Guideline on a Sound Remuneration System

Supervisory Policy Manual
CG-5
Guideline on a
Sound Remuneration System
V.2 – 12.03.15

HONG KONG MONETARY AUTHORITY
香港金融管理局

This module should be read in conjunction with the Introduction and with the Glossary, which contains an explanation of abbreviations and other terms used in this Manual. If reading on line, click on blue underlined headings to activate hyperlinks to the relevant module.

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Purpose

To provide guidance to AIs on the key elements of a sound remuneration system, to set out the approach which the HKMA will adopt in the supervision of AIs’ remuneration systems, and to outline the level and type of disclosure in relation to remuneration expected to be made by AIs

Classification

A non-statutory guideline issued by the MA as a guidance note

Previous guidelines superseded

CG-5 “Guideline on a Sound Remuneration System” (V.1) dated 19.03.2010

Application

To all AIs

Structure

1. Introduction

1.1 Legal framework

1.2 Objectives

1.3 Scope of application

1.4 Supervisory approach

1.5 Implementation

2. Elements of a sound remuneration system

2.1 Governance

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2.2 Structure of remuneration

2.3 Measurement of performance for variable remuneration

2.4 Alignment of remuneration payouts to the time horizon of risks

3. Disclosure on remuneration

3.1 Importance of disclosure

3.2 Frequency and method of disclosure

3.3 Key disclosures

Annex A : Remuneration Disclosures

Annex B : Illustrative Example on Breakdown of Remuneration Awards for a Financial Year

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1. Introduction

1.1 Legal framework

1.1.1 Section 7 of the Banking Ordinance provides that the MA shall promote the general stability and effective working of the banking system and shall promote and encourage proper standards of conduct and sound and prudent business practices amongst AIs. The MA therefore has a particular interest in ensuring that AIs’ remuneration systems are sound and prudent and do not pose risks to AIs’ safety and soundness.

1.1.2 The principles relating to sound remuneration systems set out in this module supplement the Supervisory Policy Manual module on Corporate Governance of Locally Incorporated Authorized Institutions (CG-1) issued under section 7(3) of the Banking Ordinance. The CG-1 module provides that Boards of locally incorporated AIs should be responsible for ensuring effective internal control systems are in place so that an AI’s operations are properly controlled and comply with

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policies approved by the Board as well as applicable laws and regulation, and for ensuring in this context that the AI’s remuneration policy is consistent with its ethical values, objectives, strategies and control environment.

1.1.3 This module should also be read in conjunction with IC-1 “General Risk Management Controls” and IC-2 “Internal audit function”. The sound practices contained therein are also applicable to a sound remuneration system.

1.2 Objectives

1.2.1 The main objective of this module is to ensure that AIs’ remuneration systems are consistent with and promote effective risk management, in recognition of the fact that remuneration systems which create incentives towards inappropriate and excessive risk-taking could threaten the safety and soundness of the individual AI concerned and potentially thereby the stability of the local banking system. To this end, this module also describes the HKMA’s supervisory approach with regard to remuneration practices, in the context of the HKMA’s risk-based supervision of AIs.

1.2.2 It is recognised that, so far as remuneration systems are concerned, “one size will not fit all” AIs. The HKMA’s intention in issuing this module is therefore not to prescribe a particular remuneration system, or levels of, or limits on, individual remuneration. The development of remuneration systems and the setting of such levels and limits are and remain the responsibility of AIs’ Boards of Directors (Boards) 1 and senior management. This module focuses rather on the governance and control arrangements for, and operation of, AIs’ remuneration systems in the context of the incentives for risk-taking they may create. AIs

[1] In this module, the term “Board” is used to mean the Board of Directors of a locally incorporated AI or the Board of Directors and/or local management of an overseas-incorporated AI where appropriate.

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are expected to establish and operate their remuneration policies, structures and incentives awards with due regard to the principles set out in this module.

1.3 Scope of application

1.3.1 To meet the objectives referred to in paragraph 1.2.1 above and ensure a level playing field within the local banking sector, this module applies to all AIs including, in the case of locally incorporated AIs, their overseas branches and subsidiaries subject to the HKMA’s consolidated supervision. Where, because of local laws or regulations in any relevant overseas jurisdiction, an overseas branch or subsidiary is unable substantively to reflect the principles set out in this module in its remuneration system, the HKMA should be informed.2

1.3.2 AIs are expected to demonstrate to the satisfaction of the HKMA that their remuneration systems (or, in the case of overseas-incorporated AIs, the remuneration systems applicable to officers and employees engaged in the conduct of their business and operations in Hong Kong) are sound and in compliance with the principles set out in this module. In any case where an AI’s remuneration system does not reflect certain aspects of the principles set out in this module, the AI’s Board should satisfy themselves and the HKMA that either: (a) the relevant aspects of the module are not reasonably applicable to their institution or to certain business units within their institution or to certain groups of their employees, as the case may be, or (b) their institution has adopted alternative control measures which are equally effective in ensuring that their remuneration systems do not provide incentives to take inappropriate or excessive risk and that the systems are subject to adequate oversight by the Board.3

[2] In such circumstances, the AI may be requested to demonstrate to the HKMA’s satisfaction that the remuneration systems actually operated in such branches or subsidiaries are consistent with local laws or regulations in the relevant jurisdiction, do not incentivise inappropriate or excessive risk-taking and promote effective risk management.

[3] A general reference to prevailing market practices as an explanation for any deviation from this module will not be regarded as sufficient for this purpose.

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1.3.3 A proportionate approach may be adopted by AIs in applying this module to the development and operation of their remuneration systems, based on the size, scope, nature and complexity of their business and the extent to which they use incentives-based compensation arrangements. Thus, for example, an AI with a large, complex, multifaceted business which employs large numbers of employees engaged in diverse risk-taking activities and which makes extensive use of variable incentive compensation arrangements will be expected to have more formalised, systematic and detailed policies, procedures, and systems and to undertake more extensive monitoring and reviews than an AI which is engaged in more simple business, on a smaller scale, and which uses variable incentive-based awards on a limited basis only.

1.3.4 Similarly, the provisions in this module concerning the balance of fixed and variable incentives-based remuneration, the mix of instruments used for the “payment” of variable remuneration, the measurement of long-term performance, and the arrangements for deferral of variable remuneration may be applied in a manner commensurate with the seniority, responsibility, role and activities of the relevant employees. It may not be appropriate to apply measures such as these to junior-level employees who receive relatively insignificant amounts of variable remuneration, or to employees whose duties are of such a nature that they would not be capable of, or in a position to, materially impact the risk profile of the AI.4 The taking of a longerterm perspective for the purposes of certain aspects of the operation of the remuneration system (including deferral arrangements) may also not be relevant for employees whose duties are such that the risks incurred by their activities will be fully reflected in current year performance.

[4] AIs should however remain alert to the effects of their incentive compensation arrangements on groups of employees, where each individual employee may not be in a position individually to impact the AI’s risk profile materially but where their behaviour, collectively, in response to similar incentives created by remuneration schemes, could do so.

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1.3.5 AIs are encouraged to discuss with the HKMA any concerns they may have regarding the applicability of this module to given aspects of their remuneration systems in the light of their specific conditions.

1.4 Supervisory approach

1.4.1 The HKMA will take into account the potential risks that may arise from an AI’s remuneration system5 as part of its risk-based supervisory process, reviewing the institution’s remuneration policies, practices and outcomes when assessing its overall risk environment. For this purpose, all information which the HKMA may require in order to enable it to undertake an assessment of: (a) the risks inherent in, or relating to, an AI’s remuneration system; and (b) the extent to which an AI’s remuneration system is broadly consistent with the principles set out in this module; should be made available to the HKMA upon request.

1.4.2 The results of the HKMA’s supervisory assessment will feed into the annual review of an AI’s supervisory CAMEL rating and, for locally incorporated AIs, will be taken into consideration in the determination of whether additional capital should be held by the AI to cover risks not covered, or not adequately covered, under the AI’s existing minimum capital requirements.

1.4.3 If the HKMA’s assessment indicates that an AI’s remuneration system is inconsistent with the principles set out in this module and poses a risk to the safety and soundness of the AI, the HKMA will expect the AI to implement measures promptly to address and mitigate any risks identified in respect of its remuneration arrangements, such as reducing the potential risk inherent in given employees’ activities or changing its remuneration system to bring it into line with the principles in this module. Failure by the AI to take timely corrective measures in a manner satisfactory to

[5] In the case of overseas-incorporated AIs, the remuneration systems applicable to officers and employees engaged in the conduct of their business and operations in Hong Kong.

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the HKMA will result in the HKMA taking such supervisory measures as it considers appropriate.6

1.4.4 Where an AI in Hong Kong is part of a banking group (i.e. a subsidiary of a banking group or a branch of an overseas-incorporated bank), the institution may adopt the remuneration policy formulated at the group level if it can demonstrate to the HKMA’s satisfaction that the relevant group remuneration policy is broadly consistent with the principles set out in this module, having regard to local circumstances or, if and to the extent that it is not so consistent in any respect, that such group policy contains alternative control measures that are equally effective in ensuring that it promotes effective risk management. The AI should also provide, and ensure that it is in a position to provide, to the HKMA such information and documentation as the HKMA may require in order to assess: (a) the risks inherent in, or relating to, the AI’s remuneration system; and (b) the extent to which the AI’s remuneration system is broadly consistent with this module. Where appropriate, the HKMA may obtain relevant information and opinions regarding the remuneration system from the home supervisor of the AI’s parent bank or head office for reference, or may raise any instances of inconsistency with the principles in this module with them.

1.5 Implementation

1.5.1 Following the issuance of the first version of this module in 2010, AIs should already have taken action to reflect the principles set out in the module within their remuneration systems and to bring such systems into line with the module’s provisions. The purpose of this revised module is to incorporate existing guidance in relation to remuneration disclosures as set out in the HKMA’s circular letter dated 23 November 2011. AIs

[6] In extreme cases, where the HKMA has serious concerns about the interaction of the AI’s remuneration arrangements and its capital strength, the HKMA may consider the need (notwithstanding paragraph 1.2.2 above) to set a quantitative limit on the total variable remuneration payable by the AI (such as limiting total variable remuneration to a percentage of total net revenues) if the HKMA considers this necessary in all the circumstances as a capital conservation measure.

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are generally expected to have implemented these disclosure requirements over the past three years. If however they have not fully done so, they should promptly commence any necessary system upgrades for generating the required data and information for the purpose of making the required remuneration disclosures. Any AI that has not already fully implemented the disclosure requirements and that is encountering any problem in doing so should approach the HKMA to discuss the outstanding issues and likely timeframe required for them to be resolved. The HKMA will monitor AIs’ adoption of the principles set out in the module in its on-going prudential supervision of AIs.

1.5.2 The HKMA anticipates that this module will be developed further in the light of implementation experience and the development of best practices, both locally and overseas. AIs are encouraged to consider the operation of their remuneration systems as part of their capital planning process; to monitor developments in methods and practices for making remuneration sensitive to risk-taking; and to incorporate emerging methods and practices that are likely to enhance safety and soundness into their remuneration systems.

2. Elements of a sound remuneration system

2.1 Governance

Remuneration policy

2.1.1 The Board of an AI should establish and maintain a written remuneration policy covering all employees4 which reflects the principles in this module. In particular, the policy should ensure that the institution’s overall approach to risk management is supported, and not undermined, by the remuneration arrangements for employees whose activities during the course of their employment (individually or collectively) could have a material impact on the AI’s risk profile and financial soundness. In this regard, the policy should have specific regard to the remuneration of the following

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personnel, as well as their role in the institution’s remuneration system where relevant :

2.1.1.1 senior management who are responsible for oversight of the AI’s firm-wide strategy or activities or those of the AI’s material business lines (including, but not limited to, executive directors, the chief executive, and other senior executives);7

2.1.1.2 individual employees (“Key Personnel” for the purposes of this module) whose duties or activities in the course of their employment involve the assumption of material risk or the taking on of material exposures on behalf of the AI (for example, proprietary traders and dealers who are in a position to take on material exposures);

2.1.1.3 groups of employees whose activities in the aggregate may expose the AI to material amounts of risk and who are subject to the same or similar incentive arrangements (including, but not limited to, employees who are incentivised to meet certain quotas or targets by payment of variable remuneration for example, personnel in marketing, sales and distribution functions and loan officers); and

2.1.1.4 employees within risk control functions (including, but not limited to, risk management, financial control, compliance, legal and internal audit functions).

2.1.2 The remuneration policy should be designed to encourage employee behavior that supports the AI’s risk tolerance, risk management framework and longterm financial soundness. It should be in line with the

[7] Managers (as defined in section 2 of the Banking Ordinance) may also fall within this category of personnel to the extent that their role or position within the AI gives them responsibility for oversight of the strategy, conduct and operation of material business lines in Hong Kong.

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objectives, business strategies and long-term goals of the AI and structured in a way that will not encourage excessive risk-taking by employees but allows the AI to attract and retain employees with relevant skills, knowledge and expertise to discharge their specific functions.

2.1.3 Information regarding the performance measurement and remuneration of employees should be clearly documented. An AI should conduct regular internal monitoring to ensure that its processes for ensuring compliance with its remuneration policy are being consistently followed. Such monitoring should be conducted by compliance, audit or other personnel in a manner consistent with the AI’s overall framework for compliance monitoring. In addition, the remuneration policy and its implementation should be subject to a regular (at least annual) review, independent of management, by the Board (or by a party commissioned by the Board) to ensure that the policy remains adequate and effective and that the operation of the remuneration system is consistent with the intended purposes and long-term interests of the AI. Remuneration outcomes, risk measurements, and risk outcomes should be reviewed for consistency with intentions. The AI’s internal audit function should provide support to the Board in the review process and report any material weaknesses which are identified.

2.1.4 To enforce desirable employee behavior which is consistent with the AI’s strategy and risk management, the key principles underpinning the remuneration policy should be accessible to all employees. Employees should know in advance how their performance will be measured and compensated. AIs may determine the appropriate level of information to be provided to employees at various ranks and within various business units within their organizational structures but, in order to effectively enable the remuneration policy to influence employee behaviour, at least: the financial and non-financial factors to be used to measure the employees’ performance; the risk adjustments to be made; and the “payout function” to determine how and

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when the employees will be paid for their performance; should be disclosed to employees.

2.1.5 The remuneration policy and information on the AI’s regular monitoring and review of the operation of the remuneration policy should be provided to the HKMA on request.

Board oversight and remuneration committee

2.1.6 The Board of an AI is ultimately responsible for overseeing the formulation and implementation of the AI’s remuneration policy. In exercising its oversight, the Board should ensure that its judgements and decisions relating to remuneration arrangements are taken independently of the management and in the best interests of the AI.

2.1.7 The Board of an AI (or the Board’s remuneration committee with the necessary delegated authority) should approve the remuneration packages8 (and any subsequent adjustments) of the AI’s senior management (referred to in paragraph 2.1.1.1 and the AI’s Key Personnel (referred to in paragraph 2.1.1.2). To avoid conflicts of interest, executive directors should play no part in making decisions in respect of their own remuneration. The remuneration packages of other employees granted in accordance with the AI’s remuneration policy may generally be approved below Board level.

2.1.8 The Board of a licensed bank should establish a board remuneration committee to assist the Board in discharging its responsibility for the design and operation of the AI’s remuneration system. This remuneration committee should have the following attributes:

2.1.8.1 The members of the committee should be independent non-executive directors or,

[8] Including fixed salary and incentive compensation arrangements.

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where executive directors are to be members of the committee, the majority of its members should be independent nonexecutive directors. If an AI encounters difficulties in achieving this balance of membership within its remuneration committee, it should approach the HKMA to discuss the matter. An AI may appoint other relevant persons (such as compliance managers or risk managers) as advisers or observers to the committee.

2.1.8.2 The committee should have written terms of reference which clearly define its role and responsibilities, authority and tenure, and which should be updated as appropriate.

2.1.8.3 The committee should make recommendations in respect of remuneration policy and practices to the Board. In so doing, it should ensure that the AI’s remuneration policy is consistent with the principles set out in this module and any other legal or regulatory requirements applicable to employees’ remuneration.

2.1.8.4 The committee should be able to exercise competent and independent judgement on remuneration policies and practices and the incentives thereby created for managing risk, capital and liquidity. It should carefully evaluate any practices by which remuneration is paid for potential future revenues whose timing and likelihood remain uncertain. In so doing, it should demonstrate that its decisions are consistent with an assessment of the AI’s financial condition and future prospects (please see paragraph 2.1.10 below).

2.1.8.5 The committee should make recommendations to the Board in respect of the remuneration packages for the AI’s

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senior management (referred to in paragraph 2.1.1.1) and Key Personnel (referred to in paragraph 2.1.1.2) in cases where the approval authority for such remuneration packages rests solely with the Board.

2.1.8.6 The committee should ensure that a regular (at least annual) review of the AI’s remuneration system and its operation, either internally conducted or externally commissioned, is carried out independently of management and the result is submitted to the HKMA. Such review should include an assessment of the extent to which the remuneration system is consistent with the principles set out in this module.

2.1.8.7 The committee should work closely with other relevant committees of the AI’s Board such as the risk committee and the audit committee and should have the ability to consult the AI’s compliance function in the evaluation of the incentives created by the remuneration system. The committee should report any material issues in relation to the AI’s remuneration system to the Board on a regular basis (please see paragraph 2.1.12 below).

2.1.9 Where a licensed bank is part of a banking group (i.e. a subsidiary of a banking group or a branch of an overseas-incorporated bank), the establishment of a remuneration committee at group level will be regarded as consistent with the principles set out in paragraph 2.1.8 if the committee has the attributes set out in that paragraph or, failing which, if the AI can demonstrate to the HKMA’s satisfaction that it is constituted in such a way that it is independent of management and demonstrably able to exercise competent and independent judgement on compensation practices and the incentives thereby created for managing risk, capital and liquidity. To monitor adherence to the group’s

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remuneration policies and the principles set out in this module, regular compliance monitoring should be put in place to review the management and operation of the AI’s remuneration systems at the local level. The results of the local compliance monitoring should be regularly reported to the group remuneration committee.

2.1.10 Those members of the Board most involved in the formulation and operation of the AI’s remuneration policy (including the members of the remuneration committee) should possess sufficient expertise and experience to form an independent judgement on the suitability of the AI’s remuneration policy and its implications for risk and risk management. If the Board (or the remuneration committee) seeks professional advice from external advisors, the advice should be commissioned by, and provided directly to, the Chairman of the Board (or of the remuneration committee as the case may be) independently of management.

Risk control functions

2.1.11 Risk control personnel, independent of an AI’s business units, should have appropriate authority and be actively involved in the process of design and implementation of the AI’s remuneration policy. Such personnel should also play a continuing role in the operation of the remuneration system in relation to matters such as risk measures and risk judgements. The Board (or its remuneration committee) should consult risk management, financial control and compliance personnel to obtain input, independent of the relevant business lines, on how compensation relates to risk at various levels within the organization. Whilst the views of risk control personnel on risk measures and risk judgements have a key role to play in risk adjustment of compensation, it is not necessary for risk control personnel to be involved in the allocation of remuneration at the individual staff level.

2.1.12 Remuneration of risk control personnel should be determined in accordance with their performance

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objectives and should be commensurate with their key role in the institution. To avoid possible undue influence from business units, risk control personnel should be compensated in a manner that is independent of the performance of the business areas which they oversee. Management of business units should not be able to determine the remuneration of personnel in risk control functions.

2.2 Structure of remuneration

Proportionate balance of fixed and variable remuneration

2.2.1 In determining an appropriate balance between fixed and variable incentive-based remuneration, AIs should have regard to the seniority, role, responsibilities and activities of their employees and the need to promote behaviour amongst employees that supports the AI’s risk management framework and long-term financial soundness. For some employees, including those at more junior levels, a remuneration package consisting entirely of fixed salary may be appropriate whilst for others a package consisting of both fixed and variable incentive-based elements may be considered more effective in aligning the employees’ interests with those of the AI. In devising remuneration packages which consist of both fixed salary and variable incentive-based compensation, an AI should seek to achieve an appropriate balance between these elements and should consider the need to avoid situations where: (a) the fixed component is set at such a low level that: (i) it is insufficient to attract and retain employees with relevant skills, knowledge and expertise to discharge their functions; or (ii) it effectively renders the incentive-based compensation element “non-discretionary” or severely hinders the exercise of discretion in respect of the incentive-based element; or (b) the variable component is set at such a level that it induces excessive risk-taking. Generally, the proportion of variable remuneration to total remuneration would be expected to increase in line with the seniority and responsibility of an employee such that a substantial proportion of the remuneration of the senior

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management and Key Personnel should be paid in the form of variable remuneration.9 An AI adopting a different policy for its senior management and Key Personnel should be prepared to demonstrate to the HKMA’s satisfaction that its alternative approach results in suitably balanced remuneration packages for such employees which do not undermine the AI’s prudent risk management or reward failure.

Use of instruments for variable remuneration

2.2.2 Variable remuneration should be paid in such a manner as to align an employee’s incentive awards with longterm value creation and the time horizons of risk and should reflect the employee’s seniority, role, responsibilities and activities within the AI. In this regard, equity-related instruments could be effective in restraining the risk-taking incentives of senior management and Key Personnel whose activities could have a material impact on the overall financial performance of the AI. In these cases, the payment of a substantial proportion of their variable remuneration10 in the form of shares or share-linked instruments should better align incentives with risk and longer term value creation. Where an AI considers it inappropriate to use shares or share-linked instruments in the payment of variable remuneration to its senior management and Key Personnel, it should ensure that alternative measures are in place (such as risk adjustment of awards, longer periods of performance measurement or deferral of payment, or the use of other non-cash benefits) which are designed to achieve effective alignment of incentives awards to the time horizon of risks. In the case of other employees, equity-related instruments may not be as effective in restraining risk-

[9] The FSB Implementation Standards (No.6) recommend that for significant financial institutions a substantial proportion of remuneration for senior executives and other employees whose actions have a material impact on the risk exposure of the firm should be variable and paid on the basis of individual, business-unit and firm-wide measures that adequately measure performance.

[10] The FSB Implementation Standards (No.8) indicate that more than 50% might be appropriate in the case of significant financial institutions.

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taking incentives and the proportion of any variable remuneration paid in the form of shares or share-linked instruments should take into account the level, nature and duration of the risks that such employees’ activities create for the AI and the extent to which they may affect its overall performance. In these cases, other measures should be adopted to align any incentive awards to the time horizon of risks as appropriate.

2.2.3 Awards in shares or share-linked instruments should be subject to an appropriate share retention policy which should require employees to retain such instruments for a specific period of time before they are allowed to dispose of them.11 It may be appropriate for share retention periods to differ between different levels of employee.

Exceptional use of guaranteed minimum bonuses

2.2.4 Guaranteed minimum bonuses, that have no regard to an employee’s performance, are not consistent with sound risk management.12 The award of any such guaranteed minimum bonus to senior management or Key Personnel should be subject to the approval of the Board (or the Board’s remuneration committee with the necessary delegated authority).

2.3 Measurement of performance for variable remuneration

Pre-determined criteria for performance measurement

[11] In the case of awards of shares or share-linked instruments subject to a vesting period and in the case of share-options which only become exercisable after the elapse of a specified period of time, these periods may be taken into account in considering suitable retention periods.

[12] If an AI considers it necessary, in exceptional circumstances, to offer such a bonus, the offering should be restricted for (a) the purpose of hiring new staff and in such circumstances should be strictly limited in time (as a benchmark the FSB Implementation Standards (No.11) provide for limitation to the first year of employment) or (b) the purpose of retaining existing staff in a business which is being wound-down or sold (in circumstances where the retention of the employee is reasonably considered necessary by the AI to bring the winding-down or sale to a successful conclusive) and in such circumstances should be limited to a time period considered reasonably necessary to complete the winding-down or sale.

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2.3.1 The award of variable remuneration should depend on the fulfilment of certain pre-determined and assessable performance criteria. These criteria should include both financial and non-financial factors so that the quality of the performance of employees in the overall course of their employment (and not solely their financial performance) can be assessed as an integral part of their performance measurement and hence be appropriately reflected in their awards of variable remuneration.

2.3.2 Performance in relation to non-financial factors such as adherence to risk management policies, compliance with legal, regulatory and ethical standards, results of internal audit reviews, adherence to corporate values, and customer satisfaction should form a significant part of the overall performance measurement of employees, given that poor performance in these factors can be indicative of significant risks to the AI. Adverse performance in non-financial factors, where appropriate, should override outstanding financial achievements, and be reflected by a reduction to, or elimination of, any variable remuneration.

2.3.3 To better align remuneration with sustainable performance, the overall amount of an AI’s variable remuneration should take into account the AI’s performance over the longer term.13 This approach can prevent short-term gains, generated by taking greater risks, from leading to higher variable remuneration.Adjustments to performance assessment

2.3.4 AIs may adopt financial factors (e.g. profit, revenue, turnover, or volume) as a basis for assessing the performance of their employees and determining their variable remuneration. However, the size and allocation of variable remuneration should take into account the full range of current and potential risks associated with the activities of employees, and in

[13] E.g. by reference to financial results spanning three to five years or by using a moving average of financial results.

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particular: (a) the cost and quantity of capital required to support the risks taken; (b) the cost and quantity of the liquidity risk assumed in the conduct of business; and (c) the timing and likelihood of potential future revenues incorporated into current earnings. For this purpose, AIs should incorporate adjustments for risk and capital charges based on such risk measures14 as the AI reasonably considers prudent and appropriate for this purpose.

2.3.5 To control individual employees’ risk appetites and to bring remuneration practices into line with an AI’s broader strategies and the maintenance of shareholder value, the performance measurement for, and allocation of, variable remuneration should take account of the overall performance of the relevant business units and the AI as a whole as well as the contribution of individual employees to such performance.

2.3.6 Variable remuneration should be symmetric with performance. Deterioration in the financial performance of an AI should generally lead to a contraction (and negative financial performance should generally lead to a considerable contraction) in the total amount of variable remuneration paid by the AI, taking into account both current remuneration and reductions in payouts of amounts previously deferred.

2.3.7 An AI should operate a truly discretionary and fully flexible policy such that it may withhold all or part of the variable remuneration if the payment is not justified by the performance of the institution or if business objectives are not achieved, or when it is necessary to protect the financial soundness of the institution.

Exercise of judgment

2.3.8 A purely mechanical process based on pre-determined performance criteria or formula-based assessment metrics will have its own limitations and weaknesses.

[14] E.g. regulatory capital, economic capital reflecting VaR or other metrics, or economic profit.

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Whatever performance measurements are adopted and whatever adjustments are made, a substantial amount of judgement and common sense may be required during the process to arrive at a fair and appropriate remuneration decision. The exercise of any judgement should support sound risk management and be consistent with the spirit of an AI’s remuneration policy. The rationale for the exercise of judgement and the final outcomes should be clearly recorded in writing. To the extent that it is impracticable to maintain such records at the individual employee level, an AI should at least maintain such records at the bonus pool level for given ranks of employees or for employees within given business units in a manner sufficient to enable assessment to be made as to whether the process is consistent with the AI’s remuneration policy.

2.4 Alignment of remuneration payouts to the time horizon of risks

Deferment of variable remuneration

2.4.1 Some of the risks to which an AI is exposed and the outcomes of such risks can only be adequately measured or observed over the longer term. Deferral of the payment of a portion of variable remuneration will allow employees’ performance, including the associated risks, to be observed and validated over a period of time before payment is actually made and the adjustment of the amount to be paid will enable the remuneration ultimately received by employees to more accurately reflect risk and risk outcomes. The appropriate proportion of variable remuneration to be deferred will vary from employee to employee depending upon a number of factors, including an employee’s seniority, role, responsibilities and activities within the AI, the time horizons of the risks incurred by the employee’s activities and the overall level of their variable remuneration both in absolute terms and as a proportion of their fixed salary. For some employees employed in roles where the end results of their activities are observable and susceptible to validation within a short timeframe, deferral may not be an appropriate mechanism. For others, in roles where the

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risks taken by them are harder to measure or will be realized over a longer timeframe, deferral will be appropriate. Generally, the proportion of variable remuneration made subject to deferment would be expected to increase in line with the seniority and responsibility of the employee in question.15 AIs adopting a different policy to deferral of variable remuneration should be prepared to demonstrate to the HKMA’s satisfaction that their alternative approach is conducive to restraining excessive short-term risktaking and to aligning actual variable remuneration payments with risks and risk outcomes.

2.4.2 The award of deferred remuneration should be subject to a minimum vesting period and pre-defined vesting conditions in respect of the future performance of an AI, the relevant business units and the employee in question. The deferred remuneration should generally vest gradually over a period of years and no faster than on a pro rata basis, subject to fulfilment and validation of the pre-defined performance conditions. If the vesting conditions are not fulfilled in any year during the vesting period, all or part of the unvested portion of the deferred remuneration should be foregone16 (subject to the realised performance of the AI or the relevant business unit). The vesting period and vesting conditions should be determined by the AI’s Board (or its remuneration committee) and reviewed as appropriate. The Board should strike a reasonable

[15] The FSB Implementation Standards (No.5) recommend that for significant financial institutions, a substantial portion (such as, say, 40 to 60 percent) of the variable remuneration of senior executives, and other employees whose actions have a material impact on the risk exposures of the firm, should be made subject to deferral arrangements over a period of years. For the most senior management and the most highly paid employees, the FSB Implementation Standards provide for the percentage of variable remuneration that is deferred to be substantially higher (for instance, say, above 60 percent).

[16] Often referred to as “clawed-back” notwithstanding that it is not vested and not due and payable until such time as the pre-defined vesting conditions are fulfilled. To the extent that the deferred remuneration is in the form of shares, the initial award is by number of shares rather than by value and the initial award was subject to appropriate adjustments for risk, the Board (or the Board’s remuneration committee with the necessary delegated authority) may consider whether the share price can appropriately be regarded as a proxy for the vesting condition related to the future performance of the AI.

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balance between providing effective incentives and validating the performance measures according to the nature and associated risks of the business undertaken by the employees. In this regard, the minimum vesting period should be appropriately aligned with the nature of the business, its risks, the activities undertaken by the employee in question and the timeframe during which the risks from these activities are likely to be realized. 17

2.4.3 A “claw-back” provision should also operate in respect of unvested deferred remuneration in circumstances where it is later established that any performance measurement was based on data which is later proven to have been manifestly misstated, or it is later established that there has been fraud or other malfeasance on the part of the relevant employee, or violations by the employee of internal control policies.

2.4.4 The departure of employees from an AI should not trigger early payout of deferred remuneration that is still within the deferment period. Subject to any prevailing legal requirements, severance pay, if any, should be related to performance achieved over time and designed in a way that does not reward failure. In exceptional cases, such as on compassionate grounds for ill-health, early payment of deferred remuneration might be approved. The rationale and justification for such early payment should be recorded and retained in writing and, in the case of senior management and Key Personnel, the early payment should be approved by the Board (or the Board’s remuneration committee with the necessary delegated authority).

2.4.5 Practices that involve making payments to a prospective employee to effectively compensate him for the deferred remuneration which he will forfeit on

[17] The FSB Implementation Standards (No.7) indicate that the deferral period for senior executives and other employees whose actions have a material impact on the risk exposure of the firm should not be less than 3 years. AIs adopting shorter deferral periods should be prepared to demonstrate to the HKMA’s satisfaction that the periods they adopt are sufficient to enable the performance of the relevant employees in question to be adequately observed and validated.

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leaving his previous employer, as a term to attract and recruit that employee, are not in line with the spirit of deferment of variable remuneration (please see paragraph 2.2.4 above). If, in any exceptional case, it is considered absolutely necessary to offer such a compensatory payment, the AI concerned should ensure that any such compensatory payment proposed to be made to the employee should: (a) itself be subject to deferral and pre-defined vesting conditions by reference to the AI’s future performance; and (b) in the case of senior management and Key Personnel be approved by the Board (or the Board’s remuneration committee with the necessary delegated authority); and (c) have its rationale and justification recorded and retained in writing.

Restriction on hedging exposures

2.4.6 Obviously, the spirit of, and risk management advantages to be gained by, deferment of variable remuneration will be undermined if employees who receive remuneration in this form, engage in personal hedging strategies or remuneration- and liability-related insurance to hedge their exposures in respect of the unvested portion of their deferred remuneration. AIs should therefore endeavour to seek undertakings from such employees not to engage in such activities. Further, whilst the HKMA acknowledges the difficulties inherent in attempting to “police” compliance with any such undertakings, AIs should endeavour to establish such compliance arrangements as they consider practicable in the circumstances (in the light of their existing compliance arrangements for their employees’ personal trading, investment and other financial activities). This could include, for instance, seeking declarations from employees’ either regularly or when they engage in certain trading, investment or other financial activities.

3. Disclosure on remuneration

3.1 Importance of disclosure

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3.1.1 Recognising the importance of sound remuneration policies and practices for risk management AIs (save as provided below) should, in order to increase transparency and promote market discipline, make disclosures in relation to their remuneration systems in accordance with paragraphs 3.2 and 3.3 below.

3.1.2 However, (i) if an AI has been granted an exemption by the MA under section 3(7) or 3(9) of the Banking (Disclosure) Rules (BDR) it will not be expected to make such disclosure; and (ii) overseas-incorporated AIs will not be expected to make separate disclosures in relation to remuneration in respect of their local operations, provided that such information already forms part of the disclosures made by the head office of the institutions concerned.

3.1.3 Section 52(ba) of the BDR requires locally incorporated AIs to disclose the extent of their compliance with the disclosure requirements set out in Part 3 of this guideline, and section 52(c) requires such AIs to disclose particulars of, and the reason for, any failure to so comply.

3.1.4 The remuneration disclosures described below should not be read or construed as replacing other disclosure requirements under relevant legislation or accounting and financial reporting standards. An AI should comply with all such other disclosure requirements under the Companies Ordinance (Cap. 622), the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, and the Hong Kong Financial Reporting Standards as applicable.

3.2 Frequency and method of disclosure

3.2.1 An AI should make the relevant disclosures on remuneration at least on an annual basis.

3.2.2 For ease of reference by the likely users of the information, an AI should, as far as possible, provide its remuneration disclosures on one site or in one document (e.g. in a Remuneration Report or a single section of its annual report). If equivalent disclosures

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have already been made by the AI elsewhere, it is acceptable for the AI to include on the relevant site or in the relevant document a direct link through which the disclosures can be readily accessed.

3.2.3 In order to improve clarity, all AIs’ remuneration disclosures should include quantitative figures for the previous reporting year together with the information for the current reporting year to aid comparison.

3.3 Key disclosures

3.3.1 Annex A sets out the information that AIs should include in their remuneration disclosures. AIs should also make any additional disclosures considered appropriate in the specific circumstances of a given AI. An AI should, as far as possible, articulate how the qualitative and quantitative factors in the Annex complement and support its overall risk management framework.

3.3.2 Quantitative disclosures should be made separately in respect of an AI’s senior management and in respect of its other Key Personnel. Annex B provides an illustrative format for the breakdown of remuneration awards for a financial year in relation to (i) senior management and (ii) other Key Personnel.

3.3.3 If an AI has such a small number of executives that individuals’ remuneration could be easily deduced from disclosure of a breakdown of the figures, it is acceptable for the AI, in so far as the sensitivity of the information will be disadvantageous to the AI, to disclose aggregate figures for senior management and Key Personnel. This is, however, provided that this fact and the reason for doing so (i.e. disclosing aggregate figures instead of disclosing separate figures) are adequately disclosed.

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Annex A : Remuneration disclosures

The following table sets out qualitative and quantitative information that an AI should include in its annual disclosure statements regarding remuneration:

Qualitative disclosures
(a) Information relating to the governance structure of the remuneration system, including:
 name, composition and mandate of the bodies (e.g. remuneration committee) overseeing remuneration;  external consultants whose advice has been sought, the bodies by which they were commissioned, and the areas of the remuneration process in respect of which their advice was sought;  a description of the decision-making process used to determine the firm-wide remuneration policy;  a description of the scope of the AI’s remuneration policy (e.g. by regions and/or business lines), including the extent to which it is applicable to foreign subsidiaries and branches; and  a description of the types of employees considered as (i) senior management and as (ii) Key Personnel1 , including the number of employees in each category. (b) Information relating to the design and structure of the remuneration processes, including:
 an overview of the key features and objectives of the remuneration policy;  whether the bodies charged with overseeing remuneration reviewed the AI’s remuneration policy during the past year, and if so, an overview of any changes that were made; and  a discussion of how the AI ensures that employees within risk

[1] See definitions of (i) senior management, (ii) Key Personnel and (iii) employees within risk control functions in section 2.

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control functions1 are remunerated independently of the businesses they oversee.

(c) Description of the ways in which current and future risks are taken into account in the remuneration processes, including:

•  an overview of the key risks that the AI takes into account when implementing remuneration measures;

•  an overview of the nature and type of the key criteria and measures used to take account of these risks, including risks that are difficult to measure (values need not be disclosed);

•  a discussion of the ways in which these measures affect remuneration; and

•  a discussion of how the nature and type of these measures have changed over the past year and the reasons for any changes, as well as the impact of changes on remuneration.

(d) Description of the ways in which the AI seeks to link performance during a performance measurement period with levels of remuneration, including:

•  an overview of the main performance criteria and metrics for the AI, top-level business lines and individuals;

•  a discussion of how the amounts of individual remuneration are linked to firm-wide and individual performance; and

•  a discussion of the measures the AI will in general implement to adjust remuneration in the event that performance metrics are weak.2

[2] This should include the AI’s criteria for determining “weak” performance metrics.

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(e) Description of the ways in which the AI seeks to adjust remuneration to take account of longer-term performance, including:

•  a discussion of the AI’s policy on deferral and vesting of variable remuneration and, if the fraction of variable remuneration that is deferred differs across employees or groups of employees, a description of the factors that determine the fraction and their relative importance; and

•  a discussion of the AI’s policy and criteria for adjusting deferred remuneration before vesting and (where applicable) after vesting through clawback arrangements.

  (f) Description of the different forms of variable remuneration that the AI utilizes and the rationale for using these different forms, including:

•  an overview of the forms of variable remuneration offered (i.e. cash, shares and share-linked instruments and other forms3 ); and

•  a discussion of the use of the different forms of variable remuneration and, if the mix of different forms of variable remuneration differs across employees or groups of employees, a description of the factors that determine the mix and their relative importance.

Quantitative disclosures

Information covering (i) senior management and (ii) Key Personnel, broken down between these two categories for the current and past reporting years:

(g)  Number of meetings held by the bodies (e.g. remuneration committee) overseeing remuneration during the financial year and remuneration paid to their members.

(h)  Total amount of outstanding deferred remuneration, split into vested and unvested.

(i)  Total amount of outstanding deferred remuneration, split into cash, shares and share-linked instruments and other forms.

[3] A description of the elements corresponding to other forms of variable remuneration (if any) should be provided.

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(j)  Total amount of deferred remuneration awarded, paid out and reduced through performance adjustments during the financial year.
(k)  Breakdown of amount of remuneration awards for the financial year to show:
 fixed and variable (with number of beneficiaries in each category);  deferred and non-deferred; and  different forms used (cash, shares and share-linked instruments, other forms3 ).
Remark: An illustrative example of the format for disclosure is provided in Annex B.
(l) Quantitative information about employees’ exposure to implicit (e.g. fluctuations in the value of shares or performance units) and explicit adjustments (e.g. malus, clawbacks or similar reversals or downward revaluations of awards) of deferred remuneration and retained remuneration4 :
 total amount of outstanding deferred remuneration and retained remuneration exposed to ex post explicit and/or implicit adjustments;  total amount of reductions during the financial year due to ex post explicit adjustments; and  total amount of reductions during the financial year due to ex post implicit adjustments.
(m) 5  Number and total amount of guaranteed bonuses awarded during the financial year, and number of beneficiaries of such payments;

[4] “Retained remuneration” refers to shares or share-linked instruments that are subject to a retention period under a share retention policy (see paragraph 2.2.3).

[5] AIs should disclose information described in this item at least on an annual basis to the extent they reasonably can without, in effect, disclosing the identity of the individuals concerned. Nevertheless, AIs should disclose such information to the HKMA to assist the HKMA in its assessment of AIs’ remuneration practices and outcomes.

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•  Number and total amount of sign-on awards made during the financial year, and number of beneficiaries of such payments;

•  Number and total amount of severance payments made during the financial year, and number of beneficiaries of such payments; and

•  Number and total amount of severance payments awarded during the financial year, and number of beneficiaries of such payments, and highest such award to a single person.

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Annex B : Illustrative example on breakdown of remuneration awards for a financial year

(i) Senior management
Total value of remuneration awards for the current financial year Non-deferred Deferred Fixed remuneration  Cash-based X X  Shares and share-linked instruments X X Other (Please specify) X X Variable remuneration  Cash-based X X  Shares and share-linked instruments X X Other (Please specify) X X

(ii) Key Personnel
Total value of remuneration awards for the current financial year Non-deferred Deferred Fixed remuneration  Cash-based X X  Shares and shared-linked instruments X X  Other (Please specify) X X

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Variable remuneration
 Cash-based X X
 Shares and share-linked instruments
X X
 Other (Please specify) X X

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