What is the main thrust of the new Financial Services Authority (FSA) code?
Simon Hills, executive director, British Bankers’ Association
The main issue banks have to get on top of is connecting remuneration policy to risk policy in a demonstrable way. It is very much an issue in the public eye and will probably remain so for quite some time.
Jon Terry, head of reward, PricewaterhouseCoopers
The handbook rule is about aligning compensation with risk. Some organisations are going to have to make some quite radical changes, some much less radical. But ultimately, all financial organisations are going to have to make some changes.
What should financial services companies be doing right now?
Businesses need to look at the nature of their future and current remuneration programmes and point to specific features that incentivise the recipients to maintain good risk management.
If you look at the FSA code of practice only one of the core principles is now to do with structure. So they are going to have to delve down into the organisation and understand what governance procedures are in place, what the processes for making decisions are and how the appraisal systems work.
This is a very big expansion of the remit of remuneration committees.
What will be the effect of this change in practical terms?
It means getting HR teams and remuneration specialists to actually work together with risk specialists. Those sets of teams have probably had very little to say to each other in the past. Now they are being required to do so by processes that specifically require them to explain how their remuneration policies promote good risk management.
It is extremely important that all the support functions start talking to each other. HR can’t do this all on its own because what does it know about risk? Risk can’t do it all on its own because what does it know about HR? Compliance and risk need to be talking to each other a lot more. They need to work much, much closer together than has been the case historically so that organisations can fully understand the financial risks they face.
How do companies get the ball rolling?
HR has to simply pick up the phone and start speaking to their colleagues in risk about how they are going to get a policy that they think the regulators will agree with: one that demonstrates how risk management is encouraged by the policies that have been put together. There are different languages in HR and risk, so the first thing they need to do is come to a mutual understanding of what’s needed.
I don’t think it’s simple at all. Partly, it is cultural and partly it is organisational structure. The key thing is being clear in what part of the conversational processes it is appropriate for risk and HR to be aligned to each other. It may well be considered appropriate for there to be a risk report that goes up to the remuneration committee. How that report is positioned and linked to how individuals are doing as well as the business as a whole, requires a link-up between risk and HR.
Will greater co-operation between HR and risk functions lead to lower risk-taking?
It does not necessarily have to generate a low-risk policy. Where people are being paid to create or take on risky positions, their payment mechanism must make sure they stick with that risk position. Before that even happens, the business itself also needs to think about the possible downsides as well as the possible upsides of the product they are putting in place. Their remuneration polices must ensure they are not paid front-end, but over a few years until the bank reaches a point where it is certain there aren’t any unexpected risks involved.
It is not about minimising risk. The FSA is trying to ensure that the compensation does not incentivise behaviour that allows individuals to take greater risk than the organisation wishes to take. So it is about aligning the risk of the organisation with the behaviours of the individuals, and conversations are a vital tool in that process of alignment. It is about alignment rather than minimisation.
Do you see any major stumbling blocks for employers?
Some high-level employees will have clauses which mean their terms and conditions can’t be altered but, hopefully, most firms will have the opportunity to vary their contracts fairly easily. I think there is sufficient time to get everything in place. It is a case of going through each contract one-by-one and solving every problem as it arises. Most organisations will have a database of their contracts and it is only once they start going through them that they can tackle the problems.
For many companies – particularly, listed ones – long-term incentives have historically been linked to time rather than risk or performance. So for every year worked, people have received a bonus regardless of the company results or their own performance. The FSA says this is no longer acceptable. That puts an interesting pressure on companies as it is almost a case of breaking the habit of not doing that. I don’t think it is trivial at all as it is a case of looking at what the parts of the processes are and finding how best HR, risk and finance all fit into that process, and where they need to be linked or not linked. It is not asking for an HR person to become an expert in risk or visa versa. It is asking them to lean on each other’s expertise.
All is not doom and gloom
Despite the bonuses row and the general cloud of despair hanging over the financial sector, things are not completely going to pot. Here’s why:
- London is still ranked as the world’s top financial centre in the Global Financial Centres Index
- The robustness of financial organisations operating in the UK is demonstrated by the financial services trade surplus, a record £43.3bn in 2008 – up from £37bn the previous year
- The assets of all banks in the UK rose 14% in 2008 to almost £8 trillion and have nearly doubled in the past five years
- Worldwide banking group assets grew 34% in 2008
- The Centre for Economics and Business Research (CEBR) has forecast bonus payments by UK banks will hit £4bn this year, up from £3.3bn a year ago.
Sources: British Bankers’ Association and CEBR
The spotlight may be on bonuses, but workers in the financial sector are far more concerned with another issue: keeping their job. Here’s why:
- A total of 1.04 million people were employed in UK financial services in September 2008 – down 16,000 on 2007.
- The number of new financial sector jobs created by mergers and acquisitions is also expected to fall by 50%.
- City of London employment totalled 324,000 at the end of 2008 – about 28,000 less than in 2007. The recession is expected to claim a further 29,000 City employees in 2009. This represents a 16% decline from peak levels.
- Corporate finance in the City is expected to be the hardest hit sector, with more than 50% of jobs disappearing between 2007 and 2009. This is followed by derivatives (33%) and investment banking (17%).
- City job numbers are expected to recover gradually from 2010 and rise to 313,000 in 2012. Yet, this is still well short of the 353,000 employed in 2007.
Source: Centre for Economics and Business Research
Have your say
Michael Carter, head of the employee incentives group, Addleshaw Goddard
Firms need to move quickly. Although non-compliant agreements made on or before 18 March have been given an additional period of grace, even these need to be amended as soon as possible and by 31 March 2010 at the latest. Firms will need to consider carefully the legal implications of terminating or amending any such agreement unilaterally where there is no provision in the agreement allowing this. They may need to obtain a ruling from the FSA that the agreement is non-compliant to be in the best position to defend any action by the employee for breach of contract.
Simon Bond, head of employment law, Challinors Solicitors
Although the FSA code does not concern itself with the actual level of remuneration being paid, it is clear that many firms will need to conduct a significant review of their remuneration policies and practices. In terms of current remuneration arrangements, the FSA expects firms to comply with the code no later than 31 December 2009. Where the contract of employment prevents such compliance then the FSA requires such contracts to be terminated by November 2010 to ensure compliance. The FSA believes that this should be possible on the basis that most remuneration obligations will not extend beyond one year.
Robert Collard, partner, Macfarlanes
Tricky issues are likely to arise on guaranteed bonuses which run for a period of more than one year. Where there is no express right to amend the arrangements unilaterally, the employer will be in a difficult position. Unless it has a good argument that its payment obligation will not be enforced, or it can persuade the FSA that the arrangement is acceptable, it will be negotiating with the employee from a position of weakness. As a result, ironically given the current debate regarding excessive bonuses, the re-negotiated arrangements may well provide maximum payouts in excess of those under the original contract.
David Cubitt, head of City employment practice, Osborne Clarke
By 1 January 2010, bonuses must be consistent with good risk management and sustainability. This means bonuses should be based on long-term performance and potentially paid over a longer period, allowing for a reduction if anticipated savings or profits don’t materialise. Non-compliant arrangements agreed before 18 March 2009 must be amended or terminated by 31 December 2010 or 31 March 2010 if they can be amended unilaterally. The FSA says it will rigorously police and enforce the new code. These powers are a UK-first as remuneration policy has, to date, largely been about self-regulation and best practice.