UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To
be published as HC 1167-iv
House of COMMONS
MINUTES OF EVIDENCE
TAKEN BEFORE
TREASURY COMMITTEE
BANKING CRISIS
Wednesday 19 November 2008
MR PETER HAHN, MR RONNIE FOX, MS
CAROL ARROWSMITH
and MR CHARLES COTTON
MR BRENDAN BARBER, MR MILES
TEMPLEMAN,
MR PETER MONTAGNON and MR JONATHAN TAYLOR
Evidence heard in Public Questions 494 - 667
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Oral Evidence
Taken before the Treasury Committee
on Wednesday 19 November 2008
Members present
John McFall, in the Chair
Nick Ainger
Mr Graham Brady
Mr Michael Fallon
Ms Sally Keeble
Mr Andrew Love
Mr George Mudie
Mr Mark Todd
________________
Witnesses: Mr Peter Hahn FME Fellow,
Corporate Finance and Governance, Sir
John Cass
Business School,
Mr Ronnie Fox Principal of City law firm Fox, Ms Carol Arrowsmith, Partner,
Deloitte & Touche LLP, and Mr Charles Cotton Reward Adviser,
Chartered Institute for Personnel and Development (CIPD), examined.
Q494 Chairman:
Welcome
to our ingoing inquiry into the banking crisis.
Would you identify yourself for the shorthand writer, please.
Mr Hahn: I am Peter Hahn. I am from the Cass Business
School.
Mr Fox: I am Ronnie Fox. I am City solicitor.
Ms Arrowsmith: Carol Arrowsmith. I am a partner in Deloitte.
Mr Cotton: Charles Cotton. I am an adviser at the Chartered Institute of
Personnel and Development.
Q495 Chairman:
You
are all welcome. Carol Arrowsmith, Joe
Stiglitz, the Nobel prize-winning economist, is on the record as saying that
the system of compensation in the banking sector almost certainly contributed
in an important way to this crisis. He
says that the system encouraged people to gamble. When things turned out well, they walked away
with huge bonuses, but when things turned out badly, they did not share in the
losses and walked away with the large sums.
Is Mr Stiglitz's description of reward in the banking sector one that
you recognize?
Ms Arrowsmith: I would not want to argue
with a Nobel prize winner about many things.
I think it is fair to say that incentives may well have contributed in
some part to some of the problems.
Whether it is reasonable to say it is the sole cause I think is unlikely,
but there can be no doubt that many institutions have to go and look at the way
they people and review it in the light of new experience.
Q496 Chairman:
Ronnie Fox, in your modest and understated
way, you have said, "Labour politicians seem not to understand" - they don't
get it. "Business success and the
generation of profit involves taking risks" - what are these guys about? What is your opinion?
Mr Fox: I do not agree with the Nobel
prize winner, I am afraid. I do not
think that the remuneration systems in the City, and the bonus system in
particular, contributed to the banking crisis. I think people take risks in every aspect of business
life - and so did traders - but I do not think the risks caused the banking
crisis in that sense and I do not think the bonus system is responsible.
Q497 Chairman:
You have
the International Institute of Finance, the Counterparty Risk Management Policy
Group, the Financial Stability Forum, the FSA and, indeed, Richard Lambert, Director-General
of the CBI, saying that bonuses are one of the central factors in creating the
huge financial problems engulfing the banking sector worldwide and that is
because of a cavalier attitude to risk.
If you look at bonuses - I have looked at the annual reports of a number
of the major organisations, and, for example, the chief executive of RBS had a
salary of £1.2 million but ended up with £4 million; one of the directors of
Barclays had a £250,000 basic salary but ended up with £10.6 million; and HBOS
more than doubled the amount of money the chief executive had from his basic
salary - it seems as if a lot of bonuses are hinged on what they see as seeming
success and not their basic salary. Why
are you so out of step with everybody else?
Mr Fox: I think there are quite a lot
of people who do agree with me but not necessarily those who have been widely
reported. I take a contrary view. It seems to me that there are a great many
people who took risks, and substantial risks, who were not in receipt of bonuses. They took risks because they thought it was
the right thing to do, not because of the way they were remunerated. I think the people who did receive large
bonuses, often did so because they were perceived as having performed very well
in what they did.
Q498 Chairman:
"Risk
for success and failure" Peter Hahn. "Prizes for everyone." Do you recognize that?
Mr Hahn: Yes, indeed. I have no disagreement with Professor Stiglitz. Certainly most of the reward system was too
short-term oriented. But I think you
need to address the issue on two levels within the organisation: (i) individuals
who are at different levels in trading risks and (ii) the reward
structures that are provided for the most senior managers which are determined
by boards of directors.
Q499 Chairman:
Carol
Arrowsmith, given your professional background, I would like to ask you some
precise questions to get them on the record.
Can you explain what a typical reward package for senior and executive
management in the banking sector looks like?
Charles may want to come in as well.
Ms Arrowsmith: At board level, so the
executive directors, for example the chief executive in the larger banks in the
UK would typically have a salary of between £1 million and £1.25 million;
they would, on average, have the opportunity to earn a bonus of between two and
four times that amount; they would have the right to own shares based on three
years' performance which would be somewhere between two-and-a-half and five
times their basic salary; and they would typically have a pension, the most
common being a defined benefit based on either career salary or final salary.
Mr Cotton: We did not carry out detailed
research in this area. My remit at the
CIPD is quite broad looking at reward, but we do have contacts with HR people
in the investment banking community.
When I asked them what an equity trader would typically get, they said that
somebody with a reasonable amount of experience, about eight years, would get base
pay of about £90,000, a cash bonus worth £272,000 (basically three times their
salary), and on top of that they would get deferred compensation shares, et
cetera, of about £132,000. So we are
talking about half a million pounds in all.
Q500 Chairman:
What
are the key differences in the structure and composition of pay between
investment and retail banks?
Ms Arrowsmith: I think there are two very
important characteristics. Investment
bankers typically have a much lower basic salary and will have an uncapped
incentive opportunity, so there will not be a maximum on their bonus, and it
will not be uncommon for the most highly paid people to be nowhere close to the
main board directors. When you look at
the board of most of the banks, the highest paid people will not be those
people on the board, whereas in a retail organisation you are more likely to
get the kind of classic pay hierarchy, with the most senior people paid more
than the less senior people.
Q501 Chairman:
In
terms of bonus payment, the percentage shares and cash, what does that work out
that?
Ms Arrowsmith: Investment banking is not my
specialist subject, but you will generally find that for senior people in
investment banking it would not be unusual for their salary to be no more than
about 10% of their annual earnings.
Q502 Chairman:
Stock
options?
Ms Arrowsmith: They will have stock options
relatively rarely until you get very close to the top of the organisation. Most of it is salary bonus, either paid in
cash at the time or paid in deferred shares, so that they get a number of shares
which are delivered over time.
Q503 Chairman:
What
would the typical reward package for a trader in an investment bank look like?
Ms Arrowsmith: I do not know.
Q504 Chairman:
Does
anybody know? Okay, we will move on. What
factors have encouraged the increased use of bonus payments to reward staff in
financial institutions?
Mr Hahn: Frankly, a long time ago
bonuses were a pretty minimal part of compensation and it was decided that
financial institutions were boring - we all remember prudent bankers - and that
incentive compensation encouraged risk-taking which benefited
shareholders. The structure was
incentive for shareholders to get more returns, and that has driven it for
years and years. It is all about
shareholder returns.
Q505 Chairman:
Yesterday we had the chief executive of
B&B before. He took on the job in
August. I think his basic salary is
something like £750,000, but he is entitled to something like £650,000 combined
stock options and cash. Obviously, with B&B
the shares, you know, are not things you would run for, so he has the cash
there, £360,000. He was getting that
cash irrespective of how the bank did. I
was told that was a reasonably familiar scene.
Mr Fox: These are very large amounts of
money. I think people's perception of
what happens, particularly in the financial services sector, is distorted by
the sheer size of the remuneration which people receive. I do not agree that bonuses were devised in
order to encourage risk-taking. The
bonus system is designed to reward good performance. It is a way of marking out people who
perform exceptionally well against a criteria they have been given. Sometimes the criteria have turned out with
the benefit of hindsight to be inappropriate and sometimes not, but the
essential component of a bonus is that it is supposed to be a fair way of
remunerating people who perform exceptionally well against the objectives they
have been given.
Q506 Chairman:
In
your article Personnel Today of 23 September you did say that salaries
in the financial services sector tend to be modest. Would you call £1.2
million, £975,000 and £750.000 modest?
Mr Fox: The greatest criticism has
been levelled at those people who are in receipt of between £100,000 and
£200,000 basic and a bonus opportunity of several times that.
Q507 Chairman:
But you
would not call £1 million modest.
Mr Fox: No, I would not call it
modest.
Mr Hahn: With regard to yesterday's
comments there are different reasons and different plans for paying senior executives. Today, the new senior executive may have a
different objective from someone looking at long-term shareholder value and
risk-taking. They may have a very short-term
objective to come up with a strategy and stabilise an institution, and that
type of structure and strategy should be rewarded probably more in cash and more
certainty than with shares.
Q508 Chairman:
By
the way, I think that Mr Pym, in taking on B&B, has a gigantic task. I made that point to him at the very end
of yesterday's session. But to say that
you are going to get your cash bonus irrespective seems a bit ---
Mr Hahn: Yes.
Chairman: Okay.
Q509 Mr
Mudie: Carol, I understood you to say that in retail
the board is relatively modest in terms of bonuses on the investment side, and
then it is hierarchical on the retail side.
Ms Arrowsmith: That is an
oversimplification.
Q510 Mr
Mudie: But the big bonuses are on the investment
side.
Ms Arrowsmith: Typically. The biggest bonuses are in investment
banking.
Q511 Mr
Mudie: I am trying to tie that in. With the banks now being retail and
investment, how does that relate to the board?
Does that mean a board could be on a very good salary but they are
largely dwarfed by the bonuses earned on the investment side of the same bank?
Ms Arrowsmith: I think that is true. Many of the investment banking people within
those banks will earn more than the board members.
Q512 Mr
Mudie: That seems less clear-cut than what you said,
when you say "many of them will earn ...".
We saw the Bradford and Bingley, et cetera, and we know the range, but
now you are saying something slightly different.
Ms Arrowsmith: Maybe I am not making myself
clear. If you take a retail banking organisation, the highest paid people in
the organisation are more likely to be board members. In investment banking it is very common for
the highest paid people to not be main board members.
Q513 Mr
Mudie: That is
fine when they are separated and they are separate entities, but -----
Ms Arrowsmith: When you combine the two, you
will still find a great many people in the investment banking part of the
business who have the capacity to earn or, indeed, have earned more than the
executive directors.
Mr Fox: Perhaps the reason for that
is that the people who earn the most are seen as having contributed the most to
shareholder value and profit. Perhaps I
can offer you a story. Some years ago I
was advising the head of HR in a large investment bank on the payment of a
bonus. He said, "We want to pay this guy
a bonus of £7 million". I said, "What on
earth could this guy have done to justify a bonus of £7 million?" and he looked
at me as though I was slightly touched and said, "Well, the chap made £140 million
for the bank." The moral of the story is
that there was a direct relationship in that case, as there is in many cases,
to the bonuses which individuals receive and to the profit that they have made
for shareholders.
Mr Hahn: One of the challenges that I
think you are dealing with is the fact that a lot of these large rewards did
not correctly take into consideration the amount of risk that people took to
earn those rewards. I think that is
probably where we need to focus going forward on the banking system.
Q514 Nick
Ainger: Carol, how do these packages which are in the
financial services sector compare, say, with those in the manufacturing sector?
Ms Arrowsmith: They will typically have more
based on performance. On average, it is
quite common for the financial services sector to have it so that half as much
of their package is fixed and twice as much of their packaged is variable than for
a conventional FTSE 100 company. So they
have more performance pay.
Q515 Nick
Ainger: I am not talking about directors, I am only
talking about senior managers.
Ms Arrowsmith: I am only talking about the
main board. I do not have the details of
people well within an organisation.
Q516 Nick
Ainger: Perhaps Mr Cotton can help us on this. How are senior management in manufacturing
rewarded? Do they receive bonuses on an
annual basis of up to three times their salary?
Mr Cotton: No. According to our Annual Reward Management
Survey, people in support roles could expect to earn up to 10% additionally
through a bonus, for managerial roles between 10% and 20%, and at the really
senior level, including director level, it could be 40% to 50%. That is across the whole economy, though
obviously in certain roles, such as sales, the split can be 50:50, half your
pay is in bonus and a half is in pension.
Q517 Nick
Ainger: There is a very significant difference in the
way that their remuneration is structured compared with the retail and the
investment banking system. Can you
explain why that is?
Mr Cotton: I would say that in one
respect it is the higher opportunities to earn huge amounts of money for
individuals for their organisation in the investment banking environment. Also, in the investment banking sector the bonuses
are discretionary. In many parts of the
economy and outside you have to perhaps do something. You have a formula: "Do x and you get y",
while in the investment sector and banking sector the bonuses are discretionary
and will depend upon the views of the line
management in thinking, "Has this person done a good job?"
Q518 Nick
Ainger: But it is still performance related.
Mr Cotton: Yes.
Q519 Nick
Ainger: Is it not the job of a trader in an investment
bank to try to make as much profit as possible for his employer and the
shareholders? Is that not written into
his job description?
Mr Cotton: One would hope so.
Q520 Nick
Ainger: I still keep coming back to this point: Why
does the investment and retail banking sector have a dramatically different
remuneration package from every other sector of the economy?
Mr Cotton: That may be a reflection of
the labour market. Up until a few years
ago, organisations in the investment banking sector were competing quite
aggressively with one another to get people into the organisation because they
could earn the company so much money, and so they were prepared to pay higher
bonuses. Talking again to my contacts,
the investment banking sector's HR people, they said that the turnover on
traders is around 25%, so you could expect somebody to stay with the
organisation for four years. The cost of
a trader leaving an organisation in the investment banking sector will be
£305,000. By contrast, in our own
surveys that we do, looking at turnover across the whole economy, the turnover
is about 17% and the cost of replacing somebody is around £7,000.
Q521 Nick
Ainger: Surely these banks are very large employers, of
hundreds of thousands of people across the world in some cases.
Mr Cotton: The retail banks.
Q522 Nick
Ainger: Yes, the retail banks, but also the investment
banks. Lehman Brothers employed a
considerable number of people. Did they
not think of training everyone to do these supposed very, very important jobs
which achieved these high profits?
Mr Cotton: Again, the market was such
that the perception was that it was difficult to get these individuals with
their skills.
Q523 Nick
Ainger: We have heard anecdotally that from Oxford and
Cambridge, Imperial College, you name it, mathematicians in particular were
queuing up to get into the City because of the huge bonuses that were being
paid.
Mr Cotton: The anecdotal evidence I have
is that these people were not wanting to work in the City.
Q524 Nick
Ainger: That is interesting. Mr Fox, you have referred to the risks that
warrant these absolutely gob-smacking bonuses.
What risk does a trader take personally?
Mr Fox: Losing his job. The rate of turnover in the financial
services sector is pretty high. They have
a short life anyway: there are relatively few people over the age of 40 in this
sector. They have a short life when
they have the potential as traders ----
Q525 Nick
Ainger: Does that have anything to do with the fact
that by the age of 40 they have made so much money that they can retire and
live extremely well?
Mr Fox: You hear about the successful
ones, and many are not successful in it.
Even those who are successful are often not tolerated in an organisation
for very long. The skills which are required
to make a lot of money trading in investments are quite specific. Exceptional abilities are required. The reason that banks pay large sums for the
right people is because there are relatively few of them. The bonus system gives a direct link between
the achievement and the personal remuneration. The risk of losing a job is one
that is considerable.
Q526 Nick
Ainger: Mr Fox, losing a job is not unique to the
banking system. Everyone, particularly
those who are judged on their performance and their pay is judged on their
performance, risks losing their job. I
do not think and the general public do not think that the risk of you losing
your job warrants a bonus three times your salary. Would you agree with that?
Mr Fox: I would not agree. The job of a trader in an investment bank is
not like a normal salaried job. It is
different.
Q527 Nick
Ainger: It may be different, but the rewards are
absolutely astronomical when compared with hard-working people in
manufacturing.
Mr Fox: Do I understand that you do not
think the people who work on a trading floor are hard-working?
Q528 Nick
Ainger: No, I was comparing their remuneration with
that of senior management in manufacturing, who are doing a hard job, with all
the pressure they are now under because of what has happened as a result of the
banking crisis, but they do not get three times their salary in bonus.
Mr Fox: I agree with that.
Q529 Nick
Ainger: I am trying to establish what is the
difference, and you say it is the risk of losing their job.
Mr Fox: I said that is part of it.
Mr Hahn: I would look at it in a
different way. A trader was able to
generate an enormous amount of profit largely by his individual efforts. To a certain degree, the risks he took were
not understood very well, but that is a separate subject. One trader could generate a massive amount of
profit; whereas in a retail organisation thousands and thousands of people
would be needed to generate the same profit.
The profitability that was available attracted more and more brilliant
people who wanted to take the risk and reward opportunity.
Q530 Nick
Ainger: I come back to this risk element. They were not risking their own money. They were not going down to the bank,
withdrawing money and then investing it or trading in CDOs. They were not using their own money. I can understand that an entrepreneur borrows
money, takes a risk, employs people and makes a substantial profit. Good luck to them. I do not understand, however, this claim that
traders are taking risks and as a result they personally benefit as a result of
that risk-taking. I do not understand
this argument.
Mr Hahn: I can understand your
frustration. I think the industry as a
whole is reviewing the risks that it was taking, because I think the industry
is now perceiving that it was paying people (1) for risking the firm's
money and (2) for their own performance, and it did not price the risk on
its own money very well and the money that was given by shareholders and the
public.
Nick Ainger: Thank you, Chairman.
Q531 Mr
Brady: Mr Hahn, you said that the origin of these
incentive structures was very much to maximise shareholder returns. That probably was borne out by the things
that you said Mr Fox. Would the other
witnesses agree with that?
Mr Cotton: Yes.
Q532 Mr
Brady: That is the origin of it.
Mr Cotton: Yes.
Q533 Mr
Brady: They are there to maximise the interests of
the shareholders. Do they fail? Is the
fundamental problem of these remuneration packages that they do not reflect the
need for long-term sustainability of the organisations?
Mr Hahn: Fundamentally, at the top of
organisations we use the same remuneration structure for all industries. Our combined code that talks about board
structure does not differentiate by industries.
Companies are allowed to do that.
The structure that is accepted is shareholder based, and shareholder
based has gotten ever more short term, despite the fact that we have long-term
incentives in the structures. One of the
things that many investors and shareholders probably followed was that
regulators and rating agencies were also looking after their long-term
interests in these pay structures, and of course they were not, and they really
were not charged to do that, and the incentives were becoming ever more short
term.
Q534 Mr
Brady: Looking forward, do we need to look for these
remuneration packages to protect the long-term interests of shareholders, or do
we go back to expecting the regulators to do that but lean on them heavily to
do so?
Mr Hahn: I would think the
shareholders would love a combination of short- and long-term incentives. Most of our pension money is on a long-term
basis and they want to see these institutions survive and prosper on a
long-term basis,
Q535 Mr
Brady: Are there any other comments on that?
Mr Fox: Many of the long-term incentive
plans which have been around for some years seek to protect the employer from
short-term variations. Some of the banks
introduced schemes years ago under which there was a claw back from those who
had received bonuses if the business did badly.
A lot of the detail of the way in which schemes are designed is directly
relevant to the protection of long-term and medium-term interests. The FSA has written to chief executives of
listed companies about the design of incentive schemes which intended to balance
short-term gain with medium-term gain and long-term gain. We have seen people at Lehman Brothers, who
received large sums by way of bonus in the form of Lehman shares, lose very
large sums because they were locked into shares of Lehman's.
Q536 Mr
Brady: You say some organisations have done
that. It was not the case
everywhere. Looking at the differences
in the structure of remuneration packages at these levels - the balance between
salary and bonus elements and the different structures in terms of long-term
reward, claw back and so on - did anybody get it right?
Ms Arrowsmith: I do not think you can be
unequivocally confident that there is a single right model. If you look across the organisations that
have had serious difficulties and those that have performed rather better,
there are common characteristics around many of the pay structures, so I do not
think you can say that all we need to do is find a new incentive pay model and
the problem will be solved. There are
some characteristics - and I think the FSA letter makes some good points -
where I think many organisations would be sensible to review what they do
against those characteristics and improve many of the things that they do. It is, unfortunately, a global world, so one
of the most important things is going to be to have a consistent approach,
because otherwise you risk exporting an industry which, however unpopular it is
now, is still an important part of the UK world.
Q537 Mr
Brady: Is there a particular organisation or group of
organisations that you would say had a better model in terms of protecting the
long-term interests of shareholders as well as the short-term maximisation of
profit?
Ms Arrowsmith: I genuinely think it is very
hard to say that there is a single piece.
If you look at the board pay for all the UK institutions, they have a lot of
common characteristics. They have a
salary and they have a bonus; most of them have a bonus part of which goes into
shares; all of them have a long-term piece, and the long-term piece is the largest
piece, typically, of remuneration, based on three years' performance; they all
base their long term on relative share price performance and earnings; and some
of them have other things, like economic profit, which is probably a stronger
measure because that has some element of risk-adjusted capital. But, without question, you cannot say that there
is a single common characteristic that all of the good guys had and all of the
guys that had trouble did not have.
Q538 Mr
Brady: How many have claw back and how many do not?
Ms Arrowsmith: At board level very few
people have claw back. I do not know
about below that level. My experience
would suggest that it is much less common now than it used to be. In part, that is because there has been
relatively recent competitive pressure.
Q539 Mr
Brady: Should it be more prevalent?
Ms Arrowsmith: I think there are a number of ways of managing
how you pay responsibly. The first is to with paying for the right thing. I think one of the things that most
organisations have to do is to say whether their definition of what success
looked like was right to start with. The
second is to look at what safeguards you need to build in. I think time and claw back are two things
that organisations need to consider, yes.
Mr Fox: Last year, Porsche made more
money through investments in Volkswagen shares than they did in making cars. I suspect there are some people who would
think that is very wrong, that the business of Porsche out to be making cards
and not dealing in shares in another car company. I do think that some of the discussion around
these topics has been distorted because of the sheer amounts of money involved,
but the responsibilities on those in the banking sector who are charged with
looking after very large sums of money and investing those sums of money
profitably for the benefit of pension schemes is very great. Sometimes they get it right, sometimes they
get it wrong. Sometimes they perform
really well. With the way the world is
at the moment, people should be rewarded for performing well, and if they do
not they lose out. When you look at the
long-term interests of the organisation, for a number of years I have seen incentive
plans which are designed to claw back money if the organisation does not
prosper. I have seen one in a bank where,
if the bank made losses of more than a certain amount, the senior executives,
who had large, unvested bonuses, just lost their money.
Q540 Chairman:
Can
you name them for us?
Mr Fox: I cannot. It is professional ----
Q541 Chairman:
It is
confidential. Okay. Fine.
Mr Fox: It is confidential, but it is
a well-known bank and I might be able to get permission to reveal that
information.
Q542 Mr
Brady: We have heard about the way in which a very
competitive recruitment environment leads to pressure for a bonus-based
remuneration structure. I think we can
all understand how people might respond to that if they think they can make
very large sums of money. It seems that
these claw-back arrangements though are equally unpopular. Carol Arrowsmith, you said that there had been
some move away from claw back because of competitive recruitment
pressures. If you are going to be
motivated by the opportunity to earn a very big bonus, why should you be
worried about claw back if you believe you can do that?
Mr Fox: Because the claw back may
operate unfairly. If Mr A does well in
one year, Mr B does badly in a second year, so the organisation loses a lot of
money, why should Mr A, who was very successful, lose out? That is why a claw back will be pretty
unpopular with Mr A.
Q543 Mr
Brady: Can you get the right model of claw back or
not?
Mr Fox: There are no perfect
models. There is no perfect financial
system. A lot of people in a lot of
fields, whether remunerated by way of a bonus or not, fail to assess risk
correctly. In my view, it was not the bonus system that caused them to fail to
assess risks separately, because, as we have heard, lots of people in rating
agencies, in the regulators ----
Q544 Chairman:
Can
you cut to the chase and tell us what was responsible for that. We have a limited time. You say it was not
the bonus system. What is it? Just tell us, because we want this on the
record.
Mr Fox: I wish I could answer
that. I do not think it was the bonus
system. There are world economic factors
at play. It is too simple to look at the
bonus system as being the cause or even a major contributory cause. That is my view.
Q545 Mr
Fallon: I should say that I serve on a remuneration
committee, although not in the banking sector.
I want to turn to the FSA's a letter to chief executive officers in the
banking sector about remuneration and ask each of you whether you think that
letter goes far enough or, indeed, goes too far.
Mr Hahn: The FSA letter seems general
in nature and we have to think about what the teeth should be. Essentially, I think the regulators already
have the power to look at the structure of pay at the top. Frankly, if it does not meet their requirements,
the FSA should be increasing the capital requirements of that institution. If its pay structure encourages more risk and
recklessness, it should provide more capital for risk. That will make the organisation less
profitable. It allows a market solution
to deal with a problem, and boards have the flexibility to decide how much risk
pay they want to give.
Mr Fox: I think it is a very good
letter. It says, "The FSA have no wish
to become involved in setting remuneration levels: that is a matter for boards"
- and I think that is right. But then
they give guidance as to what is good practice and what are sensible things to
take into account, and I think that is the right level of guidance. I am slightly worried at the timing of the
letter and whether government statements have prompted the letter to come out
in October when it did.
Q546 Mr
Fallon: They do draw attention to the year-end review
that most of these banks presumably will be conducting in the next few
weeks. It would seem from the letter
that they would expect fairly immediate changes. Is that right?
Mr Fox: What I meant by timing was
the fact that it followed government concerns about the bonus system having
prompted the taking of "excessive" risks. The FSA are saying that the risk issue is
really one that boards should consider and consider very carefully when they construct
a bonus system.
Q547 Mr
Fallon: I am not quite sure what you are saying. Are you saying that the Government has
prompted the FSA letter?
Mr Fox: Concern expressed by the
Government may have prompted the timing of the FSA letter.
Ms Arrowsmith: I think the FSA letter is a
very sensible letter. I think it is
quite difficult to be more specific than it has been because the diversity of
operations within banks means that some of these areas are things that will
need quite significant reform and thought and others will come through that
process fairly unscathed. I think the
questions particularly about the balance of salary and variable pay and the
questions about claw back are things that organisations should think about.
Mr Cotton: From a CIPD perspective, we
welcome the attention. We would say,
however, that the FSA letter focuses on the technical design aspects of
remuneration; it does not look at the wider context of where these remuneration
systems sit. We would say that perhaps
you have to look at the people management aspects going on in these
organisations; you cannot really just trust to setting levels and saying, "If
you hit this target, you will get this amount of money." That is not really a substitute for good
performance management.
Q548 Mr
Fallon: You would have preferred the letter to have
been more prescriptive.
Mr Cotton: I would have preferred the
letter to have addressed the people management issues, rather than just taking
it out, and context.
Q549 Ms
Keeble: Peter Hahn, you said that the justification
for bonuses was based on the level of profits which the traders generated for
their companies. Would you accept that
that should be the case even where the profits are created, for example, by
short selling?
Mr Hahn: Yes, and I think there has
been quite a debate about short selling. I generally think it has been
misunderstood. Our markets overall are
based on participation of speculators. It
is just one of those avoidable things that some people bet to go one way and
some people bet to go the other way and we have markets as a result.
Q550 Ms
Keeble: I understand that, but would you not accept
that for the wider public looking at profits - and everybody understands about
profit, everybody understands that that is what you are in business for - where
one person's profit becomes the destruction of somebody else's business so
spectacularly, why do you then reward that with a massive bonus?
Mr Hahn: Is your question that
somebody who has succeeded in short selling should not get a bonus?
Q551 Ms
Keeble: You are saying that what justifies
these huge bonuses is the fact the traders generate profits for their
companies.
Mr Hahn: Yes.
Q552 Ms
Keeble: But when you look at the way in which the profits
are generated, if the profits are generated through the destruction of a major
financial institution, do you think that should be rewarded?
Mr Hahn: I do not think the
destruction of any financial institution should be rewarded, but when we think
about short selling, short sales of companies generally keep the share prices
closer to real values.
Q553 Ms
Keeble: Would you not accept that some of the
difficulty people have in this is that people understand profit where something
is made and sold and so on but with some of what has happened in the financial
services the profit looks like funny money.
There is a real difficulty in seeing then why the creation of that kind
of value should be rewarded
Mr Hahn: I can understand the
difficulties in understanding what was going on, but if the question is how one
decides what one can short sell and what one cannot short sell, I think that is
a very difficult question and I do not know who should decide it.
Q554 Ms
Keeble: Ronnie Fox, you argue that what justified the
bonuses was the special status of those people in a special industry. It was on that basis that the taxpayer has
paid out billions to keep the financial services going because of their special
status. Do you not think there is some
responsibility on the industry to look at what the public perception is of what
is going on? In terms of large amounts
of money being paid out and these huge bonuses still being paid to individuals
who have been responsible for the crisis, in part - not entirely, but in part -
do you not understand that that creates a real problem of perception for the
financial services industry?
Mr Fox: I think it is very, very sad
that so little is really understood about the way in which the financial
services sector works. If you believe in
a free market economy, then short selling is part of a free market
economy. Selling things you do not own,
in the hope that you will be able to buy them cheaper when it comes to delivery,
is part of the way it works. Nobody
intended the destruction of any financial institution. If there was short selling, that meant that
there was somebody buying and they took a view too.
Q555 Ms
Keeble: We understand that. If the public sees what is happening now, why
should they not, and us as their representatives, say, "Increase the taxes on
the bonuses"?
Mr Fox: Why increase the taxes on the
bonuses rather than on any other form of remuneration? It is speculated that there is less tax to
pay on a bonus than on ordinary remuneration.
That is just not the case.
Q556 Ms
Keeble: I am not saying there is less, but in a sense
it is a windfall profit, so why not impose a windfall tax on it?
Mr Fox: I do not see why buying and
selling coal or fabrics should attract a different rate of tax from buying or
selling a financial currency or a derivative.
Q557 Ms
Keeble: We are not talking about buying and selling,
we are not talking about the salaries; we are talking about windfall profits,
which so far as the public can see are unrelated to any particular amount of
effort or any particular risk-taking with the person's own money.
Mr Fox: I do think that with greater
education of the public and greater understanding of the way in which financial
markets work, there will be less adverse comment about the large sums earned by
some people.
Q558 Ms
Keeble: Okay.
In terms of international pressure, there has been quite a lot of
discussion about some sort of international action because of the risk of London losing skilled
staff. What do you think realistically
the prospects for that are?
Mr Hahn: When one thinks about a major
institution moving today, I would be horribly in fear if I were the prime minister
or the finance minister of another country if a major bank said he was going to
come and locate in my country today, because I would end up having to be the
backup network in his central bank in his bail out. From the standpoint of institutions moving,
therefore, I think that is not an issue any more - at least for the time
being. The difference is on the levels,
talking about trading and trading people.
If we impose on businesses salary structures that are uneconomical for
those businesses, it would be very easy for a bank to move that business to
another country, and I think we have to be very careful there.
Q559 Ms
Keeble: How about a brain drain in terms of
individuals moving around?
Mr Hahn: That is part of it, yes. If we do not let management determine how
they are going to pay people for their businesses, we run that risk.
Q560 Mr
Todd: The shareholders have a
responsibility in this matter, do they not?
They must authorise the reward systems of the board and in some cases
senior executives. Are they empowered
sufficiently to do that task?
Ms Arrowsmith: The way the board pay works
is that the non-executives form a remuneration committee, they formulate the
policy, they, in practice, talk to the major shareholders. I think the legislation that was put in place
in 2002 giving shareholders an advisory vote has absolutely stepped up the
quality and the frequency of dialogue with shareholders. Shareholders having had a long area of
interest - the first shareholder guidelines around what executive pay should
look like focused on share options back in the early 1970s and have been evolved
and developed ever since - I think there is a very real engagement between the
biggest shareholders and particularly the medium-sized and larger public
companies.
Q561 Mr
Todd: Could more be done to inform shareholders - as
you rightly say, mostly institutional shareholders, who are the major players
in this?
Ms Arrowsmith: I think communication with
shareholders can always be improved. The
written reports that go to shareholders are not always the easiest things to
read and to understand. But I think one
has to be practical about how much time shareholders have to spend on the matters
around an individual company. They own
shares in a lot of companies.
Q562 Mr
Todd: Indeed.
It is important to grasp the importance of the shareholder interest
because of course those are normally our pension funds and the collapse in
value of these institutions has very substantially damaged the pension funds of
many ordinary people and, therefore, the guardianship by institutional
shareholders of this aspect of their role is something that we should
legitimately be concerned about, so, if you have particular suggestions, any of
you for that matter, as to how shareholders might be better informed so that
they communicate more effectively on these matters, that would be helpful.
Ms Arrowsmith: I certainly think all
shareholders recognise their importance, but also I think most boards do. The boards have a legal obligation to act in
the best interest of the shareholders.
There is a pool of non-executives who oversee any potential conflicts of
interest that the individual executives might have, so you have got one line of
defence that is within the company before it gets to shareholders and then you
have got the shareholders themselves and their representative bodies, so you
have got quite a number of layers of governance and communication. I think the UK is actually pretty well served
by its shareholders in the sense that they are actually quite a cohesive
group. They do talk to each other and,
therefore, there is a greater degree of concerted action around things that
cause particular concerns around individual companies than there is in many countries.
Q563 Mr
Todd: And they were mostly caught cold in this
particular matter, so, if they worked in concert, they worked in concert in
error.
Mr Hahn: One of the things that has
been exposed, I think, internationally is the lack of understanding of the modern
banking sector and its risks by the boards, and it is hard to understand how a
board that does not understand the risks of its organisation is able to reward
its executives appropriately if they do not understand the business.
Mr Todd: I remember vividly a question
by our Chairman of a senior board member which revealed ----
Chairman: The Chairman.
Mr Todd: Yes,
it was the Chairman actually.
Chairman: The Chairman of an investment
bank.
Q564 Mr
Todd: Yes, who clearly did not understand some of
the instruments in which his bank was trading, which rather bears out the point
that you have just made, so, if we can just turn to the remuneration committee,
which is this first line of defence that you referred to, Carol, are they
adequately prepared for what is often rather a technical task of designing a
bonus scheme that aligns with the purposes of the company and appropriately
adjusts to the risks of the transactions that they are motivating through that
scheme?
Ms Arrowsmith: Bearing in mind that the remuneration
committee concentrates on the board rather than the individual roles within it,
so much of the concern around investment banking pay is not particularly
directed at only pay, are they well-equipped?
I think they are a group of people, so there are some good ones and
there are some not so good ones. I think
almost anybody involved in the pay area, whether it is in an advisory capacity
or whether it is as a remuneration committee member, has to take a lesson from
this and go back and look at what they do to see whether they feel they are
actually doing as much as they ought to have been doing, but I do not think I
would say it is something that people were knowingly negligent of. I think it is an area where people do have to
go back and say, "What lessons are there to be learned out of this?"
Q565 Mr
Todd: I was glancing at a document that we were
provided with which was written in 2004, so long before these events, on the
function of remuneration and nomination committees and the focus, the first
task, and the area of risk was "weak alignment with strategy", so a lack of
clarity of linking the bonus scheme that you were designing to the purposes of
the business, and some of these examples, I think, are crying examples of
exactly that, that the long-term health of the business was not seen as a
critical driver in designing the bonus scheme that people were enjoying.
Ms Arrowsmith: I think though that there is
a bit of confusion about the people that the remuneration committee are
responsible for.
Q566 Mr
Todd: Indeed, you have said they are responsible for
the executive directors.
Ms Arrowsmith: Where the bulk of their pay
is typically the long-term element.
Q567 Mr
Todd: But then, to some extent, the messages they
pass on through the bonus schemes which they define for executive directors
presumably ought to be reflected in the judgments those executive directors
make of bonus schemes which they designed for these whiz-kids in the
organisation who earn far greater sums than they do.
Ms Arrowsmith: I think there is certainly a
commonality in pursuing a strategy, but there is not a simple cascade down in
the mechanisms.
Q568 Mr
Todd: There ought to be that read-through, ought
there not? Logic would say that.
Ms Arrowsmith: Except that the role you
expect of a board is to have a longer-term time horizon than the people below
them.
Q569 Mr
Todd: Yes, but they should not really ignore that
long-term horizon when defining a bonus scheme for junior persons, should
they? It would not seem good practice to
me.
Ms Arrowsmith: They do not tend to have such
long time horizons, and I think it is one of those things that the FSA has
reasonably questioned.
Q570 Mr
Todd: Could you explore one of the claw-back options
which is to hold a proportion of bonus in escrow for a period of time to
examine whether a risk crystallises during that period before paying because
one of the difficulties, I think, when I was listening to Professor Hahn and he
defined profit, is that profit is defined at a particular point in time based
on a variety of assumptions and, when it later turns out that those assumptions
were not well-founded, that profit can prove to be illusory. Now, I believe that has been mooted in some
places, actually holding an escrow account for bonuses.
Ms Arrowsmith: It forms part of the new UBS
compensation arrangements which were published yesterday, yes.
Q571 Mr
Todd: Is that an innovation unique to them?
Ms Arrowsmith: No, I do not think it
is. It appears in some places, but I
think it is one of those things where, one has to say, in some parts of some
organisations they clearly would have benefited from having something that
recognised the longer-term risks of the business, whereas it is not necessarily
the case for all of the business. I think
that is one of the great complexities of the financial services industry, that
it is a very diverse industry and with some of the things that they do you can
measure quite confidently the profit at the end of the year and with other
parts you absolutely cannot.
Mr Todd: But many not.
Q572 Mr
Love: Mr Hahn, can I ask you, as someone who, in a
sense, stands outside the system and observed, whether you believe that the
executive remuneration packages are a reflection of the short-termism inherent
in the City activity?
Mr Hahn: Yes, I think that is the
case, and I think in many ways our large financial institutions, and again it
is a similar factor in other countries, ended up having very substantially
fragmented shareholdings. They had so
many small shareholders, but without any particular material shareholder, and
what they were driving towards was very short-term goals. In fact, whilst we have got all these
structures that look at the long term, it is kind of interesting, and you have
read a report from 2004 and I went back to 2006 and I found some bank research
that was just perfect, and, if I may just read it, and it is about European
banks as a whole, it says, "We find little or no evidence to support the claims
that big banks are more efficient or more profitable or have more stable
earnings. However, our analysis shows
that big banks have capital and funding advantages", and that is probably
government support. It goes on, "We also
observed that the CEOs of big banks typically get paid more", and the numbers
are very clear, that, despite all the planning, the bigger the bank, the more
you got paid, and that is the reality of it.
What was driving the top bankers probably was getting bigger and that
was in the short term, and you can do that by extending credit, by buying
another bank, there are various things you can do.
Q573 Mr
Love: We are hearing a lot about the herd instinct
in City activity. To what extent was the
herd instinct amongst big bankers and the people who are paying themselves a
great deal, how much was that a factor, in other words, they looked over at
what somebody was paying in New York and said, "I should be doing that"?
Mr Hahn: There is a substantial amount
of research which shows that, looking at pure comparisons, you can manipulate
pure comparisons to get paid more. What I
think is a much more fundamental question about the structure and the
short-termism would probably be by looking at the one of the banks that has
failed recently. If one of those banks
in 2005 decided to be more conservative and hold back in their activity, they
more than likely would have had their CEO and board even replaced in 2006 for
failing to take advantage of the opportunities, so the structure was one which
was one widely supported by players, shareholders and everybody.
Mr Fox: It is not the case ----
Q574 Mr
Love: Ms Arrowsmith, you mentioned earlier the role
of competition for the small number of people who could do these types of
executive functions. What role did that
play in the advice that you gave as a consultant to remuneration committees that
may have been considering? In other
words, were there objective factors or did you say, "Well, objectively they
might only be paid this amount, but perhaps you had better pay them a lot more
because the competition is fierce out there"?
Ms Arrowsmith: I do not think you should
ever say that. I do not think you should
ever say, "You should pay them more just because they might get poached". I think you have an obligation to pay people
fairly and to do that in an informed way, so to understand to a greater extent
what the market really does because, generally speaking, when people aspire to
be paid more, they can identify the bits of everybody's package that they would
like to add together to create a package of their own. I think the job of a remuneration consultant
is actually to help the remuneration committee to balance some of those
objectives to get to a sensible place and that is being broadly
competitive. You do not have to match
people even pound for pound, but you have to be in the right competitive space,
so, if you have very, very good people, and that is a very big question to ask
in the first place, then you should pay them properly, but that does not mean
you pay them more than everybody else because that is a recipe for pay
escalation that is just unstoppable.
Q575 Mr
Love: Would you accept in any sense that there was
an incestuous relationship between consultants and the remuneration committees
that they were advising?
Ms Arrowsmith: I have been accused of many
things in my life, but incest, it is the first time. No, I do not think there is.
Q576 Mr
Love: Well, it may get better!
Ms Arrowsmith: No, I do not think there
is. I think my job is to be independent
and to tell it as I think it is and, if the company does not like it, then I
have the responsibility to live with the consequences of that too, but actually
my job is to help the company make the right decisions. It is absolutely not to pay people more just
for the sheer hell of it.
Q577 Mr
Love: Well, let me press you. A senior official at the ABI was stated to
say that remuneration consultants' livelihoods appear to depend on pushing an
ever-upward spiral in executive pay and that many of them admitted that they
worked for both management and independent directors. Do you recognise that? Is that a factor?
Ms Arrowsmith: It is most definitely not
part of the factor in the way I do my job.
Q578 Mr
Love: I was not suggesting it was for Deloitte's,
but do you recognise it in the industry?
The ABI seems to recognise it in the industry.
Ms Arrowsmith: I would leave the ABI to make
their own comments about what they said.
I think in any industry there are people who are better and worse at
what they do. I think remuneration
consultants need to be very clear about who they work for, and certainly in my
role I work for the company. The company
is the remuneration committee, it is not the self-interest of management, and I
might work with management to get the facts, but I do not work for the
management and it is a very important distinction.
Q579 Mr
Love: Do you think there is a need for a code of
ethics in this area?
Ms Arrowsmith: I am very comfortable with a
code of ethics. I have lived by it all
my working life, so I cannot see any reason why anybody should have an
objection.
Q580 Mr
Love: There has been some suggestion that one way in
which to try to ensure that the FSA letter, which I think all of you have
agreed is a sensible response in this area, could be implemented, as suggested
by the new Chairman of the FSA, is that we link the remuneration strategy to
the amount of capital that the organisation has to hold. In other words, if the FSA thinks that the
remuneration strategy leads to risky behaviour, they might ask them to hold
more capital. How would you respond to
that, Mr Fox?
Mr Fox: Is the FSA qualified to make
a judgment about excessive risk?
Q581 Mr
Love: Well, the Chairman seems to think so.
Mr Fox: Well, I am a bit dubious,
quite honestly, because I think that the FSA did not show that they had a
better grip on the risk issues than many other organisations.
Q582 Chairman:
So
who is to take that job, Mr Fox? Tell
us. We are looking for answers on this
Committee.
Mr Fox: Well, ultimately politicians
are running the country. You asked the
question!
Q583 Chairman:
So do
we all drop into our local banks in our constituencies and say, "How are you
doing?" and, if they are not doing so well, they are having an off day, we shut
them? Come on, give us a break!
Mr Fox: The Bank of England has had a
long-established supervisory role, but I think that the events of the past year
have demonstrated that many, many people did not understand risks and the risks
that the financial system was subject to.
I do not think it is helpful to try and locate a scapegoat.
Q584 Mr
Love: Mr Fox, you agreed earlier that the letter
from the FSA was sensible and it was suggesting that there had to be a market
solution, that regulators do not want to tread on this ground, and then you
tell us that the role is for the Government to tread on this ground. Is there a slight inconsistency there? Could you please clarify?
Mr Fox: I do not think so. I think that the financial climate, the
economic environment is created by governments.
We have seen in one country, in Argentina, that they have
nationalised the pension funds, and that has produced a series of distortions
which I hope we will never see here, but they decided that that was the right
thing for the economy in Argentina.
Q585 Mr
Love: Could I ask you, and it is a matter of
curiosity more than anything else, you mentioned a case of the executive who
got a £7 million bonus because he had made a very large sum of money for the
shareholders. If you look at
shareholders around the financial services sector at the moment, they have
either faced a dramatic decline in their share values or indeed in some cases,
where they have been nationalised, it is suspected that their shares are
worthless. Who is going to compensate
them?
Mr Fox: Shareholders are not managers
of companies. Shareholders invest and
they invest with a view to profit. Now,
sometimes they get it right and sometimes they get it wrong. A third of the shares in Lehman Brothers were
owned by employees of Lehman Brothers, current and former employees. They took the decision that it was a good
investment to invest in the company that they worked for and many of them got
it dramatically wrong. I do not think
there is a ready source of compensation for shareholders.
Q586 Mr
Mudie: You tell us not to look for scapegoats, but
there are people who are going to watch this who are in danger of losing their
jobs, if they have not already lost them, and of losing their homes. Do you not think that it is sensible to see
what happened and to examine what happened with a view to trying to prevent it
from happening again?
Mr Fox: Absolutely. I am entirely in agreement with that.
Q587 Mr
Mudie: So why, when we question when we go over this,
do you accuse us of looking for scapegoats?
Mr Fox: Well, some of the
pronouncements that I have seen suggested that the bonus system is responsible
for excessive risk-taking and the collapse of financial institutions. Now, I do not think that is based on a
well-informed analysis.
Q588 Mr
Mudie: We have heard that, Mr Fox, but you then go on
to admit, when asked, that you do not know what caused it. You specifically said that, that you do not
know what caused it, so, when we suggest something that you do not like, you
say, "Well, that's not right", and then we say, "Well, come on. This is an inquiry where we are investigating
to avoid this sort of thing happening again, so tell us", and then you say, "I
don't know". Then you patronise us by
saying, "If you knew more about financial matters, you would not be making
these statements". We do not enjoy it
and I do not think you really mean it, do you?
Mr Fox: If anything I have said has
been interpreted as being of a patronising nature, I apologise, it was not my
intention to do that, but I do recognise ----
Q589 Mr
Mudie: But, if you turn round to us and say, "If you
knew more about financial matters, you wouldn't be making this statement", what
the hell do you think we will think you are doing to us?
Mr Fox: I think there is a bona fide
intention of finding out more about the way in which the City works and about
what has gone wrong.
Q590 Mr
Mudie: Well, that is what we are trying to do.
Mr Fox: That is driven by a desire to
know more and it is one which I would like to help in and, therefore, I am
giving evidence.
Q591 Mr
Mudie: Well, I am just an old Labour member of this
Committee, just so that you know what you are dealing with! You say that something that has not been
raised is something where we accept the world as it is, but I have got a list
of the main banks here. Hornby earns
£940,000, Daniels £960,000 - you did the figures - £640,000 to Steve Crawshaw,
he has gone and it has gone up, John Varney £975,000 and Fred Goodwin £1.3
million. Now, I am just an ordinary old
Labour bloke, an old trade union official, but why does someone on £1.3 million
need to be incentivised to do their job?
That is what we ask. Why do they
need to be incentivised?
Mr Fox: Because that is what the
market is saying.
Q592 Mr
Mudie: So it is the market, we are back to the
market. You told us that you are a free
market man, untrammelled. That is what
you said and it is on the record.
Mr Fox: I think I said that, if you
believe in the free market, then you must allow the market to operate. If you do not, then you ----
Q593 Mr Mudie: Well, I absolutely do not, but you do, do you
not? This is what you are saying about
salaries, that it is nothing to do with ability, it is actually looking at what
someone else or what some other country is paying and saying, "If we don't pay
our chief executive, he'll go off to America or he'll go off here or there, so
we have to pay him", but I will just come back to the first question that
somebody out there must be asking. Why,
if you are on £1.3 million annual salary, do you need incentivising?
Mr Fox: I think many of us believe
that some individuals earn much more than they should do.
Q594 Mr
Mudie: You are looking at us again!
Mr Fox: No, I actually think that
politicians ought to be paid more, you will be interested to hear, but many
people think that the amounts earned by popstars or football players are way,
way in excess of what they should be earning.
Q595 Mr
Mudie: Stick to the financial ones, the people who
got us in this mess.
Mr Fox: If you do not believe in the
free market, then nothing that I say in relation to the operation of the free
market will convince you, but you may say, "Well, why were people willing to
pay that much?" but they were. They were
because they thought that they were getting the best talent and they thought
that other people would pay those amounts if they did not.
Q596 Mr
Mudie: That is good, so I put a question back to you
which might percolate down to boardrooms, so let us see where you go with
this. Yesterday, we interviewed a chief
executive and we had the accounts in front of us, and we said to him, "What is
the average bonus? You pay bonuses from
you down to the cleaner?" "Yes." "What is the average?" and he said, "It is
9%." "But in your annual accounts your
incentive scheme is from 50 to 150% for people who are senior executives." Now, the poor lass on the desk, earning
£13,000 a year, to incentivise her you give her 9% of that, but the fellow
earning yesterday £750,000 a year needs a 50 to 150% incentive. Now, tell me, for all that need to be
incentivised, why does a cleaner only get 9% and the chief executive gets 150%?
Mr Fox: I am going to say something
which I hope will be understood in the spirit in which I say it. It is unfortunately not a fair world and the
people who are well-remunerated and remunerated in a particular way are not
necessarily those that you or I would choose to remunerate in a particular way,
and then the market decided that certain people should receive more ----
Q597 Mr
Mudie: But you are the only one in the room who
thinks that the market is important.
Mr Fox: The difficulty, as I see it,
is to link the large amounts of remuneration and the bonus structures with the
collapse of financial institutions.
That, I see, is the difficulty and seeking to produce cause and effect
is producing stresses.
Q598 Mr
Mudie: So what you are actually saying to me is, "If
we were doing it afresh, if we were starting afresh and if there was morality
in it and some ethics, then we would not operate in the way we're
operating"? Is that it?
Mr Fox: I would love the world to
operate entirely on a moral and ethical basis, but it is not like that.
Q599 Mr
Mudie: No, but if we did, that is what we are
discussing. We are discussing if the
thing that has got us in this mess is caused by this and, if it is caused by
this, what changes would we make. Is
this not the time, if you were in our shoes as politicians, that you would seek
to put a bit of morality into it?
Mr Fox: If it were up to me, I would
focus on causation and whether A caused B.
People are very highly paid in the financial services sector and many
people think they are far too highly paid, but the question which I have
difficulty with is: did that cause the economic recession and the problems in
the financial institutions? I cannot
make the link.
Q600 Mr
Mudie: Ronnie, you are running away from it because I
think that is an argument and that is very important and, to be fair to the
Chairman, he is allowing me to press you on the morality of that because, yes,
that is an issue where I think you are wrong.
I think there is a straight connection.
They were encouraged, well, you know what happens in the City, something
sells, something is bought and everybody is in it, they do not question it, and
then suddenly the bubble bursts and we are all looking pretty bad. If you put that to one side, I am just
asking, can you sit at the table and defend the type of incentive schemes in a
firm that pays the lowest-paid 9%, and remember that is 9% of the lot, so, if
you take the 150 or the 50% out, that 9%, being the average, is down to
probably 6 or 7%. Now, can you defend
that?
Mr Fox: Do you think that the
receptionist who is paid £13,000 a year should be paid more if you can find
half a dozen people who would do the job for £13,000 a year?
Q601 Mr
Mudie: But that is the market. Do you think you should be asking someone in
a firm to go and run a household on that sort of wage when you are sitting down
and you have got brass to put back and they have all contributed to this great
result, but she can only have 9%? Do you
know what that works out at, that 9%? We
worked it out yesterday and it is £1,250, and the chief executive was going
with £75,000 on the 9%. Now, I am all
for incentives. As a trade union
official, I used to get my lads on incentives, but it was pennies, and this is
an example, is it not? Why do we need to
incentivise these chief executives, these board members so obscenely when they
are treating their people so badly?
Mr Hahn: I would put in a slightly
different way of how one can influence the behaviour of the organisation. The receptionist cannot really do that, but
here you have got the CEO and he could sit back tomorrow and say, "I'm happy to
get my 750 every year and isn't that nice.
You want that mortgage and it is a little bit over the requirements and
I don't think I'm going to give it to you because why should I? Why should I take any risks?"
Q602 Mr
Mudie: But should he be earning £1.3 million?
Mr Hahn: But what you are encouraging
in a banking environment, when the economy looks like it is a little better,
you want the head of the bank to say, "It's time to take a little more risk",
and give him the incentive to do that.
You do not want him to sit there and just keep going, like we have seen,
and I think that is a huge problem, but we are asking these people to make some
really fundamental judgments.
Mr Mudie: Could I not ask you to take a
risk? If you were employed with me, I am
the shareholder, I am employing you and I am paying you £1.3 million, I think I
would be entitled to ask you to take a wee bit of risk, would I not, and expect
you to do that, to go beyond what any of us do because you are being paid £1.3
million? Why do you need to incentivise
somebody on £1.3 million?
Q603 Chairman:
Peter, I was going to ask you a final question
because I notice in my Financial Times
today that it says that, in 1990, stock market swings and the collapse of the
junk bond market led to widespread job cuts and the elimination of bonuses, and
that Peter Hahn, then a young banker at now-defunct Kidder Peabody in New York,
remembers executives, previously on $1m a year, telling him in the elevator
about how they were going to shop at discount stores. Now, given that Barclays and Goldman Sachs
are saying that they are all planning to introduce tough new policies on
executive pay, the question is: are these organisations in the vanguard of a
new approach to pay in the banking sector, or is it simple expediency before a
return to business as usual?
Mr Hahn: I think at the moment there
is no question, it is simple expediency and political actually, but, on the
other hand, it is an extraordinary opportunity to recalibrate the system. I think we have seen now that the financial
services sector globally depends a lot more on governments than we ever really
understood, so there are probably many roles that should be negotiated out of it,
but we will see where it goes.
Chairman: On that gem of pure
information, I am going to bring the drawbridge down. Thank you very much for your time.
Memoranda submitted by the Association of British
Insurers
and the London
Investment Banking Association
Examination of Witnesses
Witnesses:
Mr Brendan Barber, General
Secretary, Trades Union Congress (TUC); Mr
Miles Templeman, Director General, Institute of Directors (IOD); Mr Peter Montagnon, Director of
Investment Affairs, Association of British Insurers (ABI); and Mr Jonathan Taylor, Director General,
London Investment Banking Association (LIBA), gave evidence.
Q604 Chairman:
Welcome to the second session of our
inquiry. Information and opinion can go
hand in hand, but I am looking for more information in this hour than opinion. Miles Templeman, earlier this year in your
blog, you stated that the City is a massive driving force behind the dynamism
of the UK
economy and the Government would do well to avoid anything that would disrupt
it. Are you concerned that the pressure
for curbs on pay and bonuses in the banking sector will end up stifling
wealth-creation and damage the prospects of the UK financial sector?
Mr Templeman: Well, I think many of us, me
included, failed to anticipate some of the problems that were inherent with
what was going on in the financial world.
I retain that view in principle, but clearly we are into a very
different environment and now we have learnt that a lot of the operational
procedures that were going on in the way the financial community globally was
working have led to excessive risk and have led obviously to major
problems. I do not believe the bonus
system per se caused those problems. I
believe the bonus system in all companies is devised to, if you like,
reinforce, and reflect, the objectives of those companies. It does not cause them in itself. Obviously, it reinforces behaviour that the
company has decreed it wants to achieve, so, therefore, I retain that
principle, but obviously there are particular problems to address now.
Q605 Chairman:
Well,
at this particular juncture, it is worth looking at remuneration and incentive
structures.
Mr Templeman: Absolutely, but I think it is
a matter of reinforcing and, to some extent, as the FSA is already doing,
looking at tighter approaches to it rather than, if you like, a wholesale
restructuring of it, and I certainly do not believe it is an area where the
Government itself can get actively involved, but I do believe that there are
some new approaches, yes.
Q606 Chairman:
Brendan Barber, the TUC has loudly and vociferously
spoken about the bonus culture in the City.
Is this just the politics of envy?
Mr Barber: I do not think it is the
politics of envy. I certainly think that
there is a bigger issue about a growing inequality in the country and one
aspect of that is certainly the issue of pay systems in the City of London, so
there is a wider agenda, but, as I think has become absolutely clear, the
payment and reward systems in our major financial institutions have been a
significant factor in the crisis that we have now seen unfold in recent months,
and I think that is the view of the Governor of the Bank of England, the
Director General of the CBI and a number of eminent economists and it is
clearly the view of the leaders of the G20 countries who, in their communiqué
at the end of the Washington Summit, have identified the reward systems in the
financial services and banking sector as one of the key issues on which there
need to be new approaches.
Q607 Chairman:
I was
very taken by a phrase of yours where you said that "plump felines became fat
cats some years ago, now they are dangerously obese". Do we need to put the executives in the
banking sector on a crash diet, and what would you recommend?
Mr Barber: Well, I do think that we need
to see some major change. Just to echo a
point that came up towards the end of your previous session, I do think this is
an important period and that we see some lasting change and we get the new
emphasis back on genuinely supporting and incentivising and rewarding genuine
wealth-creation rather than just deal-making, and it would be a tragedy if we
see some cosmetic changes and then, in a year or two's time, we are expected
all to forget about it. This is a hugely
important opportunity to get to grips with a very important issue.
Q608 Chairman:
Jonathan Taylor, in terms of business as
usual, the Centre for Economic and Business Research reported recently that
City workers are likely to receive about £3.5 billion in bonuses this year and
almost £3 billion in 2009, albeit down on 2007 levels. Is this just business as usual?
Mr Taylor: No, I do not think it is
business as usual, Chairman, in the sense that I agree, and I think the
industry agrees, that the remuneration structures generally should be looked at
further. I think that is consistent with
the reports made by various private sector groups and, as I think someone in
the previous session was saying, I think there is a very good argument for
looking at ways in which remuneration can be aligned more closely with risk.
Q609 Nick
Ainger: Do you all agree with the statement by Richard
Lambert that remuneration structures within the banking sector encourage some
employees to take spectacular short-term risks, confident that, if things work
out well, they will reap huge rewards and, if they do not, they will not be
around to pay the price?
Mr Montagnon: Yes, I do agree with that,
and I do also think that the issue fundamentally is dealing with the
risk-taking and the matching of the reward to the risk than the absolute
amounts, I think the absolute amounts would follow on, but the most important
to get right going forward is to address the structures which lead people to
take excessive risk and reward them for taking risks which are not then
properly adjusted.
Mr Templeman: I would agree with that
statement. I did not agree with the
opening one that Richard had said about it being a prime cause of the problem,
but I do think that the systems that developed did, if you like, fail to get
that alignment between reward and risk, but the critical factor seems to be one
of time and of understanding. In many
cases, I believe, those risks were taken without full understanding by either
the individual or indeed the company in total and that is the heart of the problem,
so, yes, you can look at the remuneration structure and say that we need to
tighten up some aspects of it, and I do not disagree with that necessarily, but
I think you have to look at the whole financial arrangements and say that there
need to be regulations, nothing to do with remuneration, which could help
prevent some of these problems occurring, and there needs to be much better
appreciation, which I am sure we will come back to, in the boardroom and in all
of the people involved in it about how to make sure that the incentive schemes are
aligned with what that company wants for shareholders in the longer term.
Q610 Nick
Ainger: Brendan, you have already indicated that you
are supportive of that.
Mr Barber: Yes, I do agree with what
Richard Lambert said, but clearly there are other issues to the design of these
financial instruments that even the directors of banks who hold massive assets
in that form did not fully understand.
This was an important element in the crisis too, but the reward
structure is an important factor in the crisis undoubtedly.
Mr Taylor: I think that there is, as I
said, scope for looking further at the remuneration structures in order to
ensure that they are aligned more with the risk which is undertaken.
Q611 Nick
Ainger: Starting off with you, Mr Taylor, over the
months we have been looking at this issue of the lack of transparency in the
collateralised debt obligations, the fact that the risk was never properly
assessed in many of them and that there was a drive for short-term profit, but
is there not another issue and that is the culture that exists within
particularly the investment banking sector and parts, I would guess, of the
retail banking sector of almost a machismo that was driving a culture on the
trading floors which actually encouraged excessive risk, so it was not just
that the shareholders would like to see a positive return so that there is more
credit available to make the wheels of industry go round much more smoothly,
but there was also something else going on?
Would you like to comment on that?
Mr Taylor: I am not sure I would put it
that way round. I think that there is
clearly an alignment on the trading floor between results and remuneration,
that is the way in which the structures work, but there may have been at some
point excessive risk-taking, but I think that is a consequence of the
processes.
Q612 Nick
Ainger: Bearing in mind what has happened and
basically the disappearance of investment banks either through administration
or mergers or, in terms of Goldman Sachs, becoming in effect a retail bank,
taking deposits and so on, do you think that those that are still working in
the sector recognise that huge errors were made, that the culture has to change
and that risk now generally needs to be properly assessed before investments
are made, or is it still, as the Chairman indicated earlier, business as
usual? Has there been a fundamental
change and a recognition that the responsibility for what has happened actually
lies within the banking institutions?
Mr Taylor: I think there has been a
change. I think that firms are looking
seriously at the structures and looking at ways in which they can do things
better. UBS's measures, which were
referred to earlier, are clearly one way of looking at that, but I think that
firms are looking at these things seriously, yes.
Q613 Nick
Ainger: Would anybody else like to comment on that?
Mr Montagnon: I would just say one thing in
respect of your remark. I think that the
culture really is a factor here and the culture can add to the risks if it is
not properly managed, and it does seem to me that it should be the function of
the boards of these institutions to make sure that they have in place, and
impose, an appropriate culture. That
does not mean a culture where no risks are taken because their business is to
make money, but it means a culture where reckless risks are not taken and
people are not rewarded for taking risks they should not have been taking and
penalised if they fail.
Mr Templeman: I certainly agree that there
has to have been a change in a way, and I think there is a change externally as
well which is very important in that I think business and particular financial
institutions, but all business to an extent, depend on a sense of
legitimacy. They have to be seen by
Brendan's members and the public in general to be acting in a responsible way,
and I think there is increasing pressure on all companies and particularly,
because of recent events, financial companies, but it is true in all businesses
that companies going forward are, in a variety of ways, whether talking about
sustainability or many other aspects of corporate performance, going to have to
have reputations whereby that is an aspect of it. Therefore, I think there is internally a
recognition that some degree of change, and we can come back to how much, is
also reinforced by an external perception that is now very important for
companies if they are going to be successful in the long term.
Q614 Nick
Ainger: Brendan, are your members reporting a
substantial change, a significant change?
Mr Barber: In this area, no, I would not
say they are. You are asking a question
about the culture and I think this is a hugely important dimension to this. This is a world in which people are trading
in big, big numbers, they are doing big deals, huge numbers, millions, hundreds
of millions, billions of pounds, and it seems such a tiny sliver of the deal to
carve out a few million for the guy doing the trade, but is that
justified? Is that a reasonable
proportion of reward for that activity?
I think that the gap between that culture of the big deal and the real
world that the rest of us live in is huge, and we have got a long way to go to
bridge it.
The Committee suspended from 4.15pm to 4.32pm for a division in the House
Q615 Mr
Fallon: Could we turn to the FSA letter of October on
banking remuneration, and I will perhaps start with you, Mr Barber, because the
TUC said that it did not go far enough and then you issued a press
release. Just before we turn to the
letter itself, you said, "We take the rather old-fashioned view that bankers,
like the vast majority of people..., should be paid a proper wage and should not
require bonuses to get up in the morning".
Are you opposed to all bonuses everywhere?
Mr Barber: No, I am not opposed to all
bonuses, but I think the weight given to bonuses as an element in the overall
remuneration of people in the financial world is wildly over-valued and they
ought to play a much smaller part in the overall package that people receive.
Q616 Mr
Fallon: You do not get a bonus, do you?
Mr Barber: No, I am the exemplary member
of the TUC!
Q617 Mr
Fallon: A large number of your members, for example,
in the Civil Service receive bonuses.
You are not opposed to that, are you?
Mr Barber: No. By and large, unions do not regard bonuses as
the most critical element of remuneration packages. The key emphasis is on having a decent basic
structure of pay appropriate to the job, but of course there are some areas
where bonuses are paid, yes, and those are negotiated.
Q618 Mr
Fallon: Now, on the substantive issue, you said that
the letter has no teeth, quite correctly, it does not have teeth. How would you have given it teeth? We had the suggestion in the earlier session
that it would be much simpler to give it teeth rather than all this guidance to
simply alter the capital adequacy requirements of the banks concerned if they
did not comply. Is that how you would
like to see it given teeth?
Mr Barber: Well, I think that is
certainly a possibility. I know that the
FSA letter said that, if the policies are not aligned with sound risk
management, that is unacceptable and immediate action will be required to
change the policies. I think what we
have to see is what lies behind that sentiment as to what can secure compliance
in the event that there are not changes that seriously address these concerns,
so a higher capital requirement where the FSA is not satisfied with the reward
structures is certainly a possible sanction that needs to be considered
further.
Q619 Mr
Fallon: But there might be others? Do you have your own preferred sanction?
Mr Barber: Well, I think that is
probably the key area where the FSA have to determine the adequacy of the
capital arrangements within an institution, so that is the obvious area where
potentially one might see a higher threshold being put in place.
Q620 Mr
Fallon: Mr Templeman, the advisers earlier this
afternoon all seemed to regard the letter as rather well-balanced. Is that your view? Do you think the FSA should be in this area?
Mr Templeman: Absolutely. I think guidelines, a code, the establishment
of best practice is exactly the way to approach this issue and, whether you
look at the FSA one or the IIF one, which is very similar in many respects,
this is the right way to approach it. What,
I think, you do not want to do, and there are one or two things in it,
particularly about this capital question, is get too specific and I think that
is always the danger. There is a desire
obviously that you make it as hard-edged as you can, but there are so many
different circumstances within companies that, therefore, it has to be a set of
guidelines, like corporate governance where you set a clear, principled code
and some best practices, but you do not attempt to exactly determine how a
company should operate.
Q621 Mr
Fallon: But we have had code after code for corporate
governance. Why in the end should this
not simply be a matter for shareholders?
Mr Templeman: Well, I agree with that, but
I think you need ----
Q622 Mr
Fallon: You do agree with that?
Mr Templeman: I think it is a matter where
shareholders are absolutely key in this.
Q623 Mr
Fallon: But you said you also agreed with the
FSA. Which is it?
Mr Templeman: Well, I think you want
both. I think you want a code of
behaviour that is established à la
corporate governance which, I think, is a good model to look at, but there are
very specific areas where within a company particular shareholders should have
a very strong role, and I think one of the things that should come out of all
of this is a strengthened role for shareholders and more in their behaviour
than actually in the process, so I do not think the two are in conflict at all;
one is general principles and one is specific companies.
Q624 Mr
Fallon: Mr Montagnon, why are shareholders not
stronger in this area?
Mr Montagnon: Well, we do not have any
legal ability to vote on remuneration other than for executive directors and
main board directors of listed companies and in cases where there are diluted
share schemes, so we are really rather hamstrung in terms of direct
intervention. It is also the case that
quite a lot of these banks actually are foreign and they may come from the
United States where shareholder rights are very weak, so we are not necessarily
able to do very much, but I think we could possibly do a little bit more in one
important respect, and I agree basically with everything that has been said
about the FSA letter. I think that,
insofar as the remuneration policy across the entire company is adding to the
riskiness of the company, that is a matter of interest to shareholders, and I
think that we would like to see some disclosure, not in the directors'
remuneration report, but in the business review of the companies, about how the
board views, and is managing, those risks so that, if there is a risk to the
entire company, then we can engage with the board and encourage them to manage
it better. That would, in my view,
support the primary effort which, I actually agree with the others, should be
on the part of the regulator looking at this from a risk point of view. If I could just say one quick thing about the
letter itself, I think there is an omission which is rather important, that it
does not refer to reward for failure, and I think we need to be very clear that
everybody involved in this needs to be very clear that we cannot tolerate
reward for failure.
Q625 Mr
Fallon: Does that include claw-back?
Mr Montagnon: Claw-back would be quite a
useful instrument for preventing that.
Q626 Mr
Fallon: Mr Taylor, is there any downside to the
suggested sanction of increasing the capital requirement where the regulator is
not happy?
Mr Taylor: Well, I think there is
clearly a downside if the capital requirement is excessive, but I think that
the broad principle and the broad framework which is set out in the FSA letter,
which sets high-level objectives which the firms should try to aim at, is a
good one. I think the letter is
well-crafted, and of course I would also make the point that it is the
beginning of an iterative exercise with the firms.
Q627 Ms
Keeble: If the banks and financial institutions do not
actually take some action, would you see tax as being an instrument that could
be used, Brendan, specifically on bonuses, not so much on salaries?
Mr Barber: I think there are certainly
major issues about the way the tax system applies to wealth and the enormous
rewards that are secured by some within the financial institutions and that is
a bigger issue about fairness in the tax system which, I think, is hugely
important. According to Ernst &
Young, the 54 billionaires living in this country in 2006 paid tax at a rate of
one-tenth of 1%, and that does not seem entirely fair to me, and some of those
who benefited most from the loopholes available to the wealthy and so on are
certainly those in the financial world.
If I may say so, it is an issue that I would hope at some point this
Committee may be able to address specifically, the tax system.
Q628 Ms
Keeble: But, in this regard, we are looking at one
particular issue which is high bonuses where sometimes the linkage or the
rationale for them is not always transparent.
Do you think that, in those circumstances, it might be justified if no
other action is taken? What do the rest
of you think? Do you have any other
views on that?
Mr Templeman: Yes, I do. I think your comment is right in the sense
that bonuses have got to be transparent and I do not think there is any way out
of that. They have got to be transparent
and I think that one of the things that we have to look at, going back to
Peter's thing about shareholders only having a view of directors' salaries, is
whether there may be other remuneration systems within companies that lead
individuals to very high levels of return that should be brought up in terms of
greater transparency to the external world.
If you earn above a certain amount, regardless of your position in the
company, your role in that company could be very significant and, therefore,
should be a matter of external transparency, so I think that is the answer to
the issue, and then shareholders can vote accordingly. I absolutely do not think that specific
taxation on particular types of reward is the answer because I do not know how
you separate them out.
Q629 Ms
Keeble: Can you see the argument for the greater
transparency being linked much more now to the fact that there are very large
amounts of public funds which are supporting the industry so that free market
arguments are not strictly applicable?
Mr Templeman: Well, it is a difficult
area. In principle, I do not really
think you can distinguish a government shareholder from other shareholders,
otherwise, I think the companies that have government shareholders will be so
distorted and disadvantaged in the marketplace, so I think the answer is that
the Government has got to act, in a way, like an ordinary shareholder, but I do
believe that ordinary shareholders have an important role to play in it. I do not think you can separate out those
companies from others.
Q630 Ms
Keeble: How do you deal with the really substantial
international problems about the fact that the industry and in fact the job
market is now international? How do you
deal with the problems of international regulation?
Mr Templeman: Well, there is not clearly a
simple answer, but I think the international nature of the marketplace is a
very important element because the one thing we do not want to find is that we
over-regulate British banks and institutions in the UK and disadvantage them
versus the rest of the world, otherwise, what the Chairman began with in terms
of our need for the City to be a very competitive animal will be disadvantaged,
so I think you have to have a common statement and understanding of principles
across the world and all companies and all countries have to apply them.
Q631 Ms
Keeble: Brendan, in the previous session there was
some discussion about comparing footballers and whether or not they were
entitled to their enormous earnings as well.
Now, you organise footballers, do you not?
Mr Barber: We do.
Q632 Ms
Keeble: What is the discussion there and what is the
thinking there? Is there actually any
read-across?
Mr Barber: I think in these kinds of
talent areas that there are labour markets that operate by their own kind of
rules, and I am not overly preoccupied with trying to bring David Beckham's
reward system back into line with that of the rest of the human race, but it
seems to me that the issue you are addressing is how our major financial
institutions manage these affairs. I
think there is a relationship to how companies more widely manage these affairs
and it is part of a bigger debate about equality, as I say, or a growing
inequality, but I am not too bothered about David Beckham. I would like to make one other point, if I
may, as I think I may have missed an opportunity in responding to Mr Fallon's
question. It does seem to me that there
are other issues beyond these strict questions that the FSA is directly
addressing at the moment, in particular, about the operation of remuneration
committees. I think they draw from a
fantastically narrow pool of people as to the directors of our major companies
generally and I think there is a danger of them operating like a rather cosy
club with cross-membership between companies, people serving on one company
chaired by so-and-so who, in turn, sits on the remuneration committee in
determining your kind of pay, and I think that reform in that area is an issue
that needs attention. What would be
wrong with requiring remuneration committees to actually take account, not just
of comparisons with the rewards of directors in other companies, but the
internal relativities and the pay structures right across the company? What would be wrong with the workforce being
able to be represented within the discussions in the remuneration committees of
our major companies, including the banks?
Those seem to me to be issues that would be worth attention.
Q633 Ms
Keeble: Mr Templeman, you said that there was a need
for greater transparency and I just wondered what key points you would make as
to how that is achieved and what it is we should be looking for?
Mr Templeman: Well, again, because the
financial community is ultimately something that the Government feels it has to
bail out, there are certain rules that apply to the finance community that do
not apply to other businesses, and I think that is an important distinction. I think what that means is that within the
finance community there is an even greater need for external shareholders to
see, have an opportunity to comment on and vote on, if necessary, the detailed
levels of the remuneration, what those remuneration objectives are based
against and, as I have said, possibly to go lower into the organisation such
that the high earners, who are not normally under the scrutiny of the remcom,
should be in that view.
Q634 Ms
Keeble: Those people we talked about previously?
Mr Templeman: Brendan and I do not always
agree on everything, but I would agree with him about the role of the
remcom. I think it is absolutely key in
this, that remcoms are seen to be more expert, if nothing else. I would not agree with him on all aspects
about it being a cosy club, but we do believe there is a very strong case in
the financial world, and this could be part of external guidance and maybe even
FSA comment, that there should be members in the non-executive group on a board
and indeed in the chairman himself, because in a lot of the companies that
failed the chairmen were not experts in the financial world, so I think there
is a role for expertise as well as independence that perhaps was not there
before.
Q635 Chairman:
The
Chairman and Chief Executive of Northern Rock did not have a financial
qualification and actually we put that in our report, saying that they should
have, but people have come back, saying, "I'm not going to take this
recommendation", but I suppose you would be quite happy with a recommendation
such as that?
Mr Templeman: We would. It is dangerous to be too prescriptive about
all situations and all companies and all levels and, therefore, I am nervous
about a blanket rule, but, on the other hand, it should be set up as good
practice.
Chairman: Exactly.
Q636 Mr
Todd: We have already touched on the function of
shareholders and I have noted that you feel, Mr Montagnon, that a report to
shareholders should expose the risk of the reward systems so that it should be
explicit within the annual reports of the company effectively, and I think we
have also heard suggestions for non-board high earners, that their reward
systems should also be disclosed. Are
there any other communications that should be made to shareholders which would
allow them to make that judgment as to whether these reward systems are
appropriate and effectively aligned with their interests, which is what they
are supposed to be?
Mr Templeman: I can only comment in terms
of what we have already said about time.
I think the time element is very critical in terms of that reward
system. It has to be appropriate to the
return and it is the same issue, that, when the risk is materialised ----
Q637 Mr
Todd: I am going to come back to that issue in a
second. You have been very silent on
this matter, Mr Taylor, as representing a group of people who arguably are most
directly concerned with this.
Mr Taylor: On the matter of remuneration
committees?
Q638 Mr
Todd: No, on the matter of shareholder involvement
in deciding the remuneration packages and the information given to
shareholders.
Mr Taylor: I think that certainly
remuneration committees and the way in which remuneration committees work can
be, in some cases, improved. I am not
sure whether I would agree with all the prescriptive points made by colleagues
here, but certainly, in some cases, I think they should have the information
available. I think they should have the
information available to enable them to do their job properly.
Q639 Mr
Todd: A mild comment! Those are a couple of useful things which, I
have to say, would suggest legislative action if you are going to insist on a
company placing something within its annual report, for example. That is not just an encouragement from
someone that that should happen, but it is something that is normally enshrined
in legislation.
Mr Montagnon: I think that would be very
helpful. I think it is quite important
in this discussion that we distinguish between two things. On one level, we are talking about
remuneration structures across an entire company in the case of banks and, on
another, we are talking about the remuneration of directors which is decided by
the remuneration committee. Remuneration
committees are committees of the board whose function it is to decide the
remuneration of directors, and I think we probably need to separate the tasks
out of monitoring the risk that is being run by the management in the way it
remunerates all the employees and the way that the directors are remunerated,
and the report in the business review would actually deal with the remuneration
of all the employees. When it comes to
the remuneration committees themselves, I think there are good ones and there
are bad ones and, when there are weak ones, there is not a great deal the shareholders
can do because we really have to have them working for us, so we would like to
see the remuneration committee and indeed all directors stand for election
every year so that we can hold them to account for the judgments they take and
actually we can hold entire boards to account for the judgments that they take
of the management risk because I think that would put boards more on their
mettle.
Q640 Mr
Todd: Are there any other suggestions on the reform
of remuneration committees so that they more appropriately measure the risks
involved in the particular decisions they take in authorising remuneration
packages for board directors? Is there
anything else that we should be considering there? No, okay.
It has been suggested, Brendan has suggested it, that perhaps there
should be a limit on the number of remcoms that you can sit on or the
relationship you may have between the company you are a director of and the
company in which you sit on a remcom.
Mr Montagnon: If I can perhaps come back to
the point I was making about re-election, this would be a big change and I do
not think it would be entirely popular among the director community, but it
would be a means of people being held to account. That actually has a certain advantage because
it allows them to use sometimes a little bit more discretion and judgment in
the way they approach these things because we know, as shareholders, that we
have got the safeguard of being able to vote them out.
Q641 Mr
Todd: I am assuming that you are speaking at this
moment on behalf of shareholders effectively?
Mr Montagnon: Yes.
Q642 Mr
Todd: Therefore, this is the kind of thing that your
members would look quite carefully at, so that is useful and practical.
Mr Templeman: Just to comment on the other
point, I do not think there needs to be greater, if you like, change on the
required make-up of remcoms, but I do believe that what we have touched on
already about the need for companies to be acting in a way that is appropriate
to, let us call it, the slightly different environment that we are now in will
mean that companies will want to have representatives on that remcom who are
clearly better able to represent the interests of the shareholders in judging
risk and so on, so I think a change will occur because of that.
Q643 Mr
Todd: The other thing is about resourcing the
remcoms so that they actually have the tools available to make some critical
judgments. Are there areas there that we
need to look at, and this is an opportunity, Mr Montagnon, with Ms Arrowsmith
still here, to say your bit about consultants in this area possibly.
Mr Montagnon: Well, the remuneration
consultants, in our view, collectively, and I am not referring to any
individuals here, but, collectively as an industry, they have contributed to
the general ratchet in executive remuneration because they seem to have
business models which require them to earn fees which require them, therefore,
to modify packages every year which, therefore, requires the packages to go
up. I think that is a structural issue
and it is not their fault that they are in that position, but I think it does
actually, therefore, call for some mitigation, and a code of ethics would be
very helpful in this, a code of ethics which, for example, would oblige them to
make it clear who they were actually working for. If they are advising the remuneration
committee and not the management, that is one thing and, if they are advising
the management and the remuneration committee, it gets a big complicated, and some
of them tell me that that is what they do.
It would also allow us to look at, for example, the integrity with which
they approach comparisons because that was a factor in this.
Q644 Mr
Todd: Does a remcom need, in addition to someone who
knows a lot about remuneration systems, some additional advice, and to some
extent it backs up what you are saying, in order to put some of that advice
into a rather broader perspective? Is
there not some obligation to have a broader consultation in deciding on
appropriate reward systems?
Mr Barber: I was just going to say that
I am pleased that a proposal that there should be some workforce representation
has not attracted any direct opposition from any of my colleagues, so I am
taking it that silence is assent on that point!
Just in terms of the consultancy operations and those who advise
remuneration committees, it is remarkable how many of them are given remits
which refer to a benchmark of the upper quartile. If endlessly, year after year after year, you
are referred to the upper quartile, then that is an endless ratcheting and an
ever-increasing gap between the rest of the workforce. There was a union general secretary who won a
deal that made reference to the upper quartile of male manual earnings and he
bought a greyhound and named it 'The Upper Quartile', so that shows the
appreciation that he had for that particular deal, but in this context I think
it is rather a destructive factor.
Mr Montagnon: Could I just come back to the
question because Brendan said that the silence was assent. I think, for us, remuneration committees are
committees on the board whose job it is to decide the remuneration of
directors, particularly executive directors.
If you were to put representatives from outside the board on to those
committees, you are changing the structure and the approach fundamentally ----
Q645 Mr
Todd: Which was not the question I asked. It was the advice resource they had
available.
Mr Montagnon: But I would agree that
remuneration committees should take account of the broader situation in the
economy and in the company when making their decisions and I think that the
remuneration consultants should perhaps help them sometimes to do this more
than they do.
Mr Templeman: I would agree with the point,
but I do think that the non-executive director, performing the role in the full
manner that he should be, is perfectly able to do that. That is exactly what they should bring to the
party.
Mr Taylor: I was going to make a similar
point, Chairman. I said earlier that I
did not necessarily agree with all the prescriptive remarks and, for the
avoidance of doubt, that was one that I was not on side with.
Q646 Mr
Mudie: Brendan, I would just like to raise one matter
with you. You have spoken about David
Beckham and you conceded that, because he has particular skills, it is the
market. Now, one of the worries is that
the people within the bank structure, the people who are trading on the
investment side, I would suggest that you or I could not do that job, and there
has been evidence earlier that it is a job that has a high and an early finish,
a bit like a computer programmer, an early finish in life, a bit like
footballers, and that you have to be highly skilled to actually achieve
it. Now, would you not accept that a
high salary is the same for that person as for Wayne Rooney because of the
skill element, but the worry really is that the concern should be where you
have actually not just paid them a good salary to do that job, but you have
baited the trap with, "But you can earn three or four or five times that if you
deliver this amount of money", because human nature would suggest that you will
not look too closely at something that is making you a lot of money, such as
the type of behaviour we have seen, so, for these characters, it is more the
bonus affecting behaviour which affects the firm and affects the economy than
actually the high salary?
Mr Barber: Yes, as I said earlier, I
think the proportion of the overall reward that is in the form of the bonus
rather than the base salary is one of the factors that has distorted behaviour
so significantly.
Q647 Mr
Mudie: What is your membership like in terms of the
finance sector or manufacturing?
Mr Templeman: Of the IOD?
Q648 Mr
Mudie: Yes.
Mr Templeman: It is a broad spread, so we
have a lot of finance, a lot of manufacturing.
We are pretty well reflecting everyone.
Q649 Mr
Mudie: Is there some anger in the manufacturing side,
or perhaps do not let me influence your
answer, but we are interested, the Government is interested, all politicians of
all parties are interested, in how the bankers are reacting to the people who
are now feeling the brunt in the real economy, so what are your members
actually saying to you? Firstly, are
they having a hard time or is it ----
Mr Templeman: They are, of course, many
are, but many are not. The real economy
is full of different stories even now, but sure, many of our members would
feel, a bit like some of the comments made earlier, that bankers are getting
very high rewards, so is that appropriate, and many of them would either feel
angry or not happy about that, so we are no different from a lot of other
groups. I think we have to go back to
the comments that, I know, you discussed a lot in the previous session. We are dealing with a marketplace, they are
people with exceptional talent and they do possibly have short careers, but I
think the key to the bonus, the relationship between salary and bonus, is about
the nature of the particular job an individual is in. If that extra effort of that person can
deliver very big rewards, and it is just like a win bonus for a footballer to
get, if they cause their club to win a dramatically different level by
individual effort, then they will get high rewards and a bonus system is
appropriate. However, let me just say
that I think, to answer, if you like, all the other topics we have raised, that
that bonus system must still be fully cognisant of all the risks involved in
it, look over time and, if you like, not be vulnerable to the kind of
accusation that is being raised against it, but it can be very big.
Q650 Mr
Mudie: Staying on the football analogy, Ferguson would say back
to you, and indeed other managers would say back to you that, because basic
salaries have got so big, it is hard to motivate people. Now, here you have got a big salary, so do
you need the big bonuses and are they not too dangerous?
Mr Templeman: They are only dangerous if
they are inappropriate, honestly. If you
do not structure them right, they are dangerous and that is what we have all
learnt. They do not have to be dangerous.
Q651 Mr Mudie: But what do you mean by "structure them
right"? Let us agree with how they are
dangerous, that they lead the person on into behaviour that is injurious to the
firm and the larger economy.
Mr Templeman: In the longer term.
Q652 Mr
Mudie: Well, some of them were in the short term
here. The later you got into this, the
more you were caught with the parcel when the music stopped, were you not, so
now how do we get round that?
Mr Templeman: I think by what we said, that
those remuneration schemes and those bonus schemes have got to be structured
being fully cognisant of the risks involved.
I do not think it needs more than that, but that is quite a big step
forward in the complex world that we are talking about, so there needs a lot
more examination of what those risks are and, as you said, if that were
applied, then I think the potential for high rewards, they are probably not
going to be as high as they were, we may well have lived through an exceptional
period that may not happen again, but I do not think you need more than that,
although you need to apply that very carefully.
Mr Taylor: I was going to make a very
similar point, Mr Mudie. I think the
point is that there is a sort of payment by results element here and the
traders are very incentivised by the results which they get, and the key point,
as Mr Templeman was saying, is that that should not involve the taking of undue
risks from the point of view of the firm, so the firm should have risk controls
in place which ensure that its own so-called 'risk appetite', to use the
jargon, is not exceeded.
Q653 Mr
Mudie: Brendan, how would you deal with this in that
Miles does not want the Government to do it and I am pretty sure that, when the
dust settles, all of this will be forgotten and the world will move on in the
same old way ----
Mr Templeman: That is not what I said.
Q654 Mr
Mudie: I am just looking at regulation. Everybody says that we need strong
regulation, but already in the City there are people saying, "Not too much
regulation". Well, if they say that in
the middle of this bloody crisis, what the hell are they going to say in a
year's time - "Oh no, we don't need regulation"? In fact, bankers are lecturing us that we
should be interfering in their behaviour, so what would you do, Brendan?
Mr Barber: Well, I am hoping that we are
going to see something serious come out of the FSA exercise. That is about looking to establish
potentially criteria against which the FSA would be able to evaluate not just
any directors' pay arrangements, but the overall remuneration structure within
financial institutions and evaluate whether or not that was incentivising
unwise risk.
Q655 Mr
Mudie: But, when the credit crunch broke, Hector,
over at the FSA, said, "We're going to have to spend more money on top-quality
staff. The salaries here aren't big
enough because we've got to get them back from the banks", so the FSA are
implicated and he is looking at his salaries compared to what is being paid in
the banks. It is a pretty bad world, is
it not? How do we get some reform?
Mr Barber: Well, they have been tasked
with this at this stage. They have asked
for the institutions to respond and they are trying to see if they can think
their way through to clear criteria that they could then assess institutions
against. That is, I think, the task and,
whether it is the FSA or someone else, I think the requirement has to be some
much sharper, objective way of assessing the structures against the potential
risks. I am prepared to give the FSA a
go at seeing if they can rise to that challenge, if they can meet that task.
Mr Templeman: One thing I would add, which
Peter has mentioned and others have, is that what we want to see come out of
this, the IOD along with yourselves, is some improvement in stopping reward for
failure. I think that is what gets
everyone most annoyed. It is not earning
a high bonus if your company is doing well and everyone is doing well out of
it, though there may be some disagreement about that, but in general that is
not the issue. The issue is that
individuals are rewarded too much when they fail, and I think that is about the
whole contractual area that needs to be very carefully considered by remcoms
when they are recruiting as well as when they are going, but also a notion that
a lot of the problems that we are talking about are because an investment,
which seemed to be successful and was rewarded, actually was a failure, and
that is what has led to the crisis in a way, so I think it is about getting at
this and really getting under the skin of making sure as much as is possible,
and it is very difficult, that you do not reward failure, and that is what I
think we want it to show.
Q656 Mr
Mudie: Are you and the TUC, not together, but
separately, doing anything specific other than coming here and giving verbal
evidence? Are you preparing documents or
working on anything for your respective organisations that would help us in our
deliberations?
Mr Templeman: I do not think we have got
any specific documentation, but we have certainly been very involved. For example, last week in Brussels I was at a
seminar discussing these very topics, and there was a very strong view coming
out of Brussels that, if you like, we have got to get our act in order, we have
got to show some change which is more than just back to usual, otherwise, the
Commission and others will come in against us.
Q657 Mr
Mudie: What does that mean for you? Does it mean you have come from Brussels now intent on
getting some of your high-quality staff working on a document for our
deliberations?
Mr Templeman: We have not done that. We are mainly saying, "Let's make sure we get
engaged with the FSA in terms of them coming out with guidelines".
Q658 Mr
Mudie: Brendan?
Mr Barber: We have done work on all of
these issues and we will happily actually put a note together to submit to the
Committee. Certainly we are working ----
Q659 Chairman:
You
have spoken a lot, in fairness, of taxation.
Mr Barber: Well, I wanted to come back
to the taxation point in particular. As
I was saying earlier, I do think there are some major issues here about the way
the taxation system applies to some of those accumulating the greatest wealth,
which includes certainly people in the financial community. I think at this time, when we are all
extraordinarily worried about the potential disasters that might come through
in the impending recession, fairness has got to be at the heart of finding our
way through and that needs to involve fairness in the tax system, and I would
very much hope that that is an issue that potentially the Committee at some
stage might be able to turn its attention to.
Q660 Chairman:
Would
you like to write to us, the same as Miles has written to us already, on this.
Mr Barber: Yes.
Q661 Nick
Ainger: One of the things that we have discovered in our
inquiries around the credit crunch and so on is the fact that all the
regulatory authorities were chasing the game, and, now that we are in a
position where we are staring a global recession in the face, I just wonder
whether your organisation, Mr Taylor, and generally the institute of banking
and so on are actually sitting down and coming up with schemes, not just about
the remcoms, that is fine, but actually coming up with their own suggestions
about how we can prevent this happening again rather than expecting the FSA to
regulate as well which means that they are the policemen and they are basically
chasing the burglar down the road too late again?
Mr Taylor: My organisation and others
like mine are indeed working on all sorts of ideas in relation to overall
financial regulation and so on, we are providing information, we are working on
that, yes. On things like the sort of
financial supervision and issues like that, we are working on that, yes. On the remuneration point, so far that has
not been, to be frank about it, a central point because it is matter of
commercial confidentiality to firms, but clearly there is now a policy issue
about remuneration which has been picked up by the G20 and they will be working
on that up to 31 March and we will obviously want to be doing what we can to
provide input to that exercise.
Q662 Mr
Todd: I just want to test this point about risk and
crystallisation of risk because someone, and I cannot remember who, said that
sometimes a deal looks fantastic, you appear to earn a great profit and then, a
year down the track, everyone spots what the problem was with it. The UBS model, which briefly came up in the
last session, suggests holding in escrow at least a proportion so that you work
out where the skeletons are before you pay the money. Is there something to be commended
there? A valuable tool?
Mr Montagnon: I think that is essentially a
very useful tool. There is always a
problem that, once you have paid the money out, it is very difficult to get it
back. Actually we, as investors, think
that it should be possible anyhow to write into people's contracts that the
money may be recovered if it turns out to have been paid in connection with
transactions that have generated large losses.
I think you could look at writing that into contracts, but the escrow
system, I think, is quite valuable. I
would not think it is actually relevant for every company in every sector, but,
in this particular instance where we want to make sure that people have not
been running excessive risks, I think it is a useful idea and we would like to
see it spread.
Mr Templeman: Yes, we would too, and I
would not rule out the notion that some companies might want to have claw-back
systems. I think it would be perfectly
acceptable ---
Q663 Mr
Todd: That is harder to enforce of course.
Mr Templeman: It is, but the notion where
you offered a very high upfront return with the danger or the risk that there
is a claw-back would be one company's way of approaching it, and another
company would approach it in terms of a lower going-in bonus, but without the
possibility of claw-back, and I think that is why it has to be done at the
company level in terms of appropriate risk.
Q664 Chairman:
Again, one sovereign wealth fund I was
speaking to recently was talking about having bonuses over a 79-year period
with the ability to claw back in that period of time.
Mr Templeman: Many bonuses are over a
longer period, as you know. Just to
comment on Nick's question about are we doing other things, yes, we are and we
said at the beginning that one of the key things is to only see remuneration as
a part of this, some may say a large part and some may say a small part, but
how we control the financial system, the clearing house for derivatives and so
on, there are a lot of things which are being worked on, as you know, and we
are certainly contributing to that.
Q665 Chairman:
Brendan and Miles have said they will produce
their own documents and point the way forward for us on these issues and that
is very important, but, Peter, on the issue of shareholders and shareholder
interest, I note that Barclays with their rights issue were chasing across the
Middle East instead of wanting to be getting money from the UK taxpayer, which
seems to have disadvantaged shareholders' pre-emption rights particularly, and
now they are crawling to the biggest shareholders, L&G and others, to
sweeten the pill on that. Surely, there
are things that should be done in that area to ensure that shareholders have got
more muscle, because you have commented on that?
Mr Montagnon: Well, the pre-emption
principle regime is very important to confidence in the markets. I think the shareholders do have a vote on
what Barclays is doing and that vote is going to happen next week. I think one of the difficulties that
shareholders have is that, whilst they may not particularly like what is
happening, this deal is very expensive to existing shareholders and it does not
respect pre-emption rights and it gives certain instruments at a privileged
right to outside investors, but, whilst they do not like what is happening,
they also will have to take into account what might happen to the bank if the
deal did not go through. They have been
put by the bank in a rather difficult position.
Q666 Chairman:
But
the thing is, Peter, that it is not that they were not under the bushes and
then they found out that they did this deal.
Should there not be a better way of doing things.
Mr Montagnon: Well, I am sure there should,
but I think it comes back to one of the points I made earlier, which actually
Barclays has acknowledged, that their entire board is going to stand for
re-election at the next annual meeting.
We think that that, as I have indicated, should happen as a matter of
course, and that is a way of holding boards to account if they do this.
Q667 Chairman:
But
that could be the biggest con because we know in the political world with a
vote of no confidence in the Prime Minister, "Forget it, boys, we'll all get
together", and it is the same with Barclays.
Mr Montagnon: I am not sure that it is
quite the same in the commercial world because, curiously enough, I have found
that businessmen have thinner skins than politicians!
Chairman: So we are looking to you to
claw back because you will get a vote of thanks from Mr Mudie and ourselves! On the issue of claw-back, how do you favour
claw-back for David Beckham if he does not score any goals! With that, of course I am very grateful for
your interest and I am looking forward to these submissions that you are going
to make because they will be very helpful for us to manage our way through a
very complex issue. Thank you very much.
