BaFin-FAQ 1.0 on the Remuneration Ordinance for Institutions

The FAQ IVV includes the first official announcement of BaFin on the new version of the Remuneration Ordinance for Institutions (Institutsvergütungsverordnung, IVV) dated 20.09.2021 (IVV 4.0) as well as on the EBA Guidelines on Sound Remuneration Policies dated 02.07.2021 (EBA/GL/2021/04, "EBA-GSR 2.0"). The interpretative guidance on the IVV published by BaFin on 16 February 2018 ("BaFin Interpretative Guidance") still referred to the then applicable IVV (IVV 3.0). Therefore, practitioners had already expected BaFin to issue (new) pronouncements on the guiding principle of gender-neutral remuneration determined for the first time in IVV 4.0 (Section 5 (1) no. 6 IVV, see also our Client Alert, on the implementation of ESG criteria in the remuneration systems, as well as on the implementation of the extended requirements of Section 27 IVV 4.0 to the group-wide remuneration systems. The draft of the FAQ IVV has (only) partially fulfilled these expectations. 

1. Legal methodological starting point: FAQ IVV (also) as soft law to be indirectly observed by the institutions when implementing their remuneration systems

From a legal methodology point of view, the FAQ IVV - as the BaFin Interpretative Guidance and the EBA GSR 2.0 as well - do not include a law in the material sense. They are to be observed by the legal practitioner as so-called soft law when implementing the regulatory requirements in the remuneration systems. The starting point for the concrete application of the law is (unchanged) the legal wording of IVV and the further legal methodological elements for the interpretation of IVV. The pronouncements of BaFin in the FAQ IVV are to be considered as part of the historical and the teleological interpretation element when interpreting the individual provision of IVV.

2. Embedment of the FAQ IVV in the EBA GSR 2.0 and in the BaFin Interpretative Guidance

The FAQ IVV is, according to BaFin’s understanding in FAQ IVV, intended to replace BaFin's current interpretative guidance on the InstitutsVergV dated 15.02.2018 ("BaFin Interpretative Guidance"). At the same time, BaFin clarifies that it will continue the previous administrative practice in accordance with the BaFin Interpretative Guidance, unless it is updated by the FAQ IVV. Finally, BaFin clarifies in the preliminary remarks of the FAQ IVV that the EBA-GSR 2.0 are generally directly applicable; except the EBA's pronouncements in the EBA-GSR 2.0 that all CRR institutions, regardless of their size 

1. must identify Material Risk Takers (MRT) in accordance with Delegated Regulation 2021/923/EU (RTS-MRT 2.0) (this is only applicable to significant institutions (Section 1 (21) KWG) pursuant to Section 25a (5b) sentence 2 KWG, while all other CRR institutions must identify MRTs only based on the group of persons specified in Section 25a (5b) sentence 1 KWG); and
2. must implement clawback rules on variable remuneration (which the German legislator has only determined to apply to the variable remuneration of MRTs in (qualified non-) significant institutions in the amount of more than EUR 50,000 or where the variable remuneration exceeds one third of the MRT's total annual remuneration (Sections 18 (1) sentence 3, 20 (6) IVV)).

This results in the following graduated canon for the application of the pronouncements of the EBA and the BaFin in the application of the specific statutory provisions ("graduated canon of application"):

1. The EBA GSR 2.0 are to be applied as a starting point;
2. The FAQ IVV are to be consulted for circumstances not covered by the EBA GSR 2.0 (example: pronouncements in the FAQ IVV on the remuneration officer in significant institutions (Question 19)) or for which the application of proportionality appears to be required from the perspective of the German legislator (example: restriction of clawback circumstances to the aforementioned extent);
3. At the same time, the institution must review BaFin's pronouncements in BaFin Interpretative Guidance for the specific facts of the case and take them into account when applying the law, if these contain BaFin practice notes that go beyond the FAQ IVV. 

This graduated continued consideration of BaFin's administrative practice according to BaFin Interpretative Guidance in addition to the FAQ IVV increases the complexity for legal practice; in this respect, it remains to be seen whether impulses for a simplification of the application will be provided in the consultation procedure.

3. Guiding principle of gender-neutral remuneration policy: no pronouncement in the FAQ IVV

Section 5 (1) no. 6 IVV 4.0 adds - in implementation of Art. 74 (1), 92 (2) of Directive 2019/878/EU (CRD V) - the catalog of Section 5 (1) IVV on the regulatory adequacy of remuneration systems with the guiding principle of gender-neutral remuneration policy. The EBA determined in the EBA-GSR 2.0 for the implementation of this guiding principle in remuneration systems three implementation dimensions, according to which institutions (1) have to ensure from a content perspective that all aspects of the remuneration policy are gender-neutral, including the granting and payment conditions for remuneration; (2) have to demonstrate from a formal perspective that the remuneration policy is gender-neutral, and (3) have to establish appropriate tools in remuneration governance for effective monitoring of compliance with the gender-neutral remuneration policy. From a German labor law perspective, among others, the EBA's ideas were judged to be (too) far-reaching, particularly with regard to the works constitution law dimension (see only our Client Alert)

Against this background, practitioners expected BaFin to clarify the implementation of the guiding principle of a gender-neutral compensation policy in its latest announcement. This expectation was not met - the draft of the FAQ IVV is silent on this issue. Should the consultation process yield further findings in this regard, the institutions will have to come to terms with the three-dimensional implementation in accordance with the EBA pronouncements in the EBA-GSR 2.0 for the implementation of the guiding principle of gender-neutral remuneration policy in view of the embedding of the FAQ IVV and the BaFin interpretative guidance in the EBA-GSR 2.0.

4. Implementation of ESG criteria in remuneration systems (Question 8)

BaFin chooses a pragmatic way in the FAQ IVV for the implementation of the guiding principle of the EBA in the EBA-GSR 2.0 that the remuneration policy of the institutions also must be consistent with the ESG strategy of the institution and with the related risk-related environmental, social and governance objectives (para. 16 EBA-GSR 2.0). BaFin locates the implementation of ESG objectives in the remuneration strategy in accordance with Section 4 IVV - and allows the specific maturity of the institution's ESG strategy to suffice for its implementation. The practice must therefore establish (unchanged) concrete ESG targets in the remuneration systems as soon as the concrete ESG strategy has been implemented in a sufficiently concrete manner in the business and risk strategy.

5. Determination of the total amount of variable remuneration (Section 7 IVV): FAQ IVV in interaction with EBA-GSR 2.0 and BaFin interpretative guidance (Question 12).

The graduated application canon is exemplarily clarified in the BaFin pronouncements on the framework parameters for determining the total amount of variable remuneration pursuant to Section 7 IVV.
The BaFin Interpretative Guidance still contained very comprehensive explanations in this regard, particularly with regard to the relevant content-related and process-related framework parameters (implementation of the economic perspective and the regulatory perspective; bottom up/top down/combined system for determining the total bonus pool). In contrast, the FAQ IVV is limited to individual guiding principles with regard to content and process, which to a large extent were also already included in the BaFin Interpretative Guidance (for example, on BaFin's expectation (1) for the integrated assessment of the compatibility of the intended total amount of variable remuneration with the regulatory ancillary conditions of Section 7 (1) sentence 3 IVV, (2) on the content requirements and on early communication/coordination in the case of the intended determination of a total amount of variable remuneration in the event of a negative return, as well as (3) on the necessary assessment of compliance with the requirements of Section 7 (1) sentence 3 IVV both for the determination, for the vesting and for the payment of the respective variable remuneration component). In this respect, the institutions must comply with the requirements set out in margin no. 238 et seq. EBA-GSR 2.0 regarding, among other things, the system for determining the total bonus pool and the transparency of the system and the process.
The remarks published by BaFin for the first time in the FAQ IVV are helpful for the practice, namely that institutions intending to set an overall bonus pool (1) in the event of a shortfall in the own funds recommendation pursuant to Section 6d KWG can prove by means of documented capital planning if/that they will again comply with the own funds recommendation within the following three calendar years - even if the bonus pool is set, and (2) for subsidiary institutions with exemptions from the capital or liquidity requirements, in accordance with the provisions of Section 6d KWG. liquidity waivers in accordance with Article 7 CRR, Section 2a (4) KWG/Article 8 CRR, Section 2 (4) KWG.

6. Further pronouncements on the general requirements of the IIA for remuneration systems: Negative performance contribution (Question 6), recognition awards (Question 4), severance payments (Questions 10 and 11), hedging prohibition (Question 13).

Regarding the consultation process, the following further additional pronouncements in the FAQ IVV are worth mentioning:

• Negative performance contributions (Sections 2 (10), 5(2) IVV): BaFin clarifies that negative performance contribution solely includes cases of immoral or breach of duty behavior of the employee as well as cases in which the behavior or decisions of employees have led to objectively serious negative effects for the institution. BaFin therefore rejects the understanding, which has occasionally arisen in practice, that negative performance contributions within the meaning of Sections 2 (10) and 5 (2) IVV also include a negative deviation from the performance parameters of the performance-related variable remuneration components. In addition, BaFin announces that also non-significant institutions have to specify the aforementioned case groups of negative performance contributions in the Remuneration Guideline (Section 11 (1) IVV) and furthermore have to specify cases of serious negative performance contributions in the Remuneration Guideline, in which a reduction of the variable remuneration to zero has to take place. These concretization and transparency requirements can be implemented, for example, by defining a catalog of discretionary parameters.
• Recognition Awards: BaFin considers this widespread variable compensation component granted during the financial year to be permissible for non-MRTs as well as for MRTs in non-significant institutions under the following conditions: (1) determination of the performance parameters at the beginning of the financial year, (2) consideration of negative performance contributions pursuant to Section 5 para. 2 IVV and (3) inclusion in the review pursuant to Section 7 IVV with a review during the year indicated in the individual case and in this case (written) agreement of a repayment clause.
  
  For qualified non-significant institutions pursuant to Section 1 (3) sentence 2 IVV and for significant institutions pursuant to Section 1 (3c) KWG, BaFin announces that their MRT 'in principle' cannot be beneficiaries of Recognition Awards, as the Recognition Awards (already) cannot fulfill the one-year minimum assessment period pursuant to Section 19 (1) sentence 2 IVV (and the individual performance contribution is furthermore to be determined on the basis of the achievement of agreed targets). It remains to be seen in the consultation process whether this principle is also open to exceptions.

• Severance payments (Section 5 (6) IVV): The comprehensive announcements in the FAQ IVV partly repeat guiding principles from the BaFin Interpretative Guidance and enrich them with further findings of BaFin from recent severance payment practice. In the initial point, BaFin continues to understand severance payments solely as benefits intended to compensate for disadvantages arising from the premature termination of the employment/service relationship and thus continues to deviate from the more recent concept of severance payments under labor law, which is essentially aimed at bridging the gap until the next source of funding for livelihood (new employment relationship, pension). For the assessment of the permissibility of the specific severance payment under supervisory law, the following are to be assessed in particular: (1) Time of agreement (= contractual agreement before the occurrence of the termination event?), (2) Trigger (= generally no severance payment in the case of termination forced by the employee and in the case of termination of a fixed-term employment contract), (3) Extent of severance payment (= in the case of fixed-term employment contracts, remuneration owed as an alternative maximum severance payment until the expiry of the term, otherwise standard market severance payment factors in the case of termination of an employment contract for an indefinite period; special justification generally required for the granting of transitional allowances as non-compulsory benefits).
  
  For the case groups of privileged severance payments pursuant to Section 5 (6) sentence 5 no. 1 lit. d) IVV, the FAQ IVV define when legal proceedings are directly "threatened". This is only the case if a lawsuit is already pending before the court. Contrary to the wording of the provision, a mere declared threat of legal action is thus not sufficient. This could have a significant impact on previous practice.

In addition, BaFin clarifies with regard to Section 5 (6) sentence 5 IVV that (1) among other things, so-called sprinter/turbo bonus paymentes (as benefits in the event of termination of the employment prior to the next possible ordinary termination date, which correspond in amount to the capitalization of the fixed remuneration to be granted alternatively up to the ordinary termination date), as well as (2) severance payments to compensate for the entitlement to any foregone variable remuneration for the current assessment period may each be regarded as regularly appropriate severance payments pursuant to Section 5 (6) p. 5 no. 3 IVV. In addition, severance payments that fulfill more than one privileged circumstance within the meaning of Section 5 (6) sentence 5 IVV shall (now) regularly require a special explanation.

• Prohibition of hedging (Section 8 (2) IVV): In order to ensure compliance with the prohibition on hedging, each institution should establish further control instruments in its compensation governance in addition to the mandatory declaration of commitment, which should include in particular an obligation to conduct random checks, for example on employees' securities accounts. Non-listed institutions are to be exempt from such further control instruments if they are organized in the legal form of a Sparkasse under public law or a cooperative (Genossenschaft) with BaFin as supervisory authority, or if they conduct a market search for (non-)existing derivative instruments for hedging variable remuneration at least once a year. In this respect, BaFin is taking up an instrument for risk management of the hedging prohibition that has been established in practice in line with requirements. 
   

7. Selected pronouncements on the special requirements of the IVV for the variable remuneration of MRTs in (qualified non-) significant institutions (Questions 6 and 7, 15 to 18)

With regard to the special requirements of Sections 18 et seq. IVV on the variable compensation of MRTs, the following selected further pronouncements in the FAQ IVV are worth mentioning with a view to the consultation procedure:

• Application of a modifier for target achievement: BaFin continues to permit the application of a modifier for the institution/group level with a range of up to 20 percentage points. Institutions must document as many case examples as possible in the Remuneration Guideline to substantiate their discretion in this regard when finally determining target achievement. A differentiation of the application between different MRT groups shall be permissible if the underlying remuneration parameters justify a differentiation.
• Negative performance contribution pursuant to Section 18 (5) IVV and complete loss of variable remuneration pursuant to Section 18 (5) sentence 3 IVV: Section 18 (5) sentence 1 IVV continues to cover negative deviation from the performance parameters of variable remuneration in addition to conduct in breach of duty and immoral conduct or serious breaches of duty. BaFin also emphasizes the need for further specification of the individual indeterminate legal terms and here in particular for the "significant" regulatory sanctions and the "significant" supervisory measures within the meaning of Section 18 (5) sentence 3 no. 1 IVV as well as for the "serious degree" of violation of the internal or external regulations within the meaning of Section 18 (5) sentence 3 no. 2 IVV. The pronouncements reflect BaFin's observations on good practices - affected institutions will have to review their remuneration guidelines for relevant consideration of the recent pronouncements in the FAQ IVV.
• Instrument-based remuneration component (NWE component) at non-capital-market-oriented institutions: BaFin clarifies that the NWE component must include appropriate risk ratios (e.g., CET 1 ratio, risk cover amount) in addition to an earnings-related parameter. Institutions that are not potentially systemically relevant pursuant to Section 12 KWG should be able to use the institution-specific thresholds from the Section 7 IVV test to map their performance. This simplification, which was announced by BaFin for the first time, will meet with a positive response in practice.
• Weighting of the performance parameters pursuant to Section 19 (1) sentence 1 IVV in the variable remuneration of managing directors/management board members (Geschäftsleiter): Following on from the announcement on Section 19 IVV with the same content in the BaFin Interpretative Guidance, BaFin continues to consider the merging of the levels of organizational unit objectives and individual objectives to be permissible (in particular) for the remuneration systems of managing directors/B, provided that these account for a share of at least 30% of the overall objectives. In this regard, it remains to be seen in the consultation process whether the merger of the levels of the institution/group objectives and the objectives of the organizational unit, which is also being considered for similar reasons under supervisory law, will still be included in the FAQ IVV.

8. Pronouncements on compensation governance in significant institutions: Further concretization/complexity of the expectation on the equipment of the compensation officer (Question 19) and summary of the compensation control report and the Section 12 IVV report (Question 14).

In the FAQ IVV, BaFin specifies its expectations regarding the time scope of the function of the Compensation Officer and his deputy. Unchanged is its rule assumption that the function of the Remuneration Officer should generally be performed on a full-time basis, and institutions may deviate from this by applying the supervisory proportionality principle to determine a part-time function if (1) the size, internal organization and type, scope, complexity and risk content of the institution's business, (2) number of total staff, (3) number of MRTs in addition to the managing directors with a variable remuneration of more than EUR 50,000, and (4) quantitative complexity of the remuneration systems of the MRTs in addition to the managing directors do not allow a full-time activity to be deemed necessary, whereby the part-time activity in this case shall take up a scope of at least 0.5 FTE. In this context, a reduction of the scope of activities to part-time work is still generally not to be considered if more than 10 MRTs receive variable remuneration amounting to more than 100% of the fixed remuneration. Exceptions to this expectation appear plausible from a supervisory law perspective - considering the specific (further) material and personnel resources - if they can be comprehensively substantiated in a materially sound manner, taking into account the aforementioned assessment criteria. In this regard, affected institutions will have to review the justification of the specific time scope of the remuneration officer and the deputy in the remuneration guidelines (Sections 26, 11 (1) IVV) and readjust them if necessary.

BaFin also clarifies that the Section 12 IVV Report may be integrated into the Compensation Control Report of the Compensation Officer, provided that the Compensation Control Report also sufficiently documents the action plan in accordance with Section 12 (2) IVV. If the report also contains the review of the appropriateness of the compensation of the management, this part of the report - unchanged - should be prepared by the supervisory body or by an external third party. The FAQ IVV also contain - for the first time - a pronouncement by BaFin on the expectations regarding the substantive audit subjects and their presentation in the compensation control report, whereby in practice the compensation officers had usually already included the detailed audit subjects in their terms of reference.

9. What is missing? Among other things, no (new) pronouncements in the FAQ IVV on the external employee concept under Section 2 (7) IVV, on the extended requirements for the retention bonus as understood by the EBA, and on group-wide remuneration systems.

The FAQ IVV does not contain separate announcements on many regulatory subjects of the IVV (including individual new regulations of the IVV 4.0), among others

• The term "external employee" (Section 2 (7) IVV), the concrete content of which and its implementation in the remuneration systems have still not been conclusively clarified in practice;
• on the EBA's expanded understanding of the regulatory permissibility of retention bonuses in accordance with Section 5 (7) IVV, which includes a so-called specific performance condition in addition to the institution's special justified retention interest, which is not compatible with the case law of the German Federal Labor Court on the invalidity of cut-off date clauses for (work) performance-related remuneration components (see already our Client Alert).

• on the extended requirements of IVV 4.0 for group-wide compensation systems in accordance with Section 27 IVV, which in practice also continues to lead in some cases to challenges in, among other things, the concrete definition of the subordinate companies covered by the group-wide compensation strategy.

The consultation process will be able to provide further impetus on these and other IVV issues not covered in the draft FAQ.

10. Consultation procedure until 04.08.2023 and publication of the final version of the FAQ IVV still in the calendar year 2023?

The practice can actively participate in the consultation procedure until 04.08.2023 and to send a statement to the contact details listed on BaFin's FAQ IVV website. Against this time background, finalization of the FAQ IVV and its subsequent publication still in the calendar year 2023 does not seem impossible