Just as we Brits are well-known for our addiction to queuing (that’s lining up to you lot), we are similarly enamored with rules. Somewhat unsurprisingly we’re first in the queue with some rules for bank bonuses. As reported by the New York Times, BloggingStocks and others, yesterday, the Financial Services Authority (FSA) confirmed the application of rules in a new policy statement. They are summarized below, but basically are about risk, adjusting for risk, making sure risk is taken into account, deferring bonuses if they are significant, and making them dependent on future performance as well. The kind of basic common sense compensation principles that it seems incredible were not already in place.
There is a welcome push to measuring non-financial performance – i.e. whether employees are indulging in risky behavior – and another for measuring the cost of capital when measuring profits, and not just basing bonuses on revenue. As well as what initially seemed like an extraordinary principle – make sure there is enough fixed compensation in the pay package. Huh? What was that? What do they want us to do? Raise salaries?
That’s the only principle where I’ve left the “guidance” in down below, because it needed a bit of explaining. What the FSA means is that when no bonus should be paid, they want the bank to be able not to pay it without landing the traders in the debtors’ prison (just joking, we got rid of those awhile ago).
Makes sense.
But wait a minute, is there an FSA for bar staff? I can see most waiters and waitresses going for that one too. Basic standard of pay so if we don’t get a tip…. No, no, no, hold on, hold on, this is Britain. We don’t tip. Queue, yes, but no tipping.
FSA’s Remuneration Principles
- A firm must establish, implement and maintain remuneration policies, procedures and practices that are consistent with and promote effective risk management
- A remuneration committee should:
- exercise, and be constituted in a way that enables it to exercise, independent judgment;
- be able to demonstrate that its decisions are consistent with a reasonable assessment of the firm’s financial situation and future prospects;
- have the skills and experience to reach an independent judgment on the suitability of the policy, including its implications for risk and risk management; and
- be responsible for approving and periodically reviewing the remuneration policy and its adequacy and effectiveness.
- Procedures for setting remuneration within a firm should be clear and documented and should include appropriate measures to manage conflicts of interest.
- A firm’s risk management and compliance functions should have significant input into setting remuneration for other business areas.
- Remuneration for employees in risk management and compliance functions should be determined independently of other business areas.
- Risk and compliance functions should have performance metrics based on the achievement of the objectives of those functions.
- Assessments of financial performance used to calculate bonus pools should be based principally on profits.
- A bonus pool calculation should include an adjustment for current and future risk, and take into account the cost of capital employed and liquidity required.
- The assessment process for the performance-related component of an employee’s remuneration should be designed to ensure assessment is based on longer-term performance.
- Non-financial performance metrics should form a significant part of the performance assessment process.
- Non-financial performance metrics should include adherence to effective risk management and compliance with the regulatory system and with relevant overseas regulatory requirements.
- The measurement of performance for long-term incentive plans, including those based on the performance of shares, should be risk-adjusted.
- The fixed component of remuneration should be a sufficient proportion of total remuneration to allow a firm to operate a fully flexible bonus policy.
- Proposed Guidance:
- If the fixed component (typically, base salary) of employee remuneration is low a firm will find it difficult to cut or eliminate a bonus in a poor financial year.
- One measure of the effectiveness of this principle would be the ability of a firm (or part of it) not to pay a bonus in a year in which the firm (or part of it) makes a loss.
- The majority of any bonus should be deferred with a minimum vesting period if, when compared with the fixed component of an employee’s remuneration, the bonus is a significant proportion of that fixed component.
- Any deferred element of the variable component of remuneration should be linked to the future performance of the firm as well as the employee’s division or business unit.
Paul Hodgson — Senior Research Associate
