Bank payrolls are set to come under far more scrutiny after the proposals put forward in the recent Walker Review, with far-reaching consequences for recruitment, retention and motivation in the banking industry. Victoria Hartley reports on a turbulent year.
You don’t need to look hard to find examples of the public disgust over the bonuses the banking sector pays its employees. Media comment, blog and website comments and dinner-table chat all bear testament, and the majority of people have been forced to tighten belts either at work, at home or both as a result of the credit crunch.
Media reports that Royal Bank of Scotland (RBS), majority-owned by the taxpayer, was set to pay out £1bn in bonuses to employees this year caused a political storm. The government intervened, with chancellor Alistair Darling capping RBS bonus payouts at £340m, compared to the £2.5bn it paid to employees last year, and in just shares rather than cash handouts. Darling said at the time there would be “no reward for people who have failed.”
In the fallout of the credit crunch, government and the financial services industry have been forced by the weight of public disapproval to forensically examine the relationship between risk and the bonus culture. This is proving uncomfortable for the institutions involved, unused to this level of scrutiny. Despite the bank bailouts and cash injections the government continues to use to prop up the financial system, as we pull back from the brink and the crisis begins to recede, memories have become short, and bonuses are on their way back.
Banking on success
The fact is banks – by their very nature, businesses that aim to make as much money as possible – have always attracted and held on to employees with above-average salaries and bonuses.
At the end of July, a report compiled by New York’s attorney general, Andrew Cuomo, revealed the lavish sums doled out to employees of big US investment banks, many of which had been propped up just months before by their government.
Citigroup, which admitted to losses of $27.7bn, awarded million-dollar-plus bonuses to 738 employees. Merrill Lynch, which lost $27.6bn, paid out equally lavish bonuses to 696 individuals.
Figures from other banks, including JP Morgan and Goldman Sachs, showed they also handed out bonuses, which in Goldman’s case were more than double the amount it made in profits.
In his report, Cuomo said: “Compensation for bank employees has become unmoored from the bank’s financial performance.”
However, the investment banking arms – where the lion’s share of these bonuses goes – are also responsible for producing the majority of the banking profits. In the case of both JP Morgan and Goldman Sachs, the institutions had already paid off their bail-out debts in full by June, largely from investment earnings.
This is why banks are loathed to crack down too hard on bonus payouts for fear of demoralising the people who keep the wheels of their business turning.
Meanwhile, in the UK, a gulf is already evident between the rabble-rousing, top-down public appeasing action on the continent, and the more conservative, consultation-based approach here.
City watchdog the Financial Services Authority (FSA) launched its consultation in November 2008, aiming to produce a code on pay for all regulated firms, which has now reported back. Then, in February this year, the government appointed Sir David Walker, a seasoned investment banker and ex-chairman of Morgan Stanley, to lead a consultation on the future of corporate governance in the financial sector. In July, he reported back recommending momentous changes to banking governance, in particular by boosting the role of non-executives to monitor risk and salaries and bonuses (see below).
At the time, Walker said: “Failures in governance in banks and other financial institutions made the financial crisis much worse.”
He continued: “Many boards inadequately understood the type and scale of risks they were running and failed to hold the executive to high standards of sustainable performance. Bonus schemes contributed to excessive risk-taking by rewarding short-term performance.”
The consultation on Walker’s proposals is already underway and is set to finish on 10 October, after which he will commend his final recommendations to the government in November.
The Financial Reporting Council published its own progress report on 28 July on how effective the combined code on corporate governance is in the UK. In the main, of the firms that addressed the issue, all agreed the current pay and bonus culture is problematic. But the devil appears to be in the detail on how remuneration committees operate to “attract, retain and motivate directors of the quality to run the company successfully,” which is Walker’s stated aim.
Ian Pitfield, corporate governance director at UBS Global Asset Management, one of the few investment managers to reply to the consultation, said bonus schemes had become complicated and, in some cases, easily manipulated. “Remuneration suffers from an upward ratchet as remuneration committees target median or upper quartile salaries then hide behind the data from remuneration consultants,” he suggested.
Remuneration committees also came in for criticism from the Association of British Insurers (ABI), which questioned the impartiality of remuneration committees to avoid directors setting their own pay.
An ABI spokesman said: “The remuneration consultant business model has inherent conflicts of interest, including an interest in creating changes to existing plans and introducing new ones.”
Jennifer Stacey, chief people officer at outsourced payroll firm Ceridian, says it is important from an engagement and motivation perspective to recognise and reward individual effort and success. But she also advises caution. “The rewards should be linked to company performance and form part of a wider and clearly communicated rewards structure aligned to company results,” she says.
“By rewarding your top performers in this way, you are also helping to drive desired behaviour throughout the business, as employees can see what is required – both in terms of behaviour and output – to achieve their bonus.”
Following its own consultation, the FSA has already backed down from a tough package of measures, which included enforcing a link between bonuses and the performance of the bank or firm.
However, it said firms cannot employ people on terms that guarantee bonus contracts for longer than a year, and said senior employees would have to spread two-thirds of their bonuses over three years.
The FSA defended its weakened policy document, citing “widespread concern the code as proposed could have adverse competitive implications for the UK.”
But the FSA has obliged all banks, building societies and brokerages to provide individual policy statements on pay and bonuses by the end of October, with all changes in place UK-wide by January 2010.
All over the UK, these firms will be renegotiating contracts with employees in a way that satisfies the forthcoming rule changes.
An FSA spokesperson said: “Our remuneration code is not going to remove the bonus culture overnight. That is going to take time.”
Bonus incentives remain an intrinsic part of working life for a diverse range of professions, from estate agency to recruitment through to banking and finance.
Michael White, chief executive of internet-based mortgage broker Email Mortgages, says: “In general, bonuses form the basis of any type of working relationship. Fixed costs have to be kept down, but if a business is doing well, that should be shared by all employees.
“Structuring a bonus well makes all the difference. I don’t think the FSA could ever complain about how I structure my broker bonuses.”
White adds: “More recently there has been lots more positive economic reporting going on, but if a business can get to this stage after the downturn and is in a position to pay staff bonuses, it’s all part of the drive to reward and get even more out of people.”
Cash is not the only incentive on offer to UK employees, and employers have had to be more imaginative and find other ways to encourage employees in these cash-strapped times.
“When the recession hit, many companies were not in a position to pay large cash bonuses, disappointing employees who had become accustomed to ‘predictable’ cash awards,” says Ceridian’s Stacey. “However, those businesses using a selection of bonus methods, such as discounted retail vouchers or weekend breaks, were able to continue rewarding and motivating extraordinary effort and successes.”
But ethical questions still remain over whether some deserve the bonuses they get, and the compromises employees make along the way to hit their targets.
Martin Gilsenan, partner at employee assessment software provider AxiaMetrics, says: “Now, with a reappraisal of the way bonuses are paid and why, individual companies have to take responsibility in ensuring they do not issue bonuses of such magnitude that for the beneficiary it becomes a case of the end justifying the means.
“The real issue now is that many companies have stated core values that they do not actually apply day-to-day. This is magnified by the fact that so many businesses simply do not know what values their staff actually have, and so we will continue to have a self-perpetuating but totally unsatisfactory state of affairs until these companies address the root problem.”
The Walker Review: the key pay-related proposals
Sir David Walker was asked to examine the effectiveness of risk management at bank board level, which included the incentives employees are offered and whether this conflicts with how companies manage risk. His brief was sprawling, but broadly speaking looked at board-level risk management, whether banking institutions had the right mix of skills at board level, and how effective those boards are in controlling company activity. Importantly, he was also asked to look into how UK practice compared with corporate governance in other countries.
On the 16 July, he came back with this set of proposals on pay:
- Financial firms appoint a board-level risk committee with more power to block big transactions. Must be chaired by a non-executive
- Firms appoint a remuneration committee to oversee pay packages of high-paid executives (non-board)
- Firms need to introduce a significant deferred element in bonus schemes for all high-paid executives
- Increased public disclosure about pay of these high-paid executives
- Chairman of remuneration committee to face shareholder vote if annual report gets less than 75% approval.
The payroll department
For backroom payroll staff, Ian Walters, non-executive director, Institute of Payroll Professionals, says processing bonus payments is not a complicated process.
“The complication comes around the measurement of who is entitled, and to what,” he says. “This measurement can create difficulties unless the qualification criteria is clearly stated in advance.”
But one issue that will always create more work than any other is the authorisation and payment sign-off of bonuses, he adds. “Each company will employ different methods to achieve, this but efficiency can be driven into the process by keeping it as simple as possible.”