Alignment of remuneration payouts to the time horizon of risks

Supervisory Policy Manual

CG-5 Guideline on a Sound Remuneration System

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, the parameters and key consideration on which the judgement is based, 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.

Proportion of variable remuneration to be deferred

2.4.2 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

Supervisory Policy Manual

CG-5 Guideline on a Sound Remuneration System

within a short timeframe, deferral may not be an appropriate mechanism. For others, in roles where the risks taken by them are harder to measure or will be realized over a longer timeframe, deferral will be appropriate.

2.4.3 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. In particular for staff specified in paragraphs 2.1.1.1 and 2.1.1.2, the proportion of variable remuneration subject to deferral arrangements should be substantially higher.²³

2.4.4 Where a deferral threshold is set for the variable remuneration (i.e. an employee’s variable remuneration will be subject to deferral arrangement only if it exceeds a minimum threshold), the Board (or its remuneration committee with the necessary delegated authority) should review at least annually whether such a deferral threshold is appropriate in aligning remuneration with prudent risk-taking.

2.4.5 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 risk-taking and to aligning actual variable remuneration payments with risks and risk outcomes.

Vesting period

2.4.6 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.

2.4.7 The deferred remuneration should generally vest gradually over a period of years and no faster than on a

23 For locally incorporated licensed banks (unless otherwise agreed with the HKMA) and selected foreign bank branches (taking into account their size, complexity, risk profile and business mix), it is expected that 40 to 60 percent of the variable remuneration of senior management, 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. Other AIs are encouraged to attain such a threshold.

Supervisory Policy Manual

CG-5 Guideline on a Sound Remuneration System

pro rata basis, subject to fulfilment and validation of the pre-defined performance conditions. In principle, the vesting period (at least for staff specified in paragraphs 2.1.1.1 and 2.1.1.2) should not be less than 3 years.

AIs adopting shorter vesting period 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. 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 foregone²⁴ (subject to the realised performance of the AI or the relevant business unit).

2.4.8 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 balance between providing effective incentives and validating the performance measures according to the nature and associated risks of the business undertaken by the employees.

2.4.9 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.

Deferred remuneration for departing or prospective employees 2.4.10 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

24 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.

Supervisory Policy Manual

CG-5 Guideline on a Sound Remuneration System

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).

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

2.4.12 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

Supervisory Policy Manual

CG-5 Guideline on a Sound Remuneration System

they engage in certain trading, investment or other financial activities.