In the wake of the credit crisis, searching questions are being asked about whether compensation systems in financial services had a part to play in creating or fuelling the current situation. To some observers, rewards and the culture that created them are amongst the most important factors, while to others they play no substantive role at all.
What is beyond doubt is that recent events have, rightly or wrongly, generated significant scrutiny of compensation in the financial services sector, from market participants, regulators and government officials. And while there is general agreement – even among industry participants themselves – that some degree of reform to reward systems would be beneficial, there is less consensus about the scale of the change required and about what, if anything, can be done to improve the current system in a way that benefits the industry as a whole.
Financial services executives the world over – including those from Asia-Pacific – believe there is a need to reform industry remuneration policies. Even before matters grew to apparent crisis proportions in a number of territories, executives were acknowledging that many of their practices were failing to deliver desired behaviours or, for that matter, to meet the expectations of shareholders.
Given that most financial institutions operating in Asia-Pacific tend to be part of a global organisation, it is not altogether unexpected to find a consistency between the Asia-Pacific findings across all sub-sectors and our overall research. Remuneration policies for the most part are adopted from the head office and applied consistently across the various regions in which the organisation operates.
Nevertheless, there are a number of areas where our research shows that expectations of executives in Asia-Pacific differ from the global picture. This is in part owing to the unique characteristics of various Asia-Pacific markets, but also to the fact that Asia-based financial institutions without a US or European parent are now a growing force. In any case, this lends credence to the view that there should be a higher degree of flexibility in the way financial services institutions in Asia-Pacific manage their business and remunerate their talent.
The key themes identified around the region include:
What was clear from our research, however, is that no-one is prepared to move first. There is support for longer term compensation strategies, but not as a market-leading move. In particular, the more ‘draconian’ measures such as bonus clawbacks and deferrals, while very effective, are unlikely to find favour unless ‘someone else does it first’.
Even so, the approach of organisations in the financial services sector is coming under renewed pressure through the actions taken by governments, regulators and shareholders in relation to remuneration.
Across Europe a number of governments are either introducing or discussing legislation to improve the regulation and corporate governance processes in the area of executive compensation.
A number of trends are emerging:
It is worth noting that in many countries there is currently either no or very limited legislation in the areas of executive compensation, and for these countries the proposals represent a significant step forward in the regulation of executive compensation. We are now seeing this extending to specific institutions in the US by the new Obama administration and in the other countries where there is direct government involvement in similar institutions.
With the notable exceptions of the UK Financial Services Authority, the Swiss EBK and the Australian Prudential Regulation Authority, regulators have yet to take direct action in the area of executive compensation.
However, the G20 tasked the Financial Stability Forum (FSF) to review the supervision and oversight of compensation. Those expecting a vague set of principles from the FSF will be surprised by the hard-hitting and specific nature of the report.
Publication of the FSF’s Principles for Sound Compensation Practices, together with the commitment to co-ordinated regulatory implementation globally, confirms that regulation of compensation in the financial services industry is here to stay.
The key points of the FSF’s Principles, which apply to all significant financial institutions but especially to large, systemically important firms, include:
The FSF takes it as a given that compensation played a role in exacerbating the credit crisis. The problems – lack of attention to risk, excessive short-termism and so on – have been well trailed by a number of commentators. The FSF makes clear its view that the power of incentive systems at times over-rode the other internal risk controls in place at organisations. More risk alignment needs to be brought into compensation in order to prevent this happening in the future. And given labour market pressures in the industry, the FSF is clear in its view that the only way this can happen is through sustained external pressure, coordinated at the global level.
In a number of countries where government rescue packages have made taxpayer funds available to financial organisations, conditions have been placed on the organisations participating. These typically include:
In the US, the Senate Committee on Oversight and Government Reform wrote in November 2008 to the CEO of all banks due to receive taxpayer funding (part of the $700 billion rescue package approved by Congress), expressing concern that taxpayer funds were being used to pay bonuses rather than 'shore up the capital positions of the crisis-stricken institutions'. Each letter also contained a request for information that covered the total compensation details (for financial years 2006-2008) of all personnel globally earning more than $500,000 broken down by salary, bonus and Long-Term Incentive Plan.
The challenge in Asia-Pacific is that first, many financial institutions operate globally and are affected by the interventions in Europe and the US, and second, there is evidence to suggest that intervention may follow after the FSF report.
Ultimately, the aim for all organisations should be to achieve best practice. As companies consider their remuneration strategy for 2009 there are a number of structural and strategic issues they may want to keep in mind:
As the 2009 reward round is completed, now is the time for organisations to consider their reward strategy for 2010 in the context of this new and challenging environment.