Supervision of remuneration practices and policies
Remuneration, pursuant to the Guidelines of the European Banking Authority on sound remuneration policies (EBA/GL/2015/22), means:
‘all forms of fixed and variable remuneration and includes payments and benefits, monetary or non-monetary, awarded directly to staff by or on behalf of institutions in exchange for professional services rendered by staff, carried interest payments within the meaning of Article 4(1)(d) of Directive 2011/61/EU , and other payments made via methods and vehicles which, if they were not considered as remuneration, would lead to a circumvention of the remuneration requirements of Directive 2013/36/EU.’
The institutions’ remuneration practices and policies have a material impact on the incentive structure of their staff, especially in promoting a sound and prudent management and complying with the other prudential rules. Considering the financial system as a whole, they have a material impact on financial stability.
Institutions must ensure that their remuneration practices and policies match the interests of the members of their management and supervisory bodies and of the other staff with the long-term interests of the institution, taking account of internal and external stakeholders.
They must ensure that their remuneration practices and policies promote a strong risk culture, which translates into a sound, prudent and responsible attitude to risk, and meets the legal and regulatory provisions in this regard, taking also into account the European Banking Authority’s Guidelines and international best practice.
Institutions’ remuneration practices and policies must be flexible and therefore adjustable to the financial situation of the institution at any time. They cannot threaten the financial sustainability of the institutions and, in particular, the existence of a sound capital base.
The rules on remuneration practices and policies cannot be waived, in particular through hedging strategies that undermine the risk alignment effects embedded in their remuneration arrangements or through the payment of variable remuneration by instrumental intermediary entities or other methods with equivalent effects.
Institutions are required to have in place a remuneration policy for all staff, taking account of mandatory legal rules for the following categories of staff:
- Members of the management and supervisory bodies;
- Senior management;
- Risk takers;
- Staff engaged in control functions;
- Employees receiving total remuneration that takes them into the same remuneration bracket as the above categories, whose professional activities have a material impact on the institution’s risk profile (‘identified staff members’).
The institution shall indicate which staff members are identified, pursuant to Delegated Regulation No 604/2014 of the European Commission.
Under the Single Supervisory Mechanism, significant credit institutions may circumvent the presumption that certain staff members have a material impact on the institution’s risk profile (Decision No 2015/2218 of the European Central Bank of 20 November 2015).
The remuneration policy shall be approved:
- By the general meeting, as regards the management and supervisory bodies;
- By the management body, as part of its management function, as regards the other staff.
The remuneration policy and the respective approval procedure must be duly documented. The remuneration policy must be published both internally and externally, namely on the institution’s website, where applicable.
The institutions must ensure that the ratio between the fixed and the variable components of remuneration of their staff is appropriate.
Institutions must be able to submit a prudential justification to Banco de Portugal on the adequacy of that ratio.
They must ensure that the fixed remuneration is a sufficiently high share of the variable remuneration, allowing for the application of a fully flexible policy to the variable remuneration, including the possibility where it decreases down to zero.
In principle, the variable remuneration cannot exceed the value of the fixed component of the remuneration for each staff member.
However, institutions may approve a higher maximum level, up to twice the amount of the fixed component for each staff member. For this purpose:
- The institution must present at the general meeting a detailed proposal regarding the approval of the higher maximum level of the variable component of remuneration, indicating the proposed higher maximum ratio, the reasons and scope, including the number of staff affected, their functions and a demonstration that the proposed ratio does not conflict with the institution’s obligations, especially for the purpose of maintaining a sound capital base;
- The institution must inform Banco de Portugal, without delay, of the shareholders’ proposal, indicating the proposed higher maximum ratio and the reasons therefore, and must be able to demonstrate that the proposed higher ratio does not conflict with the institution’s legal obligations, having regard in particular to the institution’s own fund obligations;
- The general meeting shall act on the submitted proposal by a majority of two-thirds of the ownership rights represented, provided that shareholders holding at least 50% of the shares are present or represented or, failing that, shall act by a majority of three-quarters of the shareholders’ voting rights present or represented;
- The institution must inform Banco de Portugal, without delay, of the decisions taken.
Staff who are directly affected by the higher maximum levels of the variable remuneration are not allowed to exercise, directly or indirectly, any voting rights they may have as shareholders.
Banco de Portugal uses the information received relating to the decision adopted to assess the institution’s remuneration practices and transmit information about this decision to the European Banking Authority.
When defining the ratio between fixed and variable total remuneration, institutions may apply a discount rate to a maximum of a quarter of the variable component of the remuneration, insofar as it is paid in instruments deferred for a period of five years or more. The discount rate must be calculated according to the Guidelines of the European Banking Authority (EBA/GL/2014/01).
In view of the sound and prudent management of the institution, the performance measurement of the members of the management and supervisory bodies and other staff should:
- Be based on financial and non-financial criteria;
- Take a multiannual processing framework, based on long-term performance;
- Allow an adjustment for all types of current and future risks, taking into account the cost of the capital and the liquidity required.
The variable remuneration should be spread over a period which takes account of the underlying business cycle of the institution and its business risks.
The institution is responsible for defining the performance indicators used in the measurement process. The institution must be able to justify these to Banco de Portugal, based on prudential arguments, where such justification is requested.
Where the institution intends to change the performance indicators, it must document the decision-making process and be able to justify that change to Banco de Portugal, based on prudential arguments.
Institutions’ remuneration policy must establish that a substantial portion of the variable remuneration should be deferred over a period which is no less than three to five years. This deferral is designed to align staff interests with the long-term interests of the institution.
The variable remuneration and the minimum length of the deferral period must be established in accordance with the business cycle, the nature of the business, its risks and the activities of the member of staff in question.
At least 40% of the variable component of the remuneration must be deferred. In the case of a variable remuneration of a particularly high amount, that portion is raised to 60%.
The variable remuneration payable under deferral arrangements must vest on a pro-rata basis over the deferral period.
All decisions taken by the institution regarding the deferral rules must be substantially based on criteria legally envisaged for the purpose.
Purely formal compliance with the legal and regulatory rules is not sufficient. Institutions must define their own deferral rules based on sound prudential rationale, which they should be able to fully justify to Banco de Portugal.
At least half of the variable remuneration, whether deferred or not, must consist of a balance of the following:
- Shares or equivalent ownership interests, admitted to trading on a regulated market, issued by the same institution, or share-linked instruments or equivalent non-cash instruments;
- Where possible, other instruments within the meaning of Articles 52 or 63 of Regulation (EU) No 575/2013 of the European Parliament and of the Council, or other instruments which can be fully converted to Common Equity Tier 1 instruments or written down, that adequately reflect the credit quality of the institution and are appropriate to be used for the purpose of variable remuneration.
Remuneration awarded in instruments is designed to align staff interests with the interests of those who effectively finance the institution, both internally (shareholders) and externally (usually bondholders), in the long term (including retention arrangements).
In order to determine which instruments can be used for the purposes of remuneration, institutions must take account of Delegated Regulation No 527/2014 of the European Commission.
Institutions are responsible for reviewing and deciding on the balance of the different types of instruments, based on an analysis of their prudential situation. Formal compliance with the law is not sufficient: institutions must be able to justify, from a prudential point of view, the selected instruments and the balance they propose, in view of their actual situation.
Institutions must ensure that the instruments used are subject to a retention policy, in that they are subject to an appropriate period of retention by the institution, designed to align the incentives with the longer-terms interests of the institution.
Institutions’ remuneration policy must provide for the risk-based ex-post adjustment of the variable remuneration, through the following mechanisms:
- Malus: allows the institution to reduce the value of all or part of the deferred variable remuneration before it has vested;
- Clawback: allows the institution to recover an amount paid or which has already vested, under which the staff member must return ownership of such an amount.
Clawback mechanisms should not be confused with retention mechanisms. In the first case, it consists of the possibility to recover remuneration already paid. In the second case, it consists in retaining a certain amount during a given period of time, until its payment.
The objective of the ex-post adjustment mechanisms is to ensure that the variable remuneration actually paid takes into account the materialisation (or not) of the risks arising from the action of staff members or from their conduct in accordance with the ethical principles inherent in sound and prudent management. In any case, the variable remuneration should only be due if financially sustainable for the institution.
Ex-post adjustment mechanisms apply to the full variable remuneration, based on criteria to be defined by the institution, including at least the following situations in which the staff member:
- Participated in or was responsible for conduct which resulted in significant losses to the institution;
- Failed to meet appropriate standards of fitness and propriety.
The discretionary pension benefit policy must be in line with the business strategy, objectives, values and long-term interests of the institution.
The discretionary pension benefits must take the form of financial instruments that may be used for the purpose of remuneration.
Where a staff member leaves the institution before retirement, the discretionary pension benefits he/she holds must be retained by the institution for a period of five years. After that period, the staff member may receive the vested benefits.
Where a staff member reaches retirement, the discretionary pension benefits he/she holds and vests must be retained by the institution for a five-year period, after which it may be paid to the staff member.
Institutions must ensure that any severance pay to staff members due to early termination of functions reflects their performance achieved over time, in order not to reward failure or misconduct while the staff member is still in office.
When compensating new staff members for the buyout of their previous employment, institutions must consider their long-term interests. Therefore, they must apply to this compensation rules on conduct, unavailability for retention by the institution, deferral and clawback.
Institutions that benefit from extraordinary public financial support
The remuneration policy of the institutions benefiting from extraordinary public support are subject to the following requirements during the intervention period:
- No variable remuneration is paid to members of the management body of the institution unless there are serious and objective reasons that would justify such payment;
- Remuneration must be restructured in a manner aligned with sound risk management and long-term growth of the institution, including establishing limits to the remuneration of the members of the management body;
- Variable remuneration is strictly limited as a percentage of net revenue where it is necessary for the maintenance of a sound capital base and timely exit from extraordinary public financial support.
Once the extraordinary public financial period is over, the institution cannot determine the variable remuneration of the staff members so that they may receive the amounts they did not receive during the intervention.
Pursuant to the Code of Commercial Companies, the institutions’ general meeting may appoint a remuneration commission to set the remuneration of the members of its management body.
According to international best practice, the members of the remuneration commission should qualify as independent, have appropriate knowledge and expertise concerning remuneration.
This commission must not be confused with the remuneration committee set out in the Legal Framework of Credit Institutions and Financial Companies.
The remuneration committee is mandatory for significant institutions for the purposes of CRD IV and CRR. It should be composed of non-executive members of the management body or members of the supervisory body and must be responsible for:
- Exercising competent and independent judgement on remuneration policies and practices and the incentives created for managing risk, capital and liquidity;
- Preparing decisions regarding remuneration, including those that have implications for the risk and risk management of the institution, and which are to be taken by the management body.
According to international best practice, the members of the remuneration committee should qualify as independent, including, as far as possible, its chair.
The remuneration committee must exercise its functions taking into account the long-term interests of the institution’s internal and external stakeholders, as well as the need to protect financial stability.
They must have appropriate authority for the exercise of their functions, and must be remunerated in accordance with the operational independence required.
Institutions must ensure that staff engaged in control functions is remunerated in accordance with the achievement of the objectives linked to their functions, independent of the performance of the business areas they control.
Institutions must ensure that the remuneration of staff engaged in control functions is overseen by the remuneration committee, or, if it has not been established, by the supervisory body.
Among best governance practices is the remuneration of the members of management and supervisory bodies to an amount that is consistent with their hierarchical position and responsibility, taking account of their duties as provided for by law.
Should they decide not to remunerate the members of their management and/or supervisory bodies, institutions must duly document and justify that decision in prudential terms. In particular, the institution must evaluate the extent to which the lack of remuneration has no effect on the proper and diligent exercise of the function concerned.
The remuneration of the executive members of the management body may include a fixed and a variable component. It is advisable to include a variable component, thus helping promote excellence in performance.
The remuneration of non-executive members of the management and supervisory bodies can only include a fixed component. The amount of remuneration must promote the effective and full exercise of their responsibilities and functions.
Institutions are subject to reporting requirements to Banco de Portugal and to provide information to the market on their remuneration practices and policies.
Institutions must disclose at least the following information, regarding their remuneration policies and practices for those categories of staff whose professional activities have a material impact on their risk profile (Article 450 of Regulation No 575/2013 of the European Parliament and of the Council):
- Information concerning the decision-making process used for determining the remuneration policy, as well as the number of meetings held by the main body overseeing remuneration during the financial year, including, if applicable, information about the composition and the mandate of a remuneration committee, the external consultant whose services have been used for the determination of the remuneration policy and the role of the relevant stakeholders;
- Information on link between pay and performance;
- The most important design characteristics of the remuneration system, including information on the criteria used for performance measurement and risk adjustment, deferral policy and vesting criteria;
- The ratios between fixed and variable remuneration;
- Information on the performance criteria on which the entitlement to shares, options or variable components of remuneration is based;
- The main parameters and rationale for any variable component scheme and any other non-cash benefits;
- Aggregate quantitative information on remuneration, broken down by business area;
- Aggregate quantitative information on remuneration, broken down by senior management and members of staff whose actions have a material impact on the risk profile of the institution, indicating the following:
- The amounts of remuneration for the financial year, split into fixed and variable remuneration, and the number of beneficiaries;
- The amounts and forms of variable remuneration, split into cash, shares, share-linked instruments and other types;
- The amounts of outstanding deferred remuneration, split into vested and unvested portions;
- The amounts of deferred remuneration awarded during the financial year, paid out and reduced through performance adjustments;
- New sign-on and severance payments made during the financial year, and the number of beneficiaries of such payments, the amounts of severance payments awarded during the financial year, number of beneficiaries and highest such award to a single person;
- The number of individuals being remunerated EUR 1 million or more per financial year, for remuneration between EUR 1 million and EUR 5 million broken down into pay bands of EUR 500 000 and for remuneration of EUR 5 million and above broken down into pay bands of EUR 1 million;
- The total remuneration for each member of the management body or senior management.
For institutions that are significant for the purposes of the CRD IV and CRR, the quantitative information must also be made available to the public at the level of members of the management body of the institution.
Banco de Portugal collects aggregate quantitative information, broken down by business area, senior management and members of staff whose actions have a material impact on the risk profile of the institution, as well as the number of individuals being remunerated EUR 1 million or more per financial year, included in the perimeter of supervision on a consolidated basis, pursuant to Instructions of Banco de Portugal Nos 4/2015 and 5/2015.
The institution shall be responsible for a robust reporting process, enabling it to provide true, correct, complete, updated, consistent and reliable information.
Reporting documents must be fully filled in and their quality assessed before being sent to Banco de Portugal.
Information reporting on remuneration practices and policies should not be a purely formal exercise. Institutions shall be responsible for ensuring that the preparation of this reporting is an opportunity for the institution to review the data in question and detect any failure and improvement opportunities.
The institution’s management body must send annually to Banco de Portugal a statement on compliance of its remuneration policy, indicating any possible shortcomings, including those detected by the control units within the scope of the centralised regular review of the remuneration policy.
Inadequate treatment of the information to be reported to Banco de Portugal may indicate that such information is not being used properly by the institution to identify and mitigate the risks inherent in its business.
Failures in the internal review process and the processing of information to be reported are strong sources of risk for the institution and may, ultimately, justify intervention by Banco de Portugal, under either the prudential or corrective arm.
The management body of the parent undertaking must send annually to Banco de Portugal a statement on the overall consistency of the remuneration policy of their subsidiaries abroad and off-shore establishments, indicating any possible shortcomings, including those detected by the parent undertaking’s control functions within the scope of the centralised regular review of the remuneration policy.
The statements must provide detailed justification of existing shortcomings and the action in progress or to be adopted to correct them, as well as the deadlines established to that end. The statements must be attached to the individual internal control reports to be submitted by the institution or financial group to Banco de Portugal, within the deadline established in Notice No 5/2008 for that purpose.