States shall ensure that the statutory requirements of the IFD on remuneration systems are to be applied by (medium-sized) investment firms in a manner that is appropriate to the size and internal organisation of the investment firms and the nature, scope and complexity of their activities.

The EBA takes these two dimensions of the prudential proportionality principle into account in its specific pronouncements in the GSR IFD on the individual IFD regulatory subjects.

2. Personal scope of IFD: Remuneration policy and gender-neutral remuneration policy for all employees in medium-sized investment firms

The EBA clarifies in the GSR IFD with regard to the specific scope of application of the IFD on remuneration systems that the general requirements of the IFD on the implementation of a remuneration policy and on the supervisory guiding principle of gender-neutral remuneration policies and practices (Art. 26 para. 1 p. 1 lit., d), p. 2 IFD) apply to the remuneration systems of all employees of medium-sized investment firms.

In the consultation process, the proposal was made to prescribe the remuneration policy only for the remuneration systems of the Identified Staff Members ("ISM"). The WVV-E also stipulates the implementation of the remuneration policy only for the remuneration systems of the ISM. The EBA rejects such a restriction with reference to Art. 26 (1) IFD, which does not contain such a restriction.

3. Similar content remuneration rules for institutions and investment firms: GSR IFD in line with the EBA GSR 2.0 - taking into account the prudential principle of proportionality

With regard to the requirements of the IFD for the remuneration systems of medium-sized investment firms, which are identical in content to the requirements of CRD V (Directive 2019/978/EU) for the remuneration systems of institutions, even after the independent regulation in the IFD, the GSR IFD are based on the guidelines already announced by the EBA in its Guidelines 2021/04 on Sound Remuneration Policies under CRD (EBA GSR 2.0), whereby the EBA modifies the supervisory expectations for individual regulatory items with a view to the supervisory proportionality principle. The requirements under the IFD, which are identical to the requirements under the CRD V, apply in particular:

• to the provisions of the remuneration strategy, which must also be in line with the ESG strategy for investment firms and therefore take into account the relevant ESG criteria (Par. 16 GSR IFD);
• to the provisions of the remuneration policy (formal and content related requirements), which must include (1) the documentation of the identification of the ISM, (2) the documentation of the analysis of the remuneration components granted to the employees and their regulatory classification as fixed remuneration or variable remuneration (the German legislator has implemented the relevant criteria for the classification as fixed remuneration in Sec. 2 (6) WVV-E), and (3) with regard to any variable remuneration granted, the performance parameters and the criteria for measuring their success, the payment system and the system for ex-ante and ex-post risk adjustment (Par. 20 et seq. GSR IFD);
• to the formal and content-related requirements and remuneration governance provisions with regard to the gender-neutral remuneration policy (paragraphs 26 et seq. GSR IFD). In this respect, the same challenges arise for the investment firms as for the institutions (see already our Client Alert on EBA GSR 2.0);
• with regard to ISM's remuneration system, the guiding principles for the performance parameters of variable remuneration at the levels of corporate, divisional and individual objectives and their risk-adjusted measurement (Par. 191 et seq. GSR IFD);
• with regard to the requirements for retention payments, the requirement of the so-called specific performance condition (Par. 141 GSR IFD; see already our Client Alert on EBA GSR 2.0);
• the requirements for the hedging prohibition, whereby medium-sized investment firms only have to establish a process for random checks of the institution-related securities accounts of employees for compliance with the hedging prohibition if hedging measures can in fact be carried out via these (Par. 174 et. GSR IFD);
• the content requirements for the supervisory classification of severance payments as variable remuneration and the corresponding privileged groups of cases in which the specific severance payment is not to be regarded as variable remuneration for supervisory purposes (Par. 167 GSR IFD).
  

4. Remuneration policy in line with adequate capitalisation - the concrete criteria for capitalisation

The remuneration policy - and thus the determination and granting of the respective variable remuneration components - must be in line with sufficient capital resources (Par. 19 GSR IFD). The EBA states in Par. 118 et seq. GSC IFD the concrete assessment criteria for sufficient capitalisation. Medium-sized investment firms have to determine the individual variable remuneration components with a risk-conservative approach and, to this end, observe the supervisory requirements of the IFD on the raising of their own assets and their composition as well as on the Common Equity Tier 1 capital. In application of the regulatory principle of proportionality, the regulatory requirements deviate from the more restrictive requirements for the remuneration systems of institutions, which also require the consideration of the regulatory requirements for risk-bearing capacity, liquidity and capital buffer requirements for the determination of variable remuneration.

5. Determination of the ratio between variable and fixed remuneration

The remuneration policy must also contain the determination of an appropriate ratio between fixed remuneration and variable remuneration and an associated upper limit for variable remuneration. The EBA explicitly specifies this guideline (only) for the variable remuneration of ISMs, with reference to the requirement of Art. 30 (2) IFD. From a remuneration governance perspective, medium-sized investment firms will apply the specified cap to the variable remuneration of all employees in the remuneration policy.

In the GSR IFD, the EBA, in application of the principle of proportionality under supervisory law, does not announce any absolute quantitative specifications for the upper limit. Such a limit is also not specified in the WVV-E (Sec. 6 (1) WVV-E). (Medium-sized) investment firms should determine the individual upper limit taking into account their business and risk strategy and the concrete influence of the individual employee on the risk profile of the institution - and the associated monetary risk and behaviour control function that the variable remuneration has to assume in the remuneration system for a risk-compliant behaviour of the employees (Par. 201 et. GSR IFD). These guidelines mean that in individual cases it may be appropriate to set different upper limits for individual groups of employees. The EBA also states that investment firms should be able to justify the specific limit(s) set (Par. 207 GSR IFD).

6. Special requirements for the variable remuneration of the ISM

With regard to the specific requirements of Art. 32 IFD for the variable remuneration of ISMs, the following EBA pronouncements Par. 208 et. seq. are worth mentioning:

• Investment firms may determine the scope of the variable remuneration components covered by the deferral and the duration of the deferral period, taking into account the statutory lower limits (40%, 3 years) and the guiding parameters set out in Par. 255 et. seq. GSR IFD to determine the guiding parameters as required. A separate differentiation for the variable remuneration of the Management board and the senior management level is not mandatory from a supervisory point of view (it may be appropriate in individual cases).
• In the GSR IFD, the EBA does not make any absolute specifications with regard to the amount of the "particularly high variable remuneration", which is to require the withholding of at least 60% of the variable remuneration components covered by the withholding. In this regard, a possible announcement by BaFin in the interpretation guidelines to the WVV will have to be awaited. In practice, the threshold value of EUR 500,000 stipulated for institutions in Section 20 (3) s. 2 InstitutsVergV can be used as a guideline (until BaFin has published the interpretation guidelines).
• The instruments-based portion of the variable remuneration is to be selected from the catalogue of Art. 32 (1) lit. j) IFD. If the investment firm cannot offer instruments in accordance with Art. 32 (1) lit. j) IFD, the firm must apply to the competent supervisory authority for the implementation of an alternative arrangement and shall comply with the requirements for the alternative arrangement set out in Par. 267 et seq. GSR IFD for the alternative design. Dividends or comparable capital gains accruing on the instrument-based portion during the retention period shall be collected by the investment firm for itself.
• Investment firms must ensure that the malus and clawback provisions are applied effectively under national labour law (Par. 283 GSR IFD). In this respect, investment firms face the same challenges under labour law (in particular with regard to the restrictive case law of the German Federal Labour Court on the effectiveness of general terms and conditions (control), especially of clawback provisions) as institutions.
  

7. Entry into force and preview

The GSR IFD will entry into force on 30 April 2022. Investment firms shall apply them for the first time in the financial year following 31 December 2021. For investment firms with a calendar year financial year, this requires a first-time application in the calendar year 2022.

For investment firms with their registered office in Germany covered by the GSR IFD, this timeframe of requirements is linked to the status quo that the German legislator has not yet completed the procedure for enacting the WVV. In this regard, BaFin announced in its announcement of 2 November 2021 that it will conduct another consultation procedure on the draft WVV in the first quarter of 2022.

A supervisory contradiction-free application of the GSR IFD will (however) only be possible after the enactment and publication of the WVV.

We accompany the further development of the legislative procedures.