FSB highlights implementation progress and gaps on effective compensation practices in financial institutions
05 November 2021
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.
The Financial Stability Board (FSB) today published a progress report
on the implementation of its Principles for Sound Compensation
Practices (Principles) and their Implementation Standards (Standards) in
financial institutions.
The report covers the practices of the largest financial institutions
in the banking, insurance and asset management sectors. 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:
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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 to promote 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.
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Emerging trends. Non-financial measures and
disclosure of compensation-related information are increasingly used 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.
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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.
Notes to editors
The 2008 global financial crisis highlighted that 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 crisis. Following the crisis, the FSB developed the
Principles and Standards to promote sound compensation practices and
align compensation with prudent risk-taking at significant financial
institutions. The Principles and Standards require the financial
industry to align employee incentives with risk and profitability of the
firm over different time horizons.
This is the FSB’s seventh progress report on the implementation of
the Principles and Standards. 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 incorporates input from FSB jurisdictions
and covers the period 2020-21, including the COVID-19 pandemic. It also
incorporates insights from an industry workshop held in May 2021.
FSB
© FSB - Financial Stability Board
