This is the text of the leaked document referred to in Bonus Balls.
Posted on monbiot.com, 24th January 2011
CEBS Guidance on Remuneration Provisions in the Capital Requirements Directive
• There are two issues at play in the various press reports covering the CEBS guidance on the CRD3 remuneration provisions: (i) the current interpretation of the upfront cash limit provisions and the tax implications of retention conditions; and (ii) the exaggeration of provisions that relate to state assisted banks and fixed/variable pay ratios.
Upfront Cash and Retention Conditions
• The provisions in CRD3 imply a cap on the maximum proportion of a bonus that can be paid in cash upfront.
• These provisions are open to interpretation and throughout the negotiation and implementation of the Directive, we have supported an interpretation that limits upfront cash to 40% of a total bonus. This interpretation is consistent with the G20 agreed FSB Standards.
• The European Parliament has taken a different view and interpret the provisions as imposing a 20% cap. This will go beyond the globally agreed position and will have a significant impact on the European financial services sector’s international competitiveness.
• In addition, the EP are looking to impose minimum retention conditions on non-cash components. These carry critical tax implications that are internally inconsistent under both the EP’s and our view on upfront cash.
• With respect to the EP’s view, an employee will face a tax liability at the point their remuneration is awarded. If an employee is awarded 40% of their bonus upfront, only half of which is paid in cash, their tax liability will consume this entire cash position and any further NICS charges will likely mean his total liabilities cannot be paid out of current income.
• With respect to our interpretation, 60% on an employee’s bonus will be deferred, 10% in cash and 50% in shares. At the point a deferred tranche is released (vests) it will incur a tax liability. However, when a tranche of deferred shares vests, they will be subject to further retention criteria and cannot be sold to pay this liability.
• The Committee of European Banking Supervisors (CEBS) has been tasked with providing non-binding guidance on the proper implementation of the provisions. Despite significant support from other Member States for our position, CEBS have issued a consultation document supporting the EP’s position.
• As such, despite the fact the EP’s interpretation threatens the sector’s international competitiveness and in is inconsistent from a tax perspective, the lack of support from CEBS means some may argue that we are supporting a position that is less onerous on bank pay than other European legislators.
State Assisted Banks and Fixed/Variable Pay Ratios
• In addition, various press reports have suggested the Directive and the CEBS guidance will impose variable/fixed pay ratios on firms and will block the payment of variable pay to Directors at banks that are in receipt of state aid. These reports are inaccurate and exaggerate the provisions of the Directive.
• To be clear – on state assisted banks, the directive says variable remuneration should only be paid to directors to the extent it is justified and that the remuneration policy should reflect the banks’ priorities to rebuild capital and provide for the recovery of taxpayer assistance. The CEBS guidance makes it clear that member states’ competent authorities have flexibility in imposing conditions on director’s pay at these banks and does not require a moratorium on their bonuses. For obvious reasons this would impair the competitiveness of these banks and have a significant impact on the recoverability of taxpayer support.
• In addition, the guidance says quite clearly “it may be necessary to pay variable remuneration to new directors, who are hired to rescue the institution. As it will be difficult to hire new adequate management capacity for an institution, it may be justified to award or pay variable remuneration to new directors”. (CEBS Guidance, p.28)
• On Fixed and variable pay ratios, the directive says “fixed and variable components of total pay are appropriately balanced […] Institutions should set the appropriate ratios…” (Annex V, Section 11, point 23). The CEBS guidance repeats this view that it is the responsibility of the institution and not the regulator, to set this ratio.
Lines to Take
• The Committee of European Banking Supervisors (CEBS) has issued a consultation document on non-binding guidelines implementing EU legislation on remuneration and bonuses.
• The consultation will run for one month before CEBS gives a final view.
• The UK believes it is important that in Europe we implement our remuneration policy in line with the principles already agreed globally by the G20.
• We need global action to tackle bonuses. The G20 principles have international agreement, which is why we believe they provide most effective basis for action.
• The UK has led the way in implementing G20 principles and doesn’t believe that the EU should go further than what was agreed by the G20.
• Two provisions in the Directive combine to impose an upfront cash limit on variable remuneration packages:
• The deferral condition states that at least 60% of a bonus must be deferred over an appropriate period; and
• The Cash/Equity condition states that at least 50% of a bonus must be paid in non-cash instruments and held over an appropriate retention period.
• We interpret the cash/equity condition as applying to the whole variable remuneration package. As such conditions can be satisfied by deferring 50% non-cash and 10% cash, leaving 40% cash available upfront.
• The EP interpret the cash/equity condition as applying equally to both the deferred and non-deferred components. As such, of the 40% not deferred, half must be paid in securities and retained, leaving only 20% of the total bonus available in cash upfront.
• In addition, the EP support minimum retention criteria on all non-cash pay components. This is inconsistent from a tax perspective and will result in unfunded tax liabilities no matter which interpretation on upfront cash is taken.
• The FSA have already issued a consultation document outlining their proposal to implement these provisions on the basis of our interpretation.
• Throughout the negotiation of the Directive we have indicated to the FSA that we support the line they have taken in the development of CEBS guidance and the view reflected in their consultation.
Worked Example of EP’s Position
20% upfront cash limit and retention conditions on all non-cash components.
• An employee receives a £1m bonus. 60% is deferred and 40% is non-deferred.
• Of the 40% non-deferred, half (20%) is paid in cash and half in non-cash securities that must be held over a minimum retention period.
• However, as a higher rate taxpayer, the employee will have to pay 50% income tax on the entire non-deferred component in the year it is awarded. This means the half paid in cash is automatically consumed by the tax liability and the employee receives zero cash upfront. Any further charges like NICS will be unfunded.
• This is a significant departure from the internationally agreed position in the FSB Standards.
Worked Example of Our Position with Minimum Retentions
• The same employee receives the same £1m bonus. 60% is deferred and 40% is paid upfront in cash.
• On the deferred component, 50% (£500,000) is paid in shares and the remaining £100,000 is cash.
• When the deferred component vests it incurs a 50% tax liability (£300,000). However, only £100,00 is available in cash to satisfy this. The vested shares are still subject to minimum retention conditions and cannot be sold. As such this results in an unfunded tax liability.
Our Position without Minimum Retentions
• The only consistent option is as above without minimum retention conditions.
• If an organisation has discretion over the appropriate minimum retention criteria, they can structure their remuneration packages such that they comply with our upfront cash cap, are consistent with globally agreed standards and do not imply any unfunded tax liabilities.
• This is the position we have supported throughout the directive negotiations.