New German Investment Firms Remuneration Regulation comes into force

The German Investment Firms Remuneration Regulation (Wertpapierinstituts-Vergütungsverordnung) was announced in the Federal Law Gazette (2024 I No 5) on 11 January 2024 and came into force on 12 January 2024. Once the Federal Financial Supervisory Authority (BaFin) published an initial draft for consultation on 4 May 2021 and an updated version on 19 October 2022, the final version of the Regulation as provided for in section 46(3) of the German Investment Firms Act (Wertpapierinstitutsgesetz) has now been published after further revision.

The requirements for remuneration systems at investment firms are only rudimentarily regulated in section 46(1) of the German Investment Firms Act. As the German Banking Remuneration Regulation (Institutsvergütungsverordnung) which applies to other credit and financial services institutions is not applicable to investment firms, the specification of the regulatory requirements for remuneration structures is very important in practice.

This article presents the key provisions of the German Investment Firms Remuneration Regulation along with tips for implementation in practice.

Scope

The German Investment Firms Remuneration Regulation generally applies only to the remuneration paid to the risk takers of midsize investment firms within the meaning of section 2(17) of the German Investment Firms Act. However, the provisions of the Regulation may also apply to superordinate companies within the meaning of section 2(12) of the Regulation via groupwide regulations on remuneration (section 1(2) and section 18 of the Regulation); this also applies if the superordinate company is not an intermediate investment firm (second sentence of section 1(3) of the Regulation).

Small investment firms within the meaning of section 2(16) of the German Investment Firms Act which are not covered by the general provisions on remuneration in section 46(1) of the Act still only have to observe the provisions of EU law that are directly applicable (and of a general nature), i.e. Article 27 of Delegated Regulation (EU) 2017/565, when designing their remuneration systems. In contrast, large investment firms within the meaning of section 2(18) of the Act still fall within the scope of the German Banking Remuneration Regulation (see section 4 of the Act in conjunction with section 25a of the German Banking Act).

When identifying their risk takers on their own responsibility, investment firms must apply the criteria set out in Delegated Regulation (EU) 2021/2154. The directors of the investment firms are always deemed to be risk takers (section 2(2) of the German Investment Firms Remuneration Regulation).

Appropriateness of the remuneration systems

The remuneration systems for risk takers at midsize investment firms must ensure that a clear and transparent distinction can be made between fixed and variable remuneration. In contrast to the German Banking Remuneration Regulation, specifications are made as to what fixed and variable remuneration should be paid for (section 6(1)(1) of the German Investment Firms Remuneration Regulation). The fixed remuneration must essentially reflect the risk taker’s relevant professional experience and organisational responsibility in the company as stated in the their job description in their employment contract. Variable remuneration, on the other hand, must reflect the sustainable and risk-adjusted performance of the risk taker as well as any performance above and beyond the risk taker’s job description.

The remuneration systems must also be gender-neutral, must include measures to avoid conflicts of interest and must not incentivise risk takers to take disproportionately high risks. If the risk taker performs badly, it must also be possible to at least reduce their variable remuneration; otherwise the remuneration system is not deemed appropriate (section 6(2) of the German Investment Firms Remuneration Regulation).

Furthermore, companies must ensure that no conflicts of interest arise when structuring the variable remuneration for risk takers who are active in control units, and that the remuneration of the risk takers is made up mainly of fixed remuneration components (section 6(3) of the German Investment Firms Remuneration Regulation). In this respect, the parallel provision of section 9(2) of the German Banking Remuneration Regulation, regarding which BaFin believes that variable remuneration should not account for more than a third of total remuneration, is likely to be useful as a guide in practice.

Severance payments as variable remuneration

Severance payments are categorised as variable remuneration and investment firms are required to define principles in writing or electronically specifying a maximum amount or the criteria for determining the severance payment amounts (section 6(4) of the German Investment Firms Remuneration Regulation). These requirements are well known from the German Banking Remuneration Regulation, as is the inclusion of privileged severance payments, which are exempt from certain regulatory restrictions (fifth sentence of section 6(4) and fifth sentence of section 5(6) of the German Investment Firms Remuneration Regulation).

However, there is a major difference between the provisions of the German Banking Remuneration Regulation and the German Investment Firms Remuneration Regulation: both of these Regulations ignore the privileged severance payments when measuring the ratio of variable to fixed remuneration and declare the regulations for determining the total amount of variable remuneration and the vesting of retained remuneration components as in applicable (section 11 of the German Investment Firms Remuneration Regulation, section 7 of the German Banking Remuneration Regulation). However, only the German Banking Remuneration Regulation states that the privileged remuneration does not fall within the scope of the provisions on the pro rata retention of variable remuneration, the pro rata payment in instruments and the reduction or clawback of variable remuneration (fifth sentence of section 5(6) in conjunction with section 20 of the German Banking Remuneration Regulation). However, the German Investment Firms Remuneration Regulation does not contain a corresponding reference to the parallel provision of section 8 of the Regulation (see below for regulatory content). This can have far-reaching consequences: midsize investment firms would probably not be able to pay out severance payments for risk takers as a lump sum upon termination of employment as is customary (and often necessary in practice in order to achieve an amicable exit).

General requirements for variable remuneration

As in the German Banking Remuneration, there are general guidelines on how the variable remuneration must be structured (section 7 of the German Investment Firms Remuneration Regulation). In practice it should be relevant that, unlike in the scope of the German Banking Remuneration Regulation, there is still no fixed upper limit for the ratio of variable to fixed remuneration (known as bonus cap). Instead, an “appropriate” ratio is required, taking into account the business activities of the investment firm, the associated risks and the impact that the activities of the risk takers have on the risk profile of the investment firm or the assets managed by it. It is also stipulated that the proportion of fixed remuneration must be sufficiently high to give the investment firm enough wiggle room on variable remuneration so that, if necessary, payment of variable remuneration can be waived completely. This rule is supplemented by the fact that the risk takers must not be significantly (financially) dependent on the variable remuneration. Bonus payments of over 200% of their fixed remuneration are therefore still possible, even if payments greatly in excess of this threshold will probably no longer be considered appropriate within the meaning of the German Investment Firms Remuneration Regulation in future.

Entitlements to guaranteed variable remuneration may only be granted for the first year of employment of a risk taker and also require that their immediately preceding job did not take place within the same investment firm group (second sentence of section 7(4) of the German Investment Firms Remuneration Regulation). When paying these sign-on bonuses, the investment firm may refrain from subjecting itself to the requirements of section 8(3) to (5) German Investment Firms Remuneration Regulation on pro rata payment in instruments and pro rata retention. However, this does not apply if the guaranteed variable remuneration compensates for lost remuneration from previous employment (third sentence of section 7(4) and section 7(5) of the German Investment Firms Remuneration Regulation).

Criteria for variable remuneration, assessment period, performance evaluation

Like in the German Banking Remuneration Regulation, criteria for calculating variable remuneration are specified (first sentence of section 8(1) of the German Investment Firms Remuneration Regulation). Accordingly, the level of variable remuneration is determined by the individual performance contributions of the risk taker, the performance contributions of the business unit concerned and the overall performance of the investment firm. With regard to the individual performance of the risk taker, both financial and nonfinancial parameters must be taken into account; in the case of risk takers in control units, only nonfinancial parameters may be used (section 8(2) of the German Investment Firms Remuneration Regulation).

The assessment period for the performance contributions must be at least one year, while the final performance assessment must cover a timeline of more than one year (second and third sentences of section 8(1) of the German Investment Firms Remuneration Regulation). According to the explanatory memorandum to the bill dated 18 October 2022, this rather cryptically worded combination of assessment period and timeline for performance measurement is to be implemented in such a way that the level of variable remuneration can be determined after one year, but an ex-post risk adjustment can then be carried out in accordance with section 8(3) to (6) of the German Investment Firms Remuneration Regulation (see below) to take into account the multi-year measurement of performance.

However, the provisions of section 8(3) to (6) of the German Investment Firms Remuneration Regulation do not apply to investment firms that do not reach the thresholds set out in the second sentence of section 44(3) of the German Investment Firms Act. Furthermore, the requirements also do not apply to variable remuneration which is less than €50,000 per year before tax and does not account for more than a quarter of the total annual remuneration of the risk taker concerned (section 10 German Investment Firms Remuneration Regulation). For these investment firms, the question therefore arises as to how performance after one year is to be assessed in concrete terms. The explanatory memorandum to the bill states vaguely that the requirements can be met by selecting “suitable remuneration parameters”, for example by including the performance assessment from previous years in the decision regarding remuneration or by using remuneration parameters based on a forward-looking policy, such as a multi-year earnings plan). In practice, this is likely to result in targets achieved at annual level being “logged in” and subsequently adjusted using multi-year assessment factors. This mechanism will have to be taken into account when drawing up future bonus agreements.

Ex-post risk adjustment

The provisions on the ex-post risk adjustment of variable remuneration are found in section 8(3) to (6) of the German Investment Firms Remuneration Regulation. They are largely based on section 20 of the German Banking Remuneration Regulation and stipulate that at least 50% of a risk taker’s variable remuneration must consist of instruments with a vesting period of at least one year. Furthermore, at least 40% of the variable remuneration must be withheld over a period of three to five years; if the remuneration is particularly high – over €500,000 per year before tax according to the threshold in section 8(5) of the German Investment Firms Remuneration Regulation – the proportion to be withheld must be at least 60%. Finally, malus and clawback provisions must be agreed, based on which the variable remuneration can be reduced or reclaimed in certain circumstances. In particular, variable remuneration is to be “appropriately reduced” in the event of a “weak or negative financial result” at the investment firm. This raises the question of what a “weak” financial result is. In any case, it is to be welcomed that this provision has been significantly toned down compared to the bill of 18 October 2022, which provided for variable remuneration to be reduced by up to 100% in the case of a weak financial result. This was corrected in the new version, probably also due to the anticipated conflicts with employment law principles.

Transition period

The transitional provision in section 19 of the German Investment Firms Remuneration Regulation, which is important in practice, was also added to the final version of this Regulation. According to this, most of the core provisions of this Regulation that are important in day-to-day business (including those relating to the assessment of severance payments, the commitment to guaranteed variable remuneration, the design of bonus criteria and assessment periods as well as the requirement for ex-post risk adjustment) must be applied for the first time at the beginning of the financial year following the year in which the Regulation comes into force. At least those midsize investment firms with a financial year corresponding to the calendar year therefore have until 1 January 2025 to adapt their remuneration systems to the new requirements.

Adjusting existing agreements

In this context, there is the question of how to deal with existing agreements that do not comply with the German Investment Firms Remuneration Regulation. Section 16 of this Regulation (analogous to section 14 of the German Banking Remuneration Regulation) stipulates that investment firms must endeavour to ensure that noncompliant contracts, company or service agreements and company practices are amended without delay, insofar as this is legally admissible. The adjustment must be made using a sound legal assessment of the legal situation that is comprehensible to third parties and takes into account the specific prospects of success. The HR departments of the investment firms concerned would be very well advised to analyse the service or employment contracts with the (current and newly identified) risk takers and also to review any collective bargaining agreements on the subject of variable remuneration.

Conclusion

• The German Investment Firms Remuneration Regulation represents a fundamentally welcome fine-tuning of the requirements for structuring remuneration at midsize investment firms, which practitioners have been waiting for some time.
• Regarding the provision applicable to the structure of remuneration, different, clearly definable categories of investment firms have been formed: small investment firms with rudimentary provisions in EU law, midsize investment firms, which in turn must be divided into two groups with regard to certain provisions of the German Investment Firms Remuneration Regulation, and large investment firms covered by the German Banking Remuneration Regulation.
• In terms of content, the German Investment Firms Remuneration Regulation is closely modelled on the German Banking Remuneration Regulation, so there are significant differences to the latter only in certain areas, although these may well be relevant in practice.