The EU Commission’s proposal to supplement Directive 2013/36/EU (CRD IV) – Proportionality principle reloaded … and InstitutsVergV 4.0?

On November 23, 2016, the EU Commission published a proposal to supplement CRD IV, which, among other things, contains a modification of the proportionality principle for the remuneration systems of risk takers in institutions. If the proposal becomes law, previously “non-significant” institutions in Germany with total assets of at least EUR 5 billion can expect a further need to revise their compensation systems.

1 The Starting Point: The Proportionality Principle as Previously Understood by the EU Legislator and its Application in the InstitutsVergV

The principle of proportionality is a guiding principle of the regulatory requirements for compensation systems in institutions. The individual institution shall apply the requirements on its compensation systems – and here in particular on the variable compensation of risk takers – in a manner that is appropriate to its size, its internal organization and the nature, scope and complexity of its business. According to the proportionality principle, large institutions with a high risk profile have to implement regulatory requirements more comprehensively than small institutions with a conservative risk profile.

The current version of CRD IV includes a restrictive application of the proportionality principle (“one size fits all”): Each institution must designate risk takers and provide their variable compensation with, among other things, the deferral of a share of at least 40% over a period of at least three years (“deferral”) and the partial granting in instruments (at least 50% of the variable compensation, “pay out in instruments”). The proportionality principle only has the effect that institutions with a conservative risk profile apply the minimum requirements, while institutions with a complex risk profile have to grant about 60% of the variable compensation as deferral with a five-year deferral period.

The German legislator, on the other hand, defines in the InstitutsVergV a typifying approach for the application of the proportionality principle with catch-all limits (“waiver”): The CRD IV requirements for the variable compensation of risk takers only apply to “significant institutions”, with the InstitutsVergV specifying a balance sheet total of EUR 15 billion as the catch-all threshold for quantitative identification as a “significant institution”. Even “significant institutions” can pay out variable compensation for Risk Takers with a total amount of less than EUR 50,000.00 without taking into account the special payment requirements of the InstitutsVergV (“exemption limit”). “Non-significant institutions” may pay out the variable compensation as a lump sum. The draft of the revised version of the InstitutsVergV (InstitutsVergV 3.0) dated August 10, 2016 also contains these catch-all limits.

In its proposal, the EU Commission adopts the typifying approach for CRD IV, albeit not in the same way as the German legislator.

2. background: evaluation of the implementation of the CRD IV requirements on remuneration systems

The EU Commission’s proposal is based on the results of its evaluation of the implementation of CRD IV in the remuneration systems of individual institutions, which was carried out this year. The findings report, published on July 28, 2016, notes that many EU countries have adopted the typifying approach to the proportionality principle when transposing CRD IV into national law.

The typifications refer to the size of the institution (balance sheet total with a catch-all limit between EUR 918.27 million (Croatia) and EUR 52 billion (Sweden)) and to the individual variable remuneration of the risk taker (with a catch-all limit between EUR 10,000 (Netherlands) and EUR 711,339 (United Kingdom, here amount of total remuneration). The typifications were made on the basis of the realization that a compensation system with deferrals and pay out in instruments is associated with a disproportionate administrative burden, especially for small institutions; this is particularly the case if the variable compensation for the individual risk taker represents a relatively small share of the total compensation.

3. the main new provisions: Waiver in case of falling below the catch-all limit of EUR 5 billion and exemption limit of EUR 50,000.

According to the Commission’s proposal, all institutions with total assets of less than EUR 5 billion (over a four-year observation period) should in future generally be exempt from the requirements of deferral and pay out in instruments when structuring the variable remuneration of their risk takers.

The competent supervisory authority shall exceptionally deny the exemption for those institutions for which the application of the deferral and the pay out in instruments is required due to the nature and complexity of their business activities, their internal organization or the activities of the group to which the institution belongs. This exemption is comparable to the provision of § 17 para. 2 InstitutsVergV, according to which BaFin may classify institutions with total assets of less than EUR 15 billion as significant institutions if this is warranted with regard to the remuneration structure and the nature, scope, complexity, risk content and internationality of the business activities conducted.

In addition, the variable remuneration of risk takers at these institutions, which does not exceed the amount of EUR 50,000.00 in a reference period and amounts to a maximum of 25% of the total remuneration, shall also be exempt from the requirements of the deferral and the pay out in instrument.

4. what other material innovation does the proposal does the proposal contain?

The EU Commission’s proposal also clarifies that even capital market-oriented institutions are not obliged to grant the pay out in instruments part of the variable compensation in shares or these comparable instruments. Rather, these institutions should also be able to use alternative parameters in the future that fulfill the purpose of the pay out in instruments in a comparable manner, e.g. so-called phantom shares.

5. outlook and conclusion

The Commission forwarded its proposal to the other parties to the procedure (European Council and European Parliament). Any adoption of the supplementary regulations to CRD IV is expected in the second half of 2017. It remains to be seen whether BaFin will already take the EU Commission’s proposal into account in the final version of the InstitutsVergV 3.0. Otherwise, from a practical point of view, it cannot be ruled out that the InstitutsVergV will have to be revised again with regard to the catch-all limit and the exemption limit in line with the version of CRD IV then supplemented by the proposal of the EU Commission, according to which the catch-all limit under the InstitutsVergV for a “significant institution” would have to be reduced from EUR 15 billion to EUR 5 billion.

We will keep you up to date on further developments with our Client Alert.