The G20 charged the FSB and BCBS with addressing compensation after contentious debate at the Pittsburgh summit between the French and Germans, who wanted hard and fast rules, and the UK and especially U.S. leaders, who opposed action. The FSB turned to the issue at a time when some national governments and agencies had already commenced unilateral action (FSB, 2010a). The FSB, BCBS, and central banking community was responding to an
apparent but contested linkage between many years of rapid increases in financial sector pay (FCIC, 2011; Johnson and Kwak, 2011), increased leverage, perverse incentives, excessive risk taking, outsized profits, and naive investors unaware of the dangerous actions of firms’ management. Given the split (Europe versus America) over the subject, the FSB sought to deal with the issue via a principles-based approach (Bolton, Marhal, and Shapiro, 2010).
Compensation is the clearest example of the internal FSB tension between a rules-based approach and a principles-based approach used by members. The latter is selected when FSB leaders differ markedly on approach, as is the case with compensation. When matters are too complex for rules, principles are the remaining option. But the approach also tends to indicate a lack of strong FSB agreement on the policy narrative on causes and solutions as is the case in this policy area. In France and Germany, bankers’ high compensation and bonuses were believed to have been a causal factor in the crisis; in that case, hard rules can be used to limit such excesses. In the U.S., officials, more ideologically sympathetic to bankers, did not agree compensation played a major factor in the crisis, maintaining it is not the job of regulators to decide compensation systems and levels in a market economy. Given this split the FSB defaulted to a principles approach.
The FSB, decided to monitor the application of the Principles for Sound Compensation
Practices (FSF, 2009). The principles are either banal or high-level depending on one’s view
and are a first step (Ferrarini and Ungureanu, 2010). They include agreement on a need for a board-level remuneration committee as an integral part of an organization’s governance structure; a possible limit on variable compensation as a percentage of total net revenues; that pay should be aligned with risk; when a firm’s performance declines, so should bonus
compensation; a recommended deferral (at least three years) of 40 to 60 percent of bonus, with a substantial proportion awarded in shares or share-linked instruments; the inclusion of a claw back provision where unvested payments can be taken back from the employeeif the performance of the of the firm declines; and a ban on employees hedging their own
compensation or taking out insurance to sidestep the compensation changes. The principles are largely uncontroversial and it is left to national supervisors to decide whether to enshrine them in national regulatory or legislative language.
To date, jurisdictions have implemented the principles using a mix of light supervisory oversight (the U.S.) and enforceable regulation and law (the EU). The precise type of
supervisory or regulatory approach depends on the equilibrium between the various domestic interests in play and the country (or region’s) cultural preference. The light supervisory approach has led to complaints of gaming the system. Some firms’ personnel, such as employees at Goldman Sachs Inc., are accused on actively avoiding FSB compensation principles, demonstrating the weakness of a supervision and principles-only approach (Dash, 2011).
EU states took a regulatory route made more robust via enforceable EU law on compensation and bonuses. The EU codified a number of the principles as minimum requirements within European law, and in 2013 the EU (backed by strong German support) placed an absolute cap on bonus levels. Individual G20 states have also issued national implementing regulations or incorporated the principles and standards into existing law, with supervisory guidance illustrating how the rules should be met (FSB, 2010a).
5.7.1 Monitoring and enforcement: A real and meaningful shift?
In this policy area, exceptionally and paradoxically, despite the tension between the U.S. and the EU, monitoring and enforcement has advanced further than any other from a structural and institutional standpoint. First, the policy area has periodic monitoring and thematic peer reviews and reporting as per other policy areas, through the FSB standing committees and up to the G20 (FSB, 2012c). This has required G20 states to survey actual compensation practice of systemic banks and report the comparative data through the FSB thematic review. But this is far from all.
5.7.2 A new dispute settlement procedure
The clash between those who wanted further thematic reviews and those who sought to close the sensitive subject down proved institutionally productive. A compromise result secured by the FSB leadership saw the creation of the first formal dispute settlement procedure within the G20-FSB architecture.
Under the 2012 Bilateral Complaint Handling Process FSB (FSB, 2012a), members can use a mechanism for judgments on compliance if they believe they are at regulatory disadvantage due to inconsistent implementation of the compensation principles.
The complaint process has a judicial ring to it. A supervisor lodges a complaint on behalf of a firm, details the complaint, specifies the target firm that undertakes such practices, the home jurisdiction, lays out the nature and magnitude of the disadvantages, and the individuals i.e., senior executives and their compensation packages) concerned. All these steps (and many others) delineate a procedure that is legalistic in its construction and approach. A
Compensation Monitoring Contact Group, composed of national experts with regulatory responsibility for compensation, meets under the oversight of the Standards and
Implementation Standing Committee, and determines the outcome (i.e., makes a judgment) on a complaint and whether there has been inconsistent implementation of the compensation principles and standards. If there has been inconsistent implementation that will be brought to the attention of the firm’s supervisor. If failures are seen, they will be ‘Verified and addressed as needed via bilateral exchanges among national supervisory authorities’ (FSB, 2012a, p. 15).
The dispute process has not yet been triggered (Interview 34, 2013), but over time it could generate decisions on inconsistent implementation of agreed FSB compensation principles and standards. The FSB indicates that it expects that such firm-specific cases will provide more clarity on the application of the standards across jurisdictions. This is a potentially significant FSB institutional process. It is the first dispute settlement mechanism in the new architecture, and it has some similarity to the World Trade Organization dispute settlement process, which is judicial (Jackson, 2004, 2008). Those in the leadership inside the FSB recognise this mechanism to be a potential innovation (Interview 24, 2012). Yet, because it is so new, the change has received little external notice or analysis. It is clearly an area for potential future study and analysis as complaints and judgments are made.
What this innovative new dispute settlement approach demonstrates is FSB leadership
reaching to create institutional strength from an internal central banking dispute. A clash over the application of compensation principles results in the creation of a quasi-judicial complaint process. Yet again, FSB policy action, this time paradigm maintenance, benefits from the strength of the epistemic community leading change, even here, where there is a dispute.
Placement on the policy reform matrix: The observer will see the FSB policy action on compensation as moving left to right across the matrix from ‘very weak’ towards ‘weak’ and to ‘weakly globally harmonised’. Over time, this policy may move it further still into the ‘strong’ category, as per the arrow indicating future movement. At present, this policy melds principles with a new untested dispute procedure and is a second-order change. In 2013 it is untried. But it is a potentially significant dispute settlement procedure. On the other hand, there are divergent national approaches, from supervisory in the U.S. to regulatory in the EU, and this could weaken the overall global effect, especially if no cases are lodged using the dispute settlement procedure.
Very Weak Weak Strong Extremely Strong
Strongly Globally Harmonised Strongly Nationally Based Weakly Globally Harmonised Regionally Harmonised X‐Axis ‐ Represents strength of regulatory response Compensation Principles – Dispute Settlement