BaFin-FAQ on the Remuneration Ordinance for Institutions

The IVV FAQs include the first official BaFin announcement on the new version of the German Remuneration Ordinance for Institutions (Institutsvergütungsverordnung, IVV) dated 20 September 2021 (IVV 4.0, now in the version dated 14 February 2023)) and on the EBA Guidelines on sound remuneration policies dated 2 July 2021 (EBA/GL/2021/04, "EBA-GSR 2.0"). The interpretative guidance on the IVV published by BaFin on 16 February 2018 ("BaFin Interpretative Guidance") still referred to the IVV in force at the time (IVV 3.0). Practitioners had expected BaFin to issue (new) pronouncements on, among other things, the guiding principle of gender-neutral remuneration (Section 5 (1) no. 6 IVV, see also our Client Alert), the implementation of ESG criteria in the remuneration systems and the implementation of the extended requirements of section 27 IVV 4.0 for group-wide remuneration systems. These expectations were (only) partially met by the draft FAQ IVV ("FAQ IVV-E") published on 21 June 2023 (see our Client Alert). In the consultation process, practitioners provided many suggestions regarding the individual statements made by BaFin in FAQ IVV-E - some of which BaFin implemented in the final version of FAQ IVV.
 

1. Legal methodological starting point: FAQ IVV (also) as soft law (indirectly) to be observed by institutions when implementing their remuneration systems

From a legal methodology perspective, the FAQ IVV - like the BaFin Interpretative Guidance and the EBA GSR 2.0 - do not include a law in the material sense. They are to be observed by the legal practitioner as soft law when implementing the regulatory requirements in the remuneration systems. The starting point for the concrete application of the law is (unchanged) the wording of the IVV and the other legal methodological legal principles for the interpretation of the IVV; specifically, the historical, systematic, legal purpose-related (= teleological) and (CRD V) directive-compliant interpretation elements. BaFin's statements in the FAQ IVV must be taken into account as part of the historical and teleological interpretation elements when interpreting the IVV.
 

2. Embedment of the FAQ IVV in the EBA GSR 2.0 and in the BaFin Interpretative Guidance

From a practical perspective, BaFin initially comes up with a surprise in the introduction to FAQ IVV: The FAQ IVV are to replace the BaFin Interpretative Guidance. In the FAQ IVV-E, BaFin had made it clear that it would continue its previous administrative practice in accordance with the BaFin Interpretative Guidance unless it was updated by the FAQ IVV. BaFin has cancelled this clarifying statement in the FAQ IVV. However, the deletion of this statement should not mean that the BaFin Interpretative Guidance no longer has any practical application, given the fact that BaFin only makes selective statements in the FAQ IVV on the individual regulatory matters of the IVV. On the contrary, the BaFin Interpretation Guidance is likely to continue to be relevant in practice, at least for those regulatory matters that are not explicitly regulated in the FAQ IVV. At the same time, however, the BaFin will no longer be able to rely on the BaFin Interpretative Guidance alone as such, meaning that institutions will benefit from greater room for interpretation and therefore more room for manoeuvre with regard to the subject matter of the BaFin Interpretative Guidance.

In the FAQ IVV, BaFin has left unchanged the application of the EBA-GSR 2.0 already announced in the FAQ IVV-E, according to which the EBA-GSR 2.0 generally apply directly with the exception of the exceptions specified in detail by BaFin in the FAQ IVV (see our Client Alert on the exceptions). 

According to the final version of the FAQ IVV, this should result in the following graduated canon for the application of the EBA and BaFin pronouncements when applying the specific statutory provisions ("Graduated Application Canon"):

1. The EBA GSR 2.0 should be used as a starting point;
2. The FAQ IVV are applicable for matters that are not covered by the EBA-GSR 2.0 (example: statements in the FAQ IVV on the remuneration officer in significant institutions (question 19)) or where the application of proportionality appears necessary from the perspective of the German legislator (example: restriction of clawback matters);
3. The institution must review BaFin's pronouncements in the BaFin Interpretative Guidance for the specific facts of the case and take them into account when applying the law if they contain practical guidance from BaFin that goes beyond the FAQ IVV. 

This graduated continued consideration of BaFin's administrative practice in accordance with the BaFin Interpretative Guidance in addition to the FAQ IVV increases the complexity for legal practice; at the same time, however, it brings with it new structuring possibilities with regard to individual regulatory issues.
 

3. Guiding principle of gender-neutral remuneration policy: no announcement in FAQ IVV - three-dimensional implementation in accordance with EBA-GSR 2.0

When implementing the guiding principle of the gender-neutral remuneration policy in their remuneration systems, institutions must (still only) come to terms with the three-dimensional implementation in accordance with the EBA pronouncements in the EBA-GSR 2.0.

Section 5 (1) no. 6 IVV 4.0 adds – in implementation of Art. 74 (1), 92 (2) of Directive 2019/878/EU (CRD V) – the catalog of Section 5 (1) IVV on the regulatory adequacy of remuneration systems with the guiding principle of gender-neutral remuneration policy. 

The EBA had determined in the EBA-GSR 2.0 for the implementation of this guiding principle in remuneration systems three implementation dimensions, according to which institutions (1) have to ensure from a content perspective that all aspects of the remuneration policy are gender-neutral, including the granting and payment conditions for remuneration; (2) have to demonstrate from a formal perspective that the remuneration policy is gender-neutral, and (3) have to establish appropriate tools in remuneration governance for effective monitoring of compliance with the gender-neutral remuneration policy. From a German labor law perspective, among others, the EBA's ideas were judged to be (too) far-reaching, particularly with regard to the works constitution law dimension (see only our Client Alert).

Against this background, practitioners expected BaFin to clarify the implementation of the guiding principle of gender-neutral remuneration policy in the FAQ IVV. This expectation was not fulfilled even after corresponding comments in the consultation procedure on the FAQ IVV - these are (still) silent on this. In view of the aforementioned embedding of the FAQ IVV in the EBA-GSR 2.0, the institutions must come to terms with the three-dimensional implementation of the guiding principle of gender-neutral remuneration policy in accordance with the EBA's announcements in the EBA-GSR 2.0. In this context, the institutions must also take into account the implementation of the EU Remuneration Transparency Directive (2023/970/EU) in the German Remuneration Transparency Act (Entgelttransparenzgesetz), which will affect a large proportion of institutions with regard to the extended information and reporting obligations (see the presentation from our Deloitte Legal Webcast of 29 November 2023, published on our website).
 

4. Implementation of ESG criteria in the remuneration systems (Question 8)

Unchanged from the FAQ IVV-E, BaFin also chose a pragmatic approach in the final version of the FAQ IVV for the implementation of the guiding principle in the EBA-GSR 2.0 that the remuneration policy of institutions must also be compatible with the ESG strategy of the institution and with the associated risk-related environmental, social and governance objectives (para. 16 EBA-GSR 2.0). BaFin locates the implementation of ESG objectives in the remuneration strategy in Section 4 IVV - and thus allows the specific (already existing) maturity level of the institution's ESG strategy to suffice for its implementation. The practice can and must therefore derive the specific ESG targets from the ESG strategy integrated into the business and risk strategy.
 

5. Determination of the total amount of variable remuneration (Section 7 IVV): FAQ IVV in conjunction with EBA-GSR 2.0 and BaFin interpretation aid (Question 12)

The graduated application canon, which is also relevant after the final version of the FAQ IVV, is exemplified in the BaFin announcements on the framework parameters for determining the total amount of variable remuneration in accordance with Section 7 IVV. The BaFin interpretation guidance still contained very comprehensive explanations on this, particularly on the relevant content-related and process-related framework parameters (implementation of the economic perspective and the regulatory perspective; bottom-up/top-down/combined system for determining the total bonus pool). In contrast, the IVV FAQ are limited to individual substantive and procedural guidelines, most of which were already contained in the BaFin interpretation aid (e.g. on BaFin's expectation (1) regarding the holistic assessment of the compatibility of the intended total amount of variable remuneration with the regulatory ancillary conditions of Section 7 (1) sentence 3 IVV and their embedding in the regulatory framework). 3 IVV and its embedding in the process of internal risk measurement, (2) the content requirements and early communication in the event of the intended determination of a total amount of variable remuneration in the event of a negative return and (3) the necessary assessment of compliance with the requirements of Section 7 (1) sentence 3 IVV for the determination, vesting and payment of the respective variable remuneration component). In this respect, institutions must comply with the requirements set out in paras. 238 et seq. EBA-GSR 2.0 regarding, among other things, the system for determining the total bonus pool and the transparency of the system and process.

The guiding principles published by BaFin in the FAQ IVV are helpful in practice in that institutions intending to set a total bonus pool (1) in the event of falling below the capital adequacy recommendation pursuant to Section 6d KWG can demonstrate through documented capital planning if/that they will comply with the capital adequacy recommendation again within the following three calendar years – even if the bonus pool is set – and (2) for subsidiary institutions with exemptions from the capital or liquidity requirements in accordance with Art. 7 CRR, Section 2a (4) KWG/Art. 8 CRR, Section 2 (4) KWG, simplified requirements for sufficient liquidity apply.

It is also helpful in practice that in the final version of the FAQ IVV, BaFin has abandoned the considerations set out in the FAQ IVV-E that the assessment of the compatibility (amount) of the intended total bonus pool must be based on the figures certified in the annual financial statements at the relevant financial year-end. Institutions can therefore continue to define a needs-based system and a needs-based process for determining and calculating the relevant valuation parameters in accordance with Section 7 (1) sentence 3 IVV and carry out their review promptly after the end of the respective financial year with the relevant involvement of the other control functions (in particular risk controlling). This also means that components of variable remuneration that fall due during the year (such as retention bonuses in accordance with Section 5 (7) IVV) can be linked to an independent review of the ancillary conditions in accordance with Section 7 (1) sentence 3 IVV and their payment by the institution after the review has been carried out does not have to be subject to a repayment proviso with regard to the review of the ancillary conditions for the - performance-oriented - remuneration component of the variable remuneration relating to the respective financial year.
 

6. Further statements on the general requirements of the IVV for remuneration systems: remuneration components within the meaning of Section 2 (1) IVV (Question 1), treatment of occupational pension commitments (Question 2), negative performance contribution (Question 6), recognition awards (question 4), severance payments (Questions 10 and 11), hedging prohibition (Question 13)

The following selected additional statements in the final version of the FAQ IVV are worth mentioning:

• Remuneration components within the meaning of Section 2 (1) IVV (Question 1): In addition to the exclusion of bonuses from the company suggestion scheme already announced in the BaFin FAQ IVV-E, BaFin has also excluded bonuses offered for the recommendation of new employees ("employees recruit employees") from the scope of application of Section 2 (1) IVV in the FAQ IVV, as these also incentivise a special benefit that is not usually associated with the original activity of the beneficiary employee for the institution and therefore does not require separate risk and behaviour management.
• Treatment of company pension commitments (Question 2): The determination of the value of occupational pension commitments in the implementation channel of direct commitments must be based on actuarial principles, whereby the calculation of provisions must be based on the accounting standard that is also used by the institution for accounting purposes - taking into account any instruments for funding, so that in the case of IFRS accounting, the expected return on plan assets is taken into account in accordance with IFRS principles.
• Negative profit contribution (Sections 2 (10), 5 (2) and (6) IVV, Question 6): BaFin clarifies that negative profit contributions only include circumstances of immoral or unethical behaviour on the part of the employee and cases in which the behaviour or decisions of employees have led to objectively serious negative effects for the institution. It therefore rejects the understanding that has occasionally arisen in practice that negative performance contributions within the meaning of Sections 2 (10) and 5 (2) IVV also include a negative deviation from the performance parameters of the performance-related variable remuneration components - in the case of these performance-related variable remuneration components, the review and determination must rather be carried out in two stages (unchanged in practice), in that the specific overall performance is first determined in accordance with the specific performance parameters at the first stage and the review of any negative performance contributions takes place at the second stage. In addition, BaFin states that non-significant institutions must also specify the aforementioned case groups of negative performance contributions in the Remuneration Guideline (Section 11 (1) IVV) and must also specify cases of serious negative performance contributions in the Remuneration Guideline in which the variable remuneration must be reduced to zero. These specification and transparency requirements can be implemented, for example, by defining a catalogue of discretionary parameters.
  
  From a practical point of view, it is helpful that BaFin, in contrast to its statements in the IVV FAQ-E (1), limits the scope of application of immoral behaviour to circumstances that are based on the general (civil) legal understanding of "all fair and just thinkers" and therefore continues to exclude the main group of cases of any negative performance contributions within the meaning of Sections 2 (10), 5 (2) IVV. 10, 5 (2) IVV focuses on the breach of institution-related (conduct) regulations as conduct in breach of duty, and (2) no longer requires that institutions should be bound as far as possible in advance in the exercise of their discretion with regard to the examination and assessment of any negative performance contributions. In this respect, institutions can continue to ensure the holistic assessment required for the review of any negative performance contributions by defining sufficiently specific discretionary parameters.
• Recognition awards (Question 4): BaFin considers this widespread variable remuneration component granted during the year (other terms used in practice include "performance recognition bonus", "spontaneous bonus") to be permissible for non-Risk Takers and for Risk Takers in non-significant institutions under the following conditions: (1) determination of the performance parameters at the beginning of the financial year, (2) consideration of negative performance contributions in accordance with Section 5 (2) IVV, and (3) inclusion in the review in accordance with Section 7 IVV (whereby BaFin no longer maintains the requirement in the FAQ IVV-E to agree a repayment clause in the event of a review during the year in accordance with Section 7 IVV in the final version of the FAQ IVV).
  
  For qualifying non-significant institutions pursuant to Section 1 (3) sentence 2 IVV and for significant institutions pursuant to Section 1 (3c) KWG, BaFin announces that their Risk Takers cannot be beneficiaries of recognition awards, as the recognition awards (already) cannot fulfil the one-year minimum assessment period pursuant to Section 19 (1) sentence 2 IVV (and the individual performance contribution must also be determined on the basis of the achievement of agreed targets). BaFin has not included the exceptions to this principle proposed by practitioners in the consultation process in the final version of the FAQ IVV.
• Severance payments (Section 5 (6) IVV, Questions 10 and 11): The comprehensive statements in the FAQ IVV partly repeat guiding principles from the BaFin interpretation aid and enrich them with further findings of BaFin from recent settlement practice. BaFin continues to understand severance payments solely as benefits intended to compensate for disadvantages resulting from the premature termination of the employment/service relationship and thus continues to deviate from the more recent definition of severance payments under labour law, which is essentially aimed at bridging the gap until the next source of financing for living expenses (new employment relationship, pension). In order to assess the admissibility of the specific severance payment under supervisory law, the following should be assessed in particular: (1) Date of agreement (= contractual agreement prior to the occurrence of the termination event? (2) Trigger (= generally no severance payment in the event of termination forced by the employee and in the event of termination of a fixed-term employment contract), (3) Scope of the severance payment (= in the case of fixed-term employment contracts, alternative remuneration owed until the expiry of the term as the maximum severance payment amount, otherwise standard market severance payment factors in the event of termination of a permanent employment contract; special justification generally required for the granting of transitional allowances as non-compulsory benefits).
  
  For the case groups of privileged severance payments in accordance with Section 5 (6) sentence 5 IVV, BaFin clarifies that (1) so-called turbo payments (as benefits in the event of termination of the employment relationship before the next possible ordinary termination date, which correspond in amount to the capitalisation of the fixed remuneration to be granted alternatively up to the ordinary termination date), as well as (2) severance payments to compensate for the entitlement to any foregone variable remuneration for the current assessment period, are each considered to be regular in accordance with Section 5 (6) no. 5 no. 3 IVV, provided that they fall below the materiality threshold of Section 5 (6) sentence 5 no. 3 IVV. From a practical point of view, it is regrettable that BaFin has retained its statement in the FAQ IVV-E that court proceedings should only be imminent within the meaning of Section 5 (6) sentence 5 no. 1 lit. d) IVV if an action is already pending before a court, even in the final version of the FAQ IVV. From a labour court perspective, in this case the court proceedings within the meaning of Section 5 (6) sentence 5 no. 1 lit. d) IVV have already occurred, so that the scope of application of this privileged provision is void if the content is understood in this way (with a view to Section 5 (6) sentence 5 no. 1 lit. c) IVV, which is then regularly applicable). Finally, severance payments that fulfil more than one privileged circumstance within the meaning of Section 5 (6) sentence 5 IVV should (now) regularly require a special explanation.
• Prohibition of hedging (Section 8 (2) IVV, Question 13): In principle, every institution should establish further control instruments in its remuneration governance to ensure compliance with the hedging prohibition in addition to the mandatory declaration of commitment, which should in particular include a random sampling obligation, for example for employees' securities accounts. Non-listed institutions should be exempt from such further control instruments if they are organised in the legal form of a public savings bank (Sparkasse) or a cooperative (Genossenschaft) with BaFin as the supervisory authority, or if they carry out a market search for (non-)existing derivative instruments to hedge variable remuneration at least once a year. In this respect, BaFin is utilising an instrument that is already established in practice to manage the risk of the hedging prohibition.
   

7. Selected pronouncements on the special requirements of the IVV for the variable remuneration of Risk Takers in (qualifying non-) significant institutions (Questions 6 and 7, 15 to 18)

On the special requirements of Sections 18 et seq. IVV on the variable remuneration of Risk Takers in (qualified non-) significant institutions, the following selected additional statements in the FAQ IVV are worth mentioning:

• Weighting of the performance parameters pursuant to Section 19 (1) sentence 1 IVV in the variable remuneration of managing directors - and of all other Risk Takers (question 15): BaFin considers - following on from the announcement on Section 19 IVV with the same content in the BaFin interpretation aid - that (in particular) for the remuneration systems of the members of the management board, the merging of the levels of the organisational unit targets and the individual targets remains permissible, provided that these account for at least 30% of the overall targets. In the final FAQ IVV, BaFin has not taken up the consideration put forward by practitioners in the consultation process that it is also conceivable under supervisory law to merge the levels of the institution/group targets and the organisational unit targets.
  
  In addition to the previous statements in the FAQ IVV-E and in the BaFin Interpretative Guidance that the performance parameters pursuant to section 19 IVV are generally to be weighted approximately equally at the levels of the institution/group, the organisational unit and the individual targets, BaFin stipulates in the FAQ IVV that a non-equally weighted consideration of the three performance parameter levels (including their reasons) must be documented.
• Application of a modifier for target achievement (Question 16): BaFin continues to allow the application of a modifier for the institution/group level with a bandwidth of up to 20 percentage points. Institutions must document as many case studies as possible in the Remuneration Guideline in order to concretise their discretion in the final determination of target achievement. It should be permissible to differentiate the application between different groups of Risk Takers if the underlying remuneration parameters justify a differentiation. Each application of a modifier must be documented in a comprehensible manner, including the justification.
• Negative profit contribution pursuant to Sections 18 (5), 5 (2) IVV and complete loss of variable remuneration pursuant to Section 18 (5) sentence 3 IVV (Question 7): Section 18 (5) sentence 1 IVV covers not only behaviour contrary to duty and morality and serious breaches of duty, but also a negative deviation from the performance parameters of the variable remuneration. BaFin also emphasises the need for further specification of the individual undefined legal terms and, in particular, for the "material" regulatory sanctions and the "material" supervisory measures within the meaning of Section 18 (5) sentence 3 no. 1 IVV as well as the "serious degree" of the breach of internal or external regulations within the meaning of Section 18 (5) sentence 3 no. 2 IVV. The pronouncements reflect BaFin's observations on corresponding practical examples - affected institutions must review their remuneration guidelines for relevant consideration of the new pronouncements in the FAQ IVV. 
• Instrument-based remuneration component (NWE component) for non-capital market-oriented institutions (Question 18): BaFin clarifies that the NWE component must include suitable risk ratios (e.g. CET 1 ratio, risk cover funds) in addition to an earnings-related parameter. Institutions that are not potentially systemically important in accordance with Section 12 KWG can use the institution-specific threshold values from the Section 7 IVV test to illustrate the performance. This simplification announced by BaFin for the first time has already met with a positive response in practice.
• Special provisions for development institutions (Question 17): BaFin announces - in continuation of its statements in the BaFin interpretative guidance - that development institutions may waive the use of quantitative or financial remuneration parameters for the variable remuneration of their Risk Takers, in each case with a view to the specific development purpose in accordance with the relevant business and risk strategy and may also waive variable remuneration altogether. BaFin clarifies that these simplifications apply equally to legally independent promotional institutions and to legally dependent promotional institutions ("institution within an institution"). 
   

8. Announcements on remuneration governance in significant institutions: Further specification/complexity of expectations regarding remuneration officer's time capacities (Question 19) and consolidation of remuneration control report and Section 12 IVV report (Question 14)

In the FAQ IVV, BaFin specifies its expectations regarding the scope of the function of the Remuneration Officer and his deputy. BaFin’s standard assumption remains unchanged that the function of the Remuneration Officer should generally be exercised full-time, and that institutions may deviate from this by applying the principle of proportionality under supervisory law and determine a part-time activity if (1) the size, internal organisation and type, scope, complexity and risk content of the institution's business, (2) the number of total employees, (3) the number of Risk Takers in addition to the management board members with variable remuneration of more than EUR 50,000, and (4) quantitative complexity of the remuneration systems of the Risk Takers in addition to the managing directors, no full-time activity is deemed necessary, whereby the part-time activity in this case should generally be at least 0.5 FTE. Part-time work should still generally not be considered if more than 10 Risk Takers receive variable remuneration amounting to more than 100% of the fixed remuneration. Exceptions to this expectation are plausible - taking into account the specific (additional) material and personnel resources - if they can be substantiated in a materially robust manner, taking into account the aforementioned assessment criteria. In the final version of the FAQ IVV, BaFin has defined the situation in which the Risk Taker's remuneration system provides for variable remuneration of a maximum of EUR 50,000 p.a. as a standard example of part-time work with less than 0.5 FTE as being helpful in practice. According to the FAQ IVV, institutions must review the justification of the specific time scope of the remuneration officer and the deputy in the remuneration guidelines (Sections 26, 11 (1) IVV) and adjust it if necessary.

BaFin also clarifies that Section 12 IVV report can be integrated into the remuneration control report of the remuneration officer, provided that this also adequately documents the action plan in accordance with Section 12 (2) IVV. If the report also contains the review of the appropriateness of the remuneration of the management, this part of the report should - unchanged - be prepared by the supervisory body or by an external third party, whereby BaFin in the final version of the FAQ IVV also defines the possible group of authors beyond the two aforementioned stakeholders to include a suitable independent body within the institution (including the remuneration officer). The FAQ IVV also contain an announcement by BaFin on the expectations regarding the content of the audit items and their presentation in the remuneration control report, whereby in practice the remuneration officers had generally already included the detailed audit items in their terms of reference.
 

9. What is missing? Among other things, no (new) statements in the FAQ IVV on the external employee concept, on the extended requirements for the retention bonus as understood by the EBA and on the group-wide remuneration systems

The FAQ IVV no longer contain separate statements on a large number of IVV provisions (including individual new provisions of IVV 4.0), including

the term of external employee (Section 2 (7) IVV), the specific content and implementation of which in the remuneration systems has still not been conclusively clarified in practice. Practitioners will have to build on the previous findings from the BaFin interpretation guidance and the respective market understanding of the other relevant stakeholders.

EBA's expanded understanding of the regulatory permissibility of retention bonuses in accordance with Section 5 (7) IVV, which includes a so-called specific performance condition in addition to the institution's special legitimate (retention) interest, which is not compatible with the case law of the German Federal Labour Court (Bundesarbeitsgericht) on the ineffectiveness of reference date clauses for (work) performance-related remuneration components (see our Client Alert). There is strong evidence in favour of also referring the specific performance condition to the legitimate interest as a result.

The extended requirements of IVV 4.0 for group-wide remuneration systems in accordance with Section 27 IVV, which in practice also continues to lead to challenges, including in the concrete definition of the subordinate companies covered by the group-wide remuneration strategy.

BaFin has not taken up the corresponding suggestions from the consultation process on these regulatory issues. Institutions must - unchanged - develop individual solutions in line with their needs and document the relevant arguments for regulatory plausibility ("paper trail"). 
 

10. Entry into force, implementation of FAQ IVV in the remuneration systems by 01.01.2025

The FAQ IVV came into force with their publication on the BaFin website on 13 June 2024. BaFin grants institutions a transitional period until 1 January 2025 to implement the changes to their supervisory practice resulting from FAQ IVV. Implementation must take into account the framework conditions under labour law (= depending, among other things, on the specific legal basis of the remuneration system in the employment relationship with the conclusion of relevant works agreements with the responsible works council or supplementary agreements to the existing employment contracts with the relevant employees of the institution).