Since the start of this year, banks, insurers and investment firms have been obliged to extend the scope of sound remuneration policies from the Executive Board to all of their employees. Remuneration policies should be based on actual longer-term performance.
Risk management the basis for remuneration practices
Variable remuneration could form incentives for employees to take undesired risks. Risk management is hence a key starting point for sound remuneration policies. In practice, effective risk management is promoted by rewarding staff for their actual long-term performance. 'Actual' means that the costs of the risks incurred must be considered when assessing staff performance. In all phases of the remuneration process, the variable remuneration must be aligned with the risks, from the setting of performance criteria to the payout of the variable remuneration. Not everyone is subject to the same requirements. The Regulation requires financial institutions to identify staff whose professional activities have a material impact on the institution’s risk profile (the Identified Staff). At any rate the Executive Board, senior management and control functions belong to this category. But functions and activities in business units (financial markets, sale of policies and mortgages, IT) may also materially affect the institution’s risk profile. Specific measures must be taken for staff in these functions and activities to manage the risks of variable remuneration such as requirements on performance criteria, deferral of variable remuneration and the form of payout. As not all functions or activities influence the risk profile to the same extent, the specific requirements may be applied proportionately. For example, in setting the time span for paying out variable remuneration over several years, the minimum deferral period of three years could be adopted for lower-risk functions or activities, whereas a longer period would be more appropriate for higher-risk functions.
Regulation to be implemented in remuneration policies by no later than 31 March
The Regulation is an important step in the laws and regulations on variable remuneration and contains all prevailing national and international standards and rules. These include the principles of the Financial Stability Board (FSB), established in 2009, and the joint DNB/Authority for the Financial Markets (AFM) Principles, the principles of the recent European Capital Requirement Directive, and its international interpretation, which have been laid down by the Committee of European Banking Supervisors in its Guidelines on Remuneration Policies and Practices, and the principles of the International Association of Insurance Supervisors. The Regulation is binding for financial institutions in order to preserve a level playing field.
DNB published the Regulation on 24 December 2010. Though it may seem as if financial institutions have only had a short time for implementation, most of the principles of the Regulation are in fact identical to those in the FSB Principles and Implementation Standards and the DNB/AFM Principles and good practices, which financial institutions have already had to comply with since 2009. Financial institutions which were compliant with the FSB and DNB Principles on 1 January 2011 need only adjust their remuneration policies on a few points. For example on the condition that certain staff must receive 50% of the upfront part and the deferred part of their variable remuneration in equities or similar financial instruments. As it takes time to set up such a payout system, financial institutions have been given up to 31 March 2011 to do so. On that date, DNB expects financial institutions to have adjusted their remuneration policies to comply with the requirements under the Regulation.
Remuneration policy for the whole institution
In order to determine the Identified Staff, an institution must examine which of its activities are of most importance for its risk profile. In the case of activities that represent a larger share in the risk profile of the institution, it is important to more effectively manage the risks arising from remuneration. Because if the variable remuneration induces an employee who has a function within such an activity to take irresponsible risks, this could have (more) serious risks for the financial institution. This not only applies to employees at the top of the organisation but also those at lower levels. DNB notes that, up until recently, financial institutions mainly paid attention to the remuneration at the top of the institution. For groups, the parent entity should determine a remuneration policy for the whole group. The decision-making processes and risk management measures hence also apply to subsidiaries (including subsidiaries abroad). At present, these often follow their own local policy. However, local legislation or local higher salary levels need not stand in the way of determining principles for governance and risk management at group level.
Regulation is stricter than self-regulation
In addition to the Regulation, self-regulation is in place for banks and insurers. The Banking Code and the Insurers Code also contain provisions on remuneration. On some points, the provisions and principles are the same as those in the Regulation (for example that performance criteria must be laid down at the level of the institution, the business unit and the individual). However, the Regulation is stricter because it sometimes stipulates more specifically how the principles should be put into practice. The Regulation contains some more far-reaching requirements, such as the task of the control functions, the malus, form of payout an transparency requirements. Compliance with the said codes hence does not automatically imply compliance with the Regulation.
Supervision after 31 March
Supplementary to its existing supervision, DNB has announced that after 31 March 2011 it will examine, from a risk-based perspective, whether financial institutions have properly implemented the new Regulation. Its examinations will focus on the structure of the institutions’ remuneration policies. Moreover, DNB will carry out an update of its 2009 remuneration survey and will draw up an aggregated report at end-2011.