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US principles-based approach gives more flexibility and competitive advantage than Europe’s prescriptive approach
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Compensation regulation falling short of achieving key objectives for managing risks
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Greater international consistency in complying with the spirit of regulations required
The different approaches taken by European and US regulators has created an unlevel playing field in financial services, putting European banks at a competitive disadvantage when attempting to attract high performing staff, says a new survey report by Mercer. As a result, European banks may find themselves having to pay more to attract top talent to overcome some of the regulated pay structure restrictions they now face compared to their US competitors.
The US approach to regulating financial services pay, post financial crisis, has been principles-based. This has involved setting out guidelines on what is expected and allowing companies flexibility in how the guidelines are interpreted and applied. By contrast, the EU has taken a more prescriptive approach; Regulators have stated specifically how they expect companies to structure deferrals and the types of pay instruments to be used. Regulators in Switzerland, China, Japan and Australia have also taken their own slightly different approaches.
“Globally, there is a patchwork approach in the regulation of financial services remuneration,” says Vicki Elliott, Senior Partner leading Mercer’s Global Financial Services Human Capital Consulting team. “Our research suggests that this is creating an unlevel competitive playing field and means that the original intent of some reforms is not being met. On one hand, the European approach has produced more consistency in compensation programme design. On the other, it has caused some changes that will cost companies more - without necessarily achieving the desired behaviours to help manage performance and risks.”
According to Mercer’s Global Financial Services Executive Incentive Plan Snapshot Survey the ‘unlevel playing field’ is caused by the differing US and European approaches to ‘deferred bonuses’. This bonus deferral is intended to discourage a short-term approach to risk as part of the post-financial crisis reforms. A portion of an individual’s bonus will be postponed, or deferred, typically for at least three years. Most European banks now have performance conditions – or “malus” arrangements – for reducing or eliminating deferred amounts if there are losses or performance conditions are not met.
In contrast, many US banks have not yet introduced these performance conditions for deferral payouts. The report highlights that 88% of European companies have long-term incentive stock awards dependent on performance conditions compared to 50% of respondents in the US. For stock option plans, 75% of European companies require performance conditions to be met compared to none of the US participants.
“Put simply, you’re currently more likely to receive your bonus payouts in the US than you are in Europe,” said Mark Hoble, Partner leading Mercer’s UK Executive Remuneration business. “Although most deferrals are delivered in stock, they remain based on service in the US. As long as an employee remains at the company for 3 to 4 years, they will receive their shares. However, this situation may change, particularly for the largest banks, in light of pending regulation.”
Mercer’s report also suggests that the regulations may be falling short of their original intent. The data showed that while 75% of companies with performance-based deferrals tie them to subsequent company performance, far fewer tie them to business unit performance (32%) or an individual’s non-financial performance (29%) Thus, the incentives for an individual are less impactful due to the longer line of sight to company performance.
According to Mr Hoble, “Although current compensation structural changes may instil a concern for longer term business outcomes, they may also result in driving up total compensation in banking. This may be the dreaded unintended consequence.”
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