Proposals by the Financial Services Authority (FSA) aimed at ensuring that pay and bonuses in financial firms are appropriately aligned with risk have encountered “serious reservations” from the investment management community.
The FSA’s new Remuneration Code is designed to shift firms away from short-termist strategies that could encourage employees to take investment risks in the hope of higher rewards. The authority is expected to issue a final policy statement on the issue next month, after consultation, that will in effect force remuneration strategies into line .
Proposals include limiting the proportion of bonuses that can be paid in cash, with at least half of all payments in stock or stock-linked instruments. At least 40% of awards must be deferred for three years, rising to 60% if a payout is more than £500,000. Guaranteed bonuses can be paid only to “exceptional” employees, and only for one year. There is also a clawback provision that will allow payments to be recovered if they breach the code. (article continues below)
Nathan Douglas of Prudential Regulation, writing on behalf of the Investment Management Association (IMA), recognises that risk management is critical, but is concerned that turning the spotlight on asset managers will lead to inappropriate regulation. Asset managers, he points out, hold client assets in segregated accounts and do not take on significant balance sheet risks. The FSA’s own data suggests that the cost of compliance could reach a “one-off” sum of £9.7m for regulated managers, with additional costs of up to £5.6m each subsequent year (see table).
Douglas says many IMA members already comply with the main principles. Many already have bonuses linked to rolling three-year performance, and sometimes longer. There has also been a noticeable shift away from cash bonus payments, partly because of vagaries in the tax system. And with higher earners caught in the 50% tax bracket, the differential with the current 28% capital gains tax rate makes capital-based payments, or income deferral, much more attractive.
So what will these changes mean for investment managers? The industry has contracted, but the market for top talent is competitive.
Tony Yousefian, the chief investment officer at OPM Fund Management, says that high remuneration at investment banks undermines asset managers’ ability to attract the best candidates, reinforcing the divide between the two.
In contrast, rising regulatory pressures have lessened the difficulty of finding hedge fund talent. Andy Sowerby, the managing director for sales, marketing and client service at Martin Currie, says it has become easier to attract the best alternative investment specialists as they are less inclined to set up alone.
With this in mind, active managers who have proved they can add value will command meaningful rewards, particularly in niche areas. Long-term stock-based incentive schemes will be increasingly important. At the same time, it looks as though guaranteed bonuses are on the way out, along with packages that fail to reflect any periods of poor performance at a firm.
What is clear is that the code is part of the new reality – more costly and more extensive regulation that encourages long-term stability.
The irony is that asset managers were less guilty of short-termism than other areas of finance. This is still an industry where a long-term performance record counts.