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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Transcribed by the Official Shorthand Writers to the Houses of Parliament:

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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.