CRD 5 Regulation: EBA Report Derogations

On 16 July 2024, the European Banking Authority (EBA) released a detailed report on the application of derogations under Articles 94(3) and 94(5) of the Capital Requirements Directive IV (CRD IV). These articles are crucial in regulating remuneration policies for identified staff within financial institutions across the EU, focusing particularly on the payout of variable remuneration through deferral arrangements and instruments. The EBA’s report highlights the significant variations in how these derogations are implemented across Member States, affecting the broader regulatory landscape under CRD 5 Regulation. This analysis delves into the report’s findings, exploring the implications of these derogations, the challenges they pose, and their impact on the financial sector.

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2024 CRD IV Amendments

The European Commission updates ITS for transparency in the EU financial sector, aiming to enhance regulatory compliance and stability. Amendments to CRD IV and investment firm regulations reflect a significant regulatory shift, emphasising robust risk management and financial transparency.

GrandAlessandro Micagni

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The EBA publishes the report on the application of derogations to the deferral and pay out in instruments under CRD | European Banking Authority

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CRD 5 Regulation Impact on Remuneration Policies

CRD 5 Regulation is a critical component of the EU’s broader legislative framework aimed at enhancing financial stability. Among its provisions, Articles 94(3) and 94(5) of CRD IV play a pivotal role in shaping remuneration policies by setting out rules for the payout of variable remuneration to identified staff, who significantly impact an institution’s risk profile. These rules are designed to align staff interests with the long-term health of financial institutions, promoting prudent risk management and discouraging excessive risk-taking.

Findings of the EBA Report on CRD 5 Regulation

The EBA report provides an in-depth review of the derogations, primarily aimed at easing regulatory burdens on smaller and less complex institutions under CRD 5 Regulation. The report analyzes how these derogations are applied by Member States, assessing their impact on administrative burdens, the ability to recruit and retain staff, alignment of remuneration with risks, and challenges faced in a group context.

1. Mandate and Legal Basis of CRD 5 Regulation

The review is grounded in Article 94(6) of Directive 2013/36/EU (CRD), which mandates the European Commission, in cooperation with the EBA, to examine the application of these derogations. The goal is to ensure that remuneration practices foster sound risk management and align with the long-term objectives of the institutions under the CRD 5 Regulation. The legal basis reflects the EU’s commitment to balancing effective supervision with proportionality principles that allow smaller institutions to adapt requirements to their operational realities.

2. Methodology of the EBA Review

The EBA employed a qualitative approach, incorporating feedback from industry stakeholders, data from remuneration benchmarking exercises, and input from competent authorities. This comprehensive methodology enabled the EBA to evaluate the practical implications of the derogations on institutions’ operations and the broader financial sector under CRD 5 Regulation. The analysis included detailed data assessments from FinRep (Financial Reporting) and benchmarking exercises to capture the real-world impact of derogations across various banking groups and jurisdictions.

Article 94(3) CRD IV: Variation in Implementation Across Member States

Article 94(3) of CRD IV under CRD 5 Regulation allows Member States to apply specific derogations that modify payout requirements for variable remuneration, such as deferral arrangements and payment in instruments. These derogations are not uniformly implemented across the EU, leading to significant variations in practice that reflect different national approaches under the CRD 5 Regulation framework.

Article 94(3)(a): Institution Size-Based Derogations in CRD 5 Regulation

• Scope and Application Differences: The derogation under Article 94(3)(a) CRD IV is primarily targeted at institutions that are not classified as large and have total assets below a specified threshold, typically set at EUR 5 billion but can be increased to EUR 15 billion under certain conditions. This derogation aims to reduce regulatory burdens on smaller, less complex institutions by exempting them from stringent payout requirements, aligning with CRD 5 Regulation objectives.

• Divergence Among Member States: Some Member States strictly limit this derogation to standalone smaller institutions, maintaining stricter payout conditions for larger consolidated entities. This approach prioritizes risk management by ensuring that remuneration practices in large financial groups remain aligned with the institution's risk profile, regardless of the size of individual subsidiaries. Conversely, other Member States extend the derogation to include smaller subsidiaries within larger groups, reflecting a more flexible approach that considers the operational needs and market realities of smaller subsidiaries, consistent with CRD 5 Regulation’s flexibility. For instance, countries like Germany and Luxembourg have allowed the threshold increase up to EUR 15 billion for specific conditions, highlighting the nuanced application of the derogation across Member States.

• Impact on Administrative Burden: Institutions benefiting from this derogation under CRD 5 Regulation experience a reduced administrative burden, as they are not required to manage the complexities associated with deferred payouts and the issuance of remuneration instruments. This reduction is particularly significant for institutions where creating and valuating instruments is costly and administratively complex. Data from the EBA report indicate that smaller institutions report lower compliance costs, particularly in areas such as creating instruments, ongoing valuation, and applying deferral and retention periods.

• Industry and Regulatory Feedback: Industry representatives highlighted that derogations significantly alleviate compliance complexities, particularly for smaller institutions that would otherwise struggle with the costs associated with these regulatory requirements. Competent authorities, however, noted that this flexibility could lead to a lack of uniform risk alignment across larger banking groups where smaller subsidiaries benefit from derogations not applicable to the parent group.

Article 94(3)(b): Remuneration-Based Derogations in CRD 5 Regulation

• Threshold Implementation: Article 94(3)(b) permits Member States to apply derogations based on the size of the variable remuneration component. Typically, it exempts staff whose annual variable remuneration does not exceed EUR 50,000 and does not represent more than one-third of their total annual remuneration. However, some Member States have implemented lower thresholds based on national remuneration practices, such as Denmark (EUR 13,400), Hungary (EUR 45,000), and Romania (EUR 30,000), reflecting localized regulatory adaptations within the CRD 5 Regulation framework. These variations illustrate the EBA’s allowance for Member States to tailor these rules to fit their specific economic environments.

• Administrative and Operational Impact: This derogation under CRD 5 Regulation significantly reduces the administrative tasks associated with managing variable remuneration, such as calculating deferral amounts, managing shares or instruments, and monitoring compliance with payout provisions. For institutions not benefiting from these derogations, these processes remain resource-intensive, leading to increased operational burdens. The EBA report noted that institutions often must maintain parallel processes to handle identified staff who do not qualify for the derogation, adding to the complexity of compliance.

• Impact on Staff and ‘Cliff Effect’: The derogation also helps alleviate the 'cliff effect' for staff whose remuneration is just above the threshold, as these staff members may otherwise be subject to deferral requirements that do not account for inflation or lack of dividends on deferred instruments. This highlights the derogation’s role in balancing regulatory intent with practical implementation challenges under CRD 5 Regulation. The report pointed out that for staff earning marginally above the derogation threshold, the deferral rules could create perceived disadvantages, impacting staff motivation and retention.
• Data on Use of Article 94(3)(b): The EBA’s remuneration benchmarking data show that approximately 80% of institutions applied this derogation to exempt lower-paid staff from stringent payout requirements. However, the impact on risk alignment was found to be minimal, given the small amounts of remuneration that would otherwise be deferred or paid in instruments.

Article 94(5) CRD IV: Lack of Identified Practices and Implications in CRD 5 Regulation

Article 94(5) CRD IV under CRD 5 Regulation provides Member States with discretionary power to impose additional conditions on the application of derogations, particularly for staff receiving variable remuneration below specified thresholds. This provision aims to address unique national market conditions, job responsibilities, and remuneration practices, enhancing the alignment of remuneration structures with institutional risk profiles.

Absence of Significant Implementation in CRD 5 Regulation:

The EBA report notes that no significant practices concerning Article 94(5) under CRD 5 Regulation have been identified, suggesting that Member States have largely not exercised this discretionary power. This lack of implementation indicates potential regulatory underuse, where the flexibility provided by Article 94(5) could be leveraged to address specific market challenges or to fine-tune remuneration structures to align with national specificities. The absence of active use of this derogation reflects a missed opportunity to tailor remuneration requirements more precisely to institutional contexts and market demands.

Implications for Regulatory Consistency in CRD 5 Regulation:

The limited application of Article 94(5) under CRD 5 Regulation highlights broader challenges within the framework—the balance between harmonisation and national discretion. While CRD 5 Regulation aims to standardise remuneration practices across the EU, the discretion given to Member States introduces variability that can complicate regulatory enforcement and comparability, underscoring the ongoing challenge of maintaining a consistent regulatory approach while accommodating diverse market and institutional needs. Competent authorities noted the absence of robust frameworks to guide the discretionary application of this provision, leading to potential gaps in the alignment of remuneration practices with risk management objectives.

Data on the Impact of Waivers Under CRD 5 Regulation

The EBA’s report includes data on the impact of waivers under Articles 94(3) and 94(5), based on financial reporting from banking groups across the EU. The data indicate that while a significant number of institutions benefit from these derogations, the overall impact on risk-taking behavior and remuneration alignment remains limited, particularly for smaller institutions with retail-oriented business models. This suggests that, while the derogations help alleviate regulatory burdens under CRD 5 Regulation, their effect on mitigating risk and aligning remuneration practices with institutional health may be modest.

The EBA report underscores the complexities and variations in implementing CRD 5 Regulation across Member States. The significant divergence in how Articles 94(3) and 94(5) are applied highlights the need for a balanced approach that respects national differences while striving for a coherent, EU-wide regulatory framework under CRD 5 Regulation.

The challenge remains to harmonize remuneration practices across the EU without compromising the ability of Member States to address specific market conditions and institutional needs, making CRD 5 Regulation a key element in the ongoing evolution of EU financial regulation. The findings emphasize the importance of ongoing dialogue between regulators and industry to refine the application of these derogations, ensuring they continue to serve the intended purpose of balancing regulatory oversight with operational flexibility.