Compensation schemes in investment banking have been subject to numerous debates in the last few years as the compensation practices played a role in promoting the accumulation of risks, leading to the crisis. Thus, it became a key point of focus among public opinion. International financial regulatory organizations and political leaders were compelled to react, improving overall governance and risk management standards.
It is now two years since the G-20 leaders adopted a set of policies on bankers' remuneration (Summits in London and Pittsburgh in 2009). Objectives were to put an end to the era of irresponsibility and avoid the previous excesses of banks.
In the EU, a political agreement was reached (July 2010), leading to the Pillar 3 of the Basel Committee, known as Â«CRD IIIÂ», which includes the FSB Standards on remunerations.
The remuneration provisions in CRD III took effect in January 2011 and implementation is monitored by both the Committee of the European Banking Authority (EBA) and the national supervisory authorities.
The implementation process of these specific standards is facing two challenges:
The first challenge is the lack of regulatory consistency across or within jurisdictions in the implementation: though, remuneration rules under CRD III should be applied "without prejudice to general principles of national contract and labor law", national regulations approaches differ in the interpretation of these rules into specific supervisory guidelines. Concerns are thus voiced about the different ways in which these principles are being implemented in local jurisdictions.
Furthermore, all countries have not yet reached the same degree of implementation. For example, France transformed CRD III principles in French Law in the December 2010 Â« Arrêté Â», whereas Italy is still working on the adaptation of its domestic law.
The second challenge in the implementation of the CRD III Principles is the inconsistency across banks and regional areas, especially in this highly competitive and international market.
The main fear with playing in an uneven field is that some may be able to offer more attractive compensation in the competition for talent. EU banks are at competitive disadvantage internationally since the US have issued light guidelines rather than strict legislation and while the Asian bank market has no compensation reform in the pipe at all.
Those concerns will remain as long as there are inconsistencies in compensation requirements among banks and regional areas.
Despite these grey areas, French banks succeeded in complying with the CRD III regulation.
The fixed and variable components of total remuneration should be appropriately balanced. This amendment results in an increase of fixed salaries as a percentage of total compensation, making employee costs less flexible. This development from variable reward and towards fixed salaries implies a potential reduction in the link between compensation and risk-adjusted performance.
The CRD III Principles propose that 50% of the deferred and not deferred variable compensation should consist of shares or share-linked instruments. Most of banks have implemented this rule, though banks' share prices are overall drowning. For example, on average, 45% of the total wholesale bonus pool of the first four French banks was paid in shares or other equivalent non-cash instruments in the 2010 compensation round .
Another CRD III principle recommends that 40% to 60% (for particularly high remuneration) of variable compensation should be deferred over a period of three to five years. Deferred payment allows banks to strengthen the link between risk time horizon and the timeline for deferred payouts since deferred compensation may be decreased depending on risk behaviours (e.g. rule breaking) and risk-based outcomes (future losses). Most of the banks are in line with this requirement: on average, 61% of the total bonus pool of the first four French banks was deferred in the 2010 compensation round . This is a significant change.
CRD III also requires total variable remuneration to be "considerably contracted where subdued or negative" financial performance occurs, taking into account both current remuneration and reductions in payouts of amounts previously earned, including through malus or clawback arrangements. Though malus and clawback tools offer ways to link deferred compensation to future performance, there is practical difficulties in the application of these tools: some member states' national labor laws prevent the use of malus or clawback and the interaction of these requirements with existing principles of national law is often complex.
Guaranteed bonus must not be offered over more than one year and may only occur in the context of hiring new staff and be limited to the first year of employment.
However, the increased intensity of competition for talent has led to an increase in the use of single-year bonus guarantees to new hires due to a difficult recruiting market. The future will confirm or not that this year's shift in single year bonuses is indeed due to market conditions and does not represent a structural shift back towards single year guarantees. 2011 is challenging for wholesale banks and hiring dynamics are changing as many banks have publicly announced reductions in headcount and restructuring of business units.
While the regulation has been applied, critical voices still wonder if it really limits imprudent risk taking.
Work needs to be done on the identification of the banks' risk profiles. Remuneration principles apply to senior management and other staff whose professional activities have a material impact on the bank's risk profile. However, a wide range of approaches can already be observed in the treatment of material risk takers (MRTs), making it difficult to assess comparisons across banks. Special efforts are to be done in identifying and managing and differentiating the compensation of the staff who perform significant influence on the bank's risk in order to limit imprudent risk taking.
In addition, according to the International Institute of Finance, most of the banks are not yet able to reliably calculate risk-adjusted profits at the more granular level of the product. Further work needs to be done on the accuracy of risk data (metrics and methodologies) to calculate their risk charges. Risk data challenges are an ongoing area of work for all banks.
The central goal of the CRD III Standards was to limit imprudent risk taking and as noted throughout the report, clear progress has been made on compensation reform. The bank industry has made significant progress on the core requirements of the CRD III by putting in place effective risk-aligned compensation structures including deferral, clawback and enhanced governance systems.
However, it is still too early to come to a final assessment of the overall combined results of compensation regulation on the industry. The final impact of all these changes on the bank industry is not yet certain but bank management will need to pay increasingly close attention to the effect of compensation changes on their business models over the next few years.
On the French 2010 Remuneration report, the proportion in shares varies from 34% for SG, to 43% for Natixis, 50% for BNPP et 51% for CA.
On the French 2010 Remuneration report, the deferred remuneration varies from 46% for CA, to 57% SG, 67% for Natixis et 73% for BNPP.