The head of the UK’s financial services regulatory watchdog has defended the need for appropriately incentivised high ‘fat cat’ City salaries, so long as they don’t impact negatively on the culture of financial firms.
In his keynote speech to Hong Kong’s financial services industry, Andrew Bailey, chief executive of the Financial Conduct Authority, defended the need for high remuneration in the industry, but warned that lessons needed to be learned, as in the past such moves had a “distinct impact on the culture of firms”.
Bailey was speaking in Hong Kong, at a Hong Kong Monetary Authority event. In his speech, entitled ‘Culture in financial institutions: it’s everywhere and nowhere’, Bailey, pictured below, outlined the changes in culture and tackled the ongoing difficult question surrounding financial services and banking salaries.
He pointed that despite the move away from the 1980s ‘Greed Is Good’ culture, salaries remain high, but are now more aligned to productivity.
Why? This depends to what extent the output and returns are realised almost instantaneously, and to what extent they emerge over often long periods of time, consistent with the length of contracts.
“Older theory suggests that output-based remuneration is more likely to be observed where managers have more discretion in what they produce. This means that the returns to managers are not independent of the underlying riskiness of the environment.
“With financial services, the added component is that measuring output is much more difficult because of the time dimension – the length of time it takes to see the results.”
Bailey pointed to the ‘solution’ that was found by accounting standards, “namely increasingly to book an estimated economic profit ahead of the contracts unfolding”. The appeal to managers was obvious, he says, and the resulting risk also looks obvious “at least from today’s vantage point”, where there is “to my mind no doubt that it influenced the culture of firms”.
“What happened next is, as they say, history,” said Bailey
“What are we doing about it? Learning the lessons of history. A big one is the old one that incentives tend to work, but it is crucial to understand how they work.
“It is critical that boards and regulators think through the consequences of structures and incentives. In bank remuneration in the UK we have emphasised the importance of deferring variable remuneration consistent with the observation that the risks and returns of activities evolve over a considerable time.”
Bailey added that during that time of deferral and after it, variable remuneration can be cancelled where problems or poor performance materialise. As a result, the objective to “align structures with incentives”, and create the culture that people have “skin in the game”, is created he said.
‘Rolling bad apples’
Bailey added that the UK regulator is also acting to stop people evading this discipline by moving jobs and cashing in deferred remuneration – the problem known as “rolling bad apples” and has established clearly that variable remuneration cannot be paid if a firm does not have adequate capital resources.
“This is an obvious point you might say,” said Bailey. “Well, not so obvious that it was followed in the past.
“In all of this, the approach is not to cap the level of remuneration, but rather to act on the structure of it and the incentives created. As financial regulators, we do not seek to control the level of pay, outside its impact on our public policy objectives.
“But, the influence that we do have will affect the culture of firms. That is intended,” he said.