Recent regulatory changes may undermine the concept of pay for performance and perpetuate an uneven playing field within the international financial sector, according to a new report by Mercer.

Mercer’s report suggests that this issue is of particular concern to European banks, which are subject to more onerous regulatory requirements compared to competitors in North America and then emerging markets, the firm said.

The report revealed that most companies (68 per cent) had not yet set a fixed/variable compensation ratio cap, and many indicated it was not on their agenda, albeit prior to the finalization of CRD IV requirements. Organisations in Europe were thinking about it more than other geographies, but setting such a ratio still represents major change and many challenges for these companies to manage.

“Organizations are also looking at other ways of maintaining pay levels to support staff retention.  However, reducing the amount of variable pay, like bonuses, weakens the link between performance and pay. With less variable pay that can be linked to performance, there will also be less pay that can be deferred and aligned with the risk time horizon of the business. This is contrary to the principles developed by the Financial Stability Board after the financial crisis. Rewards in banks and other financial organizations should be tied to multi-year performance to help manage risk,” said Vicki Elliott, senior partner at Mercer.

Seventy-six per cent of organizations stated that the proposed requirements were creating an uneven playing field, while only 22 per cent said that their organization would benefit competitively. Sixty-three per cent said that the proposed compensation caps will reduce the organization’s ability to pay for performance and 53 per cent believed that they would maintain total compensation levels, regardless of the level of bonus cap. Unsurprisingly then, 75 per cent of companies were looking at creative compensation alternatives. Interestingly, 70 per cent said that that there would be a shifting focus from compensation to other elements of the total employee value proposition, such as flexible working arrangements, training and career development.

“Since bringing new talent into the organization is becoming more costly due to higher fixed salaries and larger amounts of deferred compensation, many companies are increasingly focusing on programs to engage and develop existing talent,” said Dr Hans Kothuis, Mercer partner and executive  rewards leader for Asia and the Middle East.

Mercer’s Global Financial Services Executive Remuneration Report analyzed data from 78 financial services organizations, including banks and insurers, across Europe, North America and the emerging markets. Pay within financial services, and amongst senior executives more broadly, is the subject of much regulatory activity globally, including developments such as on pay and bonus caps, with particular impact in Europe.

Emerging markets

Mercer said that the approach on regulating executive pay in Asia has been predominantly principles-based, providing guidelines rather than instructions. The firm said that companies in the emerging markets tend to use multiple bonus pools with divisional or business unit specific performance measures determining the pools at each division or business unit.  They are more likely to use a scorecard evaluation approach, with a set of multiple measures and lenses to assess performance and fund the bonus pools.

In addition, the report found that many financial institutions do not articulate a maximum incentive opportunity (cap) and the setting of fixed to variable compensation ratio is not yet on the agenda at many financial institutions within the emerging markets.  Another point of interest is that for 2014 companies in the emerging markets plan to decrease the weight of annual incentives and increase the weight of multi-year compensation, the firm said.

The report also shows that in the emerging markets, the human resources department is much more involved than in the other markets of Europe and North America, within its performance and pay process. Mercer said that the compensation function at financial institutions in the emerging markets tends to be less strongly staffed at the corporate level, and with more staff at the region or country level, when compared to organizations from Europe and North America.

Europe

Mercer’s report revealed that European organizations will begin preparing for CRD IV changes in 2013, the most significant changes will be for the 2014 performance year. Respondents indicated that they will respond by raising base salaries for impacted employees as well as raising allowances and non-core compensation. Companies may also increase the vesting period for deferred compensation to five years and/or introduce new long-term incentive programmes to take advantage of the discount CRD IV allows for this longer vesting on 25 per cent of variable pay, the firm said.

North America

The report reveals that US regulators in particular are working with the largest banks to ensure pay practices are aligned with the FSB principles, and have resisted a “one size fits all” solution. Mercer said that North American companies expect less impact from EU regulation than their European counterparts, even though their EU-based material risk-takers will be covered by the same requirements. As in Europe, the main response in this region is to raise base salaries, allowances and non-core compensation for those employees touched by the CRD IV regulation. Mercer has observed that US banks are also reducing their maximum pay out ranges in their corporate incentive programs, thereby reducing the leverage in their plans.