THE GLOBAL financial crisis and the continuing systemic risks posed by financial institutions has led to a radical rethink on remuneration policies in the financial sector.
The rationale behind the Financial Stability Board’s (FSB) Principles of Sound Compensation Practices was to ensure a coordinated response to reforming remuneration in the financial services sector to ensure a level playing field and fair competition in the global market.
However, in reality, this has not proven to be the case. In the UK, under the Capital Requirements Directive III (CRD3), the FSA revised its Remuneration Code to ensure the FSB’s principles were addressed and for the most part, the rest of Europe followed in a similar manner.
In the US, meanwhile, regulators took a more principles-based approach giving greater flexibility and arguably a competitive advantage in respect to rewarding talent compared to Europe’s more prescriptive approach.
While the overall spirit of the principles are being addressed the world over, there are clear distinctions across continents. The result is causing concern to remuneration policy makers in the financial world and creating some challenging dynamics in the competition for talent across markets.
The unlevel playing field is caused primarily by the differing US and European approaches to deferred bonuses, according to our Global Financial Services Executive Incentive Plan Snapshot Survey.
This bonus deferral, whereby a portion of an individual’s bonus is postponed, typically for at least three years, is intended to discourage a short-term approach to risk as part of the post financial crisis reforms. Most European banks now have bonus deferral with performance conditions, or “malus” arrangements, for reducing or eliminating deferred amounts if there are losses or performance conditions are not met.
In contrast, many US banks have not yet introduced these performance conditions for deferral payouts. The malus arrangement is widely touted to be a core mechanism to control short-term risk taking behaviour and is clearly important, but without the necessary regulatory supervision to enforce such a policy, the implementation can be quite variable.
The survey also highlights that 88% of European companies have long-term incentive share awards dependent on performance conditions compared to 50% of US respondents. For share option plans, 75% of European companies required performance conditions be met while no US respondents did.
The bonus culture in financial institutions has traditionally been used to attract and retain the best talent. The question remains, if employees are more likely to receive cash bonus payouts in the US as opposed to their European counterparts can you expect your talent to leave?
Upwardly mobile talent is likely to be footloose so there could be a real risk for retention. If this escalates there is a risk that the European banking sector will be less competitive or face higher compensation costs rather than lose key talent.
Despite the risks, this should not mean that your company cannot attract the best talent or expect your top performers to cross the pond. Firstly, the window of opportunity may be closing fast; the US Federal Deposit Insurance Corporation (FDIC) approved a proposed rule regarding incentive-based compensation at covered financial institutions in February 2011.
The other US agencies are expected to approve their own similar versions of the proposed rule shortly. Together the seven regulators are coordinating in a joint interagency rule-making process to require mandatory deferred bonuses and limits on upfront cash. Hard limits on bonuses would bring US remuneration standards more in line with the tougher stance adopted by the European Union.
The EU’s approach to remuneration is likely to have far reaching impact since large companies usually prefer senior management to be covered by a consistent policy and design based on home-country regulator requirements. Therefore, convergence on practices globally is expected for EU based companies across regions.
The other factor to consider is that bonus, while important, is not the only way to engage employees. Indeed Mercer’s Human Capital business has seen resurgence in the financial services sector’s use of alternative methods to foster performance and motivation. More and more companies are going back to basics, asking themselves, what makes us attractive to employees and how do we stand out from our competition?
Usually the answer does not lie wholly with remuneration policies. Career progression, performance management and operational effectiveness appear to be leading the agendas for European firms right now. Others are seeking new ways to reward, be it monetary or otherwise. Base salary adjustments have been most evident in Europe, as have total remuneration reviews. It is clear that more may need to be done on a global level to address risk management in the financial sector, however we do not believe that a regulatory solution is appropriate in all situations.
The consequences of uneven regulatory systems has clearly brought with it further issues. There is a lot businesses can do to maintain competitiveness in the market for talent above and beyond remuneration policy. Rather than wait for the regulators to make the first move, concentrating on your company’s total value proposition and addressing employee engagement is likely to be more fruitful.
Simon Grace is an associate at HR consultancy Mercer