• German Financial Supervisory Authority (BaFin) publishes final version of new remuneration rules for financial institutions
  • Stricter requirements for variable compensation
  • Principle of proportionality retained: Small and medium-sized financial institutions in Germany largely exempted

Frankfurt, August 4, 2017. The German Financial Supervisory Authority’s (BaFin) new remuneration ordinance for financial institutions (Institutsvergütungsverordnung, InstitutsVergV) enters into force today. This ordinance implements the requirements set out by the European Banking Authority (EBA) – which have been in force since 2017 – into German law, including previously-discussed stricter requirements for compensation within financial institutions that fall under the German Banking Act (Kreditwesengesetz, KWG). These tighter regulations in particular affect the granting, payment and recovery (clawback) of variable compensation. However, under the “principle of proportionality,” non-significant financial institutions remain exempt from the obligation to identify risk takers within their organization.

The new version of the InstitutsVergV enters into force on August 4, 2017. All regulations subject to a performance assessment – such as bonus payments – must only be implemented for assessment periods that begin after this date. Asset management companies that are subsidiaries of banking groups and directly subject to relevant special regulations at the European level (UCITS or AIFMD) are not covered by the group-wide application of the InstitutsVergV.

"The new regulations represent a tightening of previous compensation practices in certain critical areas, such as the introduction of "clawbacks" – the repayment of variable compensation that has already been paid out in cases of misconduct – and stricter requirements for risk takers’ variable compensation," says Isabel Jahn, Senior Manager Financial Services at hkp/// group. "However, the principle of proportionality has been upheld – much to the relief of smaller and non-significant financial institutions. That means the number of risk takers in financial institutions in Germany will not grow significantly for the time being," she adds.

Four key areas

A first glance at the new regulations reveals changes in four main areas. The most significant is the introduction of clawbacks to sanction misconduct. This will make it possible to demand repayment of compensation that has already been paid out and forfeit any outstanding compensation for risk takers for a period of up to seven years.

How this new regulation will be implemented in practice is far from clear. “First, there is the question of how it will be formulated in employment contracts. Moreover, it is not yet clear from the regulator’s perspective what type of misconduct should result in a demand for repayment of variable compensation that has already been paid," says Carsten Roth, Senior Manager Financial Services at hkp/// group. According to Roth, even when all these points have been clarified, it is still uncertain how German labor courts will view clawbacks.

Second, the ordinance introduces stricter regulation on deferred compensation and the accompanying review of employees’ performance contributions. In the future, a risk taker’s classification will determine the period for which compensation must be deferred and underlying performance be checked retrospectively. This period will now be at least five years for a larger number of risk takers than in the past.

In the third area – the distinction of fixed and variable compensation components – the new version of the ordinance introduces an obligation to provide proof that fixed compensation elements are indeed fixed. The regulations clarify how severance payments, bonuses, allowances and "non-material compensation components" are to be treated.

The much-criticized demand for a formula to determine the maximum allowable severance payment has also been replaced by pre-established principles. The amount up to which other severance payments are considered appropriate and do not require further disclosure to the regulator has been set at EUR 200,000. Certain types of compensation, in particular allowances for staff working abroad (expat allowance) or in different positions (functional allowance), no longer qualify as variable compensation.

Finally, documentation and disclosure requirements have been tightened. From now on, financial institutions must develop an overall concept for the compensation system and draw up detailed, written reasoning for their decisions. They must plan and implement measures in the event that deficiencies arise. Transparency requirements for disclosing compensation data differ according to the size and type of the financial institution.

No end of regulation in sight – partly due to Brexit

hkp/// group believes that this new version of the InstitutsVergV will not be the last one. “Changes are already emerging as a result of the current revision of the European Capital Requirements Directive (CRD). The results of the consultation by the Financial Stability Board (FSB) on the Principles and Standards on Sound Compensation Practices, which will continue until the end of August, are also likely to influence future regulations,” says Petra Knab-Hägele, Senior Partner Financial Services at hkp/// group.

In addition, when the United Kingdom leaves the European Union there will be a realignment of financial markets in Europe. The Minister of Finance of the German state of Hesse, for example, recently called for a relaxation of the strict protection against dismissal, in particular for risk takers in German banks, in order to make Frankfurt more attractive as a potential destination for financial institutions relocating from London.