The Financial Stability Board (FSB) published the final version of its Supplementary Guidance to the FSB Principles and Standards on Sound Compensation Practices following a public consultation launched in June 2017. The guidance has been developed in collaboration with other standard-setting bodies. It supplements the FSB’s Principles and Standards.1 on compensation at significant financial institutions, published in 2009, which note that compensation should be adjusted for all types of risk. The guidance provides firms and supervisors with a framework to consider how compensation practices and tools, such as in-year bonus adjustments, malus or clawback, can be used to reduce misconduct risk and address misconduct incidents.
The Principles and Standards were developed in the aftermath of the global financial crisis to address misaligned incentives that could be created by compensation practices in financial institutions. Since the issuance of the Principles and Standards, supervisors and firms have directed considerable attention to improving the link between risk governance and compensation practices to more effectively align compensation with sound risk-taking behaviour, with a view to the long-term health of financial institutions.
Workplan to reduce misconduct
In 2015 in response to significant incidents of misconduct at financial institutions the FSB launched a workplan to reduce misconduct. The guidance published today on better practice regarding the application of the Principles and Standards to misconduct risk forms part of that overall workplan. Compensation and related performance management mechanisms help signal the importance that financial institutions place on prudent management of risk and on standards of behaviour, including compliance with related laws, regulations and supervisory expectations. Compensation tools, along with other measures, can play an important role in addressing misconduct risk by providing both ex ante incentives for good conduct and ex post adjustment mechanisms that ensure appropriate accountability.
Guidance does not establish additional principles or standards
The guidance, like the Principles and Standards, will apply to financial institutions that competent authorities consider significant for the purpose of the Principles and Standards. The guidance does not establish additional principles or standards beyond those already set out in the Principles and Standards and it has been developed in the form of recommendations on better practices. It consist of eight recommendations for firms and supervisors and is structured in three parts: (i) governance of compensation and misconduct risk, (ii) effective alignment of compensation with misconduct risk and (iii) supervision of compensation and misconduct risk.