Last week, the Financial Stability Board (FSB) published its fifth progress report on the implementation of its principles for sound compensation practices and their implementation standards in the FSB member jurisdictions.
Following the global financial crisis that began in 2007, there was a perception that ‘perverse incentives’ contributed to excessive risk-taking, threatening the financial system. As a result, the FSB (the ‘Financial Stability Forum’ at the time) published principles for sound compensation practices and implementation standards in 2009. The FSB documents set out many of the principles that we see in global remuneration regulations today, including deferral, malus and clawback, and payment in non-cash instruments.
The report was prepared by the FSB Compensation Monitoring Contact Group (CMCG) and focuses on remaining implementation gaps, key challenges and evolving practices. The report also examines the links between compensation and misconduct and considers compensation practices in the securities sector, which were issues of particular focus since the last report in November 2015.
The main findings of the report include:
- Almost all FSB member jurisdictions have substantively implemented the principles and standards for banking organisations.
- Some significant differences exist in the approaches taken to oversight of compensation practices in banking organisations between jurisdictions.
- There is increased focus on links between compensation and misconduct in banking organisations. Banking organisations are increasingly working to incorporate non-financial and misconduct risk considerations in performance and reward assessment and in governance and control structures.
- In-year adjustments to compensation remains the compensation tool of choice. Application of malus is rare in many jurisdictions, and clawback is subject to more significant legal difficulties or enforcement issues than malus in many jurisdictions.
- There are significant differences between the approach of banking organisations and supervisory frameworks relating to the identification of material risk takers (MRTs).
- Implementation in the insurance sector is significantly behind the banking sector but there has been progress, particularly following Solvency II implementation in the EU.
- Implementation in the securities sector varies significantly, reflecting the diversity of the sector.
The FSB has proposed actions to address misconduct risk at financial institutions and recently published a consultation for supplementary guidance to their principles for sound compensation practices, as discussed here.
The FSB also intends to consider ways to assess the effectiveness of aligning compensation policies and approach to risk, and will consider the extent to which compensation disclosure requirements are an effective mechanism for providing investors with meaningful information on the alignment of compensation with the long-term interests of the firm.
The FSB intends to publish its next progress report in 2019.
The FSB principles and standards act as a basis for the many of the remuneration principles that we see today and triggered wide-scale reform. Within the EU, the principles can be found to be applied in the wide range of directives and regulations which regulate the different sectors, such as CRD IV for banks and investment firms, AIFMD and UCITS for the securities sector, and Solvency II for insurance and reinsurance businesses.
The progress report contains interesting analysis and establishes an overview of how the FSB principles and standards have been applied globally. The FSB has been proactive in encouraging member jurisdictions to address implementation gaps and the supplementary guidance will help firms and regulators to better understand the FSB’s expectations.
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Janet and Matthew