Page last updated at 17:21 GMT, Wednesday, 12 August 2009 18:21 UK

Banks given new rules on bonuses

Cash being handed over
The FSA wants to discourage excessive risk-taking

Bankers' pay deals are to be linked more closely with the long-term profitability of banks under new rules from the Financial Services Authority.

The FSA says that bonuses should not be guaranteed for more than a year, and that senior employees should have their bonuses spread over three years.

Many believe that big bonuses led to excessive risk-taking at banks which contributed to the financial crisis.

But the rules have been criticised by some for not going far enough.

The new code is designed specifically to discourage short-term risk-taking, which many argue was an important factor in triggering the financial crisis.

"The fundamental objective [of the rules] is to sustain market confidence and promote financial stability through removing the incentives for inappropriate risk taking by firms," the FSA said.

These watered down plans send out entirely the wrong message to an industry which is already forgetting that, just a matter of months ago, it had to come with its begging bowl to the taxpayer
Vince Cable, Liberal Democrat Treasury spokesman

But it said that "inappropriate remuneration policies" were a "contributory, rather than a dominant factor" in the crisis.

'Watered down'

While the Association of British Insurers praised the new rules as "an important step forward", others were less than impressed.

The Financial Services Consumer Panel, established in 1998 by the FSA itself, said the fundamental problem of linking bonuses to long-term performance remained.

"[The code] fails to effectively address the issue of senior managers' incentives being linked to the performance of the business," said the panel's chairman Adam Phillips.

Vince Cable, Liberal Democrat Treasury spokesman, was more forthright: "These watered down plans send out entirely the wrong message to an industry which is already forgetting that, just a matter of months ago, it had to come with its begging bowl to the taxpayer."

Indeed many commentators believe the new rules will not signal an end to the debate about bonuses.

Nicholas Stretch at City law firm CMS Cameron McKenna said: "This is not the end of the rules for rewards for bank employees.

The FSA is determined that banks' remuneration policies should be consistent with, and promote, effective risk management
Hector Sants, FSA chief executive

"There is still substantial political pressure for capping awards, greater public disclosure and naming and shaming in this sector, both in the UK and internationally, which is likely to continue for some time."

'Right incentives'

But Hector Sants, head of the FSA, said the regulator was "determined that banks' remuneration policies should be consistent with, and promote, effective risk management".

The FSA said there were two main objectives behind the code of practice.

First, to ensure that boards focus more closely on making sure that "the total amount [of pay and bonuses] distributed by a firm is consistent with good risk management and sustainability".

And second, to ensure that overall pay, including bonuses, "provides the right incentives".

To this end, a number of new principles have been added to the FSA's financial regulation handbook.

In particular, these make clear that bonuses should only be guaranteed for 12 months, and that senior employees will see two-thirds of their bonuses paid out over three years.

Mr Sants said the new rules would take effect from January 2010.

The point that bonuses are necessary to retain talent in the City is a weak argument
Professor Stefano Harney, Queen Mary, University of London

The FSA wants banks to submit their remuneration policies to it by the end of October. Firms that do not comply with the code "could face enforcement action", or be forced to hold more cash in reserve should they want to pursue risky strategies.

However, it conceded that the code "is not going to change the bonus culture overnight".

The FSA also reduced the number of banks affected by the code to 26, down from the 47 originally covered.

Relocation concerns

The FSA launched a consultation in February looking at measures to discourage excessive risk-taking, and published a draft version of the code in March.

Bankers expressed concerns that the proposed measures on bonuses, some of which have been included in the final code, would encourage institutions to relocate employees outside of the UK, to get round the new rules.

This could have serious implications for the City's position as the world's leading financial centre, and for the UK's tax take, bankers argue.

But Professor Stefano Harney from Queen Mary, University of London, told the BBC he did not accept this view.

"The point that bonuses are necessary to retain talent in the City is a weak argument. Just where would [the bankers] go?" he said.

However, recently there have been concerns that large bonuses are returning amid a boom in profits from investment banking.



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