On 9 November 2010 the Danish Minister for Economic and Business Affairs introduced a Bill on remuneration policies in financial institutions and financial holding companies. Among other things, the Bill will implement the new rules on remuneration laid down in the European Capital Requirements Directive, and will incorporate the European Commission's recommendation to introduce remuneration policies in the financial sector as well as the so-called Danish "Government Agreement" on, for example, restricted use of share options as a remuneration tool.

The Bill is intended to receive its first reading on 23 November 2010 and is expected to be approved at the planned third reading on 16 December 2010.

Key features
The key features of the Bill are:

  • financial institutions and financial holding companies must have remuneration policies and practices which are consistent with and promote sound and effective risk management;
  • specific rules will be inserted into the Danish Financial Business Act regulating the payment of variable remuneration to the boards of directors, the executive boards and significant risk takers in financial institutions and financial holding companies;
  • major financial institutions and financial holding companies must establish a remuneration committee;
  • financial institutions and financial holding companies will be subject to more stringent disclosure requirements with regard to remuneration.

As opposed to the Capital Requirements Directive, the Bill will also regulate insurance companies, and the remuneration rules will also apply to ATP (a Danish labour market pension and social insurance firm) and to LD (a Danish employee investment management firm).

This newsletter will briefly describe the proposed new rules included in the Bill.

Remuneration policy, guidelines and disclosure

According to the Bill, any financial institution and financial holding company must have a remuneration policy which is consistent with and promotes sound and effective risk management.

The remuneration policy must be presented for approval by the supreme body of the company, i.e. typically the general meeting of shareholders, who must also approve guidelines on grant of variable remuneration and guidelines on severance pay.

The calculation of performance-related variable remuneration must be based on an assessment of the performance of the individual and of the individual's business unit, and of the overall results of the company.

Finally, in his report to the general meeting of the company, the Chairman of the company's board of directors must account for the remuneration of the members of the board of directors and the executive board during the previous, current and next financial year. The Danish Financial Supervisory Authority (Finanstilsynet) will be authorised to lay down detailed rules on the duty of financial institutions and financial holding companies to disclose information regarding the remuneration of the aforesaid groups of individuals. According to the Bill it will be a demand from the Danish Financial Supervisory Authority that the annual reports of the companies disclose the size of the total remuneration of the boards of directors, the executive boards and other significant risk takers, distributed on fixed and variable remuneration and on the number of recipients.

Regulation of variable remuneration

Specific rules will be inserted into the Danish Financial Business Act regulating the use of variable remuneration. The individuals subject to those rules are the members of the company's board of directors and executive board, and other employees whose activities have a significant impact on the company's risk profile (in the comments to the Bill referred to as "significant risk takers").

The definition of the members of the board of directors and the executive board does not give rise to any doubts. The definition of "significant risk takers" does, however, give rise to doubts. It is basically up to the board of directors to decide which individuals - in the board's opinion - have a significant impact on the company's risk profile. However, as a minimum the company must consider the following groups of individuals: the management of markets and treasury, employees in markets and treasury who can take significant risks on behalf of and at the expense of the company, managers of actuary and reinsurance functions who can take significant risks on behalf of and at the expense of the company. Furthermore, the company must consider whether its "significant risk takers" also include the management of that part of the organisation which monitors compliance with risk controls, and employees who may impose significant credit risks on the company.

Employees whose total remuneration takes them into the same remuneration bracket as the individuals described above must also be taken into consideration as significant risk takers. It is a decisive criterion, however, that in the company's assessment the individuals in question have a significant impact on the company's risk profile. If this is not the case, they will not be subject to the rules. With regard to employees engaged in control functions, the subsequent executive order on remuneration policies will lay down certain restrictions ensuring that the variable remuneration of such employees does not depend on the performance of the units or areas controlled by the individual employees.

Limit on variable remuneration

Already today there is a limit on the size of the variable remuneration paid to the executive board of a financial institution. The limit is 50% of the fixed basic remuneration, including pension. This limit will now also apply to the executive boards of financial holding companies, and a similar limit of 50% of the remuneration will apply to members of the boards of directors of financial institutions and financial holding companies. Where a financial institution or a financial holding company receives or has been promised government subsidies or is a subsidiary of the Danish Financial Stability Company (Finansiel Stabilitet A/S), the limit on the size of the variable remuneration is 20% in respect of both executive board and board of directors.

As for other employees whose activities have a significant impact on the company's risk profile, the company must determine a suitable limit on the variable remuneration. Such limit may vary depending on the activities, etc. of the relevant employees. Where a financial institution or a financial holding company receives or has been promised government subsidies or is a subsidiary of the Danish Financial Stability Company, it must in its remuneration policy lay down a specific limit - based on the company's earnings - on the total amount of variable remuneration payable to the board of directors, the executive board and significant risk takers.

Deferral of variable remuneration

At least 40% of the variable remuneration must be deferred over a period of at least three years, and the amount will vest on a pro-rata basis in equal portions over the years, or in portions increasing towards the end of the period. As for board of directors and executive board, the deferral period must be at least four years. If the variable remuneration is particularly high, at least 60% of the variable remuneration must be deferred. Whether the variable amount is high will depend on the total remuneration and risk profile of the individual concerned.

Payment of the deferred part of the variable remuneration cannot start until one year after calculation of the variable remuneration. It is further implied that the deferred part of the variable remuneration will be paid in one-year intervals.

The idea behind the rules on deferring up to 60% of the variable remuneration is to ensure the possibility of making adjustments to the accrued variable remuneration to make the remuneration consistent with the long-term effects of the performance on which the remuneration was based. Thus, the company must ensure that it is a condition for payment of the deferred part of the variable remuneration i) that the criteria constituting the basis for calculating the variable remuneration still apply at the time of payment, and ii) that the financial situation of the company has not significantly deteriorated compared to the time when the variable remuneration component was calculated.

Remuneration in shares, etc.

At least 50% of the variable remuneration at the time of calculation thereof must be granted in shares, share-linked instruments (e.g. share options) or other instruments reflecting the creditworthiness of the company concerned, including hybrid core capital in the company. The Committee of European Banking Supervisors (CEBS) is expected to issue guidelines on the instruments applicable. As for insurance companies, at least 50% of the variable remuneration may instead consist of subordinate debt in the insurance company.

As for the board of directors and the executive board, share options and similar instruments may constitute no more than 12.5% of the board remuneration and the fixed basic remuneration, respectively, including pension, at the time of the calculation thereof.

The requirement that at least 50% of the variable remuneration must be granted in shares, etc. applies both to that proportion of the variable remuneration which may be paid right away and to that proportion (up to 60%) which must be deferred over a period of at least three years (for board of directors and executive board at least four years). This means, for instance, that the company is not allowed to defer just the cash proportion or just the share-linked proportion of the variable remuneration.

Retention period

The company is required to ensure that the proportion of the variable remuneration received as shares etc. (i.e. at least 50%) cannot be sold by the recipient for an appropriate period of time, and that the employee is not allowed to hedge the risks involved with such shares, etc. With regard to share options, the employee shall have no right to sell or exercise such options for an appropriate period of time.

What an appropriate period of time is must be assessed by the company and will depend on the circumstances of each member of the board of directors or executive board or each employee or group of employees.

Payment restrictions

The company may in exceptional circumstances refrain from paying the variable remuneration, for example if the company does not satisfy the capital or solvency requirements or has been allowed a period of time by the Danish Financial Supervisory Authority to satisfy the solvency requirement. Besides, the company must ensure that the recipients of variable remuneration are required to return all or part of that remuneration if it has been calculated on the basis of performance information which is provably erroneous and the recipient was in bad faith.

Remuneration committee

Financial institutions and financial holding companies are required to establish a remuneration committee if their shares have been admitted to trading on a regulated market or if during the past two financial years they have had at least 1,000 full-time employees. The members of the committee must be members of the board of directors of the company. A group of companies which are each required to have a remuneration committee may establish a joint remuneration committee.

The remuneration committee will be in charge of the preparatory work required for the board of directors' remuneration decisions, including remuneration policy decisions and other decisions which may have a bearing on the company's risk management.

Date of coming into force

The Act will come into force on 1 January 2011, but the rules restricting the use of variable remuneration will only apply to agreements entered into, extended or renewed after that date.

Agreements on variable remuneration entered into before 1 January 2011 may therefore be observed and performed by the financial institutions. Thus, the Act will not affect the performance of the existing agreements on variable remuneration for 2010. It must be assumed, however, that in its supervisory work the Danish Financial Supervisory Authority will ensure that the companies have remuneration policies and practices which are consistent with and promote sound and effective risk management.

New agreements on variable remuneration entered into after 1 January 2011 must comply with the new rules. The same applies to the renewal or extension of existing agreements after 1 January 2011.

The rules on the establishment of a remuneration committee and on the general meeting's approval of the company's remuneration policy will be effective for a company after its first – annual or extraordinary – general meeting after 1 January 2011. However, any company is required to have a remuneration policy already as of 1 January 2011, and agreements on variable remuneration entered into in the period before the first general meeting will be valid if the remuneration policy has been approved by the board of directors of the company.

The next steps

The Bill is intended to receive its first reading in the Danish parliament on 23 November 2010 and is expected to be approved at the planned third reading on 16 December 2010.

Kromann Reumert's comments

The Bill will have far-reaching consequences for the financial institutions and holding companies concerned, and for the directors, executive officers and risk takers subject to the rules.

The implementation of the new rules will present major challenges to the companies, including in particular:

  • drafting of a remuneration policy;
  • identification of significant risk takers;
  • drafting of new agreements on variable remuneration effective as of 1 January 2011, including clauses on e.g. retention periods for shares, etc., and payment restrictions.

Kromann Reumert will continue to follow closely the legislative process and regularly publish updated news.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.