Effective Implementation of FSB Principles for Sound Compensation Practices and Implementation Standards: 2021 progress report
Compensation practices in large financial institutions were one of the key contributing factors to the excessive risk-taking that was prevalent in the run up to the 2008 global financial crisis.
This progress report assesses the implementation of the FSB’s Principles and Standards for sound compensation practices and how compensation practices have evolved since 2009.
The report covers the compensation practices of the largest financial institutions in the banking, insurance and asset management sectors. The report describes regulatory and supervisory developments; the functioning of governance mechanisms for compensation by firms; the effective use of metrics/criteria and compensation tools; and legal and regulatory challenges to the effective use of compensation tools.
It highlights uneven progress toward implementing the Principles and Standards, with banks relatively more advanced than insurance and asset management firms. This may reflect the more pressing need for banks to align compensation with risk-taking following the 2008 global financial crisis.
Against this backdrop, this report focuses on:
The effectiveness of compensation frameworks. A common approach to assess employee performance and determine variable compensation is to use a balanced scorecard based on key performance indicators, complemented by other inputs. The report notes that it is critical to establish and apply such a framework so that it promotes a sound risk culture in a firm. While in-year adjustments and malus are commonly used, the use of clawback is not widespread due to ongoing legal and practical constraints. The report advocates incorporating clawback terms and severance clauses in employment contracts to enhance their enforceability and effectiveness.
Emerging trends. The report notes the increased use of non-financial measures and disclosure of compensation-related information to shape and promote a sound risk culture and positive behaviours, as well as to contribute to robust risk management. Firms are increasingly incorporating environmental, social and governance (ESG) aspects to drive accountability for delivering outcomes. This must be underpinned by robust governance, as the increasing application of non-financial measures requires the Board and internal control functions to use discretion and judgement appropriately.
Experience during the COVID-19 pandemic. The report finds that most existing compensation frameworks, and associated governance mechanisms, have demonstrated sufficient flexibility to date. However, while banking authorities in most jurisdictions have powers to direct firms to hold back and/or limit bonuses, especially in cases where there are concerns about capital conservation, or to increase deferral periods, this is much less prevalent in the asset management and insurance sectors.