FINANCIAL SERVICES
Global banking survey shows progress towards comprehensive compensation reforms
An international survey of leading wholesale banks finds that “significant progress has been made in improving compensation policies and practices”.
Overall, the report by the Institute of International Finance (IIF), in collaboration with Oliver Wyman, concludes that most major banks are now implementing compensation systems in line with the Implementation Standards published by the Financial Stability Board (FSB) in September 2009. IIF is the global association of financial institutions and has over 420 members.
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Dr. Josef Ackermann, Chairman of the Board of Directors of the Institute of International Finance, Chairman of the Management Board and the Group Executive Committee of Deutsche Bank AG, said: “Many banks have made necessary and important changes in their compensation systems by adopting policies and practices that are in line with the views stated by the Group of 20 and which are, therefore, consistent with the ‘Implementation Standards’ agreed last year under the Financial Stability Board’s Principles for Sound Compensation Practices. While there are still areas that need further improvement, the progress reported in this new survey is most welcome.”
About the report
The report consists of responses from 37 financial services firms, supplemented by a series of individual interviews with leading wholesale banks. Between them, these institutions represent 70% of total global wholesale banking revenues for 2009.
The IIF highlighted key issues in compensation structures in its report on lessons from the financial crisis in mid-2008, where it published a set of compensation policy principles, and this was followed by the first IIF-Oliver Wyman survey report in Spring 2009. The latest report highlights progress since the survey in early 2009, while also comparing industry performance against the FSB guidelines.
The report, which involved input from the IIF Technical Advisory Panel on Compensation, is published under the overall direction of the IIF Steering Committee on Implementation (SCI) that is co-chaired by Rick Waugh, President and CEO of Scotiabank, and Klaus-Peter Müller, Chairman of the Supervisory Board of Directors of Commerzbank AG.
Main developments
"Substantial reforms" in compensation practices are taking place in governance, risk adjustment and deferred payouts.
"Further work" is needed in such areas a disclosure and allocation of bonus pools to take greater account of risk-adjusted profitability, according to the IIF.
Rick Waugh said: “This report documents the important changes the financial services industry has made in its compensation practices since the onset of the crisis. However, more has to be done by those of us in the industry, and the IIF will continue to monitor performance in this area. We are seeing greater emphasis to ensure that incentives are linked to performance and are aligned with shareholder interests. Importantly, we do not see this as restricting the level of compensation, but that banks adopt policies to ensure that incentives do not induce risk-taking in excess of the firm’s risk appetite.”
Klaus-Peter Műller said: “The IIF has stressed in past reports the critical roles that boards of directors need to play in determining compensation policies. The new survey shows that boards are now playing far larger roles than in the past, and there is a notable increase in the role and reach of the remuneration committee with greater direct oversight of the allocation of bonus pools, the determination of suitable performance metrics and the design of compensation plans.”
Increased role for risk and control functions
The report finds that since early 2009 there has been a “dramatic increase in the involvement of the risk and control functions in setting front office compensation”. Risk management involvement in the compensation process has risen from slightly less than half of the firms in 2008 to almost all firms in 2010.
The risk function is now contributing, in varying degrees, to policy reviews, determining the suitability of performance metrics, establishing compensation formulae and signing off on the risk-appropriateness of incentive plans.
Key survey results
The survey found that progress on the key area of payout structures has been "significant", with "substantial improvements" including:
increased use of payout instruments aligned with the long-term performance of the firm or business-unit, and increased recourse to non-cash instruments
the use of deferred compensation has doubled to 39% of the compensation pool
85% of surveyed banks are now using deferral periods of three years or more and are tiering deferral rates so that the remuneration of the most senior and highest paid executives is deferred for longer
nearly 70% of deferred compensation is paid out in stock or stock-linked instruments (greater than the FSB Implementation Standards’ 50% target).
Firms have also made swift progress in eliminating “potential rewards for failure”, according to the report. Unconditional payouts have been reduced by 50%, with the remainder focused on new hires, and multi-year guarantees have been all but eliminated; of the 15% of firms that had some form of a golden parachute, most have taken steps to eliminate them.
Further progress needed
However, the report points to some areas where further progress is needed. It states that a significant majority of banks remain short of the FSB Implementation Standards on disclosure, with less than half of survey participants publishing information on bonus pool sizing and allocation, and on the methodology for determining individual compensation of highly paid employees.
In addition, the report notes that while the industry has made significant progress in the way it determines and allocates bonus pools to take greater account of risk-adjusted profitability, this is “more of a multi-year effort as it requires not only moving to risk adjusted metrics but also adapting those metrics to the time horizon and specific risks of various businesses”.
A final word
“This is an encouraging report, but it shows that there are remaining challenges. For its part the industry needs to continue its efforts to resolve outstanding technical and managerial compensation challenges in order to reduce excessive risk taking and so contribute to a more resilient financial system. It is important, however, that the regulators make maximum efforts to ensure that there is meaningful international consistency in the application of these standards.” - Charles Dallara, Managing Director, IIF.
“While progress to date has been remarkable, in many ways the full year 2010 will be even more instructive as firms in the industry draw lessons from experience and take into account the new legislation impacting compensation approved in the US and the EU among others. Compensation reform will also benefit from the fundamental improvements in such critical areas as risk management, governance, and disclosure that are being implemented by the industry within the framework of the new regulatory proposals currently being developed.” - George T. Abed, IIF Senior Counselor, who oversaw the work on this report by Oliver Wyman.
Want to know more?
Title: Compensation Reform in Wholesale Banking 2010: Progress in implementing global standards, Institute of International Finance, in collaboration with Oliver Wyman.
Availability: You can download the 59-page report in PDF format at www.iif.com/press/press+156.php.
The Institute of International Finance is the global association of financial institutions and has over 420 members. For more information visit www.iif.com.