FSB Issues Clarifications Over Conduct Recommendations

The Financial Stability Board (FSB) has also published an overview of responses to its public consultation on its Recommendations for national supervisors: Reporting on the use of compensation tools to address potential misconduct risk(Recommendations), which it launched in May. 

Overall the board says it received 11 responses from associations representing supervisors, banks, a research foundation, trade associations and a trade union. 

Generally, it says, most respondents voiced support for efforts to promote good conduct, improve culture and reduce the incidence of misconduct at financial institutions. Among other issues raised, commenters offered suggestions for further tailoring the scope of the Recommendations, expressed concerns over privacy and confidentiality of the data collected, and highlighted some of the technological challenges associated with collection and analysis of data. 

“In reviewing the comments, FSB members have concluded that some of the concerns raised may be the result of a lack of clarity in the Recommendations themselves,” the board says. To this end, it has published what it terms “clarifications” aimed at elucidating some of the issues raised across various comment letters.

Specifically, these state that the Recommendations refer to compensation “tools” to address potential misconduct risk, which are both ex antemechanisms (design of variable compensation that ensures appropriate incentives and controls) and ex postrisk adjustment mechanisms that would be utilised when accountability for adverse outcomes is established. 

It adds that the Recommendations will be implemented by national/regional authorities, who will determine the scope, nature, and timing of any resulting reporting, stating, “The suggested items for consideration will be tailored by national/regional authorities to fit the circumstances of its individual jurisdiction and existing practice. The FSB will not collect the data indicated in these Recommendations.”

The clarifications stress that the reported data will remain with national/regional authorities and reporting protocols will reflect national law, including privacy and confidentiality provisions applicable to supervisory dialogues. The Recommendations do not include additional public disclosure provisions.

Equally, they do not contemplate a “uniform data collection framework” nor a one-size-fits all standard for use of compensation tools. “They are not based on the assumption that compensation tools should be used to address every misconduct risk, nor that regulators require the use of specific tools in specific circumstances, nor that compensation should be used alone to address misconduct, when it is clearly part of a wider toolkit,” the FSB states.

Instead, it notes, “They recommend collection of information on how firms actually use tools, not only the framework and processes that govern their use.”

While other risk management and governance tools complement the effects of compensation tools in managing risk-taking behaviour, collection of information on the use of compensation tools is important given the history of misconduct that has occurred, the FSB adds.

It also notes that the Recommendations are aimed at “significant” financial institutions, as defined for purposes of the FSB’s progress report on implementation of compensation standards. National authorities may, it stresses, at their own discretion, consider applying the Recommendations more broadly. 

The FSB also seeks to clarify the Recommendations’ guidance by highlighting that effective risk adjustment relies on effective identification of risk and strong corporate governance including development of policies and procedures that result in effective balance of risk and reward. “Effective risk management and strong corporate governance are key concepts for effective compensation frameworks,” it states. “In order to assess whether variable compensation is appropriately risk adjusted, supervisors must be confident that firms are effectively identifying, analysing, tracking, and considering risk events. 

“Collecting supporting data is a critical step in identifying, preventing and mitigating misconduct risk, including through the use of compensation tools,” it continues. “The absence of effective policies and procedures for risk adjustment processes, for example, would not be consistent with jurisdictions’ expectations. 

“Likewise, effective analysis considers not only how such events occur (in order to ensure accountability and address identified control gaps) but also whether they are likely to occur in other areas of operations,” it further adds. “An important part of that analysis focuses on effective compensation design and ex post adjustments which help appropriately balance risk and reward and take into account compliance performance and ethical and responsible behaviour.”

The further guidance also says that supervisors recognise that many significant firms have already made improvements to data collection and analysis related to compensation practices. “Important changes have occurred in firms’ management of compensation and conduct risk in recent years, including growing emphasis on incentivising positive behaviour rather than simply preventing negative behaviour,” it observes. 

Noting that the Recommendations “highlights better practices”, the FSB urges banks and their supervisors to engage in dialogue on the ways in which a particular institution addresses misconduct through a mix of its governance, controls, risk management, and compensation approaches that are tailored to the institution’s unique circumstances. “That dialogue, as part of the normal supervisory relationship, has proven to be a productive tool in addressing misconduct,” the FSB states. “The Recommendations gather information on how financial institutions internally define misconduct (which has a significant impact on the scope of information collected) and on how it is effectively managed. 

“Evidence that misconduct risk is being effectively managed is critical to supervisory reporting processes, however the Recommendations do not propose any compensation provisions that are globally applicable to a wide universe of employees,” it adds. “The Recommendations are consistent with allowing institutions to tailor their information collection in a way that results in effective identification, prevention and mitigation of misconduct risk as well as consideration of this risk in compensation design and decisions.”

The clarification closes by noting that since many jurisdictions already collect this information supervisors are aware of the implementation challenges that range from technological (collection of information across multiple source platforms) to potential conflicts with cultural norms or local laws (data privacy and employee protections). “The Recommendations assume that data collection, as in all supervised areas, would be an iterative process,” the FSB says. “As firms embrace technology in other areas of operations, so too should their risk management of incentive compensation practices evolve.”

Colin_lambert@profit-loss.com

Twitter @lamboPnL

Twitter @Profit_and_Loss 

Colin Lambert

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