European Scrutiny Committee Contents

19 Financial services: corporate governance




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COM (10) 286




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COM (10) 285




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COM (10) 284

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

Legal base
Documents originated2 June 2010
Deposited in Parliament(a) and (b) 11 June 2010

(c) 14 June 2010

DepartmentHM Treasury
Basis of consideration(a) and (b) EM of 19 July 2010

(c) Second EM of 19 July 2010

Previous Committee ReportNone
To be discussed in CouncilNot known
Committee's assessmentPolitically important
Committee's decision(a) and (b) Cleared

(c) Not cleared; further information requested


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.


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.


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.


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.


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

71   Belgium, Bulgaria, Cyprus, Germany, Spain, France, Hungary, Italy , Lithuania, Latvia, Luxembourg, Malta, Netherlands, Romania, Sweden, UK. Back

72   Austria, Czech Republic, Denmark, Estonia, Greece, Finland, Ireland, Poland, Portugal, Slovenia, Slovakia.  Back

73   Austria, Belgium, Germany, Denmark, Lithuania, Italy, Netherlands, Portugal, Slovenia and the UK. Back

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