The United Kingdom’s Financial Services Authority Takes Action: Regulating Executive Compensation in the UK’s Financial Sector (An Overview)

On this blog, we track issues regarding executive compensation practices and regulations.  We take some time to examine the recent actions of the United Kingdom’s Financial Services Authority (FSA).  In this four post series, we will analyze the FSA’s August Policy Statement (PS) which revealed the adoption of a new “Remuneration Code” for executive compensation in the UK’s financial sector.

Compensation practices have been targeted because of their perceived role in the current financial crisis.  Nonetheless, British regulators have been slow to tackle the problem.  The reason isn't hard to see.  London depends on revenues from the financial sector. See The devil's punchbowl, The Economist  July 9, 2009 (“[T]he earnings from the United Kingdom’s financial services in a good year add over £25 billion (US $41 billion) to government revenues, and the financial sector employs over 1 million people across the country.”).  Additional regulation, particularly with respect to compensation, could threaten this source of revenue by damaging London's role as an international financial center.   Perhaps unsurprisingly, the Economist reported in July that “[i]ndeed, the pay culture that rewards bank bosses for short-term risk-taking has barely been touched.  Bonus pools, which in some firms scoop up as much as 50% of trading revenues, are a hangover from the days of private finance houses, when partners shared losses as well as gains.”  

The FSA, the UK’s equivalent of the American Securities and Exchange Commission, has now begun to address the matter, having issued a Policy Statement, “Reforming remuneration practices in financial services." 

The FSA Statement noted: “Inappropriate remuneration policies, practices and procedures were a contributory factor rather than a dominant factor behind the market crisis.  Nevertheless fundamental changes in the approach of many financial firms to remuneration will be needed if we are to be confident that we have laid a solid foundation to avoid future crises.” (¶1.18).  The Policy Statement contains the final rules on remuneration practices incorporated into the FSA Handbook in the form of a Code of practice on remuneration policies. 

Essentially, the new rules will require 26 of the largest banks and financial institutions operating in the UK to establish compensation committees.  Non-UK firms will be exempt from the Code unless they have total regulatory capital exceeding £1 billion (US $1.64 bn).  The Code will require the compensation committees to comply with the new rules for determining compensation packages for senior level executives and employees.  Notions of director “independence” and “expertise” already familiar to firms operating in the United States are prominent features in the new code. 

Furthermore, the Code provisions require a marked change away from bonus packages that rely mostly upon the immediate payment of cash bonuses.  The new code requires that future remuneration agreements must take into account the firm’s current and future risk analysis, principles of risk management, and must integrate more deferred-payment bonus schemes such as stock option plans that only vest after 3 or 5 year periods. 

We will discuss the contents of this code in the next several posts.