Corporate governance and remuneration aspects of CRD 4.

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1 8 July 2013 Corporate governance and remuneration aspects of CRD 4. New EU rules on capital adequacy for banks and financial institutions are accompanied by new corporate governance and remuneration rules. These are contained in a Capital Requirements Directive and Regulation, together known as CRD 4. Publication of these measures in the EU s Official Journal on 27 June 2013 means that the bulk of the new rules will take effect from 1 January The Financial Conduct Authority and Prudential Regulation Authority have announced that they will consult later this summer on the necessary changes to the UK regime. The corporate governance and remuneration requirements in CRD 4 seek to address excessive and imprudent risk-taking in the banking sector by: > ensuring effective board oversight, > promoting a sound risk culture, and > enabling regulatory authorities to monitor internal governance arrangements (rather than relying on a non-binding comply or explain system dependent on monitoring by the shareholders). The requirements affect credit institutions and investment firms and address company reporting, board diversity, risk management, the responsibilities of the board and control of executive remuneration. Reporting CRD 4 provides for country by country reporting on an institution s activities and location, turnover, employees, profit or loss before tax, tax on profit or loss and public subsidies received. In this issue Reporting... 1 Diversity... 2 Risk... 2 Responsibilities of the board and the directors... 2 Time commitment and limits on mandates... 2 Good governance and qualifications... 3 Management challenge. 3 Expertise... 3 Remuneration... 4 Who is covered?... 4 Bonus cap... 4 Termination payments.. 4 Non-cash instruments... 5 Malus / clawback... 5 Remuneration committee... 5 Additional disclosures... 5 Further guidance... 6 Legislation... 6 Institutions will also need to give annual updates on governance arrangements, including the number of directorships held by the directors, recruitment policies for directors and their expertise, diversity and risk. Corporate governance and remuneration aspects of CRD 4 1

2 Institutions must explain on their website how they comply with the rules on corporate governance. Diversity CRD 4 emphasizes that a broad set of qualities and competencies should be considered when selecting directors. For this purpose, institutions are required to put in place a policy promoting diversity in general. Nomination committees are also required to decide on a target for the representation of the underrepresented gender on the board and to prepare a policy to fulfil that target. The target, the policy and its implementation will need to be disclosed on an annual basis. Risk Boards should produce a declaration on the adequacy of risk management systems and publish a risk statement on an annual basis. A separate risk committee, made up of non-executive directors, should be established and the board should devote sufficient time to considering risk issues. Institutions should have a risk management function which is independent of operations and management and has sufficient authority, status and resources. The board should determine the content, format and frequency of risk information it should receive and the risk management function should be able to report directly to the board, when necessary. The head of the risk management function should be an independent senior executive with distinct responsibility for this job. Responsibilities of the board and the directors Time commitment and limits on mandates All directors are required to commit sufficient time to performing their functions. Specific limits are also imposed on the number of mandates which may be held by directors of significant institutions. By 1 July 2014, at the latest, directors should not simultaneously hold positions exceeding the following options: > one executive directorship with two non-executive directorships, or > four non-executive directorships. Directorships held within the same group count as a single directorship and directorships in non-commercial organisations are not caught by the rules. Corporate governance and remuneration aspects of CRD 4 2

3 In addition, supervisors will be able to authorise directors to combine more directorships than permitted by the rules, as long as this does not prevent the director from spending sufficient time performing his functions. Institutions must disclose the number of directorships held by directors every year. Good governance and qualifications CRD 4 stresses that the board is responsible for effective and prudent management and should periodically assess governance arrangements with a view to correcting deficiencies. To achieve this, the board, as a whole, and the individual directors must possess sufficient knowledge, skills and experience to perform their duties. In particular, the board should be capable of understanding the institution s activities, including the main risks. Directors are also required to be of sufficiently good repute and supervisors should assess this by consulting a central database of sanctions, as well as criminal records. Management challenge To counterbalance the potential dominance of the board by one individual it is forbidden for one person within the same credit institution to act as both Chairman and CEO. This makes mandatory the existing best practice recommendation in the UK. The nomination committee is also specifically required to take account of the need to ensure that the board s decision making is not dominated by one individual or group. Separately, directors are required to act honestly, with integrity and independence of mind to effectively assess and challenge the decisions of senior management, where necessary. Expertise To make sure that directors of financial institutions have the necessary level of expertise to fulfil their duties, and supervise management appropriately, significant institutions must establish a nomination committee. This should be made up of non-executive directors and will be responsible for preparing a description of the roles and capabilities required for particular appointments. The committee should evaluate the balance of knowledge, skills, diversity and experience of the board, as well as its structure, size, composition and performance. Directors should also receive appropriate induction and continuous training. Corporate governance and remuneration aspects of CRD 4 3

4 Remuneration CRD 4 s predecessor, CRD 3, in force from 1 January 2011, introduced a number of remuneration requirements. These related to pay policy, governance, structure and disclosure. The rules included provisions governing guaranteed bonuses, deferral of pay, payment in non-cash instruments and the reduction of deferred pay in certain circumstances (also referred to as malus ). CRD 4 adds a bonus cap and expands the existing provisions on remuneration committees, guaranteed bonuses, payment in non-cash instruments, malus, termination payments and disclosure. Some of the key changes are summarised below. Who is covered? The requirements apply to Code Staff / Identified Staff. This currently means individuals who have been identified by firms as having a material impact on the risk profile of the firm. However, the definition of Code Staff / Identified Staff is due to be expanded by the European Banking Authority during The revised definition will cover, among others, all staff whose total remuneration exceeds EUR 500,000 per year, regardless of whether or not they have a material impact on the risk profile of the firm. Bonus cap Firms must limit variable pay to 100% of salary. This limit can be increased to 200% of salary if the requisite shareholder approvals are obtained. In addition, 25% of variable pay may be discounted for the purposes of calculating the bonus cap if it is paid in instruments that are deferred for a period of at least five years. The cap on bonuses will apply to remuneration awarded for services provided or performance from the year 2014 onwards whether due on the basis of contracts concluded before or after 1 January This means the first bonus round to be caught will be the 2015 bonus round for 2014 performance. Termination payments The provision on termination payments has been amended. This now states that payments related to the early termination of a contract should reflect performance achieved over time and should not reward misconduct or failure. This builds upon the position under CRD 3, which states that termination payments should not reward failure. Corporate governance and remuneration aspects of CRD 4 4

5 Non-cash instruments At least 50% of variable remuneration must consist of a balance of: > shares or equivalent instruments subject to the legal structure of the institution, and > where possible, other instruments within the meaning of Article 49 and 60 of the Capital Requirements Regulation (i.e. Tier 1 and Tier 2 capital) or other instruments which can be fully converted to Common Equity Tier 1 instruments or written down. In each case, non-cash instruments should adequately reflect the credit quality of the firm as a going concern and be appropriate. Malus / clawback Up to 100% of variable remuneration must be subject to malus or clawback. Malus arrangements enable unvested awards to be forfeited or reduced. Clawback arrangements require vested awards to be repaid. In particular, such arrangements must be applied where an individual has participated in, or been responsible for, conduct which resulted in significant losses to the institution, or which failed to meet appropriate standards of fitness and propriety. Remuneration committee A new requirement has been added that obliges remuneration committees to take into account the public interest. Additional disclosures In addition to the existing requirements, public remuneration disclosures must now include details of the following. > The number of meetings held by the main body overseeing remuneration during the financial year. > The ratios set between fixed and variable remuneration, pursuant to the bonus cap. > The number of individuals receiving at least EUR 1 million in remuneration per financial year. Remuneration between EUR 1 million and EUR 5 million will have to be broken down into pay bands of EUR 500,000. Remuneration of EUR 5 million or more will have to be broken down into pay bands of EUR 1 million. > If demanded by the Member State or competent authority, the total remuneration for each member of the board or senior management. Corporate governance and remuneration aspects of CRD 4 5

6 Further guidance The European Banking Authority is to issue guidelines by 31 December 2015 on what is meant by certain concepts referred to in CRD 4. These include the notions of: > sufficient time commitment, > adequate knowledge, skills and experience, > honesty, integrity and independence of mind, > adequate resources for director training, and > diversity. The European Banking Authority is also to issue Technical Standards by 31 March These will set out qualitative and quantitative criteria to identify: > Code Staff / Identified Staff subject to the remuneration rules, and > the classes of non-cash instruments that can be used for remuneration. Legislation The final text of the CRD 4 Directive and Regulation is available here. Contacts For further information please contact: Nadia Swann Partner (+44) nadia.swann@linklaters.com Lucy Fergusson Partner (+44) lucy.fergusson@linklaters.com Wilma Rix Senior Associate (+44) wilma.rix@linklaters.com Alexandra Beidas Managing Associate (+44) alex.beidas@linklaters.com Author: Wilma Rix, A This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. Linklaters LLP ( is a limited liability partnership registered in England and Wales with registered number OC It is a law firm regulated by the Solicitors Regulation Authority ( The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. One Silk Street London EC2Y 8HQ Telephone (+44) Facsimile (+44) Linklaters.com A list of Linklaters LLP members together with a list of those non-members who are designated as partners and their professional qualifications, may be inspected at our registered office, One Silk Street, London EC2Y 8HQ and such persons are either solicitors, registered foreign lawyers or European lawyers. Corporate governance and remuneration aspects of CRD 4 6