The European Commission’s delegated acts released in April shed light on the rules for corporate remuneration under MiFID II.
They were surprisingly wide-ranging.
Staff positions covered under the new regulations include front office personnel, members of the sales team, financial experts, supervisors, financial analysts, complaints handlers or product specialists. Other staff affected by the rule changes include “tied” agents and third party product salespeople.
The reason some in the industry were surprised by the broad nature of the findings was because sentiment has previously always suggested that regulators are unlikely to be able to successfully influence pay.
For example, a survey carried out by PricewaterhouseCoopers (PwC) in 2008 –in the immediate aftermath of the financial crash – found that only 13% of financial staff surveyed felt regulation would be a major force for change in remuneration practices.
Ten years on and regulators will be hoping to do exactly this: To affect payscales and bonus policy with regulation.
In the same set of delegated acts published on 25 April 2016 remuneration is defined as: “cash, shares, options, cancellations of loans, pension contributions, carried interest models, wage increases or promotions, health insurance, discounts, special allowances, expense accounts or seminars in exotic destinations.”
The regulation states that companies must have a remuneration policy which keeps in mind clients’ interests without creating a conflict of interest.
Compliance recruitment expert Daniel Halstead – chief executive at Kite Consulting Group – advises companies to offer staff financial incentives which are aligned with client satisfaction.
He explained: “One useful tactic is to measure staff against client return on investment, rather than fees generated. [This] helps to keep everyone in the business focused on the thing that really matters.”
Where possible, companies are also advised to ensure that departments work together.
Experts say that communication between compliance, risk, sales and audit teams can prevent a conflict of interest when it comes to pay and bonuses.
Andrew Glessing, head of compliance at Alpha FMC, says alignment between remuneration committees, HR and the compliance and risk departments will allow firms to “test to what extent commercially attractive reward structures may encourage behaviours that pose excessive risk to a client’s best interests.”
The MiFID II second set of delegated acts state that risk management and compliance staff must not have their objectivity compromised by how they are incentivised.
It is for this reason that the importance of remuneration committees has been underscored throughout
The Investment Association’s Executive Remuneration Working Group – the remuneration lobbying group for the buy-side – has done considerable work in this area.
Legal & General’s chief executive officer Nigel Wilson chairs the group. He has offered specific guidance to IA members on how remuneration outcomes should be fully aligned with business performance and strategy.
He says: “Discretion should be used, both upwards and downwards rather than committees relying on formulaic outcomes.”
The fact that someone of Wilson’s seniority is leading this group is testament to the importance of the issue within the industry.
Under the new rules, senior management will be responsible for the day-to-day remuneration policy and monitoring compliance risks related to the policy.
Can this be achieved while still providing staff with ambitious financial incentives?
Pay structures can no longer be based purely on measureable commercial criteria, but instead on regulations, client treatment and quality of service.
Developing the new success measures envisaged under MiFID II, such as assessing qualitative elements of job performance will become increasingly important.
If businesses with satisfied clients grow more rapidly than those with unhappy customers, staff should be remunerated accordingly, according to regulators’ thinking.
As stipulated above, MiFID II requires that firms offer incentives, which are not based purely on commercial criteria alone.
Prior to the credit crisis, many of the world’s leading financial institutions were incentivising staff based on quantitative metrics. Depending on job roles, this ranged from trading margins to products sold.
Since then, MiFID II has moved to specifically outlaw incentive schemes which only set targets based on quantitative commercial criteria.
It states: “Remuneration and similar incentives shall not be solely or predominantly based on quantitative commercial criteria, and shall take fully into account appropriate qualitative criteria reflecting compliance with the applicable regulations, the fair treatment of clients and the quality of services provided to clients.”
One of the biggest names to have tumbled in the credit crisis was Royal Bank of Scotland. Once one of the biggest institutional and retail banking institutions, it collapsed after the crisis, only to be bailed out by the UK taxpayer. At the start of 2016 – eight years on from the crisis – 82 per cent of RBS shares remained owned by the UK government.
In May this year, the bank suffered further losses in the first quarter, totalling almost
Despite this, and eight consecutive years of net annual losses, RBS’s staff were awarded large bonuses and chief executive officer, Ross McEwan was awarded a wage of nearly £3.8 million in 2015, double the previous year.
Shareholders at RBS strongly criticised the remuneration committee for management salaries being too high and bonuses being awarded despite the drop in revenues.
Since the financial crash, the financial services industry has done little to shake off its notorious culture of “greed”.
In the months leading up to the latest MiFID II delegated acts, shareholders at Citigroup started a public protest against executive pay with more than a third voting against chief executive officer Michael Corbat’s wage increase.
These sorts of protests have become commonplace.
Keith Skeoch, chief executive officer at Standard Life volunteered to reduce his bonus, and encouraged other executives to follow his example after shareholders raised similar concerns over his remuneration.
Hermes Investment Management openly expressed unease over Deutsche Bank’s increases in base salaries in recent years, stating that the “lack of consultation” and “inadequate transparency” on its proposed new remuneration system was a major concern.
Hermes opposed the new remuneration system at Deutsche Bank’s annual general meeting on 19 May this year.
During this time of heightened scrutiny, the Investment Association’s Executive Remuneration Working Group has advised its members to do their utmost to prevent developing a ‘bonus culture’.
It says that a long-term incentive plan (LTIP Model), for example, should consist of “a grant of shares that vest based on a performance measure over a three to five year period, against a series of pre-agreed targets.”
This type of model allows companies to analyse their long-term strategy, and as the structure becomes embedded it is well understood by shareholders and participants.
Another strategy suggested by the Executive Remuneration Working Group is a ‘deferral of bonus into shares’ scheme, under which a bonus is paid partly in cash but a significant amount is paid in shares.
The Working Group said this scheme “simplifies the task of remuneration committees when setting targets, given the difficulty that many report in setting long-term targets.
“It is also simple to understand for participants as there is only one variable element – the bonus. A similar structure could be used across the organisation for all employees, with a graduated level of deferral based on seniority.
Fixed or Variable
According to a study carried out by the Association for Financial Markets in Europe (AFME), between 2007 and 2011 firms sought to adjust fixed and variable pay for employees, actively seeking to increase the total proportion of fixed remuneration
Fixed remuneration increased 3% in 2011, and has increased 37% since 2007.
AFME said: “As a result of these changes study participants reported that 30% of total remuneration in 2007 was fixed, whereas in 2011 that figure had increased to 55%.
MiFID II states the balance between fixed and variable remuneration needs to be established.
For shareholders, it’s important that executives are rewarded for a good performance, but not rewarded for failure, the Investment Association says.
Its Executive Remuneration Working Group said this could underpin the current variable pay system that operates now.
“With changes to investor guidelines and the introduction of remuneration policies there have been limited instances of payment for failure, with the majority of departing directors only receiving their contractual notice payments,” the group explained.
It will be a difficult task for firms to establish, develop and maintain a remuneration policy which is fair to shareholders, employees and is fully compliant under MiFID II.
However, as Kite Consulting chief executive Daniel Halstead rightly highlighted, it could actually be considered an opportunity.
It’s an opportunity to find great new staff and revise remuneration policies, ultimately improving company culture and shareholders’ confidence in the long term.