CSSF Circular 23/841: Application of ESMA Guidelines on MiFID II Remuneration Requirements

Circular CSSF 23/841

1. Application of the
   Guidelines of the European
   Securities and Markets
   Authority (“ESMA”) on certain aspects of the MiFID II remuneration requirements (ESMA35-43-3565)
2. Repeal of Circular
   CSSF 14/585
3. Amendment to Circular
   CSSF 07/307

In case of discrepancies between the French and the English texts, the French text shall prevail. CIRCULAR CSSF 23/841 2/4 Circular CSSF 23/841

1. Application of the Guidelines of the European Securities and
   Markets Authority (“ESMA”) on certain aspects of the MiFID II remuneration requirements (ESMA35-43-3565)
2. Repeal of Circular CSSF 14/585
3. Amendment to Circular CSSF 07/307
   To the investment firms as defined in point (9) of Article 1 of the Law of 5 April 1993 on the financial sector, as amended (“LFS”), to the credit institutions as defined in point (12) of Article 1 of the LFS, to the UCITS management companies as defined in point (31) of Article 1 of the LFS, and to the alternative investment fund managers as defined in point (46) of Article 1 of the Law of 12 July 2013 on alternative investment fund managers (“LAIFM”). Luxembourg, 13 October 2023 Ladies and Gentlemen, The purpose of this circular is to inform you that the CSSF, in its capacity as competent authority, applies the Guidelines of ESMA on certain aspects of the MiFID II1 remuneration requirements (ESMA35-43-3565) (“Guidelines”), published on 3 April 2023. Consequently, the CSSF has integrated the Guidelines into its administrative practice and regulatory approach with a view to promoting supervisory convergence in this field at the European level. All entities listed in the scope of this circular are required to duly comply with them. Circular CSSF 14/585 on the transposition of ESMA’s guidelines on remuneration policies and practices (MiFID) shall be repealed.
   Annex V to Circular CSSF 07/307 shall be repealed.
   1 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU.

CIRCULAR CSSF 23/841
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1. The Guidelines
   The Guidelines are issued by ESMA in accordance with Article 16(1) of the ESMA Regulation2. The purpose of the Guidelines is to ensure the common, uniform and consistent application of:

• the remuneration requirements set out in Article 27 of the MiFID II Delegated Regulation3;
• the conflicts of interest requirements in the area of remuneration set out in Articles 16(3) and
  23 of MiFID II and Article 34 of the MiFID II Delegated Regulation in the area of remuneration; and
• the conduct of business rules set out in Article 24(1) and (10) of MiFID II.
  The Guidelines also clarify the governance requirements in the area of remuneration under Article 9(3) of MIFID II. The Guidelines aim to promote greater convergence in the interpretation of, and supervisory approaches to, the MiFID II remuneration requirements as well as the MiFID II conflicts of interest and conduct of business requirements in the area of remuneration, by emphasising a number of important issues, and thereby enhancing the value of existing standards. Furthermore, the Guidelines repeal those of ESMA on remuneration policies and practices (MiFID) (ESMA/2013/606). The Guidelines are attached to this circular and are available on ESMA’s website at Guidelines on certain aspects of the MIFID II remuneration requirements (europa.eu).

2. Scope
   This circular shall apply to:

• investment firms as defined in point (9) of Article 1 of the LFS;
• credit institutions as defined in point (12) of Article 1 of the LFS when providing investment
  services and activities within the meaning of point (30) of Article 1 of the LFS;
• investment firms and credit institutions when selling or advising clients on structured
  deposits within the meaning of point (7c) of Article 1 of the LFS;
• UCITS management companies as defined in point (31) of Article 1 of the LFS when providing
  the investment services or non-core services listed in Article 101(3) of the Law of 17 December 2010 relating to undertakings for collective investment, as amended;
• alternative investment fund managers as defined in point (46) of Article 1 of the LAIFM when
  providing the portfolio management services or non-core services listed in Article 5(4) of the LAIFM. 2 Regulation (EU) No 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC. 3 Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive.

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3. Amending and repealing provisions and date of
application
This circular shall apply as from the date of its publication and Circular CSSF 14/585 shall be repealed on the same date. Annex V to Circular CSSF 07/307 shall also be repealed on the same date. Claude WAMPACH Director Marco ZWICK Director Jean-Pierre FABER Director Françoise KAUTHEN Director Claude MARX Director General
Annex Guidelines on certain aspects of the MIFID II remuneration requirements

03/04/2023
ESMA35-43-3565
Guidelines
On certain aspects of the MIFID II remuneration requirements

Table of Contents
I. Scope............................................................................................................................. 2
II. Legislative references, abbreviations and definitions...................................................... 3
III. Purpose.......................................................................................................................... 5
IV. Compliance and reporting obligations............................................................................. 6
VI. Annex - Illustrative examples of remuneration policies and practices that create conflicts
that may be difficult to manage.............................................................................................15
VII. Correlation table between the ‘new’ draft guidelines and the 2013 guidelines ...............17

I. Scope
Who?

1. These guidelines apply to competent authorities and firms.
   What?
2. These guidelines apply in relation to the remuneration requirements set out in Article 27 of
   the MiFID II Delegated Regulation as well as, on the one hand, the conflicts of interest requirements set out in Articles 16(3) and 23 of MiFID II and Article 34 of the MiFID II Delegated Regulation in the area of remuneration; and on the other hand, the conduct of business rules set out in Article 24(1) and (10) of MiFID II. In addition, these guidelines clarify the application of the governance requirements in the area of remuneration under
   Article 9(3) of MIFID II.
   When?
3. These guidelines apply from six months of the date of publication of the guidelines on
   ESMA’s website in all EU official languages.
4. The Guidelines on remuneration policies and practices (MiFID)1
   issued under MiFID I will cease to apply on the same date.
   1 ESMA/2023/606.

II. Legislative references, abbreviations and definitions
Legislative references
AIFMD Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/ 20102 CRR Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/20123 ESMA Regulation Regulation (EU) No 1095/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Securities and Markets Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/77/EC4 MiFID II Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU5 MiFID II Delegated Regulation Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive UCITS Directive Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) Abbreviations ESMA European Securities and Markets Authority EU European Union Definitions 2 OJ L 174, 01.07.2011, p.1-73. 3 OJ L 176, 27.6.2013, p. 1-337. 4 OJ L 331, 15.12.2010, p. 84. 5 OJ L 173, 12.06.2014, p. 349.

5. Unless otherwise specified, terms used in MiFID II and the MiFID II Delegated Regulation
   have the same meaning in these guidelines.
6. In addition, for the purposes of these guidelines, the following definitions apply:
   firms investment firms (as defined in Article 4(1)(1) of MiFID II), credit institutions (as defined in Article 4(1)(1) of the CRR) when providing investment services and activities within the meaning of Article 4(1)(2) of MiFID II, investment firms and credit institutions when selling or advising clients on structured deposits, UCITS management companies and external Alternative Investment Fund Managers (AIFMs) (as defined in
   Article 5(1)(a) of the AIFMD) when providing the investment
   services or non-core services listed in Article 6(3) of the UCITS Directive and Article 6(4) of the AIFMD quantitative criteria primarily numeric or financial data that is used to determine the remuneration of a relevant person (e.g. value of instruments sold, sales volumes, establishment of targets for sales or new clients, etc.) qualitative criteria primarily criteria other than quantitative criteria. It can also refer to numeric or financial data used to assess the quality of the relevant person’s performance and/or service to the client e.g. return on the client’s investment, very low number of complaints over a large timescale, etc

III. Purpose
7. These guidelines are based on Article 16(1) of the ESMA Regulation. The purpose of these
guidelines is to ensure the common, uniform and consistent application of the MiFID II remuneration requirements set out in Article 27 of the MiFID II Delegated Regulation as well as, on the one hand, the conflicts of interest requirements set out in Articles 16(3) and 23 of MiFID II and Article 34 of the MiFID II Delegated Regulation in the area of remuneration; and on the other hand, the conduct of business rules set out in Article 24(1) and (10) of MiFID II. In addition, these guidelines clarify the application of the governance requirements in the area of remuneration under Article 9(3) of MIFID II.
8. ESMA expects these guidelines to promote greater convergence in the interpretation of,
and supervisory approaches to, the MiFID II remuneration requirements as well as the MiFID II conflicts of interest and conduct of business requirements in the area of remuneration by emphasising a number of important issues, and thereby enhancing the value of existing standards. By helping to ensure that firms comply with regulatory standards, ESMA anticipates a corresponding strengthening of investor protection.
9. Guidelines do not reflect absolute obligations. For this reason, the word ‘should’ is often
used. However, the words ‘shall’, ‘must’ or ‘required to’ are used when describing a MiFID II or MiFID II Delegated Regulation requirement.

IV. Compliance and reporting obligations
Status of the guidelines
10. In accordance with Article 16(3) of the ESMA Regulation, competent authorities and
financial market participants must make every effort to comply with these guidelines.
11. Competent authorities to which these guidelines apply should comply by incorporating
them into their national legal and/or supervisory frameworks as appropriate, including where particular guidelines are directed primarily at financial market participants. In this case, competent authorities should ensure through their supervision that financial market participants comply with the guidelines. Reporting requirements
12. Within two months of the date of publication of the guidelines on ESMA’s website in all EU
official languages, competent authorities to which these guidelines apply must notify ESMA whether they (i) comply, (ii) do not comply, but intend to comply, or (iii) do not comply and do not intend to comply with the guidelines.
13. In case of non-compliance, competent authorities must also notify ESMA within two months
of the date of publication of the guidelines on ESMA’s website in all EU official languages of their reasons for not complying with the guidelines.
14. A template for notifications is available on ESMA’s website. Once the template has been
filled in, it shall be transmitted to ESMA.
15. Financial market participants are not required to report whether they comply with these
guidelines.

V. Guidelines on certain aspects of the MiFID II remuneration
requirements
V.I. DESIGN OF REMUNERATION POLICIES AND PRACTICES Relevant legislation: Articles 16(3), 23 and 24(10) of MiFID II as well as Articles 27 and 34 of the MiFID II Delegated Regulation Guideline 1
16. When designing remuneration policies and practices in accordance with the requirements
under Article 27 of the MiFID II Delegated Regulation and, especially, where remuneration comprises variable components, firms should define appropriate criteria to align the interests of the relevant persons and of the firms with that of the clients. Such criteria aligning the interests of the relevant persons and of the firms with that of the clients should allow the firms to assess the performance of relevant persons.
17. In order to do so and in accordance with Article 27(4) of the MiFID II Delegated Regulation,
firms shall consider qualitative criteria that encourage the relevant persons to act in the best interests of the client. Examples of appropriate qualitative criteria include compliance with regulatory requirements such as conduct of business rules (in particular, the review of the suitability of instruments sold by relevant persons to clients, if relevant) and internal procedures, fair treatment of clients and client satisfaction.
18. Qualitative criteria used by firms in their remuneration policies and practices should be
sufficiently and clearly defined and documented to ensure that they are not being used to indirectly reintroduce quantitative commercial criteria that may create conflicts of interests or incentives that may lead relevant persons to favour their own interests or their firm’s interests to the potential detriment of any client. For instance, if a firm uses client satisfaction as a qualitative criterion in the determination of the variable remuneration of relevant persons, it should be clear from the remuneration policy how the firm will be measuring staff performance in this respect with the remuneration policy indicating what data will be used, any thresholds applicable, etc. so as to avoid creating a vague criterion that may be used by the firm to, instead, reward sales or pressure sales staff to sell certain products (although the remuneration policy would not be indicating such quantitative commercial criteria as performance indicators).
19. Regarding quantitative criteria, firms should ensure to take into account criteria that do not
create conflicts of interests or incentives that may lead relevant persons to favour their own interests or their firm’s interests to the potential detriment of any client. For example, firms may assign sales objectives to staff provided that such commercial objectives do not create an incentive for sales staff to recommend only certain products to the detriment of clients’ best interest (for instance, group products or those that are more lucrative to the firm or group) and that any remaining conflicts of interests are properly mitigated through the use of other equally weighted criteria such as staff’s performance regarding suitability requirements or clients’ satisfaction.

20. The weights attributed to the criteria used to determine the remuneration should not be
    such that they render some of the criteria, especially qualitative ones, insignificant or that they give others, especially quantitative commercial ones, too much significance.
21. When designing remuneration policies and practices in accordance with the requirements
    under Article 27 of the MiFID II Delegated Regulation, firms should consider all relevant factors such as, but not limited to, the role performed by relevant persons, the type of products offered, and the methods of distribution (e.g. advised or non-advised, face-to-face or through telecommunications/electronic communications) in order to prevent potential conduct of business and conflict of interest risks from adversely affecting the interests of their clients and to ensure that the firm adequately manages any related residual risk.
22. Without prejudice to the requirement in the second subparagraph of Article 27(4) of the
    MiFID II Delegated Regulation, the remuneration policies and practices in place should allow the operation of a flexible policy on variable remuneration, including, where relevant, the possibility to pay no variable remuneration at all.6
23. Regarding variable remuneration, firms should avoid setting performance targets that may
    incentivise the relevant persons to adopt behaviours focused on short-term gains to meet the relevant thresholds such as “all or nothing targets” when those might create a conflict of interest or impair clients’ interests. Firms should favour remuneration policies and practices in which the variable part of the remuneration paid out is calculated and awarded on a linear basis or where the variable part depends on several performance targets set at different levels and giving rights to different amounts or, preferably, different rates of variable remuneration.
24. When designing and implementing their remuneration policies, firms should take into
    account possible conflicts of interests or risks of impairing clients’ interests stemming from cross-selling objectives imposed on relevant persons. For instance, specific attention should be paid to situations where relevant persons would be encouraged to make the grant of better conditions under a mortgage loan to a client dependent on the condition that this client buys a specific financial instrument which is part of the relevant persons’ sales objectives.
25. In light of the broad definition of remuneration provided in the MiFID II Delegated
    Regulation, firms’ remuneration policies and practices should also ensure that the criteria used to assess wage increases and promotions comply with the MiFID II remuneration requirements. For instance, firms’ career progression management systems should not be used to reintroduce quantitative commercial criteria upon which may depend relevant persons’ career advancement and having an impact on their (fixed and/or variable) remuneration if this may create conflicts of interests that may encourage such relevant persons to act against the interests of their firms’ clients.
26. Without prejudice to the general principles of national contract or labour law, firms should
    consider including ex-post adjustment criteria of the variable remuneration in their 6 When determining the remuneration for tied agents, firms may take the tied agents’ special status (usually as self-employed commercial agents) and the respective national specificities into consideration.

remuneration policies and practices in order to further discourage relevant persons to disregard client’s interests or favour their own interests (for instance, by investing in products with higher short term returns but presenting more risks in the long term or not suitable to the client’s investment horizon) in order to attain short-term performance objectives. Ex-post adjustment criteria should allow firms to further align the interests of the firm and of relevant persons with that of clients by adjusting variable remuneration if a case of misconduct appears after the remuneration has been awarded or paid-out. For such criteria to be effective, firms should consider, depending on the nature, scale and complexity of their activities, including in their remuneration policies and practices appropriate ex-post adjustment mechanisms such as the application of malus (i.e. the reduction of value of all or part of deferred variable remuneration based on ex-post risk adjustments before it has vested) and clawbacks (i.e. the return of ownership of an amount of variable remuneration paid in the past or which has already vested to the institution under certain conditions).
27. Ex-post adjustment mechanisms referred to in the previous paragraph should be triggered
by relevant events impacting the firm’s or relevant persons’ compliance with the applicable provisions under MiFID II and its delegated acts aiming at the fair treatment of clients and the quality of services provided to clients. Relevant events impacting the firm’s and relevant persons’ compliance with applicable regulations should not be limited to those giving rise to supervisory action, fines or sanctions but should take into account confirmed failings or breaches. Ex-post adjustment mechanisms should be applied to the relevant persons who engaged directly in misconduct but firms should also consider whether it would be appropriate to also apply them to a larger group such as to the relevant persons whose responsibilities include the areas where the relevant events crystallised.
28. The application of ex-post adjustment mechanisms should take into account the
seriousness of any failings or misconduct impairing clients’ interests.
29. In order for ex-post adjustment mechanisms to be meaningful, firms should consider paying
the variable remuneration partly upfront and partly deferred, in an appropriate balance between the part paid upfront and the one deferred, and according to an appropriate deferral schedule allowing for the interests of the relevant persons and of the firms to be aligned with the interests of clients.
30. Furthermore, firms should adopt and maintain measures enabling them to effectively
identify where the relevant person fails to act in the best interests of the client and to take remedial action.
31. Relevant persons should be clearly informed, at the outset, of the criteria that will be used
to determine the amount of their remuneration, the weight attributed to each, the consequences of not meeting one or the other and the steps and timing of their performance reviews. The criteria used by firms to assess the performance of relevant persons should be accessible, understandable and recorded.
32. Firms should avoid creating unnecessarily complex policies and practices (such as
combinations of different policies and practices, or multi-faceted or multi-layered schemes, which increase the risk that relevant persons’ behaviour will not be driven to act in the best interests of clients, and that any controls in place will not be as effective to identify the risk

of detriment to the client). This may potentially lead to inconsistent approaches and hamper proper knowledge or control of the policies by the compliance function. The Annex to these guidelines sets out illustrative examples of remuneration policies and practices that create risks that may be difficult to manage due to their complexity, and that give strong incentives to sell specific products.
33. Firms should ensure that the organisational measures they adopt regarding the launch of
new products or services appropriately take into account their remuneration policies and practices and the risks that these products or services may pose. In particular, before launching a new product, firms should assess whether the remuneration features related to the distribution of that product comply with the firm’s remuneration policies and practices and therefore do not pose conduct of business and conflicts of interest risks. This process should be appropriately documented by firms.
34. In order to avoid conflicts of interests with respect to their role in the design and/or
overseeing of the remuneration policies and practices of the firm, the design of the remuneration policies and practices applicable to control functions (risk management and internal audit functions, where established)7 , management body and senior management of the firm should not compromise their objectivity and independence.
35. As such, the remuneration of control functions’ staff should be based on function-specific
objectives. In addition, the variable part of the remuneration of staff in control functions, if any, should not be linked to quantitative commercial performance of relevant persons whose remuneration they are in charge of designing and/or controlling. Where the remuneration of the control functions’ staff includes a component based on the firm’s commercial performance (e.g. sales volume), the risk of conflicts of interest may increase and should be properly addressed through the use of appropriate qualitative performance or adjustment criteria.
36. Where firms are permitted to combine internal control functions with operational functions,
they nonetheless remain subject to their MiFID II conflicts of interests and conduct of business obligations. As such, the remuneration policies and practices applicable to them should nonetheless permit such internal control functions to remain effective (as provided by Article 22(4) of the MiFID II Delegated Regulation for the compliance function).
37. Firms should also ensure that the structure of the remuneration of members of the
management body and of the senior management of the firm, as well as the criteria used to assess performance, should not create conflicts of interest or incentives that may lead members of the management body or senior management of the firm or relevant persons in the firm to favour their own interests or the firm’s interests to the potential detriment of any client.
38. The remuneration policies and practices applicable to relevant persons (including copy￾traders, where applicable) who are not employees of the firm but nonetheless fall within
the scope of the MiFID II remuneration requirements because they are:
7 Article 22(3)(e) of the MiFID II Delegated Regulation applies in respect of the compliance function.

i) a natural person whose services are placed at the disposal and under the control of the firm or a tied agent of the firm and who is involved in the provision by the firm of investment services and activities8 ; or ii) a natural person who is directly involved in the provision of services to the firm or to its tied agent under an outsourcing arrangement for the purpose of the provision by the firm of investment services and activities9 , should also comply with the MiFID II remuneration requirements and these guidelines.
39. Examples of good practice:
a. References used in the calculation of variable remuneration of relevant persons are common across products sold. b. In the case of an open-ended investment with no investment term, the remuneration is deferred for a set number of years or until the encashment of the product.
40. Examples of poor practice:
a. A firm has started offering advisers specific additional remuneration to encourage clients to apply for new fund products in which the firm has a specific interest. This often involves the relevant person having to suggest that their clients sell products that they would otherwise recommend they retain so they can invest in these new products. b. Managers and employees receive a large bonus linked to a specific product. As a result, the firm’s advisors recommend this specific product irrespective of the suitability of this product for the clients addressed.10 Warnings from the risk manager are ignored because the investment products generate high returns for the firm. When the risks that had been identified occur, the products have already been sold and the bonuses have already been paid out.
c. The variable component of the total remuneration is based only on volumes sold, and
increases the relevant person’s focus on short-term gains rather than the client’s best interest. d. Relevant persons engage in frequent buying and selling of financial instruments in a client’s portfolio in order to earn additional remuneration without considering the suitability of this activity for the client. Likewise, rather than considering the suitability of a product for a client, relevant persons focus on the sale of products that have a short investment term in order to earn remuneration from re-investing the product after the short term. e. Regulatory breaches under MiFID II and its delegated acts that impair clients’ interests are identified by the competent authority supervising the firm but no financial sanctions are imposed on the firm as non-compliance has since been remedied. The firm decides 8 Article 2(1)(c) of the MiFID II Delegated Regulation. 9 Article 2(1)(d) of the MiFID II Delegated Regulation. 10 In that case, the firm would also breach applicable suitability requirements.

to allocate the maximum fixed and variable remuneration for the year to its board members on the basis that the other criteria were met, thereby not drawing the consequences of the firm’s non-compliance with its regulatory obligations and its board members’ role in it. V.II. GOVERNANCE Relevant legislation: Article 9(3) of MiFID II and Article 27(3) of the MiFID II Delegated Regulation Guideline 2
41. In addition to the periodic review of their written remuneration policy11, firms should also
review it upon any relevant and significant amendment to their business activities or structure. Where the review reveals that the remuneration policy does not operate as intended or that there is a residual risk of detriment to the firm’s clients stemming from it (crystallised or not), the remuneration policy should be amended in a timely and efficient manner.
42. Proper documentation on the remuneration policy as well as the decision-making process
and procedures that lead to its approval or amendment should be maintained in a clear and transparent manner and made available to the management body and senior management as well as other control functions involved in the design, monitoring and/or review of the remuneration policy and procedures.
43. Firms should ensure that the compliance function has access to all relevant documents
and information enabling it to discharge its responsibilities in accordance with Article 22(3)(a) regarding the remuneration policies and practices relating to relevant persons, including members of the management body and senior management, in a proper and independent manner.
44. Firms should also ensure that their management body, after taking advice from the
compliance function, approves any significant amendment made to the remuneration policy of the firm.
45. Depending on the size of the firm and complexity of its business model and of the
investment services and activities provided, the review of the remuneration policy may also require the involvement of other control functions (such as the risk management and/or internal audit functions) to ensure that appropriate performance and risk adjustment criteria are used.
46. Senior management is responsible and should retain the ultimate responsibility for the day￾to-day implementation of the remuneration policy and the monitoring of compliance risks
related to the policy.
11 In accordance with Article 9(3) of MiFID II and Article 27(3) of the MiFID II Delegated Regulation.

47. Firms should ensure that they have appropriate and transparent reporting lines in place
    across the firm or group to assist in escalating issues involving risks of non-compliance with the MiFID II remuneration, conflicts of interest and conduct of business requirements. V.III. CONTROLLING RISKS RELATED TO REMUNERATION POLICIES AND PRACTICES Relevant legislation: Articles 9(3) of MiFID II and Article 27(3) of the MiFID II Delegated Regulation Guideline 3

48. Firms should set up adequate controls to assess compliance with their remuneration
    policies and practices and to ensure that these deliver the intended outcomes. The controls should be implemented throughout the firm and be subject to periodic review. Such controls should include assessing the quality of the service provided to the client - for example, monitoring calls for telephone sales, sampling of advice and client portfolios provided to check suitability or going through other client documentation on a periodic basis.

49. To carry out such controls in an effective and risk-based manner, firms should use a wide
    range of information on business quality monitoring and sales patterns, including trend and root-cause analysis, to identify areas of increased risk and to support a risk-based approach to sales monitoring, with particular focus on high performing relevant persons (regarding sales for instance).

50. Firms should ensure that the results of such analyses and controls are clearly documented
    and reported to senior management together with proposals for corrective action, if necessary. The compliance function should also assist senior management in monitoring effectively the compliance risks related to the remuneration policy of the firm (based also on the ex-post controls conducted in line with this guideline). Where potential or actual client detriment might arise as a result of specific features in remuneration policies and practices, firms should take appropriate steps to manage potential conduct of business and conflict of interest risks by reviewing and/or amending these specific features, and set up appropriate controls and reporting mechanisms for taking appropriate action to mitigate potential conduct of business and conflict of interest risks.

51. When outsourcing the provision of investment services, firms should have in mind the best
    interests of the client. Where a firm is seeking to use another firm for the provision of services it should check that the other firm’s remuneration policies and practices follow an approach consistent with these guidelines. In addition, firms should avoid setting overly complicated outsourcing or distribution structures (including through the use of tied agents) where the remuneration policies or practices applicable to such structures make it difficult for the firm to monitor the compliance risks with these guidelines and with the conflicts of interest and conduct of business policies and procedures in the area of remuneration or increase the risk of detriment to clients’ interests.

52. Firms should make sure to assess, on a regular basis, whether the information
    management tools they use adequately capture the qualitative data required to determine the variable remuneration they pay to relevant persons.

53. Examples of good practice:
    a. In order to assess whether its incentive schemes are appropriate, a firm undertakes a programme of contacting a sample of clients shortly after the completion of a sale involving a face-to-face sales process where it is not able to monitor recorded telephone sales conversations, so as to test if the salesperson has acted honestly, fairly and professionally in accordance with the best interests of the client. b. Top earners and performers are recognised as being potentially higher risk and, as a result, additional scrutiny is given to them; and information such as previous compliance results, complaints or cancellation data is used to direct compliance checking. The outputs have an impact on the design/review of the remuneration policy and practices.

54. Example of poor practice:
    a. A firm mainly relies on quantitative commercial data as the criteria for assessing variable remuneration. b. Senior management has set various strategic goals for the firm to be reached in a certain year. All goals seem to focus solely on financial or commercial aspects without taking into account the potential detriment to the firm’s clients. The remuneration policy will be in line with these strategic goals and will therefore have a strong short￾term financial and commercial focus.
    c. Despite the care taken in designing and assessing remuneration policies and
    practices, some policies and practices still lead to client detriment, creating risks that need to be identified and mitigated. d. To distribute its products, a firm relies on a multi-level sales network consisting solely of personnel or third-party distributors which are remunerated according to the volume of transactions of the clients captured directly by themselves, and their ranking in the sales structure of the firm, with a leverage effect depending on the number of distribution levels below and the number of distributors in each level.12 Such sales structures, combined with the remuneration policies and practices described in the foregoing, may make it difficult for the firm to monitor the compliance risks with these guidelines for each level (especially the most remote) and the whole structure.

55. The Annex to these guidelines includes illustrative examples of remuneration policies and
    practices that would create strong incentives to sell specific products and for which firms would therefore have difficulties demonstrating compliance with the MiFID requirements. The conduct of business and conflict of interest risks related to such examples should be taken into account by firms when designing and implementing their remuneration policies and practices. 12 In such sales structures, multi-level groups of individuals are coordinated by another individual called “supervisor” or “manager” who is in charge of the support, training, coordination and supervision of the structure. These supervisors or managers are also tasked with the recruiting of other individuals.

VI. Annex - Illustrative examples of remuneration policies
and practices that create conflicts that may be difficult to manage

1. Certain remuneration features (for example, the basis of pay, running performance-based
   competitions for relevant persons) involve higher risk of potential damage to clients than others (specifically those that include features which may have been designed to affect the behaviour of relevant persons, especially the sales force). Examples of high-risk remuneration policies and practices that will generally be difficult to manage, and where it would be difficult for a firm to demonstrate compliance with MiFID II, include:
2. Incentives that might influence relevant persons to sell, or ‘push’, one product or category
   of product rather than another or to make unnecessary/unsuitable acquisitions or sales for the investor: especially situations where a firm launches a new product or pushes a specific product (e.g. the product of the month or “in-house products”) and incentivises relevant persons to sell that specific product. Where the incentive is different for different types of products, there is a high risk that relevant persons will favour selling the product that results in higher remuneration instead of another product without appropriate regard to what is in the client’s best interests. a. Example: A firm has remuneration policies and practices linked to individual product sales where the relevant person receives different levels of incentives depending on the specific product or category of products they sell. b. Example: A firm has remuneration policies and practices linked to individual product sales, where the relevant person receives the same level of incentive across a range of products. However, at certain limited times, to coincide with promotional or marketing activity, the firm increases the incentive paid on the sales of certain products.
   c. Example: Incentives that might influence relevant persons (who may be remunerated
   solely by commission, for example) to sell unit trusts rather than investment trusts – where both products may be equally suitable for clients - because sales of unit trusts pay substantially higher commissions.
3. Inappropriate requirements that affect whether incentives are paid: remuneration policies
   and practices which include, say, a requirement to achieve a quota of minimum sales levels across a range of products in order to earn any bonus at all is likely to be incompatible with the duty to act in the best interests of the client. Conditions which must be met before an incentive will be paid may influence relevant persons to sell inappropriately. For example, where no bonus can be earned on sales unless a minimum target is met for each of several different product types, this may impact on whether suitable products are recommended. Another example is where a reduction is made to a bonus or incentive payments earned because a secondary target or threshold has not been met. a. Example: A firm has relevant persons who sell a range of products that meet different client needs, and the product range is split into three ‘buckets’ based on the type of client need. Relevant persons can accrue incentive payments for each product sold,

however at the end of each monthly period no incentive payment is made if they have not reached at least 50% of the sales target set for each ‘bucket’. b. Example: A firm sells products with a range of optional ‘add-on’ features. The relevant person receives incentive payments for all sales, with an additional payment if the client purchases an add-on feature. However, at the end of each monthly period no incentive payment is made if they have not achieved a penetration rate of at least 50% of products sold with an add-on feature.
4. Variable salaries where the arrangements vary base pay (up or down) for relevant persons
based on performance against sales targets: in such cases, the relevant person’s entire salary can become – in effect – variable remuneration. a. Example: A firm will reduce a relevant person’s basic salary substantially if he or she does not meet specific sales targets. There is therefore a risk that he or she will make inappropriate sales to avoid this outcome. Equally, relevant persons may be strongly motivated to sell by the prospect of increasing basic salary and associated benefits.
5. Remuneration policies and practices which create a disproportionate return for marginal
sales: where relevant persons need to achieve a minimum level of sales before incentive payments can be earned, or incentives are increased, the risk is increased. Another example would be schemes that include ‘accelerators’ where crossing a threshold increases the proportion of bonus earned. In some cases, incentives are payable retrospectively based on all sales rather than just those above a threshold, potentially creating significant incentives for relevant persons to sell particular products in particular circumstances. a. Example: A firm makes accelerated incentive payments to relevant persons for each product sold during a quarterly period as follows:

• 0-80% of target no payments
• 80-90% of target 50€ per sale
• 91-100% of target 75€ per sale
• 101-120% of target 100€ per sale

• 120% of target 125€ per sale
  This example can also apply where the relevant person receives an increasing share of commission or income generated. b. Example: A firm has the same accelerated scale as the firm in the foregoing example, but the increase in payments per sale is applied retrospectively to all sales in the quarter, e.g. on passing 91% of target the incentive payments accrued to date at the rate of €50 per sale are increased to €75 per sale. This creates a series of ‘cliff edge’ points, where one additional sale required to reach a higher target band causes a disproportionate increase in the incentive payment.

VII. Correlation table between the ‘new’ draft guidelines and
the 2013 guidelines
New Guidelines 2013 guidelines
Design of remuneration policies and practices
Guideline 1
V.I Governance and design of remuneration policies and practices in the context of the MiFID conduct of business and conflicts of interest requirements Governance Guideline 2 Controlling risks that remuneration policies and practices create Guideline 3 V.II. Controlling risks that remuneration policies and practices create n/a V.III. Guideline on competent authorities’ supervision and enforcement of remuneration policies and practices