Compensation policies as a strategic value creator

In the aftermath of the global financial crisis, compensation practices in the Financial Services industry have come under significant scrutiny by regulators and politicians, particularly in Europe and the US. The Financial Stability Board (FSB) and the Committee of European Banking Supervisors (CEBS) have been at the forefront of issuing a series of implementation standards on compensation with the ultimate goal of designing appropriate incentive structures that seek to align bankers’ compensation to the nature and degree of risks undertaken.

In line with their overall response to regulatory initiatives post the global financial crisis, Asian regulators have taken much more of a back seat approach regarding compensation reform, to some extent driven by substantially less visible excesses and hence less political pressure. Consequently, most Asian banks have taken a fairly passive stance to strategically reviewing their compensation frameworks, practices and governance.

However, a few Asian regulators, particularly the HKMA and the MAS, have now started to enforce their standards, which are line with the overall FSB standards. As a result, many financial institutions operating in these markets, have recently been asked to submit compensation policy statements, in which they outline to what extent the standards are met, and if not, how they plan to address the gaps going forward.

Despite this regulatory trigger, most banks remain passive with a focus on meeting minimum compliance requirements. In our view they fail to realize that as their global competitors start to change their compensation approaches, this will directly impact and change the talent market in Asia. We therefore believe that Asian banks now face a unique opportunity to strategically review their approach towards compensation by making a step-change in their current compensation structures. They should seek to differentiate themselves from competitors with a compensation framework that meets both regulatory requirements and allows attracting top industry talent.

Key changes for Asian financial institutions to consider include:

1. Strengthening compensation governance: Stronger involvement of Risk Management in the compensation process and higher degree of independence of the compensation committee 
2.  Improved bonus pool calculation and funding: Compensation should be risk-adjusted taking into account risks such as market, credit, liquidity, operational and reputational risk. Overall bonus pool calculation should be linked to group / business unit performance with a focus on the achievement of longer term-term strategic goals 
3. Stronger linkage of individual compensation to desired performance and behaviour: Performance management reviews should be improved and linking compensation to non financial metrics strengthened 
4. Increased use of deferred payout structures and schedules: “Material risk takers” should be identified and appropriate cash/non-cash bonus mix and deferral structures should be put in place, subject to clawbacks 
5. Transparent and timely disclosure: Guidelines for compensation should become more transparent to staff and adequate / timely disclosure should be made to regulators, shareholders and the general public. 

Many of these suggested changes will require the HR / Compensation function to substantially step up and play a much more strategic role. We also appreciate that that many of the suggested improvement areas (e.g. risk adjustments) will have to remain pragmatic at the beginning. However, compensation in financial services is a critical lever for retaining and attracting top-talent, maintaining market presence and ultimately meeting performance targets and shareholder expectations. Furthermore, compensation practices define culture and organizational behaviour in a fundamental manner, making them unique to every organization. Any changes made need to carefully consider an institution’s specific characteristic, but if handled with care and sufficient focus, they can substantially support the long term success of any financial institution in Asia.