As performance-based bonus policies in the banking sector continue to attract the attention of the general public, financial regulators have provided specific measures for their improvement. Such measures are expected to be reflected in the relevant laws and regulations, and individual financial institutions may also be required to mirror these changes in their internal regulations. Therefore, financial institutions will need to keep an eye on changes in the financial regulators’ stance and on future amendments to the applicable laws and regulations.
As a follow-up to the 13th Emergency Meeting on Macroeconomic and Financial Stability held by the Ministry of Economy and Finance, the Financial Services Commission (the “FSC”) and the Financial Supervisory Service (the “FSS”) have set up a “Taskforce on Improving the Management and Operating Practices of Banks and Banking System” to review issues raised in the banking sector and discuss improvement measures, and are also operating a working-level group.
Issues related to improving the performance-based bonus system under the Act on Corporate Governance of Financial Companies (the “Corporate Governance Act”) were discussed during the 6th working-level task force meeting (the “6th Working-Level TF”) held on April 19, 2023. Some of the matters discussed in the 6th Working-Level TF are already included in the proposed amendment to the Corporate Governance Act, which the government submitted to the National Assembly in June 2020, and therefore specific changes in the policy framework and the relevant laws and regulations will come into force soon.
In a meeting with the chairmen of major financial holding companies that took place on March 31, 2023, the FSC stated that to improve performance-based bonus policies, it will amend relevant laws and regulations to require financial institutions to explain their remuneration plans to their shareholders in order to further justify remuneration payments, and will clarify the legal grounds regarding clawbacks or the cancelling of payments in the event a financial institution suffers from losses attributable to executives that received a performance-based bonus.
The following summarizes the details of the regulators’ proposed amendments to the applicable laws and regulations, which were further discussed during the 6th Working-Level TF.
1. Strengthened Incentives Based on Long-term Performance of Executives
The current Corporate Governance Act provides for deferral, adjustment and/or clawback mechanisms regarding performance-based bonuses to executives and financial investment managers. However, these mechanisms have been implemented restrictively compared to how they have been implemented in foreign countries. Regarding deferrals, for example, while the law sets the deferral ratio to be 40% or higher and the deferral period to be three years or longer, many financial institutions simply set the scheme at the minimum required level (i.e., 40% of the payments to be deferred over three years). Some financial institutions do not have relevant internal standards and allow their remuneration committee to decide on a case-by-case basis, while others do not withhold performance-based bonuses at all.
To improve the effectiveness of the bonus deferral/adjustment system, financial regulators have proposed (i) to increase the minimum deferral ratio and deferral period (from 40% to 50% and from three years to five years, respectively), and (ii) to impose a statutory obligation for financial institutions to establish and operate clear and detailed internal standards for adjustment, clawback and deferral of performance-based bonuses.
2. Strengthened Shareholder Control Over Remuneration Plans for Registered Executives (“Say-on-Pay”)
The Korean Commercial Code (the “KCC”) provides that remuneration for directors shall be determined by a company’s articles of incorporation or by resolution at a shareholders’ meeting. In practice, however, shareholders of financial institutions usually approve only the total maximum amount of remuneration for all registered directors at a shareholders’ meeting, and then allow the board of directors to determine the specific bonus amount payable to each of the directors within the established maximum amount.
Under such regime, while shareholders are able to control the total amount of directors’ remuneration, they are not able to check whether or not the specific amount of remuneration paid out to individual directors is adequate. There has also been criticism that allowing directors to determine their own remuneration may create a conflict of interest.
In this regard, the proposed amendment to the Corporate Governance Act submitted in June 2020 will strengthen shareholders’ control over directors’ remuneration by requiring each registered executive (director and statutory auditor) of a listed financial company of a certain size to explain the applicable remuneration plans (i.e., the design and operation of the company’s remuneration system, the standards for the calculation of the total remuneration amount, the remuneration payment method, etc.) at the general shareholders’ meeting at least once during his/her term of office.
3. Expanded Disclosure of Remuneration for Individual Executives
Although the current Corporate Governance Act requires financial institutions to disclose the total amount of remuneration for executives in their annual reports, the specific amounts paid out to individual executives are not subject to disclosure. Thus, it is difficult to understand whether the remuneration given to a certain executive adequately reflects his/her contribution and responsibility to that financial institution.
Accordingly, the proposed amendment to the Corporate Governance Act submitted in June 2020 included a provision requiring financial institutions subject to the Corporate Governance Act to disclose the total remuneration, total performance-based bonuses, and specific calculation standards and methods, etc. for certain executives whose total remuneration or total performance remuneration exceeds a certain amount.
It appears that financial regulators are seeking to improve the performance-based bonus system under the Corporate Governance Act to ensure that “remuneration corresponds to the performance and responsibilities” of the relevant executive. In particular, as many of the key issues discussed in the 6th Working-Level TF are already included in the proposed amendment to the Corporate Governance Act, the changes may soon be implemented.
Furthermore, if the Corporate Governance Act requires financial institutions to update their internal control standards to ensure the improvements to the performance-based bonus system are properly implemented, financial institutions will also need to re-examine their internal control standards to reflect the new requirements. As such, a reform of the performance-based bonus system under the Corporate Governance Act will have a significant impact on banks and other financial companies alike.
In light of the above, financial institutions are advised to carefully review the regulators’ position on this issue, including keeping track of any changes in relevant laws and regulations.