In brief: The China Banking Regulatory Commission and the Hong Kong Monetary Authority have released to the public their own guidelines on Sound Compensation Practices of banking industry in March 2010, which the banks are expected to comply with the requirements ranging from governance, compensation structure, measurement of performance for variable remuneration and disclosure.
There are significant tax and non-tax implications for the banking industry which need to be carefully reviewed prior to complying with the guidelines. The new banking guidelines on employee compensation structure will also have far ranging effects on other industries from the corporate governance perspective.
The background 
In a concerted effort to manage excessive risk-taking which the compensation strategy of the banking industry is partly viewed to have contributed to, and which led to the financial crisis, the global Financial Stability Board ("FSB") [previously known as the Financial Stability Forum] issued the Principles for Sound Compensation Practices in April 2009, which were endorsed by the Leaders of the Group of Twenty ("G20"). The FSB then issued the Implementation Standards in September 2009 to focus on prioritized areas which require rapid progress to achieve effective global implementation of the Principles.
Adhering to the Principles for Sound Compensation Practices and the Implementation Standards, the China Banking Regulatory Commission ("CBRC") released to the public this month its Supervisory Guidelines on Compensation Practices of Commercial Banks. Within the same month, the Hong Kong Monetary Authority ("HKMA") has released its final Guideline on a Sound Remuneration System. These Guidelines are not intended to determine the amount of remuneration by the regulatory authorities but serve as the standards which the employers should take into consideration when designing and implementing their remuneration policy. We have summarized below the key features of the Guidelines' requirements on governance, compensation structure, measurement of performance for variable remuneration and disclosure. Please refer to the Guidelines for requirements in other areas.
| |
CBRC Guidelines |
HKMA Guideline |
| Effective date |
1 March 2010 |
19 March 2010 |
| Compliance deadline |
Not specified |
End of 2010 |
| Application |
Commercial Banks ("CBs") whose enterprise legal persons are incorporated in China to take public deposits, make loans, arrange settlement of accounts, etc. Should also cover foreign CBs. |
All Authorized Institutions ("AIs"), including overseas branches / subsidiaries subject to HKMA's consolidated supervision. |
| Governance |
- Board of directors
- Independent compensation committee
- Written remuneration policy
- Annual internal audit
- External audit
|
- Board of directors
- Board remuneration committee
- Compensation system
- Compliance process is regularly monitored
- Regular (at least annually) review of policy / implementation
|
| Compensation structure |
- Total compensation includes fixed compensation (base salary), variable compensation (performance linked compensation ["PLC"] and medium- / long-term incentives) and welfare benefits
- Base salary should generally not exceed 35% of total compensation
- PLC for "top executives" shall be no more than 3 times of base salary
|
- Balance between fixed and variable incentive-based remuneration
- Avoid inducement of excessive risk-taking yet competitive for staff attraction / retention
- AI adopting different policy for senior management and key personnel has to justify such policy
|
- PLC be adjusted for all types of risks and costs yet ensuring sustainable development
|
- Align variable remuneration with long-term value creation, time horizons of risk and employee's position and role (e.g. vesting period on equity based pay)
|
- Reasonable proportion of PLC, partly payable with base salary and balance payable at year end
- Medium- / long-term incentives be payable after lock-up period (at least 3 years)
- 40% of PLC for senior executives and employees with material impacts on bank's risk exposure should be deferred evenly over at least 3 years; 50% (or even 60%) for major senior executives
|
- Deferral period for employees whose actions may have a material impact on the risk exposure of the firm should not be less than 3 years
- Deferment of variable remuneration to reflect associated risks and risk outcome, through vesting period and vesting conditions
|
- Claw-back provisions on PLC for existing and departed employees
|
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- Guaranteed bonus is not recommended - if necessary should limit as incentive for new hire in 1st year
|
- Guaranteed bonus should be restricted for, e.g. new hire in 1st year, staff retention in wind-down or sale of business, subject to Board / remuneration committee approval
|
| Measurement of performance for variable remuneration |
- Sound performance assessment indicator system for PLC: economic / risk control / social responsibility indicators
|
- Pre-determined and assessable performance criteria (financial and non-financial)
- Non-financial criteria include risk management, compliance with legal / regulatory / ethical standards, internal audit result, corporate values, customer satisfaction, etc.
- Adjustments to risks on capital / liquidity / future revenues
|
- Impacts on PLC for not fulfilling / reaching risk control indicators could range from (1) freezing of per capita average PLC of current year to that of previous year or lower than that of previous year to (2) total base salary of the bank in the following year be no higher than that of current year
|
|
| Disclosure |
- The Board to set the scheme of annual performance assessment indicators at start of the year and submit the scheme to the banking regulatory authorities for records
- Disclosure in annual report
- Report remuneration disclosure practices to the banking regulatory authorities for records
|
Timely disclosure to the public and the HKMA |
The HKMA issued the Guideline on a Sound Remuneration System to all AIs on 19 March 2010 and requested that all AIs conduct a self-assessment, independent of management, on the extent to which their existing remuneration systems are consistent with the principles set out in HKMA's Guideline. The CBRC's Guidelines also empower the banking supervisory authority to conduct on-site examinations, if necessary, on the related performance and risk assessment practices of commercial banks.
Institutions in the banking industry should immediately review their current compensation policies and strategize on the steps to comply with the Guidelines, both in terms of the policy change as well as the disclosure and filing requirements. They should assess how the existing ranks and roles of senior executives and staff would match that classified under the Guidelines and seek clarification from the relevant authorities if needed. The Board members should also be fully aware of their responsibilities and an independent compensation committee should be established as soon as possible. It is also the right timing to put in place a written remuneration policy if currently not available.
The enhancement in remuneration policy to change the current split between fixed and variable compensation, to introduce mandatory deferral and to incorporate claw-back provisions will lead to complications in tax reporting position and due care should be exercised in determining the appropriate tax filing basis. It is important to assess the tax implications in the course of restructuring the existing remuneration policy, and to leverage on the potential tax planning opportunities that may be identified. Professional assistance should be sought where necessary, and it may be necessary to discuss with the relevant Chinese and Hong Kong tax authorities on the appropriate tax treatment of the remuneration policy.
The changing regulatory environment on remuneration policy affects not only the banking industry but also other industries. This is because remuneration policy is one of the important components for corporate governance which is also the subject for periodic review and enhancement in the global effort to maintain the stability in the financial system. To promote corporate governance, companies may wish to make reference to the Guidelines in designing its remuneration policy to better align its compensation practices with sound risk management and sustainable long-term growth.
