The RBI recently released a notification on the Guidelines on Compensation of Key Managerial Personnel (KMP) and Senior Management in NBFCs dated April 29th 2022 vide Circular RBI/2022-23/36 DOR.GOV.REC.No.29/18.10.002/2022-23 ("Notification"). This has been released in furtherance of para 3.2.3 (h) of Circular DOR.CRE.REC.No.60/03.10.001/2021-22 dated October 22nd 2021 dealing with the framework for Scale Based Regulation for Non-Banking Financial Companies ("NBFCs"). This notification provides guidelines for formulating a compensation program for certain NBFCs, based on their applicability.

Legal Context

NBFCs can be defined in Section 45 I (f), of the RBI Act, 1934.

(i), a financial institution that is a company;

(ii), a non-banking institution that is a company with as its principal business receiving deposits under any scheme, arrangement, in any way, or lending any way;

(iii), any other non-banking institutions, or classes of institutions, that the Bank may designate - subject to the prior approval of the Central Government.

These notifications are intended to enhance regulatory oversight by RBI regarding the management of NBFCs, taking into account its role in the financial environment. The RBI believes that NBFCs will be more efficient in their decision-making if they have better management outcomes and are compensated appropriately.

This Notification is only applicable to NBFCs.

This notification is only applicable to NBFCs that are not government-owned. This means that NBFCs which are not government-owned or are below the base layer' are exempted from this Notification. This classification is based upon the scale-based regulations by RBI for NBFCs 2

The Notification refers to the remuneration for KMPs 3 and senior managers 4 members, and not other employees/personnel.

The Notification becomes effective on April 1, st 20,23. This means that the Notification cannot be applied retrospectively. This gives NBFCs ample time to make changes to the Notification before it becomes effective.

The Companies Act 2013 Chapter XIII deals primarily with the appointment and remuneration for managerial personnel. The guidelines in the Notification can be read in conjunction, as they are more general and affect senior management.

Nomination & Remuneration Committee ("NRC") The Notification stipulates that the NRC (and the Risk Management Committee 5) ("RMC") should work together to ensure that the compensation is proportional to the risks. All NBFCs have been mandated to create NRCs. These NRCs must be governed by Section 178 of The Companies Act 2013. The NRC is responsible for drafting, reviewing, and implementing the company's compensation policy. This must be approved by its board.

Principles for compensation: Compensation must be proportional to the risk associated with the decision-making process. It must be paid in accordance with risk-related timelines. The amount of compensation that is paid must be proportional to the risk involved. Fixed and variable pay are options. The compensation package may also include equity, cash or other forms to reflect projected risk factors.
It is important to mention two types of compensation, namely fixed and variable. Fixed pay refers to guaranteed or fixed pay that is paid regardless of risk and is not performance-linked. Variable pay is the opposite of performance-linked incentive pay and encourages risk-taking.

Variable pay can be delayed according to the risk's time horizon. To ensure that compensation is not affected by an immediate payment, compensation may be delayed if the risk develops after [ x]years. Variable pay must be greater at higher levels of accountability because higher levels of risk-taking require more accountability.
In order to maximize efficiency, the Notification emphasizes the importance of balancing both types of pay structures. The rationality of the compensation policy's pay structure will depend on the individual case. This includes taking into account the role and risk factors, as well as setting the appropriate objective criteria.

As a Key Managerial Personne (KMP), the Company Secretary's role is primarily focused on compliance and regulations. They must therefore have a higher fixed component than a variable component. The Chief Executive Officer's role involves making risky business decisions. A higher percentage of variable pay must be paid than fixed pay. They are responsible for taking risks and should be incentivised for it.

Guaranteed Bonus: The bonus does not affect the performance of the person. The fulfillment of certain criteria, as specified in the compensation policy, will guarantee the bonus. A guaranteed bonus is not part of fixed or variable pay. It is also not payable to KMPs or senior management. A sign-on bonus that rewards potential employees with a guaranteed bonus may be offered to employees who are interested in joining NBFCs.

Malus/Clawback In the Notification, it was mentioned that deferred compensation could be subject to malus/clawback agreements. A malus arrangement is where the NBFC may (under certain conditions) prevent payment of deferred damages. This arrangement prevents the payment of any compensation at a later date. On the other hand, a clawback arrangement is one where (subject to the satisfaction of certain events/circumstances) the employee can be asked to return the variable pay received to the NBFC. A clawback arrangement is a compensation policy that applies to malus/clawback for a period at least equal to the retention and deferred periods. These provisions must be included in the compensation policy. These provisions should not be too restrictive or broad. Two such events are mentioned in the Notification, namely when the NBFC has poor financial performance or if an employee is found guilty of misconduct. These clauses are part of the compensation policy and provide a carrot-and stick approach. Employees are only paid if the risk element is realized successfully based upon the business decision made. If it fails, the reward (variable payment) is withheld or taken back. The policy must also be clear and fair, while allowing for discretion in assessing personnel's performance against the clawback/malus provisions.

read more here on Corporate Law Firm In India