Introduction

To provide more comprehensive guidance to securities companies in relation to establishing a robust remuneration system, including improvement of the remuneration incentive and restraint mechanism, which may promote efficient operations, sustainable development and better assumption of social responsibilities of securities companies, the China Securities Association (the "CSA") recently issued the Guideline for the Establishment of Sound Remuneration Systems for Securities Companies (the "Guideline"). In brief, securities companies are required to further adjust and regulate their remuneration systems and incentive structures in alignment with the principles and objectives set out by the CSA and to implement a more sound management concept. The Guideline ensures compliance with bottom-line requirements, while also requiring securities companies to promote positive incentives and enhance long-term corporate value. In this article, we will analyze and interpret essential points from the Guideline and provide corresponding compliance suggestions.

I. Background of the Guideline

In recent years, the high level of compensation of securities companies' employees has started to draw increasing attention from regulators and the public, both domestically and internationally. For example, a securities company issued a code of conduct that required its employees to restrict the use of luxury goods. In another example, an employee from a different securities company tweeted on a social media platform about her annual salary of CNY 2.24 million and complained about the high tax rate of her year-end bonus. Concurrently, regulators have begun to issue a series of regulations, policies, and other regulatory documents related to these types of issues on a recurring basis.

As early as 2018, the CSA and Asset Management Association of China jointly issued the Guideline for Internal Control of Bond Investment Transactions Business of Securities and Fund Operating Institutions, which provided detailed regulations on the deferred compensation of bond-related investment and research personnel. Subsequently, in 2020, the China Securities Regulatory Commission (the "CSRC") issued the Code of Corporate Governance of Securities Companies, which further clarified the remuneration incentive and restraint mechanism for directors, supervisors and senior executives of securities companies. In September 2021, the CSRC issued the Opinions on Strengthening Regulation of the Integrity of Intermediaries on Investment Banking Business under the Registration System (Draft for Comments), which required intermediaries to establish a scientific and reasonable incentive and restraint mechanism and a mechanism for internal accountability. This prohibited securities companies from directly linking employees' compensation with the revenues of projects they undertake or contract, and also prohibited the use of excessive incentives such as business contracting in the investment banking business, among others. In addition, Measures for the Supervision and Administration of the Directors, Supervisors, Senior Executives, and Practitioners of Securities and Fund Operating Institutions, which came into effect on April 11, 2022, further required securities and fund business institutions to establish a long-term and reasonable compensation management system that fully meets compliance management and risk management requirements, to avoid short-term, excessive incentives and other improper incentive behaviors.

The Guideline represents a further extension of the regulatory provisions and policy requirements set out above, and provides more comprehensive, systematic, and specific guidance for securities companies to establish a sound remuneration system and to improve the remuneration incentive and restraint mechanism. It also reflects the current trend that the regulatory authorities may gradually strengthen the regulation and guidance on the remuneration system and incentive mechanism of securities companies.

II. Analysis of the Key Elements of the Guideline and Compliance Recommendations

We briefly introduce and interpret the key elements of the Guideline as follows.

(i) To Establish a Supervision Mechanism for the Implementation of the Remuneration System

Articles 9 and 10 of the Guideline require that securities companies establish a supervision mechanism for the implementation of the remuneration system and improve internal controls, such as examination, approval and cross-checking along the company's chain of command. They also require that securities companies establish and improve the performance guarantee mechanism of the remuneration committee and supervision department. These two articles aim to further implement the remuneration restraint mechanism within securities companies and effectively regulate the implementation of the remuneration system.

We suggest that securities companies should formulate relevant rules and regulations to support the implementation, establish and improve the responsibilities of the remuneration committee and the performance guarantee mechanism, clarify the departments across all levels for the hierarchical examination and approval and cross-checking of remuneration, as well as the process, nodes, and authority of the approval, establish the supervision mechanism stipulated in the Guideline, and conduct regular verification of the implementation of the system in the areas of remuneration structure, payment, and assessment. The corresponding verification records should be preserved and submitted to the Board of Directors for consideration in accordance with the Guideline.

(ii) To Improve the Appraisal System and Standards

According to the requirements of Article 13 of the Guideline, securities companies need to improve their appraisal systems, and give a more holistic consideration that includes professional conduct, integrity, social responsibility performance, and customer service levels as important appraisal factors, instead of focusing exclusively on performance.

We suggest that securities companies pay particular attention to improving their appraisal system and dimensions, and set bespoke appraisal standards according to their specific situations and in respect of the scope of responsibilities of different departments. If the above assessment indicators do not exist in the previous assessment system of securities companies, they should be improved over time and the corresponding weights should be reasonably allocated. The appraisal mechanism should not only motivate employees' performance, but also pay close attention to employees' compliance, service, and other comprehensive performance factors to avoid a misaligned appraisal mechanism where employees may be incentivized to take short-term actions at the expense of other stakeholders, which in turn leads to increased business and regulatory risks. If there is a major compliance and risk control incident, it should be vetoed by one vote, with no other indicators to be considered.

(iii) No Direct Linkage of Remuneration to Project Revenues

Securities companies shall not directly link employee remuneration with the revenues of the projects they undertake or contract, and shall not carry out business in the form of excessive incentives such as business contracting, which have been also stipulated in other regulatory requirements and are emphasized again in Article 14 of the Guideline to attract the attention of securities companies. Consider the investment banking department as one example, which represents an important source of revenue for securities companies. If employee remuneration is not related (or is less related) to the project, then employees may be less motivated to work as they are incentivized by a guaranteed salary, which is not conducive to performance growth. If the remuneration is directly linked to the project, it may lead to the pursuit of high bonuses for employees to conduct business irrespective of compliance or reputational risks to the business, which would ultimately force securities companies to bear added project risks and regulatory fines and consequences. It therefore remains a pressing challenge for securities companies to achieve positive incentives for employees while continuing to comply with regulatory requirements and control project risks.

We suggest that securities companies consider adjusting and apportioning employee remuneration structure into discrete categories to avoid a single, short-term remuneration structure purely focused on basic salary and project bonus. It would negatively impact employees' motivation if the basic monthly salary remains fixed and the variable salary is only predicated on the project bonus to comply with regulatory requirements that the salary is "not directly linked to the project".

Therefore, securities companies may consider diversified remuneration items such as job salary, performance salary, year-end bonus, equity incentive, special benefits, etc., supplemented by a targeted and ranked assessment to achieve scientific and long-term performance incentive. After splitting employee remuneration structure into discrete categories, securities companies could then set different assessment standards and dimensions according to different remuneration items, and pay corresponding remuneration items according to employees' performance. This serves to avoid a direct linkage with projects and also can positively motivate employees. Simultaneously, the introduction of an appraisal mechanism for remuneration payment can also incorporate risk compliance and other factors into the appraisal indicators according to Article 13 of the Guideline.

(iv) To Improve the Deferred Compensation Mechanism

The deferred compensation mechanism has been implemented in securities companies for many years. The scope and percentage of employees whose remunerations are deferred and the length of the deferral period may differ. Article 15 of the Guideline once again emphasizes that the chairman, senior management, heads of major business departments, branch heads, and core business personnel are included as the main subjects of the deferred compensation mechanism. This article also emphasizes that the length of deferred compensation payments should match the risk duration of the relevant business, and the speed of deferred compensation payments should not be faster than the equal share ratio.

We suggest that securities companies should further improve and implement the deferred compensation mechanisms according to the Guideline, and coordinate the risk duration with the years and proportion of deferred compensation payment to guide employees to enhance their awareness of risk control and focus on long-term development. Employees should avoid ignoring compliance risk control requirements in pursuit of short-term and immediate benefits, or bring medium and long-term risks to securities companies. Concurrently, securities companies should also formulate more transparent, rigorous, and reasonable deferral rules and apply them to employment contracts and internal rules and regulations.

(v) To Enhance the Accountability Mechanism

Article 16 of the Guideline indicates that a strict accountability mechanism should be established to enhance the enforcement of remuneration management, including but not limited to the stop payment, recovery and deduction of bonuses, allowances, and other types of remuneration. Internal financial responsibility should be imposed on executives and officers in key positions and other relevant responsible personnel who violate the regulations or cause the company to bear excessive risk exposure. This places more stringent requirements on the risk control awareness of executives and practitioners and requires securities companies strengthen the association between project risks and related personnel to avoid a situation where employees have obtained high bonuses but the company bears all the risks and penalties, which also has a certain deterrent effect.

As a final example, in a previous incident that attracted much attention from regulators, the industry, and the media, a project managed by an investment manager caused the securities company to lose hundreds of millions of Chinese yuan. The employee demanded that the company pay the difference in his performance bonus, which was deducted as risk reserves. The court upheld the employee's claim and held that the two sides disagreed on the definition of risk reserves and the conditions for its payment, and the securities company should bear the unfavorable consequences due to a lack of sufficient evidence. If securities companies could improve the specific details of their accountability mechanisms, in accordance with the Guideline, and ensure the effective implementation of the mechanisms, they would likely avoid to a certain extent the situation in the above case, which materially impacted the company's profitability and reputation.

We suggest that securities companies formulate the details of their internal accountability mechanisms accordingly and clarify the specific operation of the accountability mechanisms, including the specific circumstances, criteria, process and scope of personnel to be applied for activating the accountability mechanisms. Accountability methods may include stopping the payment of bonuses and allowances, and recovering or deducting the returned bonuses. The scope of accountability personnel could be determined according to different levels of risks and penalties, and the percentage of recovery or deduction could vary according to the rank of the employees.

Conclusion

According to the Guideline and related regulations, if a securities company violates the Guideline or fails to establish a sound remuneration system, the CSA would enact disciplinary measures against it, and the classification regulatory score of the relevant company on the CSRC may be affected. If a securities company is found to have deficiencies in remuneration management involving corporate governance, compliance and internal control, the CSA would bring it to the attention of the regulatory authorities. Moreover, if a securities company is suspected of violating the regulations, the CSA would submit the relevant infractions to the regulatory authorities for investigation and enforcement. To avoid the risk of the company's operations being disrupted or penalized due to non-compliance of its incentive compensation system, we suggest that securities companies promptly conduct a self-examination of the internal salary policies, benefits, rewards and performance, in accordance with the requirements of the Guideline and related regulations. Finally, the securities companies should improve and adjust the remuneration system and incentive system by combining the research from its Human Resources department and the support of professional institutions, so as to promote practitioners to obtain effective work rewards and incentives in a compliance way through a long-term, stable and reasonable remuneration system, which may ultimately improve the internal compliance governance level of securities companies throughout the industry.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.