RBI issues guidelines on compensation of KMP in NBFCs

Prabhat Nigam

13 Sep, 2022

Recently, the Reserve Bank of India (RBI) had introduced a revised scale based regulatory framework for NBFCs which was aimed towards managing the risks caused by misaligned compensation packages. The framework asked the NBFCs to put in place a Board approved compensation policy. The policy should include a constitution of a Remuneration Committee, principles of variable/ fixed pay structures and malus/ clawback provisions. The framework also asked the Board of NBFCs to delineate the role of various committees such as Nomination and Remuneration Committee (NRC). The guidelines on compensation of KMP in NBFCs have been in furtherance of the above mentioned framework.     

Applicability of the Guidelines on compensation of KMP in NBFCs  

The guidelines on compensation of KMP in NBFCs are applicable to the:

• Key Managerial Personnel; and
• Members of senior management

of all the NBFCs under the Scale –based regulation framework.

These guidelines shall not be applicable to those categories of NBFCs who are:

• Under ‘Base layer’; and
• Government owned NBFCs

Highlights of the guidelines on compensation of KMP in NBFCs

Following are the highlights of the guidelines on compensation of KMP in NBFCs:

1. Nomination and remuneration committee (NRC)

All the boards of applicable NBFCs have to constitute a Nomination and Remuneration Committee (NRC). The committee shall be constituted and have powers, functions and duties according to section 178 of the Companies Act, 2013. NRC shall oversee the framing, review and implementation of compensation policy of the company which should have the approval of the Board. NRC can work in close coordination with the Risk Management Committee^[1] (RMC) of the company to achieve alignment between compensation and risks. NRC needs to ensure ‘fit and proper’ status of the existing or proposed directors and that no conflict of interest occurs in the appointment of directors on Board of Directors of the company, KMPS and the senior management.

• Principles of Compensation
  • Compensation and risk alignment: the applicable NBFCs need to ensure that the compensation of the KMPs, senior management is reasonable, taking into account all the relevant factors including adherence to the statutory requirements and industry practices. The compensation packages have to be designed in such a manner that they comprise both the variable and fixed pay components aligned effectively with prudent risk taking to ensure that compensation is adjusted to all types of risks, the compensation outcomes are symmetric with risk outcomes, compensation pay-outs are sensitive to the time horizon of risks and the mix of equity, cash and other forms of compensation are consistent with risk alignment.
  • Composition of fixed pay: The fixed items of compensation, including the perquisites and contributions towards superannuation/ retiral benefits shall be part of fixed pay. Since there are monetary ceilings on the reimbursements so all the perquisites that are reimbursable are included in the fixed pay. Monetary equivalent benefits which are of non-monetary nature, for example furnished house, company car etc. shall also become part of fixed pay.
  • Principles of variable pay
    • Composition of variable pay: The structure of variable pay shall include share-linked instruments or a mix of cash and share-linked instruments and share-linked instruments. These share-linked instruments should in conformity of the relevant statutory provisions.
    • Proportion: The proportion of variable pay should be proportionate to the role and risk taking profile of KMPs/ senior management. As the level of responsibility increases, the proportion of variable pay needs to be increased. A right balance needs to be struck between the cash and cash share-instruments in the variable pay in case variable pay contains share-linked instruments. The variable pay should be effectively variable such as in case a KMP or business unit or at company-wide level does not perform at the expected level; the variable pay can be reduced to zero. For this performance measures related to performance must be clearly defined in the beginning of the performance measurement period so that the employees perceive the incentive mechanism.
    • Deferral of variable pay: The total amount of variable pay is not given immediately after performance assessment.  A portion of the variable pay can be deferred to time horizon of the risks as decided by the Board. The portion of deferral payment can be made applicable to both cash and non-cash components of the variable pay.
    • Control and Assurance Function: The senior management and the KMPs are compensated in a manner independent of their business areas in the company and proportionate to their key role in the company. Such personnel have a higher proportion of fixed compensation. However, a reasonable proportion of compensation may be in the form of variable pay so that the options of clawback and malus do not become infructuous at the time of exercising them.

• Guaranteed Bonus

KMPs and senior management will not be paid guaranteed bonus. However, in case of new hiring/ sign on bonus can be considered but that bonus shall neither become part of base pay nor of variable pay. 

• Clawback/ malus provision

The deferred compensation may be subject to clawback/ malus arrangements in case of negative or subdued performance of the company and/ or relevant line of business or misconduct of the employee in any year. The NBFC is supposed to provide representative set of situations to invoke clawback and malus clauses which may be applicable to the entire variable pay. Along with the situations, NBFCs also need to specify the period during which the clawback and malus can be applied covering, at minimum, the deferral and retention periods.     

Date of coming into effect 

The guidelines on compensation of KMP in NBFCs shall come into effect from 1^st April, 2023.        

Conclusion

The guidelines on compensation of KMP in NBFCs provide broad guidance to the Non-Banking Finance Companies (NBFCs) and their NRCs in the formulation of their compensation policy. While formulating the compensation policy, the NBFCs are supposed to follow all the statutory rules and regulations and also be in compliance with them.

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