The Association of Foreign Banks CRD IV March 2014

www.pwc.co.uk
The Association of
Foreign Banks
CRD IV
March 2014
Introduction
• The Capital Requirements Directive (CRD) is EU legislation that establishes minimum capital and
liquidity standards for credit institutions and some investment firms within EU Member States.
• The fourth iteration of the Directive (CRD IV) includes requirements that will augment and
enhance existing remuneration regulation under CRD III.
• This includes a requirement to limit variable remuneration to 100% of fixed remuneration, which
may be extended to 200% subject to shareholder approval.
• The finalised text of the Directive was published in the European Journal on 27 June 2013.
• Accordingly, Member States were required to transpose the Directive so that the remuneration
regulations were effective for performance from 1 January 2014.
Agenda
The Capital Requirements Directive IV (CRD IV)
UK implementation of CRD IV
EU implementation of CRD IV
European Banking Authority (EBA)
Practical solutions
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The Capital Requirements Directive
IV (CRD IV)
Overview of requirements
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Overview of bonus cap
• Variable remuneration is limited to 100% of fixed remuneration. This can be increased to 200% with
shareholder approval.
• Up to 25% of variable pay can be delivered in a "long-term form" that benefits from a discounted
valuation for the purposes of the cap.
• The cap applies to firms subject to CRD subject to Member States’ application of proportionality and
is likely to apply to all Identified Staff, irrespective of whether they are based within or outside the
EU. Some Members States have adopted a stricter approach.
Overview of bonus cap
Fixed remuneration
25% long
term
Variable remuneration – capped at 100% of
fixed
Fixed remuneration
Reflects professional experience and
organisational responsibility as set out in the
employee’s job description.
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Capped at 200% with shareholder approval
£
Variable remuneration
Reflects a sustainable and risk adjusted
performance in excess of that required to fulfil
the employee’s job description.
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Overview of other requirements
Disclosure
•
•
•
•
Number of individuals being remunerated €1m or more:
-Where between €1m and €5m - broken down into pay bands of €500k
-Where €5m+ - broken down into pay bands of €1m
Total remuneration for each member of the management body or senior
management, where requested by the Member State or competent authority
(could include the EBA)
Ratios between fixed and variable remuneration, set in accordance with the
rules on bonus caps
The number of meetings held by the body overseeing remuneration, during the
financial year
Guarantees
• Guarantees must not be a part of prospective remuneration plans
• There remain ‘exceptional’ circumstances where these can be paid
Buy outs
• Must align with the long-term interests of the firm
• Should include retention, deferral, performance and clawback arrangements
Malus
• Arrangements to be in place for paid as well as unvested deferred remuneration
Capital
instruments
• Wider range of instruments to be used to fulfil the requirement that 50% of
variable remuneration should be delivered in instruments
Governance
• Remuneration committees required to account for long-term interests of
stakeholders and public interest
• Nominations/Risk Committees for “significant” firms
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UK implementation of CRD IV
Revision of the Remuneration Codes
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Implementation of CRD IV in the UK
Capping requirements
Timing
• Variable remuneration restricted to 100% of
fixed remuneration, extending to 200% with
shareholder approval.
• The cap shall apply to all remuneration
awarded in respect of performance years
starting on or after 1 January 2014.
• Up to 25% of this may benefit from a
discounted value where deferred over at
least 5 years and delivered in instruments.
Proportionality
Shareholder approval
• Final policy statements - all Level 3 firms
can ‘disapply’ the cap.
• At least 66% of shareholders are required to
vote in favour where at least 50% of
shareholders are represented.
• At least 75% of shareholders where less than
50% are represented.
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Shareholder approval
•
The PRA have confirmed how shareholder approval should be sought where an entity is part of a
consolidated group structure.
•
An overview of this process is set out below:
Overview of shareholder approval process
EEA
parent
Non-EEA
Parent
Subsidiary
Subsidiary entities can
request the approval from
the owners of its shares.
In this instance, approval
can be requested from the
immediate non-EEA
parent.
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Branch
Branch entities will be
required to seek approval
from the shareholders of the
entity it is ‘branched’ into.
Subsidiary
Branch
Both subsidiary and branch entities
are required to seek approval from
the ultimate shareholders of the
EEA group parent.
In this instance, approval
will need to be sought from
the shareholders of the
immediate non-EEA
parent.
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EU implementation of CRD IV
Diverging approaches
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EU implementation of requirements
•
Prior to 31 December 2013, all the large EU member states (France, Germany, Italy, Spain and the
UK) had issued implementation standards as final or draft rules.
•
Significant differences and inconsistencies are emerging in the scope and impact of the
implementation standards, that will increase the challenges faced by firms trying to manage the
impact of the CRD4 remuneration rules across multiple EU member states.
Final rules issued
Austria, France, Germany, and the UK
Draft rules issued
Czech Republic, Finland, Italy, Ireland, Luxembourg, the
Netherlands, Spain, and Sweden
No rules issued
Belgium, Bulgaria, Croatia, Cyprus, Denmark, Estonia, Greece,
Hungary, Latvia, Lithuania, Malta, Poland, Portugal, Romania,
Slovakia, and Slovenia
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EU implementation - Scope
Cap to apply to all employees
Austria, Germany, Italy, and the
Netherlands
Cap to apply to Identified Staff
Czech Republic, Finland, France,
Ireland, Luxembourg, Spain,
Sweden, and the UK
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EU implementation - Proportionality
P
P
Exemption for investment firms (subject to
conditions)
France*, Germany, Italy, Luxembourg, and the
UK*
Exemption for investment
firms (no conditions)
Finland
No proportionality
O
Austria, Czech Republic,
Ireland, the
Netherlands, Spain, and
Sweden
* These countries may also have an
exemption for small credit institutions
(TBC)
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EU implementation – Implementation date
After
1/1/14
After
1/1/14 O
After
1/1/14 P
After 1/1/14 (depending on financial year end)
France, Germany, the Netherlands, and the UK
After 1/1/14 (depending on date of final
rules – no retrospective application)
Finland, Italy, Luxembourg, Spain, and
Sweden
After 1/1/14 (depending
on date of final rules –
retrospective
application)
Ireland
From
1/1/14
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From 1/1/14
Austria
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European Banking Authority (EBA)
Regulatory technical standards (RTS) and
guidelines
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Overview of the European regulatory bodies
European Commission
European Parliament
European Council
Negotiate legislation at the European level (“trialogue”). Requirements transposed nationally at the
Member State level.
European Banking
Authority (EBA)
European Insurance and
Occupational Pensions
Authority (EIOPA)
European Securities and
Market Authority (ESMA)
Assist the three legislative European bodies (above) in establishing legislation at the European level,
through providing input and guidance on technical areas. Also have regulatory powers through technical
standards.
UK
Other EU Member States
Prudential Regulation Authority and Financial
Conduct Authority
EU Member State regulators
Member States are required to implement EU requirements. Most states have a regulatory body
responsible for financial regulation and supervision who will facilitate implementation locally.
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European Banking Authority – overview of role
and remit with respect to CRD IV
• The CRD IV Directive delegates responsibility to the European Banking Authority (EBA) to produce
the following:
• Regulatory technical standard (RTS) on criteria to identify material risk takers (Article 94(2));
• RTS on instruments that are appropriate for use as variable remuneration (Article 94(2)); and
• Guidelines on an appropriate discount factor that can be applied to up to 25% of total variable
remuneration for the purposes of calculating the cap (Article 94(1)).
• The EBA’s work in each of these areas is required to be finalised by the end of March 2014, by
which time the remuneration provisions of CRD IV will already be in force. As such, there is
significant uncertainty as to how these will be incorporated into local regulation.
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Final draft regulatory technical standard on the
criteria for identifying Material Risk Takers
• In most EU territories, the cap will be applied to all of those Identified Staff (also known in the UK as
Code Staff) of firms within scope of the Directive.
• The criteria set out in the final draft would consider an individual as a material risk taker where they
meet any one of the following criteria.
Qualitative criteria
a) Member of the senior management cadre;
b) Independent control function head;
c) Head of a material business unit;
d) Head of risk for a material business unit
e) Senior employee reporting into heads identified under b), c), and d) above;
f) Head of other functions including Legal, HR, IT, etc;
g) Member of committees responsible for material risks other than credit and market risk;
h) Member of staff/committees who can create credit or market exposures in excess of specific criteria;
i) Member of management responsible for managing groups of employees who can collectively create credit
or market exposure in excess of specific criteria;
j) Member of staff/committee responsible for and/or vetoing new products that can create material
credit/market risks in excess of specific criteria; or
k) Member of staff with managerial responsibility for any of the above individuals.
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Final draft regulatory technical standard on the
criteria for identifying Material Risk Takers
Quantitative criteria
With respect to the preceding financial year:
• Total remuneration exceeds EUR500,000; or
• Included in the 0.3% employees with the highest total remuneration; or
• Remuneration bracket is equal to, or greater than, other members of senior management or risk takers
(identified per qualitative criteria) in the preceding financial year .
Individuals identified per the above criteria may be excluded from the MRT population (subject to
notification/approval procedures depending on the employee’s remuneration) where they are found not to
have a material impact on the risk profile of the firm, either because:
a. They conduct professional activities and do not have a material impact on the risk profile of a ‘material
business unit’; or
b. They have a material impact on the risk profile of a non-material business unit.
Internal
In addition to stipulated qualitative and quantitative criteria, firms should also develop internal criteria with
which to assess employees.
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Final draft regulatory technical standard on
appropriate instruments for use as variable
remuneration
Any instrument used for the purposes of variable remuneration must meet both of the following
criteria:
• The instrument should adequately reflect the credit quality of the institution (by reference to
capital); and
• The instrument should give incentives for prudent risk taking and for employees to act in the
long-term interests of the firm.
Specific instrument conditions
AT1
Own fund
instruments
T2
Own fund
instruments
Other
Debt/debt-linked
instruments that are
not owned funds
• Instrument written-down/converted into Common Equity where CET1 capital ratio <7% or a level
higher than this as determined by the institution
• Either:
• Distributions capped at 8 percentage points above Eurostat annual average rate of published
CPI change; or
• At least 60% instruments privately/publicly placed.
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Draft guidelines on an appropriate discount factor
for long-term variable remuneration
• The Directive allows for up to 25% of total variable remuneration to benefit from a discounted value
for the purposes of calculating the cap. Member States may take a stricter approach.
• In order to qualify for this discounted value, the remuneration in question must be deferred over a
period of at least 5 years and must be delivered in instruments in order to qualify
Qualifying variable
remuneration
• Up to maximum of 25%
total variable
remuneration
• Deferred for 5 years
• Delivered in
instruments
• Can apply to both:
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Discount Factor
Implications
• Applied to cash flows of
variable remuneration with
different deferral and
retention arrangements
• The discount factor itself is
relatively generous, partly due to
the ‘incentive factors’ that have
been attached to reflect the length
of deferral and any post-deferral
retention.
• Discount factor accounts for
the four following factors:
• Inflation
• Interest rate
• Cliff vesting
• Length of deferral
• Phased vesting
arrangements
• Length of retention
• Firms taking advantage of the 5year deferral can increase the
effective cap to 2.2-2.3 times fixed
remuneration (with appropriate
shareholder approval).
• Not favourable to LTIP
arrangements.
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Practical solutions
Alleviating the restrictiveness of the cap
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Fixed allowances
•
Half of firms questioned in the “CRD4 remuneration impact” survey in December are planning to
use base salary increases with 93% planning to use allowances.
•
These allowances can take broadly one of three forms:
Fixed allowance
• Entitlement to fixed
cash/share allowance
• Excluded from pension
and termination with
sunset clause
• May be suitable for senior
managers not far in
excess of leverage cap
Adjustable
allowance
• Periodically adjusted on clear
criteria linked to role,
responsibility but not simply
performance
• Legal framework carefully
established to allow reduction
as well as increase over time
Allowance with
enhanced malus
• Fixed or adjustable
• In case of individual
underperformance,
enhanced ability to apply
malus to deferred stock
awards up to an amount
equal to the allowance (in
effect allows allowance to be
cancelled in case of
underperformance)
• Can alternatively structure
as an allowance with bonus
bank
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Overview of alternative approaches
Monetisation of benefits
Multi-year ratings
LLP/Participation model
Leveraged schemes
Periodically renegotiated contracts
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Use of allowances
41%
41% of firms plan to pay
allowances at least part in shares
18%
Only 18% of firms will not go to
shareholders for approval for an
increase in the cap above 1:1
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42%
91%
42% of firms plan to review
91% of firms are not planning to
allowances annually, with a further defer fixed allowances, whether
26% reviewing every two years
cash or shares
18%
18% of firms plan to apply malus
to allowances other than in
extreme case of disciplinary
occurrences or dismissal
60%
60% of firms expect to be able to
adjust allowances, downwards and
upwards due to market-based
factors
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