Relating to remuneration schemes in financial institutions etc.

Regulations relating to remuneration schemes in financial institutions etc.

On 21 February 2011, the Authority’s circular letter related to the regulations of 1 December 2010 regarding remuneration schemes in financial institutions was presented. The circular letter describes how the Authority will interpret and follow up the regulations in its supervision of the affected institutions, and it is based on relevant elements in the guidelines from CEBS. The circular letter provides clarifications on important accounts.

The following main points are of particular interest:

The Authority assumes that certain general, non-discretional bonus schemes in which payments are made of up to 1.5 times the monthly salary are exempted from the regulations on certain terms.
The Authority provides concrete guidance as regards which job categories that are normally included and not included in the categories senior executives, risk takers and employees with supervisory responsibilities.
The Authority elaborates on the regulations’ requirements for performance measurement and risk adjustment on enterprise level, unit level and individual level.
Apparently, the Authority interprets the regulations restrictively as regards the access to distribute bonus in other forms for ”tied-up capital” than for shares and other equity instruments.

Scope: clarifications and exceptions
Firstly, it is emphasised that the regulations apply to agreements entered into, extended or renewed 1 January 2011 or later. Furthermore, the enterprise must, in agreements in which the enterprise may determine the size of the variable remuneration upon discretion, adjust its decisions to the new rules. According to our understanding of this, 100% discretionary bonuses based on the result for 2010 must follow the rules in the regulations even if they are paid in 2011.

It is a requirement that the institutions must, no later than 31 August 2011, be able to provide information to the Authority on agreements with the employees that are not in accordance with the regulations or the guidelines in this circular letter, and which measures that have been implemented in order for such obligations to be discontinued.

As regards which institutions that are affected, it is emphasised that subsidiaries of institutions which are affected by the regulations, but which are not a bank, finance enterprise, insurance company, pension enterprise, securities firm or management company for a security fund, are not affected.
The Authority assumes that certain payments fall outside the scope of the regulations completely.

The condition is that the payment does not constitute more than 1.5 times the monthly salary per year and that the payment:

is made as a part of a general, non-discretionary policy,
includes the entire institution,
does not give incentive effects as regards take-over of risk

In our opinion, the exception apply to broad, general bonus schemes in which all of the employees receive the same amount or the same percentage of their salaries that constitutes less than 1.5 times the monthly salary.

Remuneration committee
As regards the requirement for a remuneration committee, it is assumed that in institutions with a management capital of more than NOK 100 billion, the remuneration committee must have at least one external independent member, whereas in other enterprises the committee may consist of the entire or parts of the board of directors. It is emphasised that the committee must have sufficient knowledge of and experience with risk analyses in order to be able to consider whether the remuneration policy is appropriate, and that suggestions from all relevant group functions – particularly the supervisory function – must be taken into account in the preparation and follow-up of the remuneration scheme.

It is emphasised that the board is responsible for approving and maintaining the remuneration policy for the institution, and that the board must also approve any substantive change or exception from the remuneration policy.

Documentation
It is a governing principle in the circular letter that each enterprise must be able to document not only the rules/principles for the remuneration scheme as such, but also how it is practiced, including: (i) which positions/employees who must be regarded as senior executives, risk takers and employees with supervisory responsibilities, (ii) which criteria that are applied when measuring the enterprise’s, the unit’s and each employee’s risk-adjusted result and (iii) which criteria that are used for “ex-post” risk adjustment of retained remuneration.

Senior executives and risk takers
The circular letter provides certain instructions for categorizing senior executives and risk takers.
The category senior executives will normally include:

Board members and the managing director
Other members of the management team in addition to the managing director, as well as everyone who is responsible for the management of business areas that are of material importance to the enterprise’s risk exposure (including those managing regional areas) such as trading, equity, interest and currency, raw materials, derivatives, sales, securities areas, issues, investment banking, credit, capital management and corporate finance.
Other employees who have a total remuneration similar to that of senior executives and risk takers, who are not already included in the above-mentioned category, and whose responsibilities are of material importance to the enterprise’s risk exposure.
Employees who are responsible for independent supervisory functions, such as compliance, controller, risk management, HR and internal audit areas.

When considering the persons/positions that are to be regarded as risk takers, a wide concept of risk shall be applied, which refers to all types of risk, including operational risk and incidents that might affect the result of the enterprise in a negative way. Nevertheless, the employees’ opportunities and incentives to affect the operational level or risk shall normally be regarded as small, unless one of the employee’s responsibilities is to limit such risk. According to our understanding of this, it will normally not be necessary to include employees who mean a lot to the sales/earnings of the business – typically “super brokers” or “super managers” – of this reason alone. However, the scope of this is uncertain.

The following employees will normally not be regarded as risk takers:

Investment managers who only manage assets on behalf of clients.
Employees who work as brokers within the capital market and who only buy and sell financial instruments when commissioned to do so by clients.
Employees who are working within corporate finance and who assist with their advice in the raising of capital and in mergers and acquisitions in their work.
Employees who are only working with investment advice.
Employees with actuary functions.
Analysts provided that they are not managers with a leading strategic position.

The following employees will normally have to be regarded as risk takers:

Employees within trading departments unless the risk influence is small.

Employees with supervisory functions.

Employees in credit committees on a local or central level who are responsible for giving credit. However, employees with very limited powers have little effect on the risk. The enterprise must therefore carry out an individual assessment of each individual’s risk influence.

Risk takers who are not listed above, but whose responsibilities are of material importance to the enterprise’s risk exposure.

The relationship between variable and fixed remuneration
The Authority provides no guidance in terms of what is generally regarded as a balanced (or non-balanced) relationship between fixed and variable remuneration. This means that each enterprise must decide for itself what the enterprise believes is a “balanced” relationship between fixed and variable remuneration. This should be done in advance, and in principle on an individual level (position level).
The Authority makes certain specific requirements for the content of remuneration schemes for employees responsible for independent supervisory functions.

As for the managing director and members of the management team in banks, special rules apply, cf. section 4, second paragraph, of the regulations.

Measuring results – risk adjustment
The Authority assumes that variable remuneration may be earned annually, based on assessments of financial and non-financial performances over at least two years.
The Authority assumes that the basis when determining variable remuneration must be the risk-adjusted result. Risk adjustment must in principle be made on all three levels: i.e. on enterprise level, unit level and individual level.

The process must take into account all risk that is associated with the business of the enterprise, and the enterprise shall use the methods that are best for the enterprise based on these premises. Examples of result terms that might be relevant are:

Economic capital
Risk-adjusted return on capital (RAROC)
Return on risk-adjusted assets
Normalized return calculated over several years
Accounting results adjusted for economic cycles

These “objective” methods for risk adjustments must be supplemented with subjective assessments and be adjusted manually on the basis thereof.

The measuring of results on an individual level shall take place based on pre-determined financial and non-financial criteria. When measuring financial criteria, the general principle is that a risk adjustment must also be made. Nevertheless, the Authority acknowledges the fact that this will be challenging, and therefore the Authority only requires such risk adjustment for employees “who may influence the enterprise’s risk level”. What is meant by this is unclear to us.

As examples of non-financial criteria we would like to mention achievement of strategic goals, actions towards clients, compliance with external rules and internal rules and policies, as well as co-operation with compliance and risk control functions, compliance with determined limits etc.

Granting and payment
As regards the requirement in the regulations that at least half of the variable remuneration shall be granted in the form of shares or other equity instruments issued by the enterprise or another enterprise in the group, or in the form of contingent capital that reflects the enterprise’s development in terms of value, the Authority seems to assume that only enterprises that “do not have access to shares or other equity instruments” can choose other forms of contingent capital. What is meant by this is unclear to us, and under any circumstances this will be a restrictive interpretation of section 4, fifth paragraph, of the regulations which we believe there are no grounds for. In our opinion, it must therefore still be up to each enterprise to consider whether the enterprise wants to use shares or other equity instruments or other forms of contingent capital.

The Authority provides no guidance as to the content of the expression ”contingent capital”. In our opinion, a traditional cash-based bonus bank model in which granted assets are withheld and paid on a pro rata basis over the withholding period will fulfil the requirements of the regulations. The condition is that the withheld assets are value adjusted as described above and that they are subject to an “ex-post” risk adjustment.

As regards the requirements for ex-post risk adjustment, the Authority assumes that the risk adjustment must be performance-related and related to the original performance goals under which the withheld remuneration was granted. The central aspect is that the enterprise must carry out a reverse test of whether the original (“ex-ante”) risk adjustments that the remuneration was measured were correct.

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