Richard Reid believes this BIS publication highlights the tension between the often protracted responses of the agencies charged with developing a strategy for tackling the causes of the financial crisis versus the political requirement of being seen to be doing something.
Richard Reid article:
As we noted in our news items, in keeping with the somewhat haphazard way in which information unfolds as the regulatory debate reveals itself, last Friday the BIS issued a paper on principles and standards for compensation practices in the financial sector. This was the day after the US president announced his new reform package. At the heart of his measures is the issue of risk and remuneration (and burden on the tax payer) in the undertaking of different types of banking business. These will very much be issues discussed at the G7 ministerial meeting in London this week and in Canada on 5 and 6 February.
The BIS outlines no less than nine principles covering three main themes: the effective governance of compensation, the effective alignment of compensation with prudent risk-taking and the effective engagement of supervisory oversight and stakeholders. The first two principles place a lot of emphasis on the role of the board.
· PRINCIPLE 1: The firm’s board of directors must actively oversee the compensation system’s design and operation. The compensation system should not be primarily controlled by the chief executive officer and management team. Relevant board members and employees must have independence and expertise in risk management and compensation.
· PRINCIPLE 2: The firm’s board of directors must monitor and review the compensation system to ensure the system operates as intended. The compensation system should include controls. The practical operation of the system should be regularly reviewed for compliance with design policies and procedures. Compensation outcomes, risk measurements, and risk outcomes should be regularly reviewed for consistency with intentions.
Relevant to the current debate with regard to the type of business being conducted, principles 4 through 7 concentrate on compensation practices that reduce employees’ incentives to take excessive risk. The BIS notes that within the industry, it has been common for amounts of incentive compensation for a performance year to be based mostly on the level of short-term revenue or profit that was achieved during the year. Principles 4 (risk adjustment), 6 (deferral of payment) and 7 (method of payment) focus on methods that may be used to alter compensation arrangements to provide more balanced risk-taking incentives.
The rest of the principles and standards relate to the supervisory processes that the BIS considers to be an integral part of the regulatory response to the financial crisis.
In a way, the publication of this document highlights the tension between the often protracted responses of the agencies charged with developing a strategy for tackling the causes (actual or perceived) of the financial crisis versus the political requirement of being seen to be doing something. As the Financial Stability Board also noted over the weekend (see second link below) President Obama’s latest proposals have some resonance with the overall thrust of the G20/FSB objectives to address the problem of moral hazard. However, the FSB timetable is considerably longer and the various proposals and consultation phases will take many more months to complete. Meanwhile the financial industry is adjusting to the policy initiatives which are being made “on the hoof”.
Perhaps such controversy and confusion is a common feature of post-crisis policy-making as the drive for a better framework mixes with the desire to make someone pay for the mess. However, from the perspective of certainty and with a view to limiting the damage to the process of financial intermediation at this crucial phase in the global economic upturn, it is essential that the G7/G20 put the process of international cooperation back on the rails as soon as possible.
© ICFR - International Centre for Financial Regulation
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