This is what the BaFin FAQs on the Remuneration Ordinance for Institutions mean

The German Federal Financial Supervisory Authority (BaFin) has published questions and answers (FAQ) on the Remuneration Ordinance for Institutions (InstitutsVergV). They replace the previous interpretation aid. The FAQs are now directly applicable.

The design of remuneration systems at credit institutions and financial services institutions is an increasingly complex task that is based on a large number of regulations. The jungle of remuneration regulatory requirements has continued to grow as a result of the BaFin’s published announcement.

BaFin provides institutions with additional information in 19 questions and answers:

Institutions can apply the requirements set out in the FAQs immediately. The remuneration systems must be adjusted by January 1, 2025 at the latest.

The BaFin FAQ replaces the old interpretation guide

BaFin’s FAQs completely replace the old interpretation aid dated February 16, 2018. This is because the explicit sentence stating that the old interpretation aid has not been abandoned was deleted in the consultation draft of the FAQ. However, the former interpretation aid was more detailed. The FAQs, on the other hand, are more specific. BaFin will therefore presumably refer to the old interpretation aid as a supplement and maintain its previous administrative practice. Supervisory authorities and auditors are also likely to continue to take these views into account.

FAQ with a law?

The FAQs are an administrative practice of the supervisory authority that specifies standards and not a law or regulation. Nevertheless, the views of the supervisory authorities are of considerable importance for credit institutions and financial services institutions. The views of the German national supervisory authorities supplement or specify the views of the European supervisory authority, the EBA, which has published its own guidelines (EBA guidelines). This results in the following hierarchy in the assessment of remuneration regulatory requirements:

1. National laws and regulations such as the KWG and the InstitutsVergV
2. European regulations such as the Delegated Regulation (EU) 2021/923.
3. EBA guidelines such as the pronouncements for a sound remuneration policy (EBA/GL/2021/04).
4. FAQs on the InstitutsVergV: BaFin’s FAQs supplement the EBA Guidelines and flesh them out, particularly in areas that are not covered by the EBA Guidelines or have been implemented differently in Germany as part of the proportionality concept.
5. Old interpretative guidance: Although the old interpretative guidance has been formally replaced, the views and practical findings contained therein remain relevant and are taken into account in audits by the supervisory authorities.

Implementation deadlines of the FAQ

BaFin has set a transitional period until January 1, 2025, within which the supervised institutions must implement the requirements from the FAQs on the InstitutsVergV in their remuneration systems. Institutions have until the end of 2024 to make and ensure the necessary adjustments. Institutions can apply the simplifications provided by the FAQs immediately.

In the upcoming audit of the annual financial statements, the auditing firms will take the FAQs into account, particularly with regard to the intended adjustments. It is therefore important that the institutions use the transition period to revise their remuneration systems accordingly.

These significant changes can be found in the FAQs

Remuneration concept

In the past, remuneration components were allocated to either fixed or variable remuneration. Fixed remuneration includes regular, guaranteed payments such as basic salaries, while variable remuneration includes performance-related payments such as bonuses. The FAQs have expanded the definition of remuneration to the effect that some benefits do not count as remuneration within the meaning of the InstitutsVergV. Remuneration in kind that is not to be regarded as income from employment for income tax purposes or income pursuant to Section 8 (2) sentence 11 of the German Income Tax Act (EStG) that is not to be considered as remuneration within the meaning of the InstitutsVergV. Furthermore, bonuses from “employee-recruit-employee” programs or comparable bonuses from the company suggestion scheme no longer fall under the definition of remuneration.

On the other hand, individually agreed pensions in the event of non-renewal of a management appointment (before reaching the standard retirement age) are now classified as variable remuneration. The FAQs state: If a pension is agreed as part of a termination agreement in the event of premature termination of the employment, management or service relationship, the requirements for severance payments pursuant to Section 5 (6) InstitutsVergV apply.

Performance recognition bonuses

Performance recognition bonuses, also known as “recognition awards” or “spontaneous bonuses”, can be granted by institutions under certain conditions. These bonuses are generally not linked to a target agreement and are intended to reward special employee performance. The main requirements for granting performance recognition awards are as follows:

• Limited scope and requirements:
  • Performance recognition bonuses may only be granted to a limited extent (in particular only to a small, changing group of employees) and under certain conditions.
  • The discretionary scope for granting performance recognition bonuses must be restricted (in particular, regulation of the amount and frequency as well as the definition of criteria and occasions for granting them).
• Requirements for non-risk carriers:
  • Performance recognition bonuses are particularly permissible for employees of non-significant institutions.
  • Risk takers from significant or partially significant institutions are excluded from the granting of such premiums. This is based on the requirements of a multi-year assessment basis and a mandatory agreement on targets.
• Treatment as variable remuneration:
  • Performance recognition bonuses must be treated in accordance with the regulations for variable remuneration.
  • In particular, negative profit contributions must also be taken into account.
• Ban as compensation for rule bonus:
  • Performance recognition bonuses may not be granted as compensation for a lost regular bonus. This is in line with the prohibition of negative performance contributions.
• Generally not granted during the year:
  • Performance recognition bonuses must be included in the audit in accordance with Section 7 InstitutsVergV; the audit must generally be carried out after the end of the financial year.
  • Performance recognition bonuses should therefore only be granted or paid out during the year in exceptional cases and only for smaller variable remuneration and with regard to a small number of employees.

Negative profit contributions

Institutions must include negative performance contributions in their organizational guidelines. This means that clear rules and processes must be defined as to how negative contributions are to be handled. The FAQs specify concrete case categories in which variable remuneration can be reduced. An institution’s organizational guidelines must also provide remuneration recipients with appropriate guidance as to which misconduct constitutes a negative performance contribution of a certain degree of severity. Internal processes must ensure that any incidents come to light in good time before the variable remuneration is paid out. A case-by-case review must be carried out in each case. Both significant and non-significant institutions must adapt their remuneration systems with regard to the existing clauses.

ESG risks

The FAQs do not currently contain any specific regulations on the consideration of ESG risks in remuneration systems. Nevertheless, there are some general guidelines and principles that institutions should observe. Institutions that have anchored ESG risks in the respective risk types due to their strategic orientation must also take them into account in their remuneration systems.

Institutions should adapt their remuneration systems accordingly. They can integrate ESG criteria into the performance assessment and into the institution’s rules for measuring variable remuneration.

Severance payments

Severance agreements must not create false incentives. Severance payments must not be designed in such a way that they encourage or reward undesirable behavior. The amount of severance pay must take into account both the length of employment and the circumstances of the termination of the contract. In addition, BaFin has set out statements on the privileged status of severance payments in the FAQs, for example on a collective notification. BaFin has issued detailed guidelines on this, which should be compared with the severance payment framework concept.

Determination of variable remuneration

The FAQs on the InstitutsVergV contain specific requirements for determining the total amount of variable remuneration, in particular with regard to the bonus pool and the exemption pursuant to Art. 7 CRR, Section 2a (2) KWG (capital waiver) for subsidiaries.

The total amount of variable remuneration (bonus pool) must continue to be determined on the basis of the annual financial statements prepared after the end of the financial year. This means that the institutions determine the bonus pool after the end of the financial year, taking into account the financial situation and the risk situation of the institution. Furthermore, the recommendation of the European Central Bank (ECB) that banks should take a prudent and forward-looking approach when deciding on their remuneration policy must also be taken into account.

Hedging and hedging prohibition

Strategies and measures aimed at reducing the risks of the variable remuneration components are prohibited. The variable remuneration must actually be risk-oriented and provide the desired incentives.

In addition to the public savings banks and cooperative banks, building societies will in future also be able to dispense with spot checks with regard to Section 8 (2) InstitutsVergV, provided their supervisory authority is BaFin. In particular, no regular spot checks on compliance with the hedging prohibition are required. Nevertheless, the institutions must continue to include a declaration of commitment in their contracts.

Appropriateness report and remuneration control report

Due to the overlaps, the FAQs allow the appropriateness report pursuant to Section 12 para. 1 InstitutsVergV and the remuneration control report pursuant to Section 24 para. 3 InstitutsVergV to be combined. The institutions may also address the review of the remuneration systems of the managing directors in the report. However, the responsibilities pursuant to Section 3 InstitutsVergV must be observed, meaning that the administrative and supervisory body is responsible for the remuneration system of the management.

Instruments

The FAQs provide information on how institutions can proceed if it is not possible to link variable remuneration to shares. The main requirements and alternatives are

If it is not possible to link variable remuneration to shares, institutions must choose equivalent instruments. These instruments should offer similar incentives and risk orientation. They must appropriately reflect the creditworthiness of the institution by being based on business ratios.

Phantom shares, for example, are equivalent. These simulate the performance of shares without shares actually being issued. However, subordinated loans, bonds or promissory bills issued by the institution can also be considered.

Remuneration officer

BaFin has clear ideas on the appointment and remit of remuneration officers. The requirements go beyond the European guidelines.

Remuneration officers should generally work full-time in order to ensure the comprehensive monitoring and evaluation of the remuneration systems. In some cases, the minimum working hours of the remuneration officer can also be less than 50 percent of the target working hours, particularly if the institution has capped the variable remuneration of risk takers below management level at a maximum of EUR 50,000. This allows for flexible handling, especially in smaller institutions. Certain dual functions of remuneration officers are excluded. Remuneration officers may not take on any other tasks that could lead to conflicts of interest. Employees may also become remuneration officers, provided that an independent monitoring function is guaranteed. Funding institutions are still not required to appoint a remuneration officer if they do not pay variable remuneration.

The FAQs bring significant changes; prompt implementation is recommended

The new BaFin requirements entail significant changes that institutions must take into account. Credit institutions and financial services institutions should review and adapt their internal processes and systems. This requires close cooperation with internal and external experts. The new BaFin FAQs are an important basis for making institutions’ remuneration systems more transparent, fair and risk-oriented. Institutions should implement the changes promptly in order to minimize compliance risks.