Changes to banker bonus rules

After a long period of waiting following the publication of the first draft in August 2016, a revised version of the German Remuneration Regulation for banks and financial services providers was published in the Federal Law Gazette on 03 August 2017 with most of the changes taking effect on 04 August 2017. One of the main purposes of the revised Regulation is the transposition of the European Banking Authority (EBA) Guidelines on Sound Remuneration Policies into German law.

The revised Regulation had initially been expected to enter into force on 01 January 2017 but was postponed various times. The publication in the middle of the German school holidays now came as somewhat of a surprise. Unfortunately the revised interpretation guidelines - which in their last published draft of 2016 had “exploded” to twice their previous length - have not been published yet so that open questions remain at this stage.

Many of the general principles of the previous Regulation remain unchanged. For example the Regulation still stipulates significantly stricter requirements for so-called major institutions with the trigger point for being qualified “major” still being at €15bn rather than the €5bn proposed by EBA.

Whilst the initial draft had proposed a requirement for all institutions to identify material risk takers (MRTs), the revised Remuneration - like the previous version only stipulates a relevant obligation for major institutions. This approach is in line with a lot of criticism that BaFin had received regarding the initial draft which would have resulted in an onerous identification exercise for smaller institutions without any actual use for remuneration purposes MRT status only has relevance for major institutions whereas for other institutions the rules of the Regulation apply regardless of the employee’s MRT status.

Definition of fixed vs variable remuneration

The revised Regulation reverses the definitions of the two categories of remuneration:

Whereas previously everything that was not variable was fixed, now all remuneration that is not fixed is variable. This shall also apply if in doubt whether a particular benefit can be considered fixed.

Under the new definition remuneration shall be fixed where the conditions for its award and its amount are:

• based on predetermined criteria
• non-discretionary
• permanent
• transparent for employees, and
• not providing an incentive for risk-taking

and where the remuneration

• cannot unilaterally be reduced, and
• does not depend on performance and is not otherwise subject to conditions precedent.

The reversal of the definition means that institutions will need to document and prove that the above requirements are met as otherwise remuneration will automatically be qualified as variable.

Guaranteed bonuses

Guaranteed bonuses continue to be permissible for the first twelve months of the employment relationship, provided that the previous job of the employee was not with another group company. They will not be considered for the purposes of the bonus cap if they have been promised prior to the commencement of employment, such as for example in the employment contract. There shall be no requirement for major institutions to apply deferral or clawback rules to guaranteed bonuses.

Allowances

Non-permanent allowances which are linked to a particular role or situation will only be fixed remuneration in the event of:

• outbound secondments abroad, or
• the temporary assumption of a more sophisticated role

however, provided that there are

• uniform, institution-wide rules for comparable cases to pay relevant benefits on a non-discretionary basis,
• pre-determined criteria for the allowance amount, and
• a resolutive condition that the entitlement will cease upon expiry of the reason of its award.

As so-called “fixed allowances” will often not be linked to the temporary assumption of a more sophisticated role but will be linked to the employee’s normal role, there can be reasonable doubt whether these allowances are still permissible.

Severance payments

A key change that has been subject to a big debate during consultation is that severance payments shall now be considered variable remuneration unless certain requirements are met. As severance is a compensation for the loss of a job and typically no remuneration, this approach is alien to the system of German employment law.

Institutions will now have to document severance principles in writing or electronically, including a maximum amount or the criteria for the determination of severance payments. In addition the institution’s organisation guidelines on remuneration practices need to stipulate a framework concept regarding determination and approval of severance payments including a clear assignment of responsibilities and decision-making authority, ie a relevant process. Any severance payments will need to be determined in line with such process which will also need to be documented.

A key issue certainly is that severance shall in principle not reward misbehaviour or bad performance whereas in reality low performers will typically receive the highest severance payments as German dismissal protection laws do not recognise poor performance as a valid reason for a dismissal.

Ultimately however all of the above requirements only add an additional level of burdensome bureaucracy for institutions and may be a storm in a teapot BaFin has provided certain exemptions under which severance will not be considered variable compensation. In practice usually one of these exemptions will apply, ie the severance will either be paid:

• under a social plan
• under a final court settlement or court judgment
• does not exceed the amount calculated in line with the pre-determined criteria and relates to a redundancy or serves the purpose of avoiding litigation, or
• does not exceed a specific amount (€200,000 and 200% of the fixed remuneration in the last full business year).

In practice it should be expected that the number of cases going to the courts will increase as the conclusion of formal court settlements will possibly become the method of choice to ensure compliance with the above principles.

Retention bonuses

With regard to retention bonuses it was in the past controversial whether these are possible or have to be regarded as prohibited guaranteed bonuses. BaFin has now provided clarity by adding a specific provision whereas retention bonuses can be allowed where the institution has a legitimate interest. Major institutions have to comply with additional requirements such as deferral rules, clawback etc. For the purposes of the bonus cap retention bonuses have to be considered either on a pro-rated basis or with their total amount at the time that they become due.

Deferral and clawback

For major institutions key changes relate to ex-post risk adjustment mechanisms. Relevant rules apply to MRT remuneration exceeding €50,000.

Negative performance deviations by the individual, the business unit, the institution or the group compared to agreed targets have to reduce the variable compensation or may even have to result of a complete loss for the relevance performance period. A full loss of variable compensation, including clawback regarding variable remuneration already paid, has to occur in any event where the employee:

• was materially involved in or responsible for a conduct that has resulted in significant losses or significant regulatory sanctions for the institution, or
• has seriously violated relevant external or internal rules with regard to suitability and conduct.

From an employment law perspective it is certainly questionable whether institutions will be able to validly agree on relevant clawback mechanisms with employees. German labour courts have become very strict with regard to the validity and transparency of bonus clauses. Not only in light of the vary vague terms used by the Regulation it will be very difficult for institutions to come up with wording that complies with both the Regulation and the courts’ onerous transparency and clarity requirements. Ultimately it may come down to a Hobson’s choice between complying with regulatory requirements and managing employment law risk.

Disclosure

The disclosure obligation under the Regulation now only applies to CRR and major institutions. Other smaller institutions no longer have relevant obligations. For those institutions that still have disclosure obligations these will become more extensive as well as subject to additional rules on format and disclosure method. These new rules will first apply to the next bonus year.

Review and action plan

An annual review of the remuneration system shall now be mandatory and has to be well documented. Any issues have to be addressed in an action plan whose implementation will also be subject to documentation requirements.

Conclusion

In summary, to end on a positive note especially for non-major institutions, the changes introduced by the revised Regulation seem to be manageable and in light of the initial consultation draft of August 2016 could have been much more burdensome. Nevertheless it remains to be seen which impact Brexit and a possibly increasing importance of the Frankfurt banking marketplace may have on future German regulation.