Questions and answers on the German Remuneration Ordinance for Institutions

From Interpretation Guide to FAQs

On 21 June 2023, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – “BaFin”) published draft FAQs on the German Remuneration Ordinance for Institutions (Institutsvergütungsverordnung – IVV) for consultation. These FAQs are intended to replace the Interpretation Guide (Auslegungshilfe) on the IVV published on 16 February 2018. At the same time, BaFin has clarified in the introductory note to the FAQs that it will not abandon its administrative practice and interpretative decisions described in the aforementioned Interpretation Guide on the IVV where the FAQs do not provide for an update. Therefore, it would probably be more adequate to refer to the FAQs as a supplement to the currently still applicable Interpretation Guide and not as a replacement thereof.

As has been the practice in the past, BaFin has adopted the European Banking Authority’s (EBA) Guidelines on Sound Remuneration Policies under Directive 2013/36/EU (EBA/GL/2021/04) in its administrative practice. In principle, these guidelines are to be applied directly, unless the FAQs provide for exceptions. 

In contrast to its previous practice, however, the FAQs are no longer interpretative guidance in a narrow sense. Rather, the FAQs are intended to summarise issues which are not covered by the EBA guidelines or where the application of proportionality appears necessary.

Essential updates

The FAQs contain a number of updates of which we will provide a brief overview below.

Variable remuneration

The new FAQs provide clarity in the assessment of certain remuneration components under remuneration law. 

So-called “group bonuses” – where, according to the definition of BaFin, part of the variable remuneration of a subsidiary institution’s employees is based on the performance of the parent company, which is neither an institution under the German Banking Act (Kreditwesengesetz – KWG) nor under the CRR – are, as variable remuneration, fully subject to the requirements of the IVV. These are specified, among other things, to the effect that the strategic business and risk objectives of the institution on which the remuneration parameters are based (cf. section 4 IVV) must consider the group’s performance and that, in the case of material risk takers (“MRTs”), the ex-post risk adjustment must be based on the levels “individual”, “organisational unit” and “institution/group”, but not on the group’s performance. 

What is new are the statements on the payment of recognition awards which qualify as variable remuneration within the meaning of the IVV. These awards are only permissible under limited conditions (e.g. there must be certain requirements or criteria regarding the possible reasons and events for granting such an award) and they may not be granted to MRTs as a general rule. 

Finally, the FAQs contain more specific rules on the valuation of contributions to company pension schemes and of bridging payments after completing a term of office (Ruhegehälter) as well as on the exemption of certain benefits in kind and bonuses as part of any operational suggestion system (betriebliches Vorschlagswesen) from the concept of remuneration.

Negative performance contribution

Negative performance contributions include conduct contrary to public morals or in breach of duty (sitten- oder pflichtwidriges Verhalten) or cases with objectively serious negative effects for the institution. If a negative performance contribution has been identified, a remuneration system according to section 5 para. 2 IVV is adequate if the variable remuneration is partially reduced or, in the case of serious negative performance contributions, completely cancelled (also in the case of non-MRTs). Institutions must, as far as possible, define how they will exercise their discretion in the event of negative performance contributions in advance in the organisational guidelines and must ensure through internal processes that negative performance contributions are made known in good time so they can be taken into account when variable remuneration is granted.

Environmental, Social & Governance (ESG)

For the first time, the FAQs contain statements – albeit few – on Environmental, Social & Governance (ESG) issues. The FAQs state that ESG risks in relation to remuneration are to be taken into account in line with section 4 IVV. In order to achieve an alignment of remuneration parameters with business and risk strategies as well as strategic goals set, material sustainability risks in the sense of ESG risks should also be considered in the remuneration systems. As a concrete example, the FAQs specify the setting of certain sustainability targets as remuneration parameters.

Severance payments

With regard to severance payments, the FAQs state for the first time that the time of severance, the trigger and the extent of the severance payment must be taken into account. A severance payment promise that is not made in a direct temporal and causal connection with a separation becoming concretely apparent can represent an incentive to take risks. So-called change-of-control clauses agreed with members of the management as a trigger for a severance payment are generally justified if the severance payment is linked to the existence of a change of control event and the termination of the appointment of the member of the management.

Furthermore, it is clarified that severance payments which compensate for existing remuneration claims and the loss of a job are generally reasonable in terms of their amount. In this respect, compensation for any loss of variable remuneration for the current performance year does not preclude the privileged treatment of severance pay under section 5 para. 6 sentence 5 IVV.

On the other hand, bridging payments and the like, which serve a post-contractual support, are generally regarded as critical and require a special justification, especially if they are to be granted for more than two years.

It should be noted that according to the FAQ, each institution must ensure by contractual arrangement that severance entitlements can be reduced or cancelled with effect for the future. This also applies to severance payments promised to non-MRTs, since according to BaFin such an obligation arises from section 5 para. 2 in conjunction with para. 3 no. 2 IVV.

If several criteria regarding the privileged nature of a severance payment according to section 5 para. 6 sent. 5 no. 1 IVV are met, it remains unclear whether a notification of the supervisory authority is required. In our opinion, however, the example chosen in the FAQ would tend to argue against this. It is also new that in the event of several criteria regarding the privileged nature of a severance payment being met - in deviation from the wording of the IVV - a notification is not necessary if the requirements of section 5 para. 6 sentence 5 no. 3 IVV are fulfilled. According to the FAQs, a collective notification can also be submitted if the severance payments relate to a large number of similar circumstances.

Bonus pool

Whilst the FAQs repeat certain statements on the determination of the bonus pool made in the Interpretation Guide, new aspects are also highlighted. For example, the appropriate procedure for determining the bonus pool should include, in addition to the intended process, in particular a determination of the underlying criteria and threshold values on an institution-specific basis. A deviation from this requires the approval of the management or the supervisory body and must be justified and documented.

The review of the criteria pursuant to section 7 IVV must be carried out on the basis of the figures certified in the annual financial statements at the end of the relevant financial year. If, in exceptional cases, a variable remuneration is granted in advance, a repayment clause must be agreed upon according to which the payment is subject to a positive bonus pool determination.

Specific remuneration requirements for MRTs

The FAQs also contain more detailed specifications regarding the remuneration of MRTs. The criteria for a complete loss of variable remuneration pursuant to section 18 para. 5 sentence 3 IVV are specified in the FAQs. In this context, the statements on fault (Verschulden) and on the amount of damage are to be emphasised in particular: as a general rule, an MRT must have acted with intent (vorsätzlich) or gross negligence (grob fahrlässig) at least, except for “extreme exceptions” where no fault is required, and must have created a danger by his conduct which resulted in a failure. Significant losses according to section 18 para. 5 sentence 3 no. 1 IVV are given if, for example, (i) the expected loss triggers an ad hoc notification pursuant to Article 17 MAR, (ii) the unexpected loss corresponds to at least 1.0 per cent of the equity capital actually held by the institution and the MRT has significantly contributed to an exposure to which an unexpected loss of at least 1.0 per cent of the equity capital is attributable by acting with gross negligence at least, or (iii) always, i.e. even without fault, if the (expected and unexpected) loss amounts to at least 5.0 per cent of the equity capital actually held. In this context, several losses must be added, if applicable.

Like the currently applicable Interpretation Guide, the FAQs state that, according to section 19 para. 1 sentence 1 IVV, the two levels of consideration “personal performance contribution” and “departmental contribution” can be merged for hierarchically higher MRTs. What is new in this respect is that BaFin considers a weighting of 30% regarding the merged level and 70% regarding the overall performance of the institution/group to be appropriate.

Furthermore, it has to be considered that specifics apply to the variable remuneration of the member of the management responsible for risk compared to other employees in control functions.

Section 20 para. 5 IVV sets forth the requirement to pay out at least 50% of the variable remuneration in instruments. In the case of listed stock corporations, shares and share-based instruments are to be used according to the FAQs. In all other cases, depending on the legal form, share-based instruments or other equivalent instruments sustainably reflecting the equity value should be used as well. The FAQs specify what qualifies as a share-based instrument or equivalent instrument. Other equivalent instruments include subordinated loans, bonds or promissory notes that link redemption to threshold values based on certain KPIs. According to the FAQs, contractual constructions must meet certain criteria, such as the corporate performance determined on the basis of key figures, in order to be considered an equivalent instrument.

The instruments must be valued at their market price or fair value on the date of grant, although it should also be sufficient to apply an average value (based on a period of up to one month close to the date of grant).

Remuneration officer (Vergütungsbeauftragter)

Finally, the FAQs specify the knowledge the remuneration officers (and their deputies) to be appointed in significant institutions must have in the area of risk controlling.  If a remuneration officer does not perform the role of a remuneration officer exclusively, the time spent on this role must be determined and stipulated and amount to at least 50% of his planned working time. In significant institutions, the remuneration control report (Vergütungskontrollbericht) prepared by the remuneration officer may be combined with the report pursuant to section 12 IVV on the adequacy of remuneration systems in a single report that includes all necessary information. The FAQs list the elements which a remuneration control report needs to contain at least.

Miscellaneous

    In addition to the key modifications mentioned above, the FAQs include further provisions, inter alia on the obligation to carry out spot checks as well as on specifics applicable to development institutions (Förderinstitute).

Forecast

It is possible to submit comments on the draft FAQs to BaFin by 4 August 2023. It therefore remains to be seen whether and to what extent the existing FAQs will be modified further. 
We will keep you informed about further developments on this website.