FIL response to EBA consultation on Draft CRD IV Remuneration Guidelines (EBA/CP/2015/03)
Fidelity International Ltd ( FIL) is pleased to respond to the European Banking Authority’s consultation of remuneration.
FIL is a global asset manager managing € 260bn in twenty five countries around the world, including sixteen in Europe. W have long had a single, global remuneration policy both for reasons of fairness but also because it assists job mobility, a key tool in the development of executives.
FIL has had a remuneration policy which we believe closely aligns remuneration with the interests of our clients. Individuals who are managing client money are paid a basic salary and the potential to increase those earnings is entirely dependent on the results they deliver for clients in terms of performance in their funds over 3 year and 5 years. Bonuses are also based on an assessment of their approach to risk in that performance generation, as well as the assets under management in their funds. There is usually some deferral in bonuses.
Senior investment professionals and management employees are also invited to invest their own, post tax cash in Fidelity Worldwide Investment shares at market net asset value. These are built up over a long period of time rather than given in one large block, are usually only sold when an individual leaves the company or retires, and even then they are subject to a phased pay-out.
We do not grant stock options or give ‘golden hellos’ or ‘golden parachutes’. All our shareholders put up their personal wealth to invest in the business.
The policy not only aligns employee interests with those of clients it also allows us to manage the company very flexibly, on occasions cutting bonus levels severely when the economic and market outlook is poor. This behaviour is supported by our prudential regulators.
Fixing the ratio of fixed to variable pay undermines this policy and would be damaging both to our clients and the company.
Where a question is not answered it can be assumed FIL agrees with the EBA proposition.
Q 1 - Are the definitions provided sufficiently clear; are additional definitions needed?
The definition of staff proposed by EBA under Point 3.6 (g) – “any other person acting on behalf of the institution and its subsidiaries” – is unclear and we would encourage EBA to clarify that only employees of an entity covered by CRD are caught by the definition of “staff”. The definition as it is proposed will lead to very different interpretations in different member states, depending on the national laws of agency. Circumvention should be eliminated by other means.
We would note that the term “staff” was not defined in the ESMA guidelines on remuneration under AIFMD nor in the legal texts of AIFMD, UCITS and CRD/CCR. According to Point 6 (g) of Chapter 3 – Definitions of the draft guidelines […] any other person acting on behalf of the institution and its subsidiaries shall be considered as staff of an institution. This definition is not entirely in line with the approach taken by ESMA in the guidelines on sound remuneration under AIFMD.
Article 13 AIFMD gives some guidance on the scope of person falling under the category of identified staff according to their occupations and responsibilities.
According to Part V Paragraph 18 of the ESMA guidelines on sound remuneration under AIFMD, AIFMs have to ensure when delegating portfolio or risk management that the entities to which tasks have been delegated are subject to rules on remuneration that are equally as effective as those under AIFMD or appropriate contractual arrangements are put in place ensuring that there is no circumvention of the remuneration rules. This provision with regard to equally effective regimes implies that the rules are not applicable to persons who are not directly employed by the AIFM, even though the definitions in the guidelines include staff of delegates. ESMA’s response in their consultation paper on those guidelines supports the view that only individuals employed by an entity could be seen as staff of that entity. We commend that interpretation to the EBA for CRD.
FIL agrees entirely with the EBA’s proposals for guidelines on remuneration policies in principle, - and specifically with the need to align a firm’s remuneration policies with the firm’s customer’s best interests. Unfortunately we believe that the EBA’s repeal of CRD 3 variable-based remuneration structures actively works against the best interests of customers of Asset Managers.
FIL believes that the application of the CRD IV remuneration principles on entities within a group which are themselves not subject to CRD IV is both beyond EBA’s mandate and causes several problems.
Paragraph 63 of the EBA’s Draft Guidelines proposes that subsidiaries within a CRD IV group which are not themselves subject to the CRD should apply the group-wide remuneration policies to all staff; while also stating that the specific pay-out-process requirements contained in Articles 92(2), 93 and 94 of CRD should be applied at least to those staff members whose professional activities have a material impact on the consolidated group's risk profile.
FIL contest both elements of cross-application from CRD IV to UCITS and AIF Managers on a number of grounds.
Firstly, we believe that the application of the CRD IV rules to entities not subject to CRD is beyond EBA’s mandate. Remuneration policy for UCITS and AIF Managers is already established in primary legislation with each type of entity falling within ESMA’s not EBA’s scope along with the relevant Guidelines.
Secondly, the Co-legislators of AIFMD and UCITS V consciously and deliberately modelled their primary legislation on CRD IV in the first instance. In this respect, the application of CRD IV to AIF and UCITS Managers has already been considered in the co-legislation process leading up to AIFMD and UCITS V. Moreover, the AIFMD and UCITS Co-legislators careful applied their CRD IV model to AIF and UCITS Managers proportionately. The UCITS V co-legislators explicitly debated and rejected the bonus cap as the AIFMD co-legislators had done previously implicitly. Both sets of Co-legislators also explicitly wrote the concept of neutralisation into law specifically enabling less ‘significant’ Managers to disapply the pay-out process rules.
FIL do not see why – or more importantly how –the EBA can invert the UCITS and AIFMD Co-legislators’ intentions for primary legislation with Level 3 Guidelines, and as a result would urge a complete removal of the application of CRD IV to affiliate entities within a consolidated group.
At the very least the EBA should explicitly exempt consolidated Asset Management groups (i.e. groups that do not contain banks or other balance-sheet entities within consolidation) from the provision of having to cross-apply CRD IV controls to consolidated affiliates. This would enable consolidated Asset Management groups to continue to apply AIFMD, UCITS and CRD IV provisions solely to the entities for whom each set of primary legislation was designed in the first instance.
The rationale for this exemption is (again) that consolidated agency-based Asset Management groups do not pose the same risks as consolidated Banking / mixed activities balance-sheet groups, and thus remuneration controls should be appropriate to the activities being undertaken.
Take for example, a consolidated group that comprises an AIF and UCITS Manager (“supermanco”) alongside a MiFID Portfolio Manager and MiFID Distributor – a consolidated Asset Management Group. Even if the MiFID firms within such a consolidated group have permission to hold money or securities belonging to their clients and /or to place financial instruments without a firm commitment basis (the key permissions that trigger inclusion in CRD IV in the first instance ) they are still agency-only firms. They do not have the permission a bank would have to deal on own account or to underwrite financial instruments (place on a firm commitment basis) or to operate an MTF.
Furthermore, any client money held by the MiFID Portfolio Manager or MiFID Distributor will be segregated from the firm’s own money and assets in separate and regulated client money accounts just as the client’s assets will be held within regulated custody accounts and depositaries. This is in clear contradistinction to balance-sheet entity comingling of own and client money/assets. In other words, even if senior managers within the wider consolidation group were capable of taking material risks with the consolidated group’s balance-sheet, this balance-sheet belongs to an agency group in the first instance and poses very little risk to the financial system and even less to investor protection.
Thirdly and finally, we would observe that ESMA’s AIFMD Guidelines already embody the alternative approach to cross-sectoral application of remuneration rules that FIL would suggest the EBA pursue instead. ESMA’s AIFMD Guidelines contain the concept of remuneration rules within parallel sectoral regulation that are capable of having “equivalent effect” over in-scope (delegate) entities as the AIFMD Guidelines themselves. The AIFMD Guidelines even explicitly recognise CRD as one such “equivalent” regulation. We would therefore suggest that the proper – and simpler – step under CRD Guidelines would be to reverse the polarity of the EBA’s current direction to recognise UCITS and AIFMD as “equivalent regulation” for the purposes of group compliance with CRD.
FIL believes that the EBA and Commission Legal Service’s re-interpretation of proportionality is not correct as a point of law. In terms of costs, our chief concern is the cost to customer interests, as hitherto well aligned remuneration practices for portfolio managers in particular will be dismantled by EBA policy, and Asset Managers will effectively be required to reward individuals regardless of performance.
FIL has now read the two letters on the application of Article 92(2) of CRD IV, exchanged between the EBA and the Commission’s Legal Services as published on the EBA’s website. We find it hard to understand precisely what the Commission Legal Service’s point of law is, and instead read their letter to the EBA more as assertion than legal re-interpretation. We would welcome clarification on this point but until then stand by our own interpretation of the very minor shift in the legal character of proportionality from CRD III to CRD IV as outlined below.
While the EBA expressly recognises that CRD IV continues to include the proportionality principle, it is now of the opinion that the proportionality principle no longer extends as far as complete neutralisation (that is, complete disapplication) of certain elements:
“Although the former CEBS Guidelines on Remuneration Policies and Practices allowed for the so-called ‘neutralisation’ of some provisions in small and less complex institutions. The terms of the CRD do not explicitly grant for such a right and therefore the preliminary assessment of the EBA is that a full waiver of the application of even a limited set of remuneration principles for smaller and non‐complex institutions would not be in line with the CRD.”
Like many others, FIL takes the opposite view in believing that proportionality still allows firms to neutralise certain elements of policy – rather than having to apply all of the pay-out process rules as a de minimis and having to move upwards from this base, which is the EBA and Commission’s new position.
It is FIL’s view that since 1 January 2014 CRD IV has carried forward all of CRD III’s policy with only two amendments – neither of which make a material difference to CRD III policy. Again, CRD IV makes clear reference to neutralisation:
• CRD IV Article 92 (Remuneration policies)(2) now states that “Competent authorities shall ensure that… institutions comply with the following principles in a manner and to the extent that is appropriate their size, internal organisation and the nature, scope and complexity of their activities”;
• CRD IV Article 94 (Variable elements of remuneration) operates “under the same conditions as those set out in Article 92(2)”; and
• CRD IV Recital 66 states that “the provisions of this Directive on remuneration should reflect differences between different types of institutions in a proportionate manner, taking into account their size, internal organisation and the nature, scope and complexity of their activities. In particular it would not be proportionate to require certain types of investment firms to comply with all of those principles.”
Thus – the two key amendments are:
• CRD III Recital 9 is not carried forward into CRD IV; and
• CAD-exempt firms are no longer called out by name in CRD IV Recital 66 as they were in CRD III Recital 4. Instead they appear as “certain investment firms”
All other elements of CRD III policy remain the same.
Otherwise, the intended operation of ‘proportionality’ under CRD IV continues to be that (i) certain unnamed credit institutions, and (ii) “certain types of investment firms” may still chose to neutralise certain elements (whether principles or requirements) of CRD IV. Again the now-unnamed “certain investment firms” are called out “in particular.”
Notwithstanding the rather confusing slippage in terminology between ‘credit institution’ and ‘investment firm’), FIL believes that by “certain investment firms” CRD IV Recital 66 clearly means to refer to CRD III Recital 4’s “investment firms referred to in Article 20(2) and (3) of Directive 2006/49/EC” or CAD-exempt firms. The sentences are in all other ways identical and the clearest distinction drawn between types of firms throughout CRD IV (as called out above) continues to be that between balance-sheet entities and agency-based CAD-exempt entities.
FIL therefore also believes that the ability of CAD-exempt firms to neutralise certain elements of CRD IV survives the transition from CRD III to CRD IV.
We wish to highlight to the EBA the high number of members of staff of the asset managers’ industry who will be caught as Material Risk Takers (“MRTs”) under EBA policy regardless of the fact that their professional activities do not have a material impact on the institution’s risk profile.
This is because the professional activity of an Asset Managers’ investment professionals – and portfolio managers in particular –has a material impact on our customers’ assets but not on the firm’s risk profile. To be clear a portfolio manager puts customers’ assets at risk in the market but does not put the firm’s balance-sheet directly at risk. The EBA mentions in the context of MRT, “the percentage of internal capital allocated according to Article 73 of CRD to the business unit where the staff member is active” should be included in notifying NCAs about exclusion. In the case of portfolio managers the answer would be close to zero. Portfolio management as a professional activity is based entirely on external / client funds not the risking of internal / balance-sheet capital.
Notwithstanding this lack of impact on the firm’s capital, many portfolio managers will fall within scope as MRTs on the EBA’s new ‘quantitative’ basis as their total compensation will exceed €1million.
This being the case, FIL will wish to take advantage of Article 4(2) of the Regulatory Technical Standards (“RTS”) enabling firms to seek exclusion for ‘quantitative-only’ MRTs from the scope of CRD IV Identified Staff. We would therefore welcome a conversation with the EBA about the best process for seeking and agreeing these exclusions – for NCAs, the EBA and firms alike. Ideally, FIL would recommend a professional activity-based exclusion that might begin with a general exclusion for all agency portfolio managers with some key exceptions – for example, for portfolio managers who might have an operational or reputational impact on the firm itself, although we do not believe FIL has any such managers.
We would also suggest that these sorts of exclusions are allowed to run beyond the EBA’s proposed annual review period. Again, ideally FIL would suggest that exclusions are ongoing as long as the individual’s professional activity is ongoing and unchanged – that is, only subject to re-approval under set change circumstances and not subject to annual review. We would also suggest that the EBA empowers NCAs to communicate with the Asset Management industry in good time on a likely set of procedures for seeking exclusion. An exhaustive set of criteria and/or proofs that Asset Managers will need to supply in order to satisfy NCAs and/or the EBA itself would also aid the efficiency of the exclusion mechanism for NCAs, EBAs and firms alike.
FIL believes that the guidelines are sufficiently clear, but would again raise the point that fixed-based compensation practices have knock-on effects for Asset Managers’ P&L that in turn have effects for the balance-sheet and individuals Asset Manager’s ability to ride out downturns in the market. As CRD IV capital for asset managers is based on Fixed Overhead Requirements (“FOR”) then the Asset Management industry’s capital base will rise substantially as the balance of remuneration shifts from variable to fixed.
FIL has some doubts about the EBA’s proposal to exempt members of the supervisory function in principle from variable remuneration in Section 16. Such an exemption is not foreseen by CRD. Furthermore, variable remuneration can help in a very efficient manner to establish a cultural change in institutions when the incentives are set in the right way. It is not helpful to ask for an improved role for the supervisory function in institutions and making their positions unattractive at the same time. Improvements in risk management, successful challenges of business decisions and early identification of problems should be rewarded, they can often make a considerable contribution to the improvement of the business and there fore part of the reward should be based on business outcomes. Making it appear that control and supervisory functions have no contribution to make to the success of the business is counter-intuitive and bad practice. We consider the exemption of the supervisory function from variable remuneration in principle as counterproductive and harmful.
As in our response to Q 13,FIL have concerns about the variable remuneration of control functions. We consider EBA’s proposal in Paragraph 206 as inappropriate. The limits on the ratio between fixed and variable remuneration of 1:1 is already tight enough to prevent conflicts of interest with regard to control functions. Shareholders will only decide only under extraordinary circumstances to raise this limit to 1:2 for control functions, but they should be able to do so if necessary. The control functions are crucial with regard to a cultural change in some firms and variable remuneration can be the right tool to achieve such a change.
It will also be operationally difficult to operate one type of non-cash instrument for rewarding control staff and another for rewarding all other members of staff. Furthermore, the EBA’s proposed metrics are (again) based on control of a balance-sheet entity and not an agency-based firm.
FIL would suggest that the EBA proposal could be clearer with regard to Paragraphs 253 and 254. It would be helpful if EBA could clarify that the valuation of deferred instruments at the end of deferral and retention periods is only used for the application of potential ex-post risk adjustments and malus or claw back measures. The ratio between fixed and variable remuneration is to be based on the valuation of instruments at the point of their award.