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FSA eyes City pay structure


Financial Services Authority
chief executive Hector Sants’s latest
missive may not exactly have left the regulator’s subjects quaking in their
boots, but could end up a bellwether document for the financial services sector.

The 13 October
Dear
CEO
’ open letter on remuneration, sent to around 28 financial
institutions, set out the FSA’s belief that there is a link between remuneration
in the financial services sector and the current market paralysis ­ but used
such veiled language that few could tell if it was trying to hint at a future
clampdown, or just having a gentlemanly word in the industry’s shell-like to
please do things in a more sporting fashion.

“It is possible that [existing remuneration policies] frequently gave
incentives to staff to pursue risky policies, undermining the impact of systems
designed to control risk,” Sants writes, “to the detriment of shareholders and
other stakeholders, including depositors, creditors and, ultimately, taxpayers.”

Friendly visit
The letter did say that the FSA will be visiting all the firms that received the
letter to examine their policies. But in the same breath as saying reform was
needed, Sants also made it very plain that the FSA is not interested in setting
new remuneration levels, writing any new regulations or coming up with strong
guidance against which banks and trading companies (the two institutions the FSA
named as key perpetrators) could benchmark their pay policies. Rather, it
intends only to “assist and encourage” firms to review their remuneration
practices because, it seems, it has enough confidence in their ultimate goodwill
to “expect firms to avoid (or to be implementing plans to eliminate) bad or poor
practices concerning the measurement of performance, the composition of the
remuneration and governance arrangements.”

The FSA says it does not itself know what constitutes ‘good’ or ‘bad’
remuneration policy despite the work it has done to date and its position as the
market regulator. The best Sants could offer in his letter for now was to “urge
all firms… to consider carefully their remuneration policies, especially in
light of recent market developments”.

Next year, however, following the FSA’s visits to examine firms’ remuneration
policies in more detail, the regulator will “communicate our findings regarding
good practice to you and have a further discussion with you about them, if
appropriate.” The FSA will also publish some “general findings about
remuneration structures in the London market, on a no-names basis” ­ which
should make for interesting reading.

Sants adds in his letter that he is “mindful” that action needs to be taken
at an international level if it is to be effective, adding, “We hope to be able
to report on the international work in our published report early next year.”

Too soft guidance
The note has caused confusion among compliance people. They used to look on the
FSA’s Dear CEO notes as ‘soft guidance’, but the FSA itself pitches them merely
as tools “to draw attention to areas within the existing guidance and
regulations where the FSA believes more focus is needed,” as it told Compliance
Reporter when quizzed about this one.

In decoding the note, Clifford Chance’s Regulatory Group said they believed
that, while the letter doesn’t constitute formal guidance, “it clearly seeks to
impose obligations on firms to act” and added that “underlying” the letter was
“the suggestion that remuneration practices will be assessed by the FSA as part
of its risk assessment of firms, and that it will take [this] into account in
setting the capital requirements imposed on firms.”

Lack of clarity

Denton Wilde Sapte
, another law firm, simply put Sants’s words in
closed captions to denote its feelings on the lack of clarity. “The FSA is
avoiding being prescriptive; instead, it is seeking to provide high-level
criteria against which firms’ policies can be assessed. It already has a ‘firm
view’ of what constitutes ‘bad practices’… This is accompanied by its ‘initial
view’ of ‘good practices’.”

The law firm is in no doubt about one thing, however: “The FSA’s letter
clearly cannot be ignored,” it tells its clients.

Sants did vaguely allude to being interested in doing something if his
subjects were not shocked by the FSA’s interest into making changes. “If
[remuneration] policies are not aligned with sound risk management, that is
unacceptable,” he wrote. “Immediate action will be required to change the
policies.”

Denton Wilde Sapte says that firms will need to “comprehensively review”
their remuneration schemes, explain them to the FSA and set out their proposed
actions. “Whilst the [Dear CEO] letter seems to recognise that firms cannot
change their approach to remuneration overnight, it does expect them to be
moving towards good practice.”

The law firm summarises what remuneration practices should be scrapped:

  • Bonuses calculated on the basis of revenues, without any counterbalancing
    risk controls and without taking risk or capital cost into account;
  • Bonuses calculated solely on the basis of financial performance and for the
    current financial year only;
  • Remuneration that has little or no fixed component and is paid wholly in
    cash;
  • Remuneration that does not include performance-adjusted deferred
    compensation; and
  • Deferred compensation not linked to the future performance of business
    undertaken in previous years.

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