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Revival of the Employee Stock Ownership Plan in Hungary

As a result of a 2015 amendment, financial institutions, insurance companies, and investment firms may launch an ESOP with the aim of managing rights on financial instruments for the benefit of the employees within the framework of the remuneration policy. This opportunity may well lead to the widespread use of ESOPs.

Dr. Eszter Kamocsay-Berta, LL.M., Managing Partner ,  KCG Partners HUNGARY 

Background – The History of the Principle of Self-Regulation in Hungary 

Hungary’s Act XLIV of 1992 on the Employee Stock Ownership Plan (the “ESOP Act”) allows employees to acquire an ownership stake in their employing company by means of an organization established on the basis of the principle of self-regulation. The purpose of this legal instrument was to boost a company’s economic performance by bringing together the ownership and co-workers’ collective interests. However, the ESOPs established in the ’90s ceased to exist after a dynamic initial period, which might be explained by the fact that several benefits related to the ESOP were abolished

Seismic Shift in Hungary – the New ESOPs 

The amendment of the ESOP Act by Act CLXXXVII of 2015 established a new form of ESOP operating with centralized management. As a result of the amendment, financial institutions, insurance companies, and investment firms may also launch an ESOP with the aim of managing rights on financial instruments for the benefit of the employees within the framework of the remuneration policy. This opportunity may well lead to the widespread use of ESOPs. Depending on which employees are covered by the ESOP, the personal scope might be extended from the managers to all employees of the company and its subsidiaries within the company group.

If the ESOP is based on securities representing shareholders’ rights, the employees do not necessarily become owners of the founding company that established the ESOP, but acquire membership shares in the ESOP organization, which itself becomes owner of the founding company. Upon meeting the conditions set in the remuneration policy, the employees may exchange their membership in the ESOP organization for cash or securities or for a combination of these.

According to the mandatory rules of the act, ESOPs may only be established for the purpose of facilitating employees in acquiring an ownership stake in their employing company. This implies that ESOPs can only be based on instruments representing shareholders’ rights; simply holding bonds or other instruments that do not represent rights similar to shareholders’ rights is not in compliance with the mandatory law. In addition, payments must generally be dependent on the yields of the instruments allocated to the ESOP organization. As such yields can comprehensively be established and validated by the annual financial report of the company providing the instruments, it is best practice to let the instruments be held by the ESOP organization for a minimum of one year.  

High Hopes – ESOPs from an International Perspective 

From an international perspective, ESOPs could be a major economic growth factor in Hungary. In the United States, for instance, roughly 7,000 ESOPs were launched before 2015, in which approximately 13.5 million employees were involved, owning more than 8% of American corporate assets. According to U.S. surveys, companies launching ESOPs can expect an extra profit growth of 2.3-2.4% annually, reflecting the extra motivation arising from the participating employees and managers. Although the newly introduced ESOPs are still in their birth phase in Hungary, the above figures project high hopes for this entirely recent legal institution.

Competitive Advantage – the Main Advantages of an ESOP-Based Remuneration Policy 

The revised ESOP legislation significantly encourages a “stakeholder” approach from employees while control remains with the employer over the instruments provided to the ESOP organization.

In addition, it ensures favorable taxation compared to the traditional form of share transfer programs; i.e., payments made to the employees within the ESOP are solely subject to a 15% personal income tax, meaning 18.5% savings by the employees on one hand, while the employers can reduce their public burdens by 23.5% on the other hand.

All in all, it gives priority to the company’s long-term business goals over the employees’ short-term interests in a way that ensures employees’ performance is rewarded in accordance with the company’s business performance.