19 Financial services: corporate governance
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(b)
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(c)
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Commission Report on the application by Member States of the EU of the Commission 2009/384/EC Recommendation on remuneration policies in the financial services sector
Commission Report on the application by Member States of the EU of the Commission 2009/385/EC Recommendation (2009 Recommendation on directors' remuneration) complementing Recommendations 2004/013/EC and 2005/162/EC as regards the regime for the remuneration of directors of listed companies
Green Paper: Corporate governance in financial institutions and remuneration policies
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| Legal base | —
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| Documents originated | 2 June 2010
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| Deposited in Parliament | (a) and (b) 11 June 2010
(c) 14 June 2010
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| Department | HM Treasury
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| Basis of consideration | (a) and (b) EM of 19 July 2010
(c) Second EM of 19 July 2010
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| Previous Committee Report | None
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| To be discussed in Council | Not known
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| Committee's assessment | Politically important
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| Committee's decision | (a) and (b) Cleared
(c) Not cleared; further information requested
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Background
19.1 In May 2009 the Commission published a Communication setting
out the context of and justification for Commission Recommendation
2009/384/EC on remuneration policies in the financial services
sector and Recommendation Commission 2009/385/EC complementing
Commission Recommendations 2004/013/EC and 2005/162/EC as regards
the regime for the remuneration of directors of listed companies.
The Commission said that it was recommending a series of principles
and best practices, which Member States should ensure that companies
apply, by 31 December 2009, in the design and implementation of
pay policies that reward long-term sustainable performance. The
objective of the first Recommendation was to ensure that remuneration
policies of financial institutions do not encourage excessive
risk taking and are in line with the long-term interests of financial
institutions. The purpose of the second Recommendation, and the
Recommendations it was complementing, is to improve transparency
of listed company reporting on the remuneration of directors,
appropriate shareholder accountability and effective supervision
by independent directors and the remuneration committee.[70]
The documents
19.2 The first Commission Report, document (a), is about the application
of Recommendation 2009/384/EC and the second, document (b), is
about the application of Recommendation 2009/385/EC. Both documents
were produced on the basis of replies that Member States made
to Commission questionnaires. And each report is accompanied by
a Commission staff working paper, which contains tabular information
on the state of application of the Recommendations.
19.3 In the Report on Recommendation 2009/384/EC the Commission
evaluates the extent to which Member States have given effect
its main areas of the recommendation. It says that, overall, 16
Member States[71] were
found to have adopted national measures in accordance with the
Recommendation, whereas 11 Member States[72]
have not yet adopted any specific national measures. It notes
that the UK is one of the Member States that has taken action
to implement the vast majority of this Recommendation.
19.4 The Recommendation and the Report deal with
four areas of remuneration.
Structure of pay
19.5 The Recommendation dealt with a number of issues,
including the balance between fixed and variable pay, deferral
of bonuses and the potential for claw-back of a bonus where there
has been subsequent poor performance. The Commission finds that:
- all 16 Member States that took
action have implemented the Recommendation's general requirements
on remuneration policies being linked to sound risk management
and being aligned with the long-term interest of the financial
institution; and
- significant differences exist in the actions
Member States have taken in relation to the more detailed requirements
on the structure of pay.
Governance
19.6 The Recommendation said remuneration policies
should be transparent internally and contain measures to avoid
conflicts of interest and dealt with the board's oversight of
remuneration and the involvement of internal control functions.
The Commission notes that:
- a limited number of Member
States fully implemented recommendations on governance;
- implementation was patchy on recommendations
concerning the role of boards and the expertise of remuneration
committee members; and
- there was fuller implementation of the aspects
relating to the need to avoid conflicts of interest and the involvement
of control functions in setting remuneration.
Disclosure
19.7 The Recommendation said that remuneration policies
and the decision making process should be adequately disclosed
to relevant stakeholders. The Commission finds that:
- of the 16 Member States that
had taken action almost all had either required disclosure or
were in the process of enacting legislation aimed at enhancing
disclosure; and
- there is variation in the type of firms that
Member States have chosen to cover.
Supervision
19.8 The Recommendation said that Member State supervisors
(the Financial Services Authority in the case of the UK) should
ensure that financial institutions apply these remuneration principles
and that information should be communicated by firms to their
supervisor. The Commission finds good implementation of this area
of the Recommendation among the 16 Member States that had taken
action.
19.9 The Commission concludes that:
- there are substantial differences
in the state of national implementation and "[f]urther efforts
are needed" to address this;
- the main area of concern is differences in approach
to the structure of pay;
- it believes that EU legislation is necessary
to ensure the application of sound remuneration principles across
the financial services sector; and
- proposals are being or will be taken forward
through the Capital Requirements Directive, the Alternative Investment
Fund Managers Directive , the Undertakings for Collective Investment
in Transferable Securities Directive and the Solvency II Directive.
19.10 In the Report on Recommendation 2009/385/EC,
document (b), the Commission analyses application of the matters
dealt with in the Recommendation itself and the two it complemented.
Recommendations 2004/913/EC and 2005/162/EC dealt with:
- production of annual policy
statement, to include information on the breakdown of fixed and
variable remuneration, performance criteria and contract policy;
- inclusion of remuneration policy
as an AGM agenda item — to increase accountability it should
be submitted to a vote, which may be either binding or advisory;
- individual disclosure of details about share-based
payment and contributions to pension schemes;
- shareholder approval of share-based remuneration
schemes;
- boards to include an appropriate balance of executive
and non-executive directors to provide for balanced decision-making;
- nomination, remuneration and audit committees
to be created to deal with conflicts of interest, with minimum
standards defined for the creation, composition and role of these
committees; and
- the need for diversity of knowledge, judgement,
and adequate time and attention to the role amongst independent
directors.
19.11 Recommendation 2009/385/EC supplemented these
Recommendations by adding more detail about the structure of directors'
remuneration and the role of the remuneration committee, including:
- the need for performance criteria
for variable and equity-based elements of remuneration;
- performance criteria should promote long-term
value creation and be deferred as appropriate;
- directors' service and remuneration agreements
should include provisions about the "reclaim" of variable
remuneration where remuneration was awarded "on the basis
of data which subsequently proved to be manifestly misstated";
- any payments for termination of services should
not be excessive;
- at least one member of the remuneration committee
should have relevant expertise; and
- remuneration consultants advising the remuneration
committee should not also advise other directors or the human
resources department of the company.
19.12 The Commission finds that:
- ten Member States[73]
have implemented at least half of the recommendations; and
- endorsement of the disclosure and shareholder
vote provisions of the 2004 Recommendation has increased significantly
in recent years, although there are differences in Member States'
approaches.
19.13 The purpose of the Commission's Green Paper,
document (c), on which it invites responses by 1 September 2010,
is to identify and propose possible solutions to the failures
of corporate governance that contributed to the financial crisis.
It is accompanied by a staff working document "Corporate
governance in financial institutions: Lessons to be drawn from
the current financial crisis, best practices".
19.14 The Commission analyses the contribution of
failures in the areas of management of conflicts of interest,
board composition, role and functioning, oversight of risk management
and remuneration, shareholder control, the role of supervisory
authorities and auditing.
19.15 The Commission puts forward a number of proposals
for discussion, including:
- improving board composition
and functioning by limiting the number of boards on which a director
might sit, prohibiting combining the role of chairman and chief
executive, specifying directors' job descriptions, increasing
board diversity and external board evaluation;
- requiring firms to have a risk committee, make
a risk declaration and seek board approval of new financial products;
- an obligation by directors to inform supervisors
of material risks and a duty of care to depositors and other stakeholders;
- improving risk management by enhancing reporting
to the board and the status of the chief risk officer;
- improving cooperation between auditors and supervisors
and extending auditor responsibilities to provide information
to directors and supervisors and to cover risk-related information;
- strengthening the role of supervisors by extending
their oversight of the board and risk management and of director
eligibility criteria to cover technical and professional skills;
- strengthening the legal framework by increasing
the accountability of directors and reinforcing civil and criminal
liability;
- improving the consistency and effectiveness of
EU action on remuneration, including addressing the treatment
of stock options, strengthening the role of shareholders, improving
severance arrangements and addressing variable pay in firms receiving
public assistance; and
- measures to prevent conflicts of interest.
The Commission discusses how these measures could
address the failures of corporate governance identified and seeks
to generate a wider debate on these issues. It raises the question
as to whether these issues are better dealt with at the EU or
national level and of the costs and benefits of greater harmonisation
in these areas.
19.16 The Commission seeks views on both the analysis
and potential improvements, which it will take into account in
deciding on next steps. However, the Commission identifies a linkage
between governance problems in the financial sector and the governance
of listed companies and suggests that some measures proposed for
the financial sector may also be appropriate in listed companies.
It intends to consider this further in a broader review of corporate
governance in listed companies. This review will examine the place
and role of shareholders, the distribution of duties between shareholders
and boards of directors with regard to supervising senior management
teams, the composition of boards of director, and corporate social
responsibility.
The Government's view
19.17 In relation to the Commission Report on Recommendation
2009/384/EC on remuneration policies in the financial services
sector, document (a), the Financial Secretary to the Treasury
(Mr Mark Hoban) tells us that:
- the UK has adopted measures
which cover much of the ground of the Recommendation;
- under the Financial Services Act, the Financial
Services Authority has an obligation to ensure that remuneration
in the financial services sector is consistent with prudent risk
taking;
- the authority has adopted a Rule on remuneration
which has been applied to a group of large banks and other financial
institutions;
- the Rule is supported by a code of practice on
remuneration, which contains principles relating to the governance
of remuneration, risk management and performance measurement and
the structure of remuneration for senior staff;
- the Rule includes guidance on deferral of compensation,
performance contingency and avoidance of guaranteed bonuses of
more than one year;
- the authority can subject firms to supervisory
and enforcement action, including requiring firms to hold additional
capital, for breaches of its remuneration code;
- the code came into force on 1 January 2010, ahead
of which regulated firms subject to it were required to supply
a remuneration policy statement for review by the authority;
- the authority will be consulting on changes to
its code later this year;
- in its Budget the Government announced that in
addition to introducing a banking levy, it is taking action to
tackle unacceptable bank bonuses;
- the Independent Commission on Banking will look
at structural and non-structural measures to reform the banking
system and promote competition;
- the Government will consult on a remuneration
disclosure scheme and, working with international partners, will
explore the costs and benefits of a Financial Activities Tax on
profits and remuneration;
- the Government has asked the Financial Services
Authority, in its forthcoming review of its remuneration code
to consider imposing more stringent requirements on the deferral
and award of variable pay, to examine the mechanism for strengthening
the link between performance and remuneration to ensure that incentives
are aligned with the long-term performance of the firm and to
consider how to vary capital requirements to offset risk in remuneration
practices; and
- at EU level the Government is participating in
negotiations on legislation with remuneration provisions —
the revised Capital Requirements Directive will shortly be finalised
and contains requirements on the governance, structure and disclosure
of remuneration of investment firms and credit institutions in
the EU and the draft Alternative Investment Fund Managers Directive,
still under negotiation with finalisation scheduled for Summer
2010, contains requirements for payment structuring and risk adjustment
conditions on remuneration in hedge funds, private equity investment
firms and other specialist asset managers.
19.18 In relation to the Commission Report on Recommendation
2009/385/EC on the regime for the remuneration of directors of
listed companies, document (b), the Minister says that:
- the original Recommendations,
2004/913/EC and 2005/162/EC, drew heavily on UK experience and
their content was closely aligned to UK practice, for example
the Directors' Remuneration Report Regulations 2002, the Combined
Code on Corporate Governance and the Listing Rules;
- the Government supported the
Recommendations as they matched the UK's strategic approach to
EU action in the field of corporate governance — that is
using measures which respect the diversity of corporate governance
frameworks in Member States and allow for a flexibility of approach;
- the UK's performance in terms
of applying the Recommendation is good — it is among the
group of Member States which has implemented the greater part
of it, through the requirement in the Companies Act 2006 and the
Financial Reporting Council's UK Corporate Governance Code;
- there are two main areas that
are not addressed in the revised Code — that remuneration
consultants should be prevented from having any other contractual
relationship with the company (the Code states that any other
relationship must be disclosed) and that at least one member of
the remuneration committee should have "knowledge of and
expertise in the field of remuneration policy";
- the Commission has said that intends to consider
whether further measures are needed to improve the coherence and
effectiveness of EU action in this area; and
- it is likely that the Commission will propose
a Directive in this area — depending on its scope, the UK
would be well-placed to implement it with minor changes to current
requirements.
19.19 On the Commission's Green Paper, document (c),
the Minister comments that:
- governance shortcomings in
parts of the banking sector contributed to the onset and severity
of the financial crisis;
- the Government believes that a co-ordinated response
at the national, EU and international levels is desirable; and
- it welcomes the Green Paper and will carefully
consider the proposals and respond to them.
19.20 The Minister continues that in the UK the Walker
Review has already assessed corporate governance practices in
the financial services sector and its recommendations are now
being implemented and this provides a valuable benchmark in shaping
an effective and proportionate EU response. He tells us that the
Walker Review measures fall into four thematic areas:
"First, in response to the failure by some bank
boards to effectively fulfil their role in challenging executive
management, the Governance Code has been changed and proposals
for more intensive scrutiny of boards by regulators are being
consulted on. These will promote further improvements to board
quality and oversight, including better selection processes, more
relevant skills and greater time commitment by directors, and
improved board, training and evaluation processes.
"Secondly, in risk management, some boards showed
insufficient understanding of risk, information flows were poor
and there was a lack of independence in risk management functions.
Supervisors are putting in place measures to address these. These
include board level risk committees for significant firms, setting
the parameters used to align remuneration with risk, to ensure
board ownership of risk appetite and strategy. The independence
of the risk function is to be secured through a chief risk officer
with access to the risk committee and to external advice. The
risk committee will oversee enhanced reporting to shareholders
of risk strategy and appetite.
"The third area of governance shortcomings concerns
shareholder oversight. Institutional shareholders acquiesced in
banks' 'gearing up' and were sometimes slow and ineffective in
acting on concerns. To encourage institutional shareholders to
engage more effectively to protect the interests of their beneficiaries,
the Financial Reporting Council has established a Stewardship
Code as a standard of engagement best practice against which performance
can be assessed. The FSA is considering how to frame a rule ensuring
that fund managers disclose their approach to engagement.
"Finally, boards were not sufficiently accountable
for the poorly structured remuneration policies that incentivised
excessive risk taking. Supervisors are taking steps to require
appropriate control of remuneration in significant firms through
a board remuneration committee responsible for firm-wide remuneration
policy and the remuneration of staff whose activities have a material
impact on the firm's risk profile."
19.21 The Minister concludes by saying that:
- the Government will consider
how the measures being implemented in the UK might be applicable
in the EU context and how they could best be taken forward;
- the process for developing a EU response must
thoroughly consider the costs and benefits of different options
for improving corporate governance in the financial services sector,
and in particular the need for legislation;
- many aspects of corporate governance regulation
in the UK rely on flexible application of qualitative principle,
for example, 'comply-or-explain' disclosures against the Governance
Code, or flexible application of supervisory principles; and
- the Government will want to see a robust justification
for any legislative proposals, where non-legislative proposals
might be appropriate.
Conclusion
19.22 We have no questions to ask in relation
to the Reports on the Commission Recommendation 2009/384/EC on
remuneration policies in the financial services sector and the
Recommendation Commission 2009/385/EC on the regime for the remuneration
of directors of listed companies, documents (a) and (b), and clear
them.
19.23 However, before considering the Green Paper,
document (c), further we should like to see the Government's response
to it. Meanwhile this document remains under scrutiny.
70 (30268) 9495/09 (30641) 9589/09 + ADDs 1-2 (30642)
9590/09: see HC 19-xviii (2008-09), chapter 27 (3 June 2009). Back
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Belgium, Bulgaria, Cyprus, Germany, Spain, France, Hungary, Italy
, Lithuania, Latvia, Luxembourg, Malta, Netherlands, Romania,
Sweden, UK. Back
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Austria, Czech Republic, Denmark, Estonia, Greece, Finland, Ireland,
Poland, Portugal, Slovenia, Slovakia. Back
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Austria, Belgium, Germany, Denmark, Lithuania, Italy, Netherlands,
Portugal, Slovenia and the UK. Back
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