As we wrote in October (see HERE), global bank regulators had been getting a clearer picture on banker pay, and they did not like what they were seeing, despite improvements.

 

Since then, they have revisited their analysis and conclusions, after making sure they received feedback from all the stakeholders.

 

The result?  They still do not like what they see. This is evident in their final report after receiving feedback, published on 10 May 2011 (see HERE).  At least they are consistent, which most would say is a good thing for regulators.

 

The concerns of the global bank regulators are too many, and too complex, to give full justice to here.  Comments relevant to Australian banker remuneration practices are noted below.

 

While they do not like total shareholder return, they dislike it more when it is relative!

 

This has been a consistent theme.  Specifically, “the use of indicators like share prices (or similar external measures) may be influenced particularly in the short term by various factors like market sentiment or general economic conditions, not specifically related to firms’ or employees’ actions.  Relative performance measures may increase incentives to take more risk or may, under certain circumstances, reward failure by decoupling remuneration from absolute value generation”.

 

The problem is that while bank regulators have recognized this, many governance groups and institutional investors have not been as quick.  This may explain, in part, why many banks retain relative TSR.  We expect that some time down the not too distant track, something has to give.  We do not think it will be the regulators.

 

It is ok to be risk averse, but let’s not encourage it!

 

It has been interesting to observe the regulators view of adjustments to pay that is yet to vest. The regulators like banks to apply “negative” discretion, and forfeit an employee’s pay if, in hindsight, a result was obtained that was later corrected for, or obtained by, excessive risk taking.  But they are not keen on banks increasing the amount due to an employee if, in hindsight, they controlled risk with better outcomes than initially considered.  In their view “Deferral is more effective when deferred remuneration can only be adjusted downward. Methodologies that allow increases of deferred remuneration, to reflect for instance a lower level of losses observed than expected, may undo some or all of the effect on incentives of risk adjustment.”

 

The regulators recognise some countries’ tax systems make rational risk adjusted incentives difficult

 

A poignant reminder that the Australian government’s own short-term priority of reducing the deficit makes the country’s banks and insurers more risky than they need be.  That is, maintaining a tax on unvested equity incentives at termination of employment just discourages applying deferred equity pay that could be risk adjusted after employment has ceased.

 

One size does not fit all

 

The report notes that it is necessary to recognise that pay systems cannot simply be applied in the same way to all those who impact risk.  In some of Australia’s banks there are long tail risk operations where the management and key people could have an ex ante measure of risk built in to their performance measure.  Others have short tail risk impacts, whereby the outcomes can be discovered and adjusted for risk within a year of the initial performance assessment, requiring only a 12 month deferral of pay.  Some would argue that there is not enough differentiation in pay structures within some Australian banks to recognise these differences.

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