FSA 2008 outlook focuses on SocGen bonus lessons

The Financial Services Authority (FSA) has urged investment banks to re-examine their attitudes towards annual staff bonuses in the wake of last week's record rogue-trading loss at Société Générale.

In its annual Financial Risk Outlook, the UK regulator highlighted staff remuneration as a particular area of supervisory concern, noting that ailing performances by many investment banks are not reflected in employees' pay packets.

"There are indications that remuneration charges are not necessarily adjusting commensurately with falls in banking earnings. More fundamentally, there is a concern over whether investment banks' [bonus] policies provide the right incentives for risk assessment," the regulator wrote.

"The size of bonuses can be a powerful incentive for staff to focus on the quantity of business they undertake during a year and pay less attention to its quality. There is a concern that in some cases remuneration policies can work against the systems and controls that have been put in place to control risk," the FSA stated.

The regulator's comments could be interpreted as a direct allusion to the €4.9 billion rogue-trading loss divulged last week by Société Générale. According to Jean-Claude Marin, the prosecutor leading the case against Jerome Kerviel, the 31-year old trader took €60 billion of unauthorised positions on SocGen's equities derivatives desk because he wanted to qualify for a €300,000 annual bonus.

Among other issues highlighted in the report, the FSA noted an increase in the ratio of net value at risk (VAR) to investment banks' tangible equity over recent months, indicating increasing risk is the business environment.

"Unlike previous years, the rate of increase of VAR exceeded the increase in investment banks' tangible equity and by August 2007 the VAR/equity ratio had reached levels not seen since early 2002," the FSA notes.

The regulator predicts that VAR will continue to increase as the impact of last year's market turbulence feeds through the trading cycle.

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