IIF report shows banks making changes to pay structures

The banking industry is acting together to assure regulators it recognises the need for reform of compensation structures to be more long-term, risk-based

Washington DC - Financial services firms are moving forward with far-reaching changes in their approaches to employee compensation, according to a new report from 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".

Josef Ackermann, chairman of the IIF board of directors, chairman of the management board and the group executive committee of Deutsche Bank, said: "The message today is that progress is being made in reforming compensation in firms across our industry. 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). On Monday, March 30, the IIF released a report on compensation practices carried out by 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.

Ackermann said: "The industry broadly recognises that compensation structures in the past had shortcomings. It is necessary for firms to put in place practices that are more appropriately aligned to the current and prospective needs of our industry and to the exigencies of market stability. The IIF's principles are unique in their global emphasis and scope, and have been endorsed by senior executives from major firms from a large number of countries. They established benchmarks for the industry, and we are pleased to note the recent announcements of principles for compensation by key regulatory and supervisory bodies that are broadly consistent with those of the IIF."

Klaus-Peter Mueller, chairman of the supervisory board, Commerzbank, and co-chairman of the steering committee said: "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. 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 said a lot of work still remains to be done to fully reform compensation structures, but it noted that this report showed 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.
As the process of reform moves forward throughout the industry, the problem of "first-mover disadvantage", or the risk that the first firms to introduce new compensation schemes will lose talent, is diminished.

Click here for the survey.