The Financial Stability Board (FSB) today published for public consultation draft Supplementary Guidance to the FSB Principles and Standards on Sound Compensation Practices regarding the use of compensation tools to address misconduct. The proposed guidance has been developed in collaboration with the standard-setting bodies and it supplements the Principles and Standards that note that compensation should be adjusted for all types of risk. Once finalised, the guidance will provide firms and supervisors with a framework to consider how compensation practices and tools, such as in-year bonus adjustments, malus and clawback, can be used to reduce misconduct risk and address misconduct incidents.
The Principles and Standards were published in 2009, in the aftermath of the global financial crisis. They have been implemented across FSB member jurisdictions. Since the issuance of the Principles and Standards, supervisors and firms have directed significant 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 institution’s long-term health.
Recent events related to misconduct have focused the attention of many supervisors and financial institutions more intensively on the need to develop robust frameworks for identifying, preventing and remedying misconduct. Compensation and related performance management mechanisms help signal the importance that financial institutions place on prudent management of risk and acceptable 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. To ensure such accountability, firms should have tools available to consider using when misconduct occurs. Therefore in 2016, the FSB agreed to develop guidance on better practice regarding the application of the Principles & Standards to misconduct risk.
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 highlights eight considerations that are relevant for firms and supervisors in terms of governance of compensation and misconduct risk, effective alignment of compensation and misconduct risk and supervision of compensation and misconduct risk.
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