Financial services firms are moving forward with far-reaching changes in their approaches to employee compensation, says the Institute of International Finance (IIF). Firms are proceeding with reforms that are both in line with the principles published by the IIF in July 2008 and by the Financial Stability Forum that said its principles “aim to ensure effective governance of compensation, alignment of compensation with prudent risk taking, and effective supervisory oversight and stakeholder engagement in compensation.”
“The message today is that progress is being made in reforming compensation in firms across our industry,” says Josef Ackermann, chairman of the board of directors of the Institute of International Finance, chairman of the management Board and the group executive committee of Deutsche Bank AG. “The leading edge of these efforts reflects the first of the IIF’s principles, which stresses that compensation incentives should be based on actual performance and should be aligned with shareholder interests and long-term, firm-wide profitability, taking into account overall risk and the cost of capital.”
Last summer the IIF published a comprehensive report highlighting needed industry reforms in a range of areas including compensation (Final Report of the IIF Committee on Market Best Practices ). The IIF released a report on compensation practices carried out by the consultancy firm Oliver Wyman comprised of a survey of financial services firms, which includes corporate and institutional banking sectors, and interviews with senior industry executives at a range of firms. The report found wide agreement that compensation incentives should not induce risk-taking in excess of the firm’s own risk appetite, and significant support for the view that compensation should include a component reflecting the firm’s overall results in line with sound risk management and business goals.
“The majority of firms surveyed are moving towards full alignment with the seven principles set out by the IIF Committee on Market Best Practices in its 2008 Report and they are doing so on an urgent basis,” says Klaus-Peter Mueller, chairman of the supervisory board, Commerzbank AG, and co-chairman of the Steering Committee. “The consensus around the direction of change in industry compensation practices is unprecedented and provides a solid basis for the initiatives underway in the financial services industry.”
The IIF says that a lot of work still remains to be done to fully reform compensation structures, but it noted that today’s report showed that a number of firms have already developed systematic approaches towards reflecting risk in performance measurement, handling deferred compensation mechanisms and establishing sound governance standards for the overall compensation process. The survey, which involved firms in North America, in Europe, and Asia conducted during a three-month period just ended, found that 98% of respondents agree that compensation structures may have been one of several factors underlying the current market crisis. With regard to competitive considerations, the IIF pointed out that as the process of reform moves forward through the industry so this can contribute to a diminution of the “first-mover disadvantage”, i.e., the risk that the first firms to introduce new compensation schemes will lose talent.
D.C.