Circular Letter No. CC/2020/00000072: Recommendation on Distributions During the COVID-19 Pandemic

Circular Letter No. CC/2020/00000072
Sent to:
Credit Institutions and Investment Companies.
Mod. 40000375/T – 01/14
Subject: Recommendation on distributions during the COVID-19 pandemic

In Recommendation ESRB/2020/15 of December 18, 2020, which amends Recommendation ESRB/2020/7 on the restriction of distributions during the COVID-19 pandemic1, the European Systemic Risk Board (ESRB) recommended that relevant authorities request that financial institutions under their supervision refrain, until September 30, 2021, from:
(i) distributing dividends or assuming irrevocable commitments to distribute dividends; (ii) repurchasing ordinary shares and (iii) assuming commitments to allocate variable remuneration to employees with a material impact on the institution's risk profile, which have the effect of reducing the quantity or quality of own funds, unless the institutions ensure a high level of prudence in carrying out each of the aforementioned actions and the resulting decrease does not exceed the conservative limit defined by their competent authority. The ESRB recommends that competent authorities promote dialogue with institutions before they carry out the actions mentioned in points (i) and (ii) above.

In Recommendation ECB/2020/622, of December 15, 2020, the European Central Bank (ECB) issued recommendations for significant institutions, in line with the ESRB's recommendation, and recommends that competent authorities adopt recommendations for less significant credit institutions.

The Banco de Portugal, taking into account these recommendations from the ECB and the ESRB, as well as the communication from the European Banking Authority (“European Banking Authority” - EBA)3, as well as the persistence of a high level of uncertainty regarding the effects on the financial system of the current COVID-19 pandemic context, considers it essential to ensure that institutions continue to refrain from carrying out distributions that reduce their own funds and their capacity to finance the economy and absorb potential losses arising from adverse financial impacts. Institutions intending to carry out distributions must take into account their impact on own funds projections, as well as any possible effects arising from the COVID-19 pandemic that may yet materialize.

In this context, the Banco de Portugal adopts the ESRB Recommendation ESRB/2020/15 and the ECB Recommendation ECB/2020/62, updating the recommendations previously communicated on this matter. This Circular Letter thus replaces Circular Letter No. 2020/00000050 of July 29.

1 https://www.esrb.europa.eu/pub/pdf/recommendations/esrb.recommendation201215_on_restriction_of_distributions_during_the_COVID-19_pandemic~2502cd1d1c.en.pdf?cffccb800b8f13054c8400576466fe8e 2 https://eur-lex.europa.eu/legal-content/PT/TXT/PDF/?uri=CELEX:52020HB0062&from=EN 3 https://eba.europa.eu/eba-continues-call-banks-apply-conservative-approach-dividends-and-other-distributions-light-covid

Mod. 40000375/T – 01/14
The Banco de Portugal will continue to monitor the economic and financial situation and will assess the need to extend these recommendations as appropriate.

Restriction on dividend and related payments
The Banco de Portugal recommends that less significant credit institutions and investment companies, as well as their finance companies that are not directly supervised by the ECB (hereinafter referred to as entities), refrain, until September 30, 2021, from distributing dividends or repurchasing ordinary shares that have the effect of reducing the quantity or quality of own funds at an individual or consolidated level, with the exception of situations where a legal obligation regarding such payments has already been established.

Entities that may consider the decision to distribute dividends or repurchase ordinary shares with the aim of remunerating their shareholders must contact the Banco de Portugal with adequate advance notice, preferably by February 1, 2021, demonstrating that such distribution is prudent and ensures compliance with these recommendations. In particular, entities must take into account the impact of distributions on own funds projections and demonstrate the capacity for sustained and prospective compliance with own funds requirements, based on prudent projections and ensuring that they retain sufficient resources to cope with a possible deterioration in the quality of assets on the balance sheet and to ensure the maintenance of financing to the economy.

In particular, the Banco de Portugal recommends that:
a) Distribution proposals must respect the limit corresponding to the lower of the following values: (i) 15% of the accumulated profit from the financial years 2019 and 2020, or (ii) a reduction in Core Tier 1 own funds of up to 20 basis points; b) Entities that have losses in 2020 must not propose distributions; c) Interim profits for 2021 must not be distributed.

Restriction on variable remuneration payments
Regarding the variable component of remuneration, the Banco de Portugal considers it necessary to extend the supervisory expectations transmitted in Circular Letter No. CC/2020/00000050 of July 29, 2020.

In this sense, entities must, until September 30, 2021, continue to limit their payments regarding the variable component of remuneration to the maximum extent possible, with the exception of situations where a legal obligation regarding such payments has already been established.

It should be noted that the adoption by the recipients of these recommendations must continue to take into account an effective application of the principle of proportionality, which will be duly weighed by the Banco de Portugal.

Thus, it is the expectation of the Banco de Portugal that entities refrain, at least with regard to the 2020 performance year, from assuming any new commitments regarding the variable component of remuneration, particularly for employees with a material impact on the institution's risk profile.

Mod. 40000375/T – 01/14
It is also expected that entities adopt a more prudent approach, where possible and preventing possible litigation situations, with regard to payments subject to deferral of amounts of variable remuneration attributed with reference to the performance of previous years and whose right to payment has not yet been acquired by the respective employees.

It is noted that, under any circumstances, it is not expected that entities adopt any alternative measures aimed at compensating for the loss or reduction of the variable component of remuneration amounts for the targeted employees, namely by increasing the amounts attributed as a fixed component of remuneration. The adoption of such measures, in addition to potentially constituting an evasion of the currently in force regulatory provisions, would not be consistent with the supervisory expectations of the Banco de Portugal regarding remuneration, as such measures would adversely impact the overall objectives intended with the issuance of this Circular Letter.