New remuneration regulations for investment firms (Wertpapierinstitute)
On 11 January 2024, the new German Remuneration Ordinance for Investment Firms (Wertpapierinstitutsvergütungsverordnung – WplVergV) was published in the German Federal Law Gazette (Bundesgesetzblatt – BGBl.). After two drafts in 2021 and 2022, the final Ordinance now implements the arrangements of the European Directive on the Prudential Supervision of Investment Firms ((EU) 2019/2034; Investment Firm Directive (IFD)) as well as the guidelines developed by the European Banking Authority (EBA).
The German Remuneration Ordinance for Investment Firms is substantially based on the German Remuneration Ordinance for Institutions (Institutsvergütungsverordnung – IVV). This applies to the statutory provisions as well as the legislative intent to set incentives for both performance-driven and risk-aware conduct of the employees. Despite a certain similarity to the German Remuneration Ordinance for Institutions, perceptible from many passages, the German Remuneration Ordinance for Investment Firms also provides for a multitude of simplifications for medium-sized investment firms regarding remuneration systems. Even though more than a year has passed since the consultation on the previous draft started, the German Remuneration Ordinance for Investment Firms contains – compared to the 2022 draft – only very few amendments most of which are only editorial.
The following article examines the essential aspects of the German Remuneration Ordinance for Investment Firms regarding its requirements for variable remuneration and its adequacy and draws a comparison with the previous drafts.
1. Scope of application
Considering the scope of application, there are no amendments compared to the last published draft of the German Remuneration Ordinance for Investment Firms. The Ordinance only applies to medium-sized investment firms (cf. section 2 para. 17 of the German Act on the Supervision of Investment Firms (Gesetz zur Beaufsichtigung von Wertpapierinstituten – WpIG) and to superordinated companies.
In contrast to the German Remuneration Ordinance for Institutions, which provides for general rules for all employees and specific requirements for so-called risk takers, the scope of application of the German Remuneration Ordinance for Investment Firms is limited to the latter. According to section 2 para. 2 of the German Remuneration Ordinance for Investment Firms, all managers and all employees whose professional activities have a significant impact on the risk profile of investment firms or the assets managed by them are to be classified as risk takers. They are to be identified by the investment firms themselves on their own responsibility by means of a risk analysis, with the quantitative and qualitative criteria of the Commission Delegated Regulation (EU) 2021/2154 of 13 August 2021 being decisive (cf. section 3 of the German Remuneration Ordinance for Investment Firms).
2. Adequacy of remuneration
The adequacy of remuneration and remuneration systems is regulated in section 6 of the German Remuneration Ordinance for Investment Firms which is based on the regulatory content of the German Remuneration Ordinance for Institutions. Like the German Remuneration Ordinance for Institutions, the German Remuneration Ordinance for Investment Firms is based on the principles of a sound remuneration policy. This includes, for example, avoiding incentives to take disproportionate risks, no conflict with the control units’ monitoring function, reducing variable remuneration in the event of negative performance contributions and principles for how to treat severance payments and non-competition payments.
Despite the harmonisation of the two remuneration provisions, there are also differences. In particular, the German Remuneration Ordinance for Investment Firms explicitly addresses – in contrast to the German Remuneration Ordinance for Institutions (relevant explanations can only be found in the interpretation aid of the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin)) – the amount of fixed remuneration (see section 6 para. 1 of the German Remuneration Ordinance for Investment Firms):
- The fixed remuneration primarily reflects relevant professional experience and organisational responsibility as set out in the risk takers’ job description as part of their terms of employment.
- The variable remuneration, in turn, should reflect the sustainable and risk-adjusted performance of the risk takers and should reward the latter for any performance in excess of their job description.
According to section 6 para. 1 of the German Remuneration Ordinance for Investment Firms, the remuneration systems developed by the investments firms are deemed adequate if, among other things, a clear distinction is made between fixed and variable remuneration and both remuneration components meet the aforementioned requirements.
In addition, the German Remuneration Ordinance for Investment Firms contains provisions on severance payments, non-competition payments and retention incentives similar to those contained in the German Remuneration Ordinance for Institutions.
3. Requirements for variable remuneration
The requirements for variable remuneration were partially amended compared to the last published draft. While there were only minor changes to the general requirements, the specific requirements underwent some substantive adjustments compared to the first two drafts of the Ordinance.
3.1 Ratio between variable and fixed remuneration
Investment firms must ensure an adequate ratio between the risk takers’ variable and fixed remuneration. The business activities of the investment firm, the associated risks and the influence the specific risk takers have on the investment firm’s risk profile and the assets managed by it are to be taken into account. It therefore remains the case that the German Remuneration Ordinance for Investment Firms – unlike the German Remuneration Ordinance for Institutions – does not provide for an upper limit for the adequate ratio (bonus cap).
Guaranteed variable remuneration is only permitted in exceptional cases for the first year of employment or service. Buy-out bonuses must be in line with the investment firm’s long-term interests.
3.2 Variable remuneration related to performance
The amount of variable remuneration is determined by performance and is calculated based on an assessment of the risk taker’s individual performance contributions (using financial and non-financial parameters), the relevant business unit’s performance contributions and the investment firm’s overall performance. Contrary to what was envisaged in the previous draft, the relevant performance assessment period was shortened. While the previous draft provided for a period of several years to be used for the performance assessment, this period now only has to cover more than one year, meaning that performance assessment periods of between one and two years also meet the regulatory requirements. The resulting increased flexibility allows investment firms to adjust the assessment period to the specific business risks. As a rule, the risk taker’s performance must also be assessed subsequently (section 8 para. 1 of the German Remuneration Ordinance for Investment Firms).
3.3 Instruments and deferral
Similar to the requirements of the German Remuneration Ordinance for Institutions, at least 50 per cent of the variable remuneration must consist of instruments. In turn, at least 40 per cent of this variable remuneration must be deferred on a pro rata temporis basis over a three- to five-year period; this proportion may be increased to 60 per cent in the case of variable remuneration of a particularly high amount (section 8 para. 4 of the German Remuneration Ordinance for Investment Firms). The thresholds for variable remuneration of a particularly high amount may be determined by the investment firm itself on its own responsibility, but they may not exceed an amount of EUR 500,000 (section 8 para. 5 of the German Remuneration Ordinance for Investment Firms). In contrast to the 2022 draft, section 8 para. 4 of the German Remuneration Ordinance for Investment Firms also sets out more precisely that a subsequent assessment of the originally determined performance is required before claims for, or benefit entitlements to, deferred remuneration amounts may arise after the expiry of the relevant deferral period.
3.4 Malus / clawback
According to section 8 para. 6 of the German Remuneration Ordinance for Investment Firms, investment firms must ensure the reduction or repayment of variable remuneration through malus and clawback arrangements. These are determined by criteria set by the investment firm. Unlike provided for in the draft, however, a reduction or repayment of 100% of the variable remuneration in cases where the financial performance of the investment firm is subdued or negative is no longer a general requirement but is “only” applicable where the relevant risk taker was responsible for, or participated in, activities resulting in significant losses for the investment firm or is no longer considered fit and proper.
3.5 Exceptions
The introduction of a so-called de minimis provision, which had been proposed in the second draft of the German Remuneration Ordinance for Investment Firms for the first time, was also adopted by the legislator in the final text of the new Ordinance. The requirements regarding pay-out in instruments, deferral and malus/clawback do not apply to annual variable remuneration that does not exceed EUR 50,000 and does not account for more than a quarter of the total annual remuneration of the relevant risk taker. In addition, the aforementioned provisions do not need to be applied if the investment firm meets one of the criteria set out in section 44 para. 3 sentence 2 of the German Act on the Supervision of Investment Firms. Therefore, investment firms whose balance sheet assets and off‐balance sheet assets do not exceed EUR100 million based on the average of the four preceding financial years or – if further requirements are met – do not exceed EUR 300 million based on the average of the four preceding financial years are not obliged to comply with the aforementioned specific pay-out provisions. Contrary to what was envisaged in the draft, the German Federal Financial Supervisory Authority is not authorised now to unilaterally order the applicability of the requirements for granting variable remuneration due to the activity or internal organisation of the investment firm despite falling below the maximum limit for assets set out in section 44 para. 3 sentence 2 of the German Act on the Supervision of Investment Firms.
4. Setting the amount of variable remuneration
According to section 11 para. 1 of the German Remuneration Ordinance for Investment Firms, the total amount of variable remuneration must be set in a formalised, transparent and comprehensible process, adequately involving the control units in accordance with their relevant scope of responsibilities. The determination of performance that is used as the basis for the bonus pool must take into account all categories of existing and future risks as well as the costs of raising own funds and liquid assets. Above all, the variable remuneration must be structured in such a way that it does not impair the investment firm’s ability to ensure an adequate level of own funds.
5. Governance
5.1 Responsibilities, documentation and review obligations, remuneration control committee
Like the 2022 draft, the final version of the German Remuneration Ordinance for Investment Firms is structured in line with the German Remuneration Ordinance for Institutions as regards the responsibility of the senior management (Geschäftsleitung) for adequately structuring the remuneration systems of those risk takers who are no senior managers (Geschäftsleiter). In this context, the administrative or supervisory body is responsible for senior managers.
The documentation and review obligations laid down in the German Remuneration Ordinance for Investment Firms stipulate that the principles of the remuneration systems are be documented in the investment firm’s organisational policies. Decisions on variable remuneration and its distribution must also be recorded, and the adequacy of the remuneration systems and parameters must be reviewed at least once a year in a centralised and independent internal audit.
According to section 18 paras. 2 and 3 of the German Remuneration Ordinance for Investment Firms, the remuneration control committee to be established in accordance with section 44 para. 3 of the German Act on the Supervision of Investment Firms must play a supporting role in reviewing the remuneration systems – both for risk takers who are no senior managers and for senior managers.
5.2 Group-wide remuneration provision
A group-wide provision on the remuneration strategy has also been implemented in the final version of the German Remuneration Ordinance for Investment Firms, namely in section 18. In addition, the legislator has achieved the extension of the scope of application to firms based not only in member states of the European Union but also in contracting states. However, a mitigating effect results from the exemption from this provision for subordinated companies which, in turn, are themselves bound by remuneration requirements according to other legal acts of the European Union or would be bound by them if they were based in a member state.
6. Entry into force
The German Remuneration Ordinance for Investment Firms came into force on 12 January 2024, and from this date it is mandatory for medium-sized investment firms to comply with it. Investment firms must work to ensure that existing agreements with risk takers, shop agreements and establishment agreements in the public sector or customs and practices that are not in line with the German Remuneration Ordinance for Investment Firms be adapted without undue delay (unverzüglich) to the extent this is legally possible. This can result in directly required action for concerned investment firms.
In contrast to the previous drafts, fortunately a transition period beginning with the financial year following the entry into force and ending at the end of the relevant investment firm’s financial year was determined for selected provisions. This affects especially the provisions concerning severance payments and non-competition payments as well as retention incentives according to section 6 para. 4 and para. 5 of the German Remuneration Ordinance for Investment Firms, specific requirements for variable remuneration according to section 8 of the German Remuneration Ordinance for Investment Firms (i.e. in particular performance assessment, instruments, deferral, malus/clawback), the application of the criteria to determine the bonus pool according to section 11 para. 2 sentence 1, sentence 2 and para. 3 of the German Remuneration Ordinance for Investment Firms as well as the obligation to carry out an annual internal review of the remuneration systems according to section 14 of the German Remuneration Ordinance for Investment Firms.
Now that, after a long time, the regulatory requirements for renumeration systems of medium-sized investment firms have been finalised, the latter should as soon as possible start to carry out a gap analysis and identify possibly required adjustments in order to be able to implement the necessary amendments in due time.
