Communication from the Commission accompanying Commission recommendation complementing recommendations 2004/913/EC and 2005/162/EC as regards the regime for the remuneration of directors of listed companies and Commission recommendation on remuneration policies in the financial services sector {C(2009) 3159} {C(2009) 3177}
Date: 2009-04-30
Institutions: European Commission
Subjects: board of directors, business management, company law, corporate governance, financial market, remuneration of work, stock-exchange listing

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 30.4.2009 
COM(2009) 211 final 

COMMUNICATION FROM THE COMMISSION 

accompanying 

Commission Recommendation complementing Recommendations 2004/913/EC and 
2005/162/EC as regards the regime for the remuneration of directors of listed companies 

Commission Recommendation on remuneration policies in the financial services sector 

and 

{C(2009) 3159} 
{C(2009) 3177} 

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COMMUNICATION FROM THE COMMISSION 

accompanying  
Commission Recommendation complementing Recommendations 2004/913/EC and 
2005/162/EC as regards the regime for the remuneration of directors of listed companies 
and Commission Recommendation on remuneration policies in the financial services 
sector 

I. Introduction  

The financial crisis has exposed serious weaknesses in the way financial markets are regulated 
and supervised. The Commission is leading a wide-ranging reform to apply the lessons of the 
crisis  and  deliver  responsible  and  reliable  financial  markets  for  the  future.  In  the  present 
context,  remuneration  policies  have  been  a  particular  focus  of  attention  from  the  public, 
media, academics and policy makers alike. 

There  is  broad  consensus  that  compensation  schemes  based  on  short-term  returns,  without 
adequate  consideration  for  the  corresponding  risks,  contributed  to  the  incentives  that  led  to 
financial  institutions’  engagement  in  overly  risky  business  practices.  Wider  concerns  have 
also  been  voiced  about  recent  substantial  increases  in  executive  remuneration  and  the 
constantly growing importance of variable pay in the composition of directors’ remuneration 
across all sectors of the economy. 

The  two  Recommendations  that  accompany  this  Communication  are  the  first  stage  in  the 
Commission’s  strategy  to  address  this  important  issue.  As  announced  in  its  Communication 
on  ‘Driving  European  Recovery’1,  the  objective  is  to  improve  risk  management  in  financial 
firms and align pay incentives with the sustainable performance of companies in general.  

In this first stage the Commission is recommending a series of principles and best practices 
that Member States should ensure companies apply in the design and implementation of pay 
policies  which  reward  long-term  sustainable  performance.  A  successful  reform  in  this  area 
depends  on  a  real  culture  change  in  the  businesses  concerned.  By  bringing  forward  its 
Recommendations  now,  the  Commission  seeks  to  encourage  companies  to  implement  the 
principles  of  sustainable  remuneration  policy  when  reviewing  staff  contracts  for  the  year 
2010. 

The  Commission  will  follow  up  these  Recommendations  with  legislative  proposals  to  bring 
remuneration  schemes  into  the  scope  of  prudential  oversight.  In  June  the  Commission  will 
present  proposals  to  revise  the  Capital  Requirements  Directive  to  ensure  that  regulatory 
capital  adequately  covers  the  risks  inherent  in  banks’  trading  books,  securitisation  positions 
and remuneration policies. The Commission is prioritising legislative measures in the banking 
and  investment  banking  sector  since  this  is  where  the  evidence  of  the  negative  impact  of 
misaligned incentives is greatest. At a further stage, the Commission will examine additional 
measures in relation to non-banking financial services.  

II.  Commission  Recommendation  complementing  Recommendations  2004/913/EC  and 
2005/162/EC as regards the regime for the remuneration of directors of listed companies 

The Commission's existing Recommendations on directors´ remuneration in listed companies 
(2004/913/EC) and on the role of non executive/supervisory directors and supervisory board 

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COM(2009)114 final of 4 March 2009. 

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committee  (2005/162/EC)  do  not  cover  all  the  relevant  issues  exposed  in  recent  months.  In 
particular, the Recommendations do not require executive remuneration to be aligned with the 
long term interest of companies.  

Following  several  recent  high-profile  cases  and  mounting  evidence  that  executive  pay 
structures need to be improved, the Commission’s new Recommendation on the structure of 
directors' remuneration and on the process of design and operation of the remuneration policy 
for  directors  in  listed  companies  sets  out  a  series  of  new  principles  complementing  the 
existing  Recommendations.  This  is  in  line  with  the  ECOFIN  Council's  conclusions  of  2 
December  2008,  which  invited  the  Commission  "to  update  its  recommendation  so  as  to 
promote a more effective control by shareholders, and encourage a stronger link between pay 
and performance, including on leaving pay (“golden parachutes”)". 

The scope of the new Recommendation is the same as the existing Recommendations, namely 
applying to directors of all listed companies.  

An appropriate remuneration policy ensures pay for performance and stimulates directors to 
ensure  the  medium  and  long  term  sustainability  of  the  company.  Whilst  the  existing  2004 
recommendation  is  based  on  the  idea  of  pay  for  performance  through  disclosure  of  the 
remuneration policy, the new Recommendation gives further guidance in order to attain this 
goal based on best practices for the design of an appropriate remuneration policy. It focuses 
on certain aspects of the structure of directors' remuneration and the governance of directors´ 
remuneration, including shareholder supervision. 

On the structure of remuneration policy, the new Recommendation introduces the principle of 
proportionality  of  remuneration  within  the  company,  namely  by  benchmarking  directors' 
remuneration to the other executive directors in the board and the (senior) employees in the 
company. Severance pay (golden parachutes) should be subject to quantified limits and should 
not  be  payable  in  case  of  failure.  In  addition,  in  order  to  reinforce  the  link  between  pay  to 
performance,  the  new  Recommendation  requires  a  balance  between  fixed  and  variable  pay 
and subjects the award of variable pay to predetermined and measurable performance criteria.  

In  order  to  promote  the  long  term  sustainability  of  the  company,  the  new  Recommendation 
provides for a balance between long and short term performance criteria; for a deferment of 
variable directors' remuneration; for a minimum vesting period for stock options and shares; 
and for the minimum holding of part of shares until the end of employment. As a last resort, 
companies should reclaim variable components of remuneration that were paid on the basis of 
data which later proved to be manifestly misstated. 

On  governance  of  directors'  remuneration  policy,  the  new  Recommendation  includes 
principles  aimed  at  improving  shareholders'  oversight  of  remuneration  policies.  It  is  crucial 
that  shareholders,  especially  institutional  investors,  exercise  their  voting  rights  on  directors' 
remuneration.  To  mitigate  conflicts  of  interest,  non-executives  should  not  receive  share 
options as part of their remuneration.  

Remuneration  committees  play  a  key  role  in  responsible  pay  policy.  To  strengthen  the 
operation and accountability of the remuneration committee, the new principles state that at 
least  one  member  of  the  committee  should  have  sufficient  expertise  in  the  field  of 
remuneration.  In  addition,  the  new  principles  contain  an  obligation  for  the  members  of  the 
remuneration  committee  to  be  present  at  the  general  meeting  where  the  remuneration 
statement  is  discussed  in  order  to  provide  explanations  to  shareholders.  Finally,  in  order  to 
mitigate  situations  of  conflict  of  interests  of  remuneration  consultants,  remuneration 
consultants  who  advise  the  remuneration  committee  should  not  advise  other  organs  of  the 
company at the same time. The new Recommendation clarifies the operation and composition 

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of  remuneration  committees  to  improve  their  efficiency  but  within  the  existing  role  and 
functions as set out in the 2005 Recommendation. So the balance of power and relations with 
boards  (or  with  a  supervisory  board  structure,  where  applicable)  remain  unchanged.  Any 
board, being set up only of non executive members of a listed company and deciding on the 
remuneration  of  executive  members  may  also  be  considered  equivalent  to  a  remuneration 
committee. 

It  should  be  noted  that  nothing  in  the  Recommendation  affects  the  autonomy  of  the  social 
partners in collective bargaining.  

III.  Commission  Recommendation  on  remuneration  policies  in  the  financial  services 
sector 

In  addition,  the  Commission  is  also  tabling  a  new  Recommendation  on  remuneration  in 
financial  services  to  address  perverse  incentives  and  excessive  risk-taking  throughout  firms 
active  in  this  area.  The  Recommendation  puts  the  EU  in  the  vanguard  in  implementing  the 
commitments  made  at  the  G20  Summit  in  London  on  2  April  2009.  The  G20  agreed  to 
"endorse  and  implement  the  Financial  Stability  Forum  (FSF)  tough  new  principles  on  pay 
and compensation and to support sustainable compensation schemes and the corporate social 
responsibility  of  all  firms".  The  second  Recommendation  on  remuneration  in  financial 
services is consistent and complementary to the FSF principles. 

In terms of scope, it covers all sectors in the financial services industry, regardless of the size 
of the financial institution or whether or not it is a listed company. This avoids any possible 
loopholes  and  prevents  a  distortion  of  competition  between  different  sectors  and  financial 
institutions. The principles apply to all categories of staff whose professional activities have 
an impact on the risk profile of the financial institution. 

The  new  Recommendation  includes  principles  on  the  structure  of  the  remuneration,  on  the 
process of design and operation of the remuneration policy, on the disclosure of remuneration 
policy  to  stakeholders  and  on  supervisory  review.  This  balance  between  structure, 
governance, disclosure and supervision should have a positive impact on sound remuneration 
policies  in  financial  institutions,  in  particular  to  ensure  such  policies  are  consistent  with 
effective risk-management and long-term viability. 

Remuneration policies in the financial services sector should be consistent with and promote 
sound and effective risk management. For this purpose, financial institutions should strike an 
appropriate balance between fixed and variable components of remuneration.  

The  fixed  component  should  be  sufficiently  high  so  as  to  ensure  that  staff  do  not  rely 
exclusively on bonus payments. The variable component should be linked to performance and 
a  major  part  of  it  should  be  deferred  in  order  to  take  into  account  the  risk  horizon  of  the 
underlying  performance.  Variable  payments  should  be  subject  to  performance  measurement 
criteria  which  should  privilege  longer-term  performance  of  financial  institutions  and  adjust 
the  underlying  performance  for  risk,  cost  of  capital  and  liquidity.  Further,  financial 
institutions  should  claim  back  variable  components  of  remuneration  that  were  paid  on  the 
basis of data which are subsequently proven to have been manifestly misstated.  

The  new  Recommendation  also  introduces  important  new  principles  on  the  governance  of 
decision-making  on  remuneration  policies  in  financial  institutions.  Remuneration  policy 
should  be  transparent  internally,  clear  and  properly  documented  and  contain  measures  to 
avoid  conflicts  of  interest.  This  also  implies  that  the  (supervisory)  board  should  have  the 
responsibility  for  the  oversight  of  the  operation  of  the  remuneration  policy  for  the  financial 
institution as a whole with an adequate involvement of internal control functions and human 

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resources  departments  or  experts  as  well  as  shareholders.  Board  members  and  other  staff 
involved  in  the  design  and  operation  of  remuneration  policies  should  be  independent.  To 
ensure that the remuneration policy achieves its objectives, it should be updated over time to 
reflect  the  financial  institution's  changing  situation  and  staff  members  should  know  in 
advance  the  criteria  which  will  be  used  to  determine  their  remuneration  and  have  access  to 
their appraisal process. 

The disclosure  of  remuneration  policies in financial institutions is an essential condition for 
effective oversight. Remuneration policy should be adequately disclosed to stakeholders in a 
clear and easily understandable way.  

The new Recommendation also sets new principles on the supervisory review of remuneration 
policies  in  financial  institutions.  Supervisors  should  ensure,  using  the  supervisory  tools  at 
their disposal, that financial institutions apply the principles on sound remuneration policies to 
the  largest  possible  extent  and  have  remuneration  policies  consistent  with  effective  risk 
management.  

In  order  to  address  the  question  of  proportionality,  supervisors  should  take  account  of  the 
nature  and  scale  of  the  financial  institution  and  the  complexity  of  its  activities  in  order  to 
assess its compliance with the principles on sound remuneration policies. 

Indeed,  some  of  the  general  principles  on  sound  remuneration  practices  may  be  of  more 
relevance  to  certain  categories  of  financial  institutions  than  others.  Therefore,  in  order  to 
avoid unjustified costs and to ensure proportionality, it is foreseen that Member States, when 
implementing  the  general  principles,  may  adapt  and  complement  them  according  to  the 
situation of the financial institutions concerned.  

IV. Next steps 

These  Recommendations  represent  the  first  stage  in  a  series  of  proposals  to  realign  pay 
incentives  with  sustainable  long-term  performance  of  companies.  In  a  second  phase  the 
Commission  will  present  legislative  proposals  to  empower  national  supervisors  to  compel 
financial institutions to implement remuneration policies that are consistent with effective risk 
management.  

In June the Commission will address remuneration policy in banks and investment firms (this 
is  where  the  clearest  market  failure  has  occurred  on  the  basis  of  the  evidence  available  to 
date)  through  the  package  of  modifications  of  the  Capital  Requirements  Directive.  The 
legislative changes that will be proposed will bring remuneration policies and their link with 
risk management clearly within prudential oversight in the supervisory review process under 
that  Directive.  Credit  institutions  and  investment  firms  will  be  legally  obliged  to  have 
remuneration policies that are consistent with effective risk management, and supervisors will 
be able to take measures to address any failures by credit institutions and investment firms in 
this regard.  

The principles set out in the Commission new Recommendation on remuneration policies in 
the  financial  sector  will  be  highly  relevant  to  compliance  with  this  obligation.  They  will 
provide further guidance as to how the binding obligation can be met, and a framework for 
regulators  when  assessing  firms'  remuneration  structures  in  the  course  of  the  'Pillar  2' 
supervisory review.  

The  forthcoming  amendments  of  the  Capital  Requirements  Directive  will  not  supersede  the 
Recommendation, but will complement it. The Recommendations have a clear ongoing added 
value, both in terms of signalling clearly to the markets the best practices that the Commission 
considers  appropriate,  pending  the  adoption  of  legislative  requirements,  but  also  since  a 

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legislative approach will need to focus on principles and will not be appropriate for setting out 
best practices in the level of detail that is possible in the Recommendations.  

Similar  legislative  initiatives  in  other  financial  sectors  (such  as  insurance)  might  have  to  be 
considered.  Meanwhile,  the  Recommendation  on  remuneration  policies  in  financial  services 
will provide guidance on the principles to be applied in these sectors too and a starting point 
for dialogue between financial institutions and relevant supervisors in these sectors too. 

The evaluation reports of 2007 of the previous Recommendations showed both strengths but 
also  some  weaknesses.  The  Commission  intends  to  increase  monitoring  mechanisms  to 
enhance effective application of both Recommendations. After one year, the Commission will 
examine  both  Recommendations  in  the  light  of  the  experience  acquired  and  the  outcome  of 
the aforementioned monitoring and submit an evaluation report on the application by Member 
States of both Recommendations.  

Finally,  it  should  also  be  noted  that  the  Recommendations  are  without  prejudice  to  specific 
national measures on remuneration in the context of national rescue packages for the financial 
sector. The Commission has welcomed such national measures in the context of its state aid 
decision-making. But these measures are exceptional, serving to compensate for the distortive 
effects of state intervention. They can not substitute for general guidelines to be applied by all 
financial institutions in normal as well as exceptional market conditions.  

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