By Nicole D. Prysby, J.D.
The Financial Stability Board announced on March 9, 2018, that it has published the final version of its Supplementary Guidance to the FSB Principles and Standards on Sound Compensation Practices. This guidancesupplements the FSB’s 2009 Principles and Standards on compensation at significant financial institutions and is intended to apply the Principles and Standards to misconduct risk.
The Principles and Standards were developed following the global financial crisis in an attempt to address misaligned incentives that could be created by certain compensation practices. Since their issuance, said the press release, firms have improved the link between risk management and compensation practices to better align compensation with sound risk-taking behavior. In 2015, in response to incidents of misconduct, the FSB began an initiative to reduce the problem by creating guidance regarding application of the Principles and Standards to misconduct risk. This guidance is the result of that initiative.
Recommendations. The guidance notes that inappropriately structured compensation agreements can cause individuals to take imprudent risks, leading to potential harm to the financial institution and its customers, and states that compensation tools should be used as part of an overall strategy to limit risks and costs of misconduct. The guidance contains eight recommendations in the areas of governance of compensation, effective alignment of compensation, and supervision of compensation and misconduct risk:
- boards and senior management should implement and oversee compensation systems designed to promote ethical and compliance behavior;
- sound governance and risk management frameworks in compensation design are critical to addressing misconduct risks;
- the ultimate authority for ensuring accountability for misconduct is with the board of directors;
- senior management should hold line of business management accountable for communicating and implementing expectations regarding business practices;
- consistent with the Principles and Standards, compensation should be adjusted for all types of risk, including risk associated with misconduct;
- to accommodate the potentially long-term nature of misconduct risks, compensation systems should have mechanisms to adjust variable compensation, including clawback arrangements;
- effective policies must be in place to decide cases that may result in reductions to variable compensation, based on clear specifications; and
- supervisors should monitor and asses the effectiveness of compensation policies, including the application of compensation tools in addressing misconduct risk.
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