Compensation systems and for compensation governance: Non-significant institutions are not (anymore) subject to the obligation to identify risk takers. Major institutions have clawback arrangements in place.

The revised draft of the InstitutsVergV 3.0 dated January 19, 2017

The InstitutsVergV 3.0 further develops the requirements for remuneration systems; this is primarily against the background of the Guidelines for Sound Remuneration Policies (EBA Guidelines) published by the European Banking Authority (EBA) on December 21, 2015. The revised draft takes into account feedback from practitioners from the consultation process on the first draft of August 10, 2016. InstitutsVergV 3.0 is scheduled to come into force on March 1, 2017.

The key finding: how does the revised draft treat the proportionality principle? Does the revised draft contain substantive innovations to the Risk Taker analysis?

The revised draft reverts to the current law: only significant institutions have to identify risk takers. The balance sheet total of EUR 15 billion for quantitative identification as a significant institution remains in place; the parameters for qualitative identification as a significant institution (section 17 (2) InstitutsVergV) continue to apply unchanged. The risk taker analysis is to be carried out according to the criteria of Regulation 604/2014. The practice has to pay special attention to the comprehensive documentation and traceability of the analysis, especially in the de-identification of employees (Art. 4 para. 2 Regulation 604/2014).

2) What are the requirements of the clawback rules for Risk Takers?

The legislator has made its decision: The clawback is making its way into risk taker compensation. Institutions are also to reclaim variable compensation already paid out, on the basis of an accrual-based allocation. The obligation to reclaim relates (only) to serious negative profit contributions of the individual Risk Taker within the meaning of Section 18 para. 5 p. 3 InstitutsVergV

3.0. The clawback period should be at least five to seven years, depending on the deferral system implemented (Section 20 (1) of the Instituts- VergV). The implementation of clawback poses challenges from an employment law perspective – individual agreements with the individual risk taker are subject to statutory general terms and conditions control and here above all to the transparency requirement, which the German Federal Labor Court applies restrictively in its case law on the reduction of bonus payments. If the clawback is implemented in a company agreement or service agreement, the parties to the agreement must observe the statutory equity requirements.

It remains to be seen to what extent the practice of cliff vesting (i.e., the complete retention of variable compensation over the same period), which is an alternative to clawback, will be used.

3. what requirements are severance payments subject to?

Severance payments are also considered variable compensation under the revised draft. Institutions shall document their severance pay system in the general compensation principles. Compared to the first draft, the legislature has made two simplifications:
(1) The catalog of privileged severance payments (section 5 (7) sentence 4 InstitutsVergV 3.0), which do not have to be taken into account for the calculation of the ratio of variable remuneration and, in the case of Risk Takers, do not have to meet the requirements of section 20 InstitutsVergV, shall be extended to include severance payments up to a maximum amount of 200% of the last fixed annual salary or to be determined as appropriate by BaFin.
(2) All privileged severance payments shall not be taken into account when determining the total bonus pool (Section 7 InstitutsVergV) and shall not be subject to any reduction in relation to the non-fulfillment of the ancillary conditions pursuant to § 7 InstitutsVergV. § Section 7 sentence 2 InstitutsVergV.

What are the rules governing disclosure (Section 16 InstitutsVergV)?

The revised design calls for a four-way split:

(1) Significant institutions shall cumulatively meet the requirements of Art. 450 of Regulation 575/2013 and § 16 par. 1 InstitutsVergV must be observed;
(2) non-significant institutions with a balance sheet total of more than EUR 3 billion shall disclose their remuneration system in accordance with the general (i.e. not related to individual employees or groups of employees) disclosures of Art. 450 of Regulation 575/2013,
(3) Non-significant institutions with total assets of EUR 3 billion or less shall disclose general information on the relationship between fixed compensation and variable compensation as well as on the individual quantitative data in accordance with the German Corporate Governance Code. Art. 450 par. 1 lit. (h) publish Regulation (EC) No 575/2013; and
(4) non-significant institutions that are not CRR institutions are not subject to disclosure requirements.

5. what are the requirements for group-wide compensation systems?

The revised draft removes capital management companies from the group-wide remuneration system (again). Significant institutions, as higher-level entities, shall apply the Risk Taker compensation system requirements to all Group Risk Takers. Compared to the first draft, it is clarified that the obligation to identify group risk takers only applies if the parent company qualifies as a significant institution. The revised draft also clarifies that in groups with several significant institutions, the function of the compensation officer can be centralized.

6. what other significant changes does the revised draft contain compared to the first draft?

Worth mentioning are:

• The definition of fixed compensation and the requirements for distinguishing it from variable compensation are clarified in terms of language.
• The restriction on the amount of variable compensation for the business manager responsible for the risk controlling function is removed.
• The target agreement system for risk takers in major institutions must alternatively take into account a group or institution performance parameter at the institution/group level.
• According to the revised wording of Section 12 of the InstitutsVergV, the regular review of compensation systems is not (or no longer) mandatory for Internal Audit. The revised draft stipulates (only) that, when reviewing existing test reports
  (1) the internal audit function,
  (2)of the auditor of the annual financial statements and
  (3)of the Compensation Officer are to be taken into account. It remains to be seen whether the revised interpretive guidance on the function of internal audit in the process will provide further clarification.
• As part of its monitoring of the external compensation consultants, the Compensation Control Committee must also comply with Section 5 para. 1 Legal Services Act and take into account here that the first non-lawyer (remuneration) consultants have already issued cease-and-desist declarations to individual bar associations regarding the non-provision of legal advice on the InstitutsVergV.
• Findings of the internal control functions regarding the compensation system are to be processed with a detailed action plan.

Outlook

BaFin has announced the publication of the final version of InstitutsVergV 3.0 for February 2017. The publication of the revised interpretative guide to the InstitutsVergV 3.0 is expected at the latest with this publication. We will keep you up to date on further developments with our Client Alert.