FSA gives banks a management lesson

Yesterday a letter went out to the CEO's of financial institutions from Hector Sans, the Chief Executive of the FSA. The letter pointed to the fact that there were concerns that inappropriate remuneration schemes had led to the current market crisis. It states that "it would appear that in many cases the remuneration structure of firms may have been inconsistent with sound risk management."

The FSA say they have no wish to become involved in setting remuneration levels, however they want to "ensure that firms follow remuneration policies which are aligned with sound risk management systems and controls, and with the firm's risk appetite". The FSA will ensure under its Principle 4, that the insitution has among other things, capital and liquidity that aligns with its "risk appetite". In other words the riskier the trading the more capital it will need.

The letter is aimed at executive directors pay as that of non executives was covered in the 2003 Higgs Review.

Hector Sans goes on to acknowledge the variations between institutions, but sets out some high level criteria on good practice, including using risk-adjusted return calculations, moving averages and calculated profits, but combined with other measures such as managment skills or adherence to company values.

It is suggested that the fixed component of remuneration should be large enough to meet the financial commitments of the employee, and should be a mix of cash and other components designed to align the interests of the employee with the firm such as shares or appropriately priced share options. A majority of the bonus should be deferred so that the impact on long term profits can be established.

The report goes on to suggest best practice for governance such as independent risk and valuation reporting.

In other words the letter is outlining what any well run company would already be doing, so while the vast majority of directors that have overseen this mess still remain in place it does not create great confidence for the future.

There is also the worry that under the extra constraints imposed on the banks that are utilising government funds there remunaration policies will in the short term mean that they lose out on the best employees who can get more money elsewhere.