On 20 March the Financial Stability Board (FSB) released its progress report on the G20 countries’ implementation of sound compensation.
The scores so far are:
Australia gets an A, as do France, Germany, Italy, The Netherlands, Saudi Arabia, Switzerland, and the U.K. These countries have already implemented regulation and are overseeing results.
Canada and Spain receive a B+. Not all the pieces are in place, but definitely a good start.
China, Hong Kong, Korea, Japan, and the U.S. receive a B. They have made a start, but have a way to go.
Argentina, Brazil, Mexico, Singapore, South Africa, and Turkey receive a C. Definitely these countries could do better, and generally have poor attention to getting the details right.
India, Indonesia, and Russia receive a D. Basically a poor job, with banker pay and risk management receiving low priority and no action being undertaken.
The FSB review made a number of findings that are of direct relevance to Australian APRA-regulated institutions and beyond.
Unfortunately FSB emphasises aspects for further regulation, such as disclosure, that are not warranted in the Australian context, while failing to address operational risk by talent loss to unregulated companies.
In this article we have highlighted the FSB recommendations that have relevance for APRA and APRA-regulated entities.
Recommendation 2: Firms should continue to make progress on risk and performance alignment of compensation schemes through 2010 and beyond. This would include the ability to demonstrate how their compensation schemes incorporate risk adjustments.
Noted in the Principles and emphasised by a number of FSB members, “golden handshake” payments that reimburse unvested compensation foregone at the employee’s predecessor firm may be problematic and should be discouraged. APRA’s prudential guidelines attempt to tackle this issue, but the practicalities of making it work resulted in significant dilution from the FSB’s intent.
Indeed, Guerdon Associates’ initial feedback to APRA on its draft guidelines was that the regulation did nothing to prevent serial job hoppers from taking risks, jumping ship and being feather bedded in their next employer with a recruitment bonus (albeit deferred) to make the recruit “whole” for the forgone deferred bonus at his/her prior employer. Meanwhile, the job hopper’s prior employer could have imploded, with the resulting loss of their deferred bonus had he/she remained.
Such practices may weaken the incentive effects of deferred compensation structures by removing the employee’s exposure to risk outcomes. Firms may not be in a position to alter the hiring practices of others, but should consider the impact of the buy-out problem on their efforts to constrain excessive risk taking by employees and, if necessary, make changes to their incentive compensation policies to minimise the problem.
Among the FSB’s concerns is the need for a greater focus on ex-ante adjustments to bonuses. That is, bonuses sourced from a bonus pool that already has the recognition of risk built into the profit on which it is based. This has a number of implications for APRA and for APRA-regulated companies. Firstly, Australia’s “too big to fail” (as commentators including David Murray of the Future Fund, Ralph Norris of CBA and Cameron Clyne of NAB have already pointed out or implied) banks all have profit pooling that is risk adjusted before distribution, at least for their APRA-controlled bits. But, as APRA has been finding out during its review of each regulated entity’s compliance self-assessments, this is not the case with mostly foreign owned competitors. Unlike Australian listed companies with built in mechanisms of good remuneration governance imposed by disclosure regimes, many foreign owned entities pay the earth to encourage employees to gamble with other people’s money. While not prudentially sound, such practices make it difficult to impose a consistent regulatory standard when the responsible officer also has to comply with his/her parent company’s global compensation practices. This also makes it difficult for Australian entities to attract and retain executive talent in an inconsistent and high paying global market.
Also, our bigger regulated entities maintain inconsistent pay policies by continuing to provide asymmetric rewards in non-APRA regulated bits of their business. For example, fund managers continue to pocket 20% of returns in excess of their benchmarks for taking risky bets but do not have to return the money next year when these bets bomb. So banker talent wants out of the regulated bits to the unregulated bits, even within banks. The FSB’s report notes this (on page 20), but does not promote any move to apply similar regulation to others offering “heads I win, tails you lose” compensation, such as hedge fund managers.
Recommendation 7 also attempts to address incorporation of risk adjustment in pay.
However, the operational risk of talent loss from regulated sectors to unregulated sectors due to pay, also pointed out by Guerdon Associates in its feedback to APRA on the draft regulations, is not addressed anywhere in the FSB’s review.
Recommendation 6: Supervisors should actively check that the composition of compensation committees meets appropriate standards of expertise and of independence.
The FSB recognises that a major challenge for regulators and companies is available expertise – ensuring that board- level remuneration committees have the appropriate level of experience and expertise on remuneration policies and practices in general, and on the incentives created for managing risk, capital and liquidity in particular. This issue has been addressed in the APRA guidelines but, as many will attest, is not yet close to being resolved to a satisfactory standard. Key challenges to efforts to strengthen remuneration committees cited by industry participants include the limited pool of directors with the requisite expertise to serve on compensation committees, coupled with increased accountability and expectations of board members by regulators and, not least, shareholders.
APRA’s executive member responsible for oversight of pay regulation, John Trowbridge, will address these issues at the 2010 Remuneration Forum for board directors, executives and institutional investors to be held on 3 May. (see HERE)
Guerdon Associates’ observations are that remuneration knowledge and capability varies significantly across, and even within, the remuneration committees of APRA-regulated companies. In addition, proactive steps to improve these levels of expertise also vary. This is a worry.
Recommendation 8: The Basel Committee in consultation with the FSB should consider incorporating disclosure requirements for compensation into Pillar 3 of Basel II, to add greater specificity to the current requirements for compensation disclosure under Pillar 2, by the end of 2010.
APRA did not address disclosure in its regulations or prudential guidelines, noting that a comprehensive disclosure regime already exists in Australia. In addition, as a regulator, public disclosure is not necessary for APRA’s effectiveness as long as it has private access to policy and practice information.
However, the FSB noted that, on a global basis, disclosures were less than ideal due to company concerns regarding “commercial sensitivity”. These same concerns have been raised by Australian public companies to justify the absence of STI detail in KMP disclosures, despite criticism that as these disclosures pertain to a prior financial period, the commercial sensitivity argument is weak.
APRA’s approach appears to be adequate for regulatory purposes, suggesting public disclosure is not a pre-requisite for good regulation. However, incorporation of disclosure requirements into Basel II may result in APRA-regulated entities providing more forward looking public disclosures (rather than disclosures relating to the prior financial year) at some time in future, which do not seem warranted at this stage.
To date, while Australia has been heavily engaged in the drafting and review of FSB compensation principles, it has chosen not to implement elements considered too prescriptive (see this admission by Wayne Byers in an APRA speech delivered on 9 April HERE). But while there was some elasticity allowed countries in their application of FSB compensation principles, it is difficult to see any country getting much wiggle room if they were built into Basel II pillars.
Further information on all FSB recommendations, and their interesting global review, can be found HERE.© Guerdon Associates 2023 Back to all articles