Aims Of The Memo

This client memo intends to give you a brief overview of the CRD III transposition in Belgium and addresses certain key implementation issues, including questions that various clients have posed to us in the past weeks:

  • what are the deadlines to be met in 2011?
  • should it be expected that the CBFA will add stricter requirements to the European rules?
  • for smaller financial institutions, the proportionality exemption will be crucial. How should you apply this proportionality test? What will be the likely position of the CBFA?
  • what are the legal effects of CRD III on existing employment contracts? Do they need to be amended? How should the expectations of the CBFA be put in line with the labour laws?
  • do you need to establish a remuneration committee? What other corporate governance implications should be considered?

How can our CRD III Focus Team assist you?

We have established a CRD III Focus Team, headed by partners from the regulatory, corporate, labour and tax law departments and with one associate following up CRD III on a daily basis. We are happy to assist clients on the full range of CRD III related issues, such as:

  • the regulatory set-up, including negotiations with the CBFA on the proportionality test, amendments of internal procedures and assessments of implementation choices
  • the corporate governance implications of CRD III, including the assessment whether a remuneration committee needs to be set up, the control functions (and new role of internal control and human resources departments) and review process of the remuneration policy
  • amendments to existing employment contracts, including the drafting of malus and claw-back provisions and including the potential tax impact.

What entities are subject to the CRD III remuneration rules?

Regardless of their size, the following entities are subject to the CRD III remuneration rules (the "Financial Institutions"):

  • Belgian credit institutions and Belgian investment firms
  • Belgian branches of non-EEA credit institutions and non-EEA investment firms
  • Belgian settlement institutions and financial holdings supervised by the CBFA.

What is the status of the Belgian transposition of CRD III?

The CRD III remuneration rules can be found in:

  • the Directive 2010/76/EU of 24 November 2010 amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-securitisations, and the supervisory review of remuneration policies ("Capital Requirements Directive III" or "CRD III")
  • the Guidelines on Remuneration Policies and Practices of 10 December 2010 (the "EBA Guidelines") adopted by the Committee of European Banking Supervisors (as of 1 January 2011 renamed as the "European Banking Authority" or "EBA")
  • a Bill transposing CRD III in Belgium is currently being prepared, but has not been published yet. This Bill will amend the Belgian Banking Law of March 22, 1993
  • the Belgian Banking, Finance and Insurance Commission (the "CBFA") has indicated in its communication 2010-23 of November 17, 2010 (the "CBFA Communication") that it expects financial institutions to comply with the provisions of CRD III with regard to remuneration policies, including the EBA Guidelines
  • the CBFA is currently in the process of drafting a circular ("Draft Circular") offering further guidance. The EBA Guidelines will be added as annex to this Draft Circular, so that they will receive "hard law" legal force in Belgium.

What are the deadlines in 2011?

The Financial Institutions should meet the following deadlines:

  • theoretically, they are expected to implement the CRDIII remuneration provisions by January 1, 2011, even though CRD III will not be transposed in Belgian legislation by that date. We have been informed by the CBFA that this is sort of a "best effort" obligation: Financial Institutions should set up processes to evaluate their compliance with CRD III
  • we recommend Financial Institutions to contact the CBFA in Q1 2011 and to officially submit, or informally discuss, the proposed implementation plan. This is especially important for entities of smaller size (because it can be expected that subsequent discussions with the CBFA will happen on a collective basis; see fourth bullet point below)
  • by March 15, 2011, Financial Institutions must inform the CBFA of their revised remuneration policies when they submit their governance memorandum
  • even though theoretically, where applicable, a remuneration committee ("Rem Co") should have been established by January 1, 2011, the CBFA has announced in the CBFA Communication that Financial Institutions (other than "systemic institutions and large and medium-size institutions") should establish a Rem Co by June 30, 2011
  • in Q2 to Q4 2011, the CBFA will discuss the information it received and might propose amendments. Importantly, for smaller entities these discussions will likely happen on a collective basis; consequently, it can be expected that the individual negotiation margin will be limited.

The CRD III remuneration rules in a nutshell

CRD III sets out three main categories of remuneration rules: (a) rules on risk alignment, (b) rules on governance and (c) rules on transparency.

Rules on risk alignment

Financial Institutions should:

  • ensure that their remuneration policies are well designed and implemented
  • include the impact of remuneration payout levels – both upfront and deferred amounts – in their capital planning and in their overall capital assessment process
  • ensure that the remuneration policy covers all aspects of remuneration including fixed components, variable components, pension terms and other similar specific benefits
  • ensure that the pension policy (including fixed and variable pension payments) is aligned with their long term interests, with special attention to discretionary pension benefits schemes.
  • connect their remuneration policy to the setting of their risk appetite levels, their business strategy and their long term interest. The remuneration policy must also be connected with the risk management and the control and compliance tools as well as the code of conduct
  • only allow guaranteed variable remuneration ("guaranteed bonus", "welcome bonus", "sign-on bonus", "minimum bonus", etc) for the first year of employment in the context of hiring new staff
  • determine and approve severance pay (e.g. payments related to the duration of a notice period, redundancy remuneration for loss of office, even if including a non-competition clause) that is reflecting performance achieved over time and does not reward failure
  • ensure that their staff members do not use personal hedging strategies or insurance to undermine the risk alignment effects embedded in their remuneration arrangements
  • ensure that fixed remuneration is sufficiently high to remunerate the professional services rendered
  • set and explain in the remuneration policy explicit maximum ratios on the variable component in relation to the fixed component of remuneration, which can be downsized when income and profitability are decreasing, or in case of negative individual performance
  • ensure that variable remuneration is subject to "risk alignment" processes. In this respect, the EBA Guidelines set out detailed rules regarding (a) the performance and risk measurement process, (b) the award process and (c) the payout process
  • ensure that a substantial proportion of the variable remuneration (ranging from 40 to 60 %) is deferred. The minimum deferral period is 3 to 5 years. The deferral period always starts at the moment the upfront part of the variable remuneration is paid out and ends when the last variable remuneration has vested. Vesting should not take place more frequently than on a yearly basis (e.g. not every six months)
  • ensure that a substantial portion of the variable remuneration component consists of shares or share-linked instruments of the Financial Institution. Importantly, this also applies to unlisted Financial Institutions. If no market price is available, alternative instruments (also those based on cash pools) that reflect the Financial Institution's value may be used. Neither dividends nor interests are paid on these types of instruments before vesting
  • determine a retention policy with respect to the shares and share-linked instruments of the Financial Institution, including a minimum retention period between 3 and 5 years. Longer retention period may need to be considered if the risks underlying the performance can materialize beyond the end of the minimum retention period
  • Set up "ex post adjustment" mechanisms, including malus (i.e., an arrangement that permits the Financial Institution to prevent vesting of the amount of a deferred remuneration award in relation to risk outcomes) and clawbacks (i.e., contractual agreement in which the staff member agrees to return ownership of an amount of remuneration to the Financial Institution). The EBA Guidelines suggest including clawbacks in cases of established fraud or misleading information or for remuneration received in breach of CRD and these Guidelines.

Rules on governance

Financial Institutions should:

  • ensure that the "management body in its supervisory function" – in Belgium typically the board of directors – includes non-executive members that collectively have sufficient knowledge of remuneration policies and structures and are compensated with fixed remuneration only
  • ensure that the remuneration policy is not primarily controlled by the CEO or other executive directors
  • ensure that procedures to determine remuneration are "clear, well-documented and internally transparent". For example, proper documentation should be provided on the decision-making process, the determination of the Identified Staff (see further below), the measures used to avoid conflicts of interest, the criteria used to determine the ratio between the fixed and variable remuneration components, the risk-adjustment mechanisms used, etc.
  • ensure that all relevant corporate functions (i.e., risk management, compliance, human resources, strategic planning, etc) are properly involved in the design of the remuneration policy of the Financial Institution.
  • ensure that the Financial Institution's overall corporate governance principles and structures are considered within the design and implementation of an the remuneration policies and practices (such as the clear distinction between operating and control functions, the skills and independence requirements of managers, conflicts of interests rules, etc.)
  • ensure that the "management body in its management function" does not determine its own remuneration
  • ensure that the supervisory function specifically approves the remuneration of senior executives and staff members who receive the highest amounts of total remuneration
  • ensure that the remuneration policy is reviewed on an annual basis at a minimum
  • if they are "significant" in terms of its size, internal organisation and the nature, scope and complexity of its activities, establish a Remuneration Committee ("Rem Co"). The CBFA Communication specifies that a Rem Co should only be established by Financial Institutions that are required to establish an audit committee under article 3 of the Law of December 17, 2008 regarding the establishment of an audit committee in listed companies and financial institutions
  • if applicable, ensure that the Rem Co is comprised of members of the supervisory function who do not perform executive functions, and, at least the majority of whom qualify as "independent" (in the meaning of art. 526ter of the Code of Companies). The chairperson of the Rem Co should be an independent, non-executive member. At least one member of the Rem Co should have sufficient expertise and professional experience concerning risk management and control activities. The CBFA has further announced that it intends to apply the same criteria as those applicable to the establishment of an audit committee
  • ensure that the Rem Co is responsible for (amongst other things) (a) the preparation of recommendations regarding the remuneration of the managers as well as of the highest paid staff members, (b) the advice on the design of the overall remuneration policy and (c) the oversight of the remuneration system's design and operation
  • provide for an active participation of control functions in the design, ongoing oversight and review of the remuneration policies for other business areas. They should in particular consider the tasks and responsibilities of control functions, such as (a) the human resources function, (b) the risk management function, (c) the compliance function and (d) the internal audit function. The EBA Guidelines state in that respect that: "Human resources, while traditionally not seen as a control function, play an essential role in the design and implementation of the remuneration policies developed by the supervisory function"
  • ensure that the remuneration level of staff in the control functions allows the Financial Institutions to employ qualified and experienced personnel in these functions. The mix of fixed and variable remuneration for control function personnel should be weighted in favour of fixed remuneration.

Rules on transparency

Financial Institutions should:

  • disclose (a) the basic characteristics of their institution-wide remuneration policies and practices and (b) detailed information regarding their remuneration policies and practices for members of staff whose professional activities have a material impact on the Financial Institution's risk profile[,including aggregate quantitative information by business area and on the remuneration for such members of staff]. Small or non-complex Financial Institutions will only be expected to provide some qualitative information and very basic quantitative information where appropriate
  • ensure that such disclosure is easily accessible and is published on, at least, an annual basis and as soon as practicable. The CBFA expects Financial Institutions to provide the first disclosure reports in compliance with the requirements in the course of 2011
  • set out in the disclosure report the decision-making process used to determine the remuneration policy. The EBA Guidelines set forth what information is to be disclosure report
  • ensure that the remuneration policy is accessible to all staff members of the Financial Institution. The information regarding the remuneration policy disclosed internally should reveal at least the details which are disclosed externally

Key elements to be considered when implementing CRD III

Which staff is concerned?

The general risk alignment remuneration rules apply to the Financial Institutions' staff as a whole, while specific requirements apply to the individual remuneration packages of the so-called "Identified Staff" only. These are individuals whose professional activities have a material impact on the risk profile of Financial Institutions.

Whilst CRD III does not define what is covered by the notion of Identified Staff, the EBA Guidelines confirm that Identified Staff should be interpreted broadly. In our view, which was also informally confirmed by the CBFA, the notion refers not only to "employees" (as defined under Belgian labour law) but also to tied agents or independent workers, if they have a material impact on the Financial Institution's risk profile. The remuneration rules can thus not be circumvented by vehicles such as management companies.

The following categories of staff are automatically considered Identified Staff, unless the Financial Institution can demonstrate that they have no material impact on its risk profile. Importantly, according to the EBA Guidelines, this list contains examples and therefore is not conclusive:

  • executive members of the Financial Institution's corporate bodies, such as the directors, the CEO and the chairman of the management body if he/she is an executive
  • senior management responsible for day-to-day management, such as the members of the management committee, the individuals who directly report to the Financial Institution's corporate bodies and the individuals responsible for heading significant business lines (including those responsible for heading regional areas) such as trading, equities, fixed interest, foreign exchange, commodities, derivatives, sales, capital markets, securitisation, investment banking, credit, asset management and corporate finance
  • staff responsible for independent control functions, such as senior staff responsible for heading compliance, risk management, human resources, internal audit and similar functions (e.g. the CFO)
  • other risk takers such as staff members, whose professional activities – either individually or collectively – can exert influence on the Financial Institution's risk profile, including persons capable of entering into contracts/positions and taking decisions that affect the risk positions of the Financial Institution. Such staff can include individual traders, specific trading desks and credit officers.

Which remuneration is concerned?

For the purpose of CRD III, remuneration consists of all forms of payments or benefits made in exchange for professional services rendered by "staff", whether in cash or in kind, fixed or variable. This is a wide notion of remuneration, which is not identical to the definition of remuneration under other specific laws (labour, tax and/or social security law, etc). Ancillary payments or benefits that are part of a general, non-discretionary, institution-wide policy and pose no incentive effects in terms of risk assumption can be waived under the definition of remuneration for the purpose of CRD III specific risk alignment remuneration requirements.

Are existing remuneration schemes concerned?

The remuneration rules are to be applied immediately, i.e. both to (a) remuneration due on the basis of contracts concluded before January 1, 2011 and awarded or paid after that date and (b) for services provided in 2010, remuneration awarded, but not yet paid, before the date of the effective implementation of the remuneration requirements in each member state.

How will existing employment contracts be affected?

Financial Institutions should ensure that they adapt their contractual agreements with staff members. This obligation applies not only to contractual agreements that are concluded individually (such as an employment contract) but also to contractual agreements that are concluded collectively (such as collective bargaining agreements).

However, on the basis of Belgian contract and labour law principles, this adaptation will require the mutual agreement of all parties concerned. In this respect it can also be noted that the EBA Guidelines explicitly confirm that the remuneration rules do not prejudice the general principles of national contract and labour law.

This raises several questions when implementing CRD III in practice. A first question relates to the right of the employee to refuse amendments to an existing contract. A second question relates to the right of a Financial Institution to claim reimbursement of remunerations paid in breach of CRD III from its staff. The answer to these – and other – questions will depend on how CRD III will be transposed in Belgium. More specifically, based on the hierarchy of Belgian legal sources, the analysis whether CRD III prevails over national labour law will depend on the legal nature of the implementation instruments (e.g. in a law, a royal decree or a circular) and the assessment of the mandatory or public order nature of such instruments. For instance, under Belgian labour law, as far as employees are concerned, any sum already paid to an employee or that should be paid in accordance with existing contractual obligations, is currently to be considered as a vested right for the employee. Consequently, we believe that in the event a current or future payment (made or to be made on the basis of existing contractual obligations) would infringe CRD III remuneration rules, as a general rule, the Financial Institution will not be able to claim its reimbursement from the employee.

In any event, we believe that it is not self-evident that CRD III will put aside the protection of employees under Belgian labour laws, unless these labour laws are amended.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.