Bankers’ pay and governance reforms key to reducing ‘risk-taking behaviour’, says IMF head

Speaking at an event in Washington, Christine Lagarde said that intervention by global regulators had done much to address the issues that led to the financial crisis in 2008, but that regulation alone could not address the risks to financial stability caused by the “culture” at some firms. Firms needed more powers to claw back pay and bonuses in the event of misconduct, while internal governance and risk management needed further reform, she said.

“Whether something is right or wrong cannot be simply reduced to whether or not it is permissible under the law,” she said. “What is needed is a culture that induces bankers to do the right thing, even if nobody is watching.”

“Ultimately, we need more individual accountability. Good corporate governance is forged by the ethics of its individuals … I want to see institutions themselves take up this matter – shareholders and bondholders too. There should be a drive in the private sector for better alignment of risks and incentives,” she said.

The IMF, which works for global economic cooperation and financial stability, carried out some “in-depth work” on how compensation and governance structures could be reformed to help reduce risk-taking behaviour and “re-align” incentives towards the end of last year, according to Lagarde. This work considered the effectiveness of cancellation and claw-back provisions, and of giving shareholders a “stronger voice” on executive pay, she said.

Share plans and incentives expert Matthew Findley of Pinsent Masons, the law firm behind Out-Law.com, said that the idea of bank shareholders being given more say on pay raised questions, given that London-listed companies were “already subject to some of the most extensive say-on-pay rules in the world”.

“The unanswered question is whether everybody else should aspire to the level of regulation found in London or whether all countries, including the UK, should go further,” he said. “The proposed Shareholder Rights Directive – the EU-wide say-on-pay rules – may have a role to play in answering that question.”

“The continued focus on malus and clawback and linking pay to long-term performance is understandable. What is questionable is whether the bonus cap – the key measure introduced by the EU to date – achieves that. The result has been to increase fixed pay, which cannot be subject to malus or clawback in the same way as long-term variable pay,” he said.

Global regulators, including the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (‘Basel Committee’) have considered the links between bankers’ pay and performance as part of their responses to the financial crisis, while the UK’s Parliamentary Commission on Banking Standards (PCBS) explicitly addressed professional standards and UK banking culture as part of its work following the various LIBOR benchmark interest rate regulatory interventions. From next year, changes to the way in which senior managers of banks in the UK are regulated will make it easier for regulators to hold them individually accountable for failures in their area of responsibility.

The fourth Capital Requirements Directive (CRD4), which implemented the ‘Basel III’ global banking regulatory reform package in the EU and European Economic Area (EEA) introduced new rules limiting bonuses and other forms of variable pay to 100% of a banker’s fixed remuneration, or 200% with shareholder agreement; along with new rules on deferral and payment in financial instruments.

The UK, which has the largest financial services sector in the EU, has opposed the introduction of a bonus cap since it was first proposed and even went so far as to lodge a now-abandoned legal challenge to the policy at the Court of Justice of the European Union (CJEU). Senior bank regulators including Andrew Bailey, chair of the Prudential Regulation Authority (PRA), and Bank of England governor Mark Carney have said that the policy has only pushed up fixed pay and made it more difficult for regulators to penalise senior bankers for misconduct.

“Ms Lagarde’s comments on clawback might be thought not to be an issue across the EU/EEA, as EU law requires substantial deferral and malus/clawback of ‘variable remuneration’ – that is, short-term bonuses and long-term incentives together,” said Financial Services Employment expert Steven Cochrane of Pinsent Masons.

“However, the interpretation of the ‘bonus cap’ results in an effective limitation on the scope and impact of clawback, as fixed pay – now tending to inflate – is not subject to clawback, and clawback is treated by the EBA as one of the identifying traits of true ‘variable’ remuneration. Also, the cap makes it harder to place more weight on long-term variable remuneration, as the EBA wants to require the limit to be applied at vesting of long-term awards, which simply does not make sense with classical equity long-term incentive plan awards,” he said.

Cochrane added that Lagarde’s references to clawback of “pay and bonuses” (emphasis added) chimed with recent remarks by Mark Carney calling for part of fixed pay to be delivered in a deferred form, that would be ultimately related to the long-term performance of the firm.