A Deep Dive into BaFin’s Ordinance on Supervisory Requirements for Medium-Sized Investment Firm

22nd January 2024

Navigating Regulatory Changes: BaFin’s New Ordinance for Medium-Sized Investment Firms

On 11 January 2024 the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzaufsicht – “BaFin”) has issued the Ordinance on supervisory requirements for remuneration systems of medium-sized investment firms (Verordnung über die aufsichtsrechtlichen Vorgaben an Vergütungssysteme von Mittleren Wertpapierinstituten the Ordinance”).

The main objective of the Ordinance is to create a suitable set of rules for appropriate remuneration and remuneration structures of medium-sized investment firms within the meaning of Section 2 (17) of the German Investment Firms Act (Wertpapierinstitutsgesetz WpIG“).

The remuneration framework under the Ordinance will apply with immediate effect.  

The German Investment Firms Act came into force in 2021. This act implements Directive (EU) 2019/2034 on the prudential supervision of investment firms (Investments Firms Directive – “IFD”) into German law. Together with Regulation (EU) 2019/2033 on the prudential requirements of investment firms and amending Regulations (Investment Firms Regulation – “IFR”), the German Investment Firms Act establishes the legal framework for the authorisation, supervision and prudential requirements of German small and non-interconnected and medium-sized investment firms.  

The Ordinance only concerns the remuneration systems of medium-sized investment firms within the meaning of Section 2 (17) of the German Investment Firms Act. It also includes provisions concerning group-wide remuneration systems and strategies.

The Ordinance does not apply to small and non-interconnected investment firms and large investment firms as they are subject to other specific remuneration ordinances.

 BaFin’s Remuneration System Requirements

The Ordinance outlines the requirements and restrictions of financial benefits and remuneration of any kind, including retirement benefits, benefits in kind (regardless of their nature), and services from third parties that a risk taker receives with regard to his professional activity for the investment firm.

Risk takers within the meaning of the Ordinance and the German Investment Firms Act, are members of the executive board, and all employees of an investment firm whose professional activities have a significant impact on the risk profile of the investment firm or the assets it manages. Investment firms are responsible for identifying risk-takers, based on a risk analysis, and the criteria set out by the IFR have to be taken into consideration when assessing a risk-taker status. 

 The executive board of a medium-sized investment firm is responsible for the appropriate organisation of the remuneration systems for risk takers that are not members of the executive board. The executive board is required to inform the administrative or supervisory body, as applicable, at least once a year about the organisation of the remuneration systems.

 The Ordinance contains detailed requirements for remuneration strategies and systems, as well as their appropriateness. It also contains specific requirements concerning variable remuneration of risk takers.

In accordance with Section 5 of the Ordinance, renumeration systems must be aligned with the objectives set out in the business and risk strategies of the investment firm, whereby the investment decisions and corporate culture must also be taken into account when compiling the remuneration systems.  

Appropriateness of remuneration systems 

Section 6 of the Ordinance contains rules for the appropriateness of these systems. Amongst other things, remuneration systems are considered to appropriate when they include provisions for a clear distinction between fixed and variable remuneration, when they are gender neutral, and are compatible with the solid and effective risk management (and are conducive). Remuneration systems shall also minimise speculative incentives for risk takers.

Clear guidance is also given when it comes to variable remuneration in case of negative performance. The Ordinance states that remuneration systems are not appropriate when the entitlement to variable remuneration remains unchanged despite negative performance profit contributions.

Variable remuneration 

With regard to the general requirements for variable remuneration, a medium-sized investment firm must set appropriate parameters for the ratio between variable and fixed remuneration of risk takers, taking into account the business activities of the investment firm, the associated risks and the impact that the activities of the risk takers have on the risk profile of the investment firm, or the assets managed by it. The proportion of fixed remuneration in comparison to the variable remuneration must be sufficiently high so that the payment of a variable remuneration can be waived in full where necessary. This is because the remuneration systems should not be designed in a way that a risk taker would be significantly dependent on it. In addition, the respective remuneration policies should also emphasise that the payment of variable remuneration is not definite.

 The Ordinance determines additional specific requirements for variable remuneration. The amount of the variable remuneration shall be determined by the performance of the risk taker and is calculated on the basis of an assessment of the individual performance contributions of each risk taker, the performance of the business area concerned and the overall success of the investment firm. Furthermore, Section 8 of the Ordinance specifies the composition of variable remuneration, concerning minimum thresholds of specific payment instruments and minimum withholding periods of such.

Principles of the remuneration systems in the organisational guidelines and documentation requirements 

A medium-sized investment firm must define the principles of the remuneration systems in its organisational guidelines, such as internal policies. In particular, the principles shall include information on the design and adjustment of the remuneration systems and composition, rules concerning responsibilities and decision-making powers of the management body and other persons involved in the decision-making. Investment firms shall document results of decision-making processes appropriately.

Rules concerning group companies and remuneration control committees 

Where the medium-sized investment firm is part of a group, the parent company must define a group-wide remuneration strategy that implements the requirements of the Ordinance. Please note that the Ordinance includes additional provisions if the group companies are based in different jurisdictions.  

Where an investment firm has a remuneration control committee in accordance with Section 44 of the German Investment Firms Act, this committee shall, in addition to the tasks stipulated in the German Investment Firms Act, perform the following additional tasks:  

  •  Support with the appropriate structuring of the remuneration systems for the management body and risk takers; and 
  • Assess the impact of the remuneration systems on the risk, capital and liquidity of the investment firm and whether these are in line with the business strategy. 

 Additional information and considerations

 The appropriateness of the remuneration systems and the parameters on which they are based must as part of the internal audit be reviewed at least once a year, in particular with regard to their compatibility with the business strategies. The review must be documented, and the results presented to the supervisory board. The investment firm must inform the risk takers about the structure of the remuneration systems and the parameters on which they are based.

 Of particular importance is the fact that the investment firms must ensure that existing contracts with risk takers, all company and service agreements, and company practices (betriebliche Übungen) that are not compatible with this Ordinance are amended immediately, insofar as this is legally permissible.

How can Zeidler help? 

As your trusted partner, the Zeidler legal team stands ready to assist and provide support. Our global team of professionals is well-versed in the latest legal, regulatory, and compliance developments impacting the asset management industry. If you have questions or require further information on the Ordinance or the German Investment Firms Act, please contact us.

Author

Patricia Nitschke