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Proposal details (identical to 2016) |
Key questions on potential changes |
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Tiered approach |
Covered institutions are categorized into three tiers based on average total consolidated assets with thresholds of $1 billion, $50 billion and $250 billion in assets (Level 3, Level 2 and Level 1 covered institutions, respectively). More stringent rules apply to incentive-based compensation paid to “senior executive officers” and “significant risk-takers” at Level 1 and Level 2 institutions. |
The re-proposal asks about modifying this to a two-tier approach with $50 billion as the primary threshold to trigger enhanced requirements and requiring institutions to identify significant-risk takers with disclosure of their identification methodology to their primary regulator. |
Limits |
At Level 1 and Level 2 institutions, the maximum earned incentive for senior executive officers is limited to 125% of the target amount, and for significant risk-takers is limited to 150%. There are no fixed limits on the size of potential targets but there are prohibitions on basing performance measures solely on comparison to industry peer performance and basing incentive compensation solely on revenue or transaction volume. |
The re-proposal asks whether the limits should be higher or lower as well as whether the relative performance restrictions should apply only to a more limited group of employees. It also asks about requiring performance measures and targets to be set before the beginning of the performance period. |
Deferral |
Includes incentive compensation deferral periods up to four years after the end of the performance period with minimum deferral amounts between 40-60% depending on whether the covered institution is Level 1 or Level 2 and whether the individual is a senior executive officer or significant risk-taker. |
The re-proposal asks whether Level 1 and Level 2 employees should be treated more similarly with regard to deferrals as well as whether longer performance periods can provide risk balancing benefits similar to those provided by deferral. |
Downward adjustment, forfeiture and clawback |
Includes requirements to respond to various adverse outcomes by reducing incentive compensation that has not yet been awarded. It further requires a minimum seven year period from the end of vesting to clawback incentive compensation in the event of misconduct, fraud or intentional misrepresentation. |
The re-proposal asks about requiring specific events to trigger forfeiture, downward adjustment and/or clawback rather than leaving it to the institution’s discretion. |
Governance and reporting |
Covered institutions would be required to have a compensation committee made up of members that are not senior executive officers and take input from the risk and audit committees, as well as annual assessments of the effectiveness of the institution’s executive compensation program. They would be subject to seven-year record retention requirements, with records disclosed to regulators on request. |
The re-proposal asks whether assessments should be submitted more or less frequently to the committee. |
Our Take
A false re-start? 13 years after it was first mandated by the DFA, this re-proposal comes after last year’s bank failures raised questions about senior executive compensation and consequences for significant risk management lapses. However, with even one holdout agency, it will not have an official comment period much less be on track for timely finalization - particularly with the looming election. Fed Vice Chair for Supervision Michael Barr will almost certainly be asked if the Board’s position has changed from Powell’s past skepticism when he appears before Congress next week.
Don’t write it off just yet. Unless Congress reverses or amends DFA Section 956, the requirement to implement incentive compensation rulemaking remains on the books and the 2016 proposal remains the most likely starting point for any future attempts. Accordingly, covered institutions should refresh their analyses of how their incentive compensation programs would need to change to comply with the re-proposal, including by determining their in-scope employee populations as well as the impact of any senior hiring or transitions. As part of this effort, they should broadly evaluate how their compensation programs account for risk management and compliance. Given the widespread public criticism of the failed banks’ executive compensation programs, institutions should consider reasons beyond regulatory requirements, such as potential reputational harm, to ensure that their compensation programs are effectively aligned with risk management outcomes.
Our Take
Limited comparability amidst uncertainty. As the pilot climate scenario analysis does not have any supervisory implications or indicate any plans for future exercises, the summary report largely serves as a closer look at the climate risk management capabilities and challenges of the largest U.S. banks. Further detail may come in these banks’ disclosures for the EU’s Corporate Sustainability Reporting Directive (CSRD), California’s SB261, or the recently finalized SEC climate risk disclosures (if they survive ongoing legal challenges) as all call for firms to describe their climate scenario analysis activities. From the Fed’s perspective, the summary report shows that there is considerable difficulty in comparing individual banks’ results due to their differing approaches to models, assumptions and data on top of their varied business models and risk profiles.
Interesting insights for other banks. The summary report demonstrates that even the largest U.S. banks continue to face challenges with data availability and substantial uncertainty around climate risk impacts. Banks that did not participate in the exercise should closely review the summary to get ahead of challenges they may face as they seek to enhance their climate risk management capabilities. In particular, banks with over $100 billion in assets seeking to align with the banking regulators’ climate risk management principles may find climate scenario analysis useful to inform their assessment of their climate risk exposures – as some of the participating banks did before doing this pilot. If they take a similar approach of utilizing vendors, they should take ownership of understanding and documenting the process and methodology. Even global banks that are required to conduct climate scenario analysis by their primary regulators may find the report’s discussion of insurance dynamics valuable as most foreign exercises do not include an expectation to consider insurance coverage. Ultimately, the report shows that these challenges will require further investment, innovation and collaboration.
Our Take
The regulators have provided community banks with a helpful resource - now they expect them to use it. Banks have long sought greater insight into regulatory expectations around TPRM, and the agencies have now provided ample information. The detailed information provided by the guide significantly expands upon the broad principles from the earlier June guidance, and while it is intended to assist community banks, banks of all sizes can benefit from the guide’s considerations and suggestions. Accordingly, all banks should:
While the guide suggests a degree of flexibility for community banks by acknowledging that their programs should be designed commensurate with their size, complexity and risks, it ultimately reminds them that they remain responsible for any compliance failures or consumer harm. Considering that community banks’ TPRM programs continue to face obstacles related to uneven bargaining power, limited technology capabilities and resource constraints, banks are now on notice that they should prioritize enhancing their programs to close gaps quickly and effectively in anticipation of increasing scrutiny.
These notable developments hit our radar recently: