On 11 June 2013, the European Securities and Markets Authority (ESMA) published Guidelines on remuneration policies and practices which are based on the Markets in Financial Instruments Directive (MiFID) and which took effect on 30 January 2014. BaFin implemented the requirements of the Guidelines into German administrative practice in its Circular 4/2010 (WA) – MaComp¹⁾.

The provisions are designed to prevent the creation of inappropriate remuneration incentives that might cause staff to no longer act in the best interests of their clients and in accordance with the rules of conduct of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG). The rules focus on the requirements for designing variable remuneration components. For example, the rules define which variable remuneration components are appropriate, prohibit variable remuneration components based on purely quantitative criteria and prescribe using qualitative criteria in the interest of clients. They also prohibit creating different incentives for various products.

Remuneration

Remuneration within the meaning of Module BT 8 of MaComp (currently only available in German) is any form of payment or benefit granted by investment services enterprises to relevant persons. As a general rule, therefore, any benefit granted is deemed to qualify as remuneration, including both financial and non-financial benefits. BT 8.1 no. 3 contains a non-exhaustive list.

New module in MaComp

To implement the Remuneration Guidelines, BaFin expanded MaComp to include the new Module BT 8. It complements the extensive body of remuneration rules already existing under supervisory law, as defined, for instance, in the German Banking Act (Kreditwesengesetz – KWG) and the German Remuneration Regulation for Institutions (Instituts-Vergütungsverordnung – InstitutsVergV).

Whereas these supervisory frameworks essentially relate to prudential legislation and are intended to prevent systemic risks from arising for the respective institution, the remuneration rules of BT 8 have a different thrust: they concentrate on remuneration-specific risks to the interests of clients. Some of the provisions of the new module exist alongside the existing rules without mutual limitations, whilst others supplement them by additional requirements. This is intended to exclude any overlaps. In the event that a conflict should arise, BT 8 subordinates itself to the other rules.

Relevant persons

The requirements of BT 8 relate to remuneration paid to those referred to as ‘relevant persons’. These are persons who can have a material impact and influence on the investment or ancillary investment services provided or on the corporate behaviour of the investment services enterprise, particularly with respect to client interests. Consequently, relevant persons are essentially client-facing front-line staff such as investment advisers, asset managers, tied agents or regular sales force staff and their superiors.

Also deemed relevant persons are staff involved in designing the framework conditions for investment and ancillary investment services and, for example, have a say in defining the firms’ policies and practices, service and work instructions, or requirements such as schedules of commissions or product portfolios. Lastly, relevant persons also include those providing technical support or materials for the service or ancillary service that may directly or indirectly influence the client’s decision. For example, this group includes staff who create marketing materials or financial analyses.

To a certain extent, staff involved in complaints handling, claims processing, client retention and product design may also bring about a material influence and thus act in the interests of clients. For example, product development staff in particular have to consider the interests of clients if they structure the features of new products to their needs. Similar significance is likely to be ascribed to a firm’s compliance function staff who, given their training, advisory and monitoring duties, at least indirectly also act in the interest of clients and play a role in numerous relevant processes, such as defining the principles applying to distribution targets. Lastly, BT 8 also applies to all those involved in corporate governance – particularly the firm’s management.

Organisational measures

BT 8 of MaComp stipulates that all investment services enterprises are required to introduce a remuneration system. Since this was already defined as an obligation in the prudential legislation rules, it should be possible to integrate the requirements of BT 8 for relevant persons without involving any disproportionate additional work and effort.

A few formal requirements have to be observed when establishing the remuneration system. For example, conflicts of interest and risk management have to be included. The remuneration system also has to be linked to the new products or services approval process. Ultimate responsibility for designing and implementing the remuneration system lies with the management, even where it has delegated such tasks. In the design process for remuneration practices, i.e. when creating, modifying or (partially) revoking the same, the compliance function is to be consulted.

Monitoring

The compliance function is moreover responsible for monitoring the design, content and application of the remuneration system. This is governed by procedural principles set out in BT 1.2.1. These include, for example, requirements for on-site inspections or random sampling. They also require the compliance function to include the remuneration system in risk analysis. Remuneration-specific risks are thus incorporated into the firm’s risk profile.

Furthermore, Module BT 8 contains a list of examples of good monitoring practices. It is intended to show the compliance function on non-binding basis the various possibilities it has for performing its duties in a particularly exemplary manner. One proposal is ensuring that the broadest possible range of information is analysed, stemming e.g. from client surveys, a review of client returns, analyses of trends and causes, complaints, or audits by the auditing department or the statutory auditor.

Features of the remuneration system

For the specific features of the remuneration system, BT 8 first of all establishes some general requirements. One of them is that remuneration systems must not be unnecessarily complex. This is firstly intended as a safeguard against the risk of the remuneration system not being understood by staff. Secondly, the remuneration is to be as uniform as possible, simple to use and easy to monitor.

Also important under BT 8 is for the design and review of the remuneration system to identify and reflect all factors and risks that are relevant for remuneration and its effects. The firm is also to perform an analysis to enable it to better measure and reflect the scope, intensity, accompanying circumstances and potential expenditure involved in avoiding remuneration-specific conflicts of interest.

Variable remuneration components

A special focus of BT 8 is on variable remuneration components. That is what most of the specific requirements refer to. Here, the MaComp requirements recognise that there is no better way of managing staff than variable remuneration, making it an indispensable tool of corporate management. It enables the management not only to create incentives for conduct of business but also to implement supervisory law requirements. However, experience also shows that variable remuneration can easily give rise to inappropriate incentives. These must be minimised through greater vigilance on the part of supervisory authorities as well as clear and comprehensible requirements.

This concern is reflected by BT 8 in three key requirements. Firstly, a cap on variable remuneration elements was introduced: these must be in a reasonable relationship to fixed remuneration components and as a rule must not exceed the latter in terms of their amount. Secondly, variable remuneration components may no longer be calculated exclusively on the basis of quantitative criteria. Instead, their amount must also be governed by qualitative criteria that are in the interests of clients. Such quantitative criteria may be e.g. clients’ rate of return, client satisfaction, the number of client complaints or the particularly careful observance of legal requirements.

Thirdly, different products must not be provided with different commissions. That means that an employee must not receive a higher bonus for the successful distribution of an actively managed fund than, for example, the distribution of a share. Any deviations from these principles are allowed only in rare, justified exceptional cases. The purpose of the provision is to encourage employees to be guided in the fair treatment of their clients by their interests, not to act out of regard for what the most lucrative products are for such employees.

How investment services enterprises will implement such rules will depend in each case on how pronounced the potential conflicts of interest are. BT 8 therefore does not lay down any absolute requirements such as a specific number of required qualitative assessment criteria or a precise aggregate cap on variable remuneration components. Beyond the minimum provisions already mentioned, firms are to avail themselves of these tools with the requisite flexibility to compensate for conflicts of interest that they have identified internally.

Implementation of BT 8

BT 8 of MaComp entered into force on 30 January 2014. Since then, each investment services enterprise is required to at least analyse the scope of adjustment required for their remuneration system.

Implementation of the remaining requirements is subject to a flexible time limit that is based on how high the adjustment work is in the individual firm. Those parts of the remuneration system that can be adjusted promptly can thus be changed quickly. For example, new employment contracts or works agreements yet to be entered into can thus be changed within a short time – unlike those that are already in force and legally binding whose expiry has to be awaited. That said, the provisions of BT 8 are not asking firms to do the impossible: adjustments are to be made only if this is legally permissible, for example through termination, or if there is no legal right to receive the remuneration. In all other cases, the firms are required to endeavour to bring about an adjustment by, for instance, proposing new contracts.

Footnote

1) Minimum Requirements for the Compliance Function and Additional Requirements Governing Rules of Conduct, Organisation and Transparency pursuant to Sections 31 et seq. of the Securities Trading Act (Wertpapierhandelsgesetz - WpHG) for Investment Services Enterprises (MaComp).

Interview with Dr Günter Birnbaum: “Focus on investor protection”

Dr Günter Birnbaum is the head of the BaFin Department for basic issues relating to the interpretation and supervision of rules of conduct

Dr Birnbaum, who stands to benefit from the new remuneration rules?

In the revision of MaComp, the primary focus was on the protection of investors. The new remuneration requirements make clear that there is a specific connection between the interests of clients and the remuneration of staff at firms. They are required by law to act above all in the interests of their clients – and not only in the interest of a firm’s profits.

Do the persons concerned, for example investment advisers, now have to start worrying about their salaries?

The remuneration rules do not lay down how much an adviser is allowed to earn. That is and remains something to be decided by the parties negotiating the salary. However, the nature and manner of remuneration must sufficiently reflect the interests of clients. In short: implausibly excessive salaries may not be handed out at the expense of clients. Conversely, an employee who has provably provided particularly good advice to clients is also to be remunerated accordingly.

And yet: Is it really necessary, now that we have investment advice minutes, the employees and complaints register and product information sheets, to now also regulate the payroll of investment advisers?

Yes, absolutely. Adverse developments based on inappropriately defined remuneration incentives must be corrected. However, these rules must not be lumped together: unlike investment advice minutes and the employees and complaints register, the remuneration requirements do not merely relate to investment advice to retail clients. Rather, they apply to all persons entrusted with providing investment services, including, for example, staff working in the area of financial portfolio management. In this regard it does not matter whether the clients are retail clients or professional clients.

What do the firms concerned have to observe?

They are now required to examine, review and where appropriate correct the remuneration structures of their securities business. That holds true particularly for those firms that remunerate their staff in part using variable components since it is here that conflicts of interest can arise quite frequently. If the level of variable remuneration is too high, that may lead to undesirable incentives – where, for example, sales and thus commissions are generated with securities accounts of clients even though they are not in the interest of the clients. The firms must now organise remuneration in orderly structures if they have not already done so in the past. That also means that the firms must ensure ongoing and plausible monitoring of implementation.

How does BaFin ensure that the firms implement the remuneration rules?

We will of course keep a watchful eye on the process, both through regular on-site inspections and with the help of auditors. That will hopefully provide us with a consistent picture rather quickly. If we identify adverse developments or shortcomings, we will draw attention to the same emphatically and require the firms to correct them. With the new Markets in Financial Instruments Directive (MiFID), the supervision of remuneration will in any case be specifically incorporated in legislation. That is something the firms can prepare for already now.