New Approach to Remuneration Policy for Investment Firms: A Polish Capital Market Perspective

The experience of the recent financial crisis leads to reflections on the relevant mechanisms of risk reduction of an investment firms activity. Within the European Union, the Directive 2010/76/EU (CRD III) has introduced new rules regarding the remuneration policy for investment firms. The main goal was to reduce the risk of investment firms’ activity. This is a prudential regulation. The purpose of this article is to evaluate, from the point of view of an investment firm, proposed by the EU legislator approach to remuneration policy aimed at reducing the risk of the operation of this type of financial institutions. The aim was to identify the key problems with which Polish investment firms may face in the future in connection with new remuneration policy rules. As far as the methodology is concerned, the author carried out in-depth and standardized interviews with the representatives of several investment firms in Poland. In addition, the method of observation has been applied. The results of the research demonstrates that the above mentioned regulations will have limited impact on reducing the risk of the activities of these financial institutions as well as their implementation will be difficult for them in practice.


Introduction
One notable feature of a properly functioning capital market is the stability and safety of its participants.

The ground of the problem
The financial sector problems over the world, leading not only to the failure of financial institutions, but also to systemic problems, tend to discuss the sources of occurring irregularities. One of the frequently reported reason having a significant negative impact on the financial condition of investment firms, was improperly functioning remuneration policy. Th e remunera-Th e remunera-The remuneration systems have in a number of cases not been closely related to the strategy and risk appetite of the company and its longer term interests (Kirkpatrick, 2009 not existed in the UE legal system before. It is worth noting that these regulations do not apply to entities such as investment funds, pension funds, and private equity funds. It is a kind of package requirements, prudential regulations, in order to prevent potential adverse effects of poorly designed remunerations structures for the accuracy of risk management and risk-taking control by individual employees. It obliges investment firms to establish and implement policy and remuneration practices contributing to effective risk management in respect of the particular categories of staff whose professional activities have a significant impact on the risk profile of the investment firm.

Methodology
The author of the following paper conducted research

Remuneration policy
In the light of the conducted analysis by the remuneration policy should be understood the policy including salaries and discretionary retirement benefits. This is broader approach because it also includes within its scope some kind of benefits payable to former employees who are retired. It is worth noting that according to the CRD III this policy applies to certain distinct groups of individuals acting within the investment firm, i.e. senior management, risk takers, staff engaged in control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on their risk profile. It can be concluded that the above applies to a part of the wider remuneration system of a particular investment firm. Therefore, these institutions face the challenge of adapting the existing remuneration schemes to the requirements of EU law. This will require taking a series of actions at the operational level, including changes in labour contracts with existing employees. This approach certainly makes that employees having an impact on the risk profile of an investment firm would seek to ensure that the relevant capital adequacy requirements have been met. However, this may be controversial, from the point of view of those employees who do not receive variable compensation, despite the fact that they did not have any impact on decision-making influencing capital adequacy requirements.

Results measurement and granting of remuneration
According to the CRD III, the remuneration to be paid must be based on a kind of joined results, i.e. results of the individual employee, the individual for whom the employee works and the whole investment firm.
This approach means that in certain situations, the employee may suffer the consequences of poor performance of other entities subject to assessment. Subject to the CRD III, in assessing, the financial criteria must be taken into account (quantitative) and non-financial (qualitative). In the opinion of the author, the first one appears to be objective, the employee has knowledge of the factors that affect the amount of his remuneration.
As regards the second type of the problem the objectiveness is limited. The criteria can be characterized by relatively high discretion and must be used very carefully. In line of the CRD III, evaluation of each employee should take place over a number of years.
However, the problem appears in the case of newly hired employees who, in extreme cases will be able to bear the negative consequences of decisions made in the past when they were not employed in the current investment firm.

Remuneration in the form of financial instruments
One of the requirements imposed on investment firms is obligation to introduce remuneration in the form of financial instruments. Therefore, the CRD III expects that at least 50% of the variable remuneration shall

Severance pay
In accordance with the principles of remuneration, which are aimed at reducing the investment firm's risk, the severance pay caused by termination of the contract should reflect the results achieved by the particular employee over time. The rules for such payments shall be determined in the way that does not reward failure (CRD III). In this case, the above refers primarily to limit the introduction of solutions encouraging to take actions leading to a higher risk than preferred by the owners of investment firm. This negative effect can occur in case of implementation of golden parachutes (Evans & Hefner, 2009;Singh & Harianto, 1989;Choi, 2004) causing that employees after leaving the institution receive above-average remuneration regardless of the results already obtained and the level of risk of the investment firm.

Guaranteed variable remuneration
To encourage jobseekers to employment in particular However, it can be assumed that it may have the form of both cash and financial instruments. According to the CRD III, in the next years guaranteed payment of variable remuneration is unacceptable. This solution may be a field for abuse for investment firms. They could potentially be used for short periods of employment in order to circumvent the stringent requirements. In this case, the variable remuneration may have no effect on reducing the risk of investment firms.

Retirement benefits
The new rules also introduce a special approach to retirement benefits. It is assumed that remuneration policy should take into account the investment firm strategy, its goals, values and long-term interests. If an employee leaves the investment firm before reaching retirement age, the investment firm should retain unspecified retirement benefits for a period of five years in the form of specific financial instruments. However, in the case when an employee has reached retirement age, an employee is obliged to keep unspecified pension benefits paid in the form of financial instruments within five years (CRD III). In the opinion of the author, this solution seems to be controversial, particularly in the second of these cases. Retirement benefits will be granted, but disposal shall be limited within defined period.

Hedging strategies and insurances
Pursuant to the regulations of the CRD III, staff members are required to undertake not to use personal hedging strategies or remuneration-and liability-relat- it must be concluded that investment firms will face in practice many problems.
It seems that, the introduction of stringent remuneration rules, causing in the opinion of investment firms, many limitations and uncertainties regarding payments, may result in a permanent increase of fixed remuneration. Therefore the expectations of employees in this field will probably change. In the opinion of the author, offering higher fixed remuneration by investment firms meeting expectations of employees means that these employees will approach with indifference to variable remuneration and thus it will not be treated as the incentive to limit decisions affecting the growth of the risk of the investment firms. The basic goal of the new remuneration rules will not be probably achieved in this case.
As far as the remuneration policy is concerned, in the opinion of the author, the EU legislature has made too deep harmonization. It is worth noting that, despite the distinctions of the common EU capital market, there are also the capital markets of each Member States and operating within these markets investment firms. Each capital market has its specific characteristics, especially in the meaning of its structure, and participants. Moreover, each capital market is in par- Secondly, as indicated earlier, it appears that the expectations of employees will change and they will be interested in the increase of fixed rather that uncertain and deferred variable part of remuneration. Although, the cost of adapting may by partially passed on the end user (client), this solution seems to be limited. This would probably have negative effects on the dynamic of development of these financial institutions.