The Italian Banking Association (ABI) welcomes the opportunity to comment on the draft Regulatory Technical Standards (RTS) on classes of instruments that are appropriate to be used for the purposes of variable remuneration (henceforth, “the draft RTS” or “the proposed standards”).
ABI broadly agrees with EBA's basic choices on criteria for identifying features indicating that an instrument is appropriate for the purposes of variable remuneration.
ABI agrees with associating the performance of the instrument with the capital ratios. ABI also agrees that distributions of instrument values should reflect market conditions for comparable instruments, in order to avert the risk of circumventing Directive requirements for remuneration policies.
Nevertheless, in ABI's opinion, the proposed solutions can be refined in places, in order to enhance the framework’s consistency and/or reduce the compliance costs (without undermining the effectiveness of the regulation).
ABI’s suggestions to these ends are presented below, in the answers to the questions asked in the Consultation Paper. However, before commenting on specific points, ABI wishes to draw EBA’s attention to two general issues.
SCOPE OF PROPOSED STANDARDS
A major concern is represented by the “scope” of application of the RTS, i.e. the institutions that are supposed to use these classes of instruments for the purposes of variable remuneration. In fact, Directive n. 36/2013 only states that institutions shall use these instruments “where possible”, taking into account the proportionality criterion.
It is undisputed that providing guidance on this point goes beyond the Directive’s mandate to the EBA. However, since the evaluation of the proposed standards depends on the kind of institutions that will actually be involved in their use, it is worth pointing out that the banks required to use these instruments have not been clearly identified yet. To this end, the reference to smaller banks made by EBA in paragraph 25 of the cost-benefit analysis/impact assessment is not helpful.
ABI believes that “possible” should not be intended as referring to the mere ability to issue instruments of the specified kind, but also to the possibility of managing the related issues without incurring compliance costs that are disproportionate to the variable remuneration awarded. That is, in our understanding, the proportionality principle should be applied with respect not only to the size of the institution, but also to other elements such as the materiality of the variable remuneration awarded (in absolute terms and/or as a percentage of the total remuneration), the number of staff involved and the previous utilization of capital instruments other than shares by the institution.
MARKETABILITY OF INSTRUMENTS
ABI wants to highlight the issue of the marketability of these instruments. It is very important that the forthcoming rules are aligned with market standards for instruments of this kind, because otherwise their (il)liquidity would represent a serious concern. In fact, there is a great difference between awarding staff instruments that are market traded and those that are not, because this determines whether or not the awarded persons can, at the end of the retention period, sell the instruments and “cash in” the remuneration (it should be remembered that AT1 instruments are perpetual, therefore staff cannot “cash in” at the time of the maturity).
A. Another general concern is represented by the complex identification of eligible instruments with respect to the allowed relationship between:
(a) the issuer of the instrument,
(b) the institution which is using it for the purposes of variable remuneration, and
(c) the institution on whose capital ratios the trigger event is based.
In this regard, the framework envisaged in the proposed standards is not straightforward.
In ABI’s understanding, it should be read as follows.
Additional Tier 1 and Tier 2 instruments:
Institutions can always use instruments issued through an entity within the scope of consolidation as variable remuneration. Reference is made to recital 11 “such instruments should also be usable for the purpose of variable remuneration, provided that there is a clear link between the credit quality of the institution using these instruments for the purpose of variable remuneration and the credit quality of the issuer of the instrument, as this is assumed to be usually the case between a parent undertaking and a subsidiary”.
Nothing is said about the trigger event, thus allowing triggers to be based on the capital ratios of the issuer, or the institution awarding the instrument, or another entity within the scope of consolidation or, indeed, the consolidation.
Instruments other than Additional Tier 1 and Tier 2:
Article 4 (1) (a) states that “instruments shall be issued directly or through an entity included within the group consolidation […] provided that a change to the credit quality of the issuer of the instrument can reasonably be expected to lead to a similar change to the credit quality of the institution using the instrument for the purpose of variable remuneration”. It seems in this case that consolidation is not considered in itself proof of the link between the credit quality of the institution and that of the issuer. It is not clear what additional proof could be provided.
As to the trigger events, what was said in relation to Additional Tier 1 and Tier 2 instruments also applies here.
Instruments linked to Additional Tier 1 and Tier 2 instruments:
As to the issuer, Article 4 (1) (a) applies.
Article 4 (2) (c) affirms that the trigger event shall refer to the institution that is using the instruments for the purposes of variable remuneration. It is worth noting that according to recital 11 and the cost-benefit analysis/impact assessment (paragraph 14), this condition should, instead, only be valid for issues made by parent institutions resident in third countries.
While pointing out that the rationale for these different provisions is not clear, ABI suggests that the framework could be simplified as follows.
Institutions can always use, for the purposes of variable remuneration, instruments issued by an entity within the scope of consolidation. Trigger events can be based on the capital ratios of the issuer, or the institution awarding the instrument, or another entity within the scope of consolidation or, indeed, the consolidation, except in the case of instruments linked to issues made by parent undertakings resident in third countries. In this case, the trigger event shall refer to the institution that is using the instrument for the purposes of variable remuneration.
B. Another doubt in this field arises because, in some cases, instruments issued by subsidiaries cannot form part of the consolidated own funds by virtue of the provisions concerning minority interests (Articles 81-88 of Regulation n. 575/2013). It is not clear whether or not institutions different from the issuer can use these instruments for the purposes of variable remuneration.
In fact Recital 11 of the draft RTS says that “Regulation (EU) No 575/2013 enables Additional Tier 1 and Tier 2 instruments issued through an entity within the scope of consolidation to form part of an institution’s own funds subject to certain conditions. Therefore such instruments should also be usable for the purpose of variable remuneration”.
ABI would argue that the rationale underlying the rules on minority interests pertains to the availability of funds at the point of non-viability, not the link between the credit quality of entities within the same consolidation. Therefore these rules should not affect the possibility of using these instruments for the purpose of variable remuneration by banks within the scope of consolidation. Clarification on this point would be welcome.
The 7% threshold is in line with the long term (by the year 2019) target level for the CET1 ratio set by the Basel III rules (4.5% minimum CET1 requirement + 2.5% capital conservation buffer). In ABI's opinion, the proposed level of 7% of the CET1 would be too high as a minimum threshold for the trigger event which determines the write down or conversion of the instruments. In fact, this would lead to the inconsistent result that a bank having a CET1 ratio of between 4.5% and 7% would, to a certain extent, be able to pay dividends to shareholders, while staff see their variable remuneration heavily cut.
Moreover, an unintended consequence of setting a 7% minimum CET1 ratio for the trigger event should be considered, i.e. the rise in reputational risk. In fact, many banks can choose to hold their CET1 ratio close to 7% simply because of the higher cost of capital qualifying as CET1, while being compliant with the capital requirements and absolutely safe under the stability profile.
Setting a 7% minimum CET1 ratio for the trigger event could be read as if EBA considers 7% to be the level below which the credit quality of the institution as a going concern is compromised. Therefore people's trust in banks could be jeopardized. In ABI's opinion this risk should be carefully averted.
In ABI’s opinion, the minimum trigger should be set at 5.125% as established elsewhere for AT1 instruments.
In ABI’s opinion the reference to different capital ratios for the different classes of instrument could be maintained, since this solution offers banks greater flexibility.
Anyway, as a matter of fact, current capital instrument trigger events are most frequently linked to a core tier 1 ratio (forthcoming CET1 ratio).
For these reasons, provided that each capital ratio represents an indicator of credit quality, in ABI’s opinion the option of basing the trigger event on the CET1 ratio should be allowed for all classes of instruments, along with reference to the other capital ratios proposed by EBA.
A unique minimum trigger level is considered reasonable
Given that the structure of the proposed cap is not considered appropriate in general terms, since a benchmark based on the actual cost of capital/ funding for similar instruments would appear to be better than making reference to the inflation rate (see answer to question 5), in ABI’s opinion the proposed level of the cap is too low, given the features and the risk profile of the instruments addressed. In fact, given the current level of the Eurostat Harmonised Indices of Consumer Prices, the rates for a number of outstanding fixed rate Tier 1 instruments exceed the proposed cap. Moreover, it should be taken into account that, if a general cap for all institutions is set, this should not reflect the rates applied by primary banks (which are probably the issuers of the instruments currently marketed), but those that are likely to be applied by banks with the lowest credit quality or by banks of smaller size (who usually pay higher rates for funding because are less known to investors).
In ABI’s opinion a benchmark based on the actual cost of capital/funding seems better than making reference to the inflation rate. EBA explains the choice of the inflation rate in terms of the availability of an objective value. However, in the specific case, the value would merely represent a threshold and should not heavily affect the distributions paid. Therefore the benefit of objectivity appears less substantial, as compared with the greater consistency of a benchmark based on the actual cost of funding for similar instruments (considering that the inflation rate is not necessarily correlated with conditions in the funding market).
If a general cap is set for all institutions, ABI suggests that a waiver from the cap is granted to institutions able to demonstrate, to the satisfaction of the competent authority, that the rate of distributions paid on instruments issued for the sole purpose of variable remuneration is in line with those paid on similar instruments issued in the same period by the institution or by a peer group.
It seems that no additional costs derive from the constraint of market issue, except for possible divergence between compensation and funding needs and the higher rates required if the envisaged instruments are riskier than the market standards.
The administrative burden linked to checking compliance with the 60% threshold seems reasonable, except for the request to treat as not issued to other investors the instruments held by staff, but not awarded as variable remuneration. In fact, it is not clear how the institution can collect the data on holdings. The RTS seems to imply that the institution must impose an obligation on staff to disclose their holdings of financial instruments in personal accounts. This is not simple and, in ABI’s opinion, the significance of this information does not outweigh the related costs. In fact, it should be sufficient that holdings of the instrument by staff to the knowledge of the institution are treated as not issued to other investors. It is not clear how the fact that a staff member purchases holdings of the instrument could lead to a circumvention of the provision (or to conflicts of interest at a later stage), if the institution is unaware of it. Besides, it should be considered that these instruments are not usually placed to individual investors like employees.
Moreover, clarification is needed on the timing/frequency of checks on the 60% condition. In fact, the proposed text of art.1 (2) (b) says that “at least 60% of the instruments issued are publicly or privately placed, other than as variable remuneration and other than with staff members, when the instrument is awarded”. Art. 2 (1) (c) (ii) and Art. 4 (1) (f) (ii) use exactly the same wording. Instead, the cost-benefit analysis/impact assessment (paragraph 12) says that “institutions will need to monitor the amount of instruments owned by staff and by other persons to ensure that 60% of the instruments used for paying variable remuneration is held by third parties other than staff”. Further, Table 1 presents ongoing costs due to the annual monitoring of the 60% condition.
In ABI’s opinion, to ensure that the institution is not willing to circumvent the provision, it is sufficient to verify that the 60% condition applies when the instrument is awarded. In addition, the results of the envisaged annual monitoring would be meaningless, since it is not clear what would happen if the 60% threshold were crossed. Therefore, in ABI’s opinion, EBA should confirm the text of the cited articles.
Beside what was said in the answer to Question 2 about the need to allow the use of triggers based on CET1, in ABI’s opinion the proposed Tier 1 thresholds are too high. The considerations expressed in the answer to question 1 apply here in relation to both the inconsistency introduced in the framework, with respect to the differing treatment of staff and other holders, and the reputational aspect. Furthermore, it is not clear why Tier 2 instruments should be subject to two trigger events, instead of the unique trigger for Additional Tier 1 instruments. Anyway, the two thresholds seem too close to each other. A greater difference would give more room to adjust the capital structure in the middle.
In ABI’s opinion the percentage set for the first trigger is too penalizing. A write down of at least 40% would be enough
The proposed mechanism seems complicated, even though ABI acknowledges that it is important to keep the mechanisms aligned with those set in other regulations.
ABI suggests that the option of conversion in CET1, along with the write-down, is also allowed for Tier 2 instruments
The inclusion of instruments linked to Additional Tier 1 and Tier 2 instruments in the class of other instruments is considered appropriate.
The requirements appear appropriate except for the aforementioned profiles concerning the triggers (see the answers to questions 1, 2, 7 and 8).
Yes, it is considered appropriate
In this regard, ABI would argue that temporary write-downs could also be allowed. In fact, in order to prevent the risk of a write-up weakening the capital base of the institution, mechanisms and limitations could be provided similar to those applying to other capital distributions (such as paying dividends).
Otherwise, if the bank recovers, staff would suffer greater losses than shareholders.
No, in ABI’s opinion they need to be fine-tuned. The considerations expressed in the answer to question 7 are valid.
See the answer to question 8
The proposed conditions seem appropriate and no additional condition is deemed necessary. See the answer to question 8.
Yes it is, except for the obligation to inform without delay the staff who have been awarded the instrument if the trigger event occurs. See the answer to question 10.
Yes they are.
ABI broadly agrees with the analysis. Some observations on costs not addressed in the draft document are presented in the answers to the questions above.
As mentioned earlier, ABI assumes that only institutions skilled in the issuance of sophisticated capital instruments, and for which variable remuneration is material, will award staff using these instruments. If the RTS also applies to smaller banks, or banks which pay low amounts of variable remuneration, the scale of expected costs would be significantly higher.
We agree with the conclusion about limited additional costs for implementation of the new standards.
This is true on condition that, as specified in the EBA document, only the marginal costs directly associated with the profiles defined by the EBA are addressed.
If reference is made to the entire obligation of using instruments other than shares for the purpose of variable remuneration, a wide range of other (huge) costs must also be considered.
No, it does not lead to any direct impediment. However, if provisions that enhance the risk of the instruments (such as the high minimum level of the capital ratios proposed for the trigger event) are maintained, an increase in the cost of own funds instruments must be expected.