European Compensation Crackdown Seen

The European Union lawmaker will get tough if member states don't go far enough in imposing new rules.

The European Commission is gearing up to mandate compensation restrictions for financial institutions and all companies listed on stock exchanges in the European Union, if member states do not voluntarily implement recommendations that the EC issued on April 30.

That would be near-anathema to the European countries, which, despite their EC membership, have a strong bent toward self-regulation. The good news for them is that, as with most other guidelines from the commission in recent years, the recommendations are mostly statements of principle that leave quite a bit of room for interpretation.

Whether legislation ultimately will in fact be needed is questionable. Not only are some countries already adopting compensation restrictions that go beyond some of the EC’s proposals, but the public pressure to rein in remuneration is so great that the member states know they must act on their own or face the loss of sovereignty that they dread, Geert Raaijmakers, a corporate partner at NautaDutilh, a law firm serving Belgium, the Netherlands, and Luxembourg, told CFO.com.

The EC announced in March that it was working on a legislative effort to address compensation policies in the financial-services sector. The effort would be included in a broader package of modifications to rules governing financial firms’ capital requirements, scheduled to be proposed in June.

The extent of the compensation requirements ultimately will be determined, however, at least partly by the degree of self-regulation the sector undertakes, noted Raaijmakers.

That was made clear in EC documents detailing two sets of recommendations, one applicable to employees of financial institutions and the other to directors of public companies in any sector. The commission “invited” member states to notify it by December 31 of measures taken to address the guidelines. That would “enable the Commission to monitor closely the situation and, on that basis, to assess the need for further measures.”

The director recommendations in particular could have a global impact, because they apply to companies outside the EC that list their stock on an exchange in a member country. About 89% of the companies in the S&P 500 index are listed on a foreign exchange, according to data from CapitalIQ.

Some of those recommendations are more specific than any of the ones for financial institutions. For example, stock-based compensation shouldn’t vest for at least three years after shares are awarded, and termination payments generally should not be more than two years’ worth of the non-variable component of a director’s remuneration.

But most of the provisions are more general in nature. “Limits” should be set on any variable compensation, which should be subject to “predetermined, measurable performance criteria.” Those criteria should “promote the long-term sustainability of the company.” Variable remuneration should be deferred “for a minimum period of time.” After share awards vest, directors should retain “a number” of them for the duration of their tenure.

The measures are needed because, according to the commission, “Experience over the last years, and more recently in relation to the financial crisis, has shown that remuneration structures have become increasingly complex, too focused on short term achievements, and in some cases led to excessive remuneration which was not justified by performance.”

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