The Advisors' Blog

– Eeva Raikkonen and Salvatore Tedesco, ISS’s European Research Team (Brussels)

The European Commission recently released reports on Member States’ application of two recommendations on executive remuneration and financial services sector pay. The reports complement a package of proposals intended to strengthen the European financial system. The pay guidance, released in April 2009, is a non-binding instrument that invited Member States to take measures to implement the main principles by the end of 2009. The EC reports outline the state-of-play one year after the publication of the remuneration guidelines.

The first, more general recommendation on remuneration gave guidance on the structure of remuneration policies and their governance with a focus on variable pay, in order to better align pay with performance. The EC’s report finds that half of the recommendations on remuneration at listed companies have been endorsed by 10 of 27 Member States, while eight countries say they are still in the process of taking necessary steps.

The guidelines were not aimed at harmonising remuneration rules across Europe, and national provisions vary from one market to the next. For instance, while a minority of Member States have followed the recommendation that severance pay be limited to two years’ fixed remuneration, a number of countries have taken either a more lenient approach (by also including variable pay) or a more stringent one (by capping pay at one year’s fixed salary). The Member States were given discretion as to whether to incorporate the EC’s guidelines through legislation or corporate governance codes. The EC finds that recommendations have mostly been included in national corporate governance codes functioning on a comply-or-explain basis.

Clawback clauses (i.e., arrangements which permit companies to reclaim variable remuneration paid on the basis of financial results that proved to be flawed) have been very popular and were more likely to be regulated in law than other recommendations. Member States’ interpretation of the guidelines has also led to varying results. For example, few have complied with the recommendation to defer a major part of variable remuneration. In the EC’s view this is mainly due to varying degrees of familiarity with the concept.

The second EC recommendation specifically targeted remuneration at financial services sector companies. It was intended to ensure that remuneration policies do not encourage excessive risk-taking and are in line with the long-term interest of financial institutions. According to the June 2 EC report, 16 of 27 Member States have fully or partially applied the recommendation. While a further six are in the process of taking necessary steps, a “relatively high number” (five) have not initiated any measures or have put into place inadequate ones. The EC also points out that the scope of application of national measures varies. Only seven Member States apply consistent measures across the financial services sector, while six countries address only credit institutions.

The EC finds that at this stage it is difficult to assess if and to what extent financial institutions have put into place sound remuneration policies. In the EC’s view, financial institutions are unlikely to commit to a long-term and comprehensive reform of their remuneration policies before the adoption of pending legislation in this area, namely in the form of proposed amendments to the Capital Requirements Directive and the proposed directive on alternative investment fund managers. With regard to both recommendations, the EC concludes that “progress has been made but a significant number of Member States have yet to implement the Recommendations fully.”

In addition to gauging stakeholders’ views on general remuneration issues at listed companies through its green paper on corporate governance in financial institutions and remuneration policies, the EC has stated it will focus on the following issues in light of the findings: 1) proposing legislative measures targeting remuneration in the non-banking financial services sector in 2010-2011; 2) pushing for a swift agreement between Member States and the European Parliament on the pending legislative proposals that deal with remuneration issues, as well as strictly monitoring their implementation by Member States; 3) promoting, through its participation in the Financial Stability Board and the G-20, an effective application of similar rules on remuneration in the financial services sector on a global level; and 4) reassessing the situation regularly and proposing additional measures as necessary.